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PROJECT BRIEF

1. IDENTIFIERS: PROJECT NUMBER P069996 PROJECT NAME Uganda: Energy for Rural Transformation (APL) DURATION 10 Years IMPLEMENTING AGENCY World Bank EXECUTING AGENCY Ministry of Energy and Mineral Development, Private Sector, Local Government REQUESTING COUNTRY Uganda ELIGIBILITY Uganda ratified UNFCCC on September 8, 1993. GEF FOCAL AREA Climate Change GEF PROGRAMMING FRAMEWORK OP 6: Promoting the Adoption of Renewable Energy by Removing Barriers and Reducing Implementation Costs

2. SUMMARY: This project is the first long-term programmatic proposal submitted under the WB/GEF Strategic Partnership for Renewable Energy and will serve as a platform on which to demonstrate and test several programmatic modalities and operational procedures envisioned under this Partnership. It will remove market barriers to support the development of approximately 70 MW of biomass, hydro, and solar renewable energy capacity over ten years in a commercial, private sector orientation, and will be implemented under an Adaptable Program Loan approach utilizing three funding tranches. Funding releases will be guided by performance indicators for each tranche. The proposed approach will stimulate accelerated development of rural energy sources strongly interlinked with rural development needs and objectives, increasing rural connections from the current 1 percent rate to 10 percent over the life of the project, while providing a significant shift away from diesel power sources. Initial investments co- financed with GEF support will build on new energy supply opportunities created by a recently enacted private power law, and will be strengthened by a comprehensive set of capacity building and institutional strengthening and the introduction of ‘light regulation’ approaches designed to facilitate growth in environmentally sustainable private sector delivery mechanisms. Non-grant financing modalities will be explored to the greatest extent possible in tranches II and III.

3. COSTS AND FINANCING (MILLION US): GEF: Project 30.00 PDF 0.35 GEF Subtotal 30.35

Co-financing IA 150.00 (IDA) Other International 195.00 (Private sector, Government and bilateral donors, Clean Development Mechanism sources)

Total Project Cost 375.35 4. OPERATIONAL FOCAL POINT ENDORSEMENT: Name: C. M. Kassami Title: Deputy Secretary to the Secretary Organization: Ministry of Finance, Planning and Economic Development Date: September 6, 1999

5. IA CONTACT: Christophe Crepin, GEF Regional Coordinator Tel. (202) 473-9727; Fax : (202) 522-3256 World Bank Group - Global Environmental Facility Strategic Partnership for Renewable Energy Background Note to Accompany the First Project Proposal

Uganda: Energy for Rural Transformation is the first project submitted under the World Bank/Global Environment Facility Strategic Partnership for Renewable Energy. This cover note summarizes some of the unique strategic features the Uganda project, as well as the larger context of future projects likely to be proposed under the Partnership and the programmatic and operational approaches anticipated for the effective processing and implementation of these initiatives.

Background

Despite the availability of GEF support for renewable energy barrier removal projects for nearly a decade, the ability of GEF and its implementing agencies to stimulate renewable energy development has remained hindered by a plethora of competing development demands and limited development capital in the client countries. To build on the valuable learning and some notable project successes that have resulted from GEF Climate Change investments, the World Bank/GEF Strategic Partnership for Renewable Energy is working to engage client countries on a long-term, systematic approach rather than on the basis of individual projects and single technologies, and in a context that is inextricably linked with the development priorities of the country. As reviewed and approved by the GEF Council in May 1999, one of the primary modalities for achieving these aims is to use Adaptable Program Loans (APLs) to more strongly establish Renewable Energy Technologies (RETs) in the Bank’s financing operations, providing phased, sustained support for the development of long-term RET programs while strengthening client country commitments to promote RETs.

The Uganda Rural Energy for Development proposal is for a $375 million IDA and donor- suported project which will include $30 million in GEF resources to remove market barriers in development of approximately 70 MW of biomass, hydro, and solar renewable energy capacity in a commercial, private sector orientation. The project will be implemented under an APL approach utilizing three funding tranches over ten years. The proposed approach will stimulate accelerated development of rural energy sources strongly interlinked with rural development needs and objectives, increasing rural connections from the current 1% rate to 10% over the life of the project, while providing a significant shift away from diesel power sources. Initial investments co-financed with GEF support will build on new energy supply opportunities created by a recently enacted private power law, and will be strengthened by a comprehensive set of capacity building and institutional strengthening and the introduction of ‘light regulation’ approaches designed to facilitate growth in environmentally sustainable private sector delivery mechanisms. Specific quantifiable indicators for each of the three tranches include: Quantitative Project Objectives

Under the APL approach, the triggers for proceeding to Tranche II are linked to the accomplishment of the objectives of Tranche I. These triggers (with additional detail to be developed during project appraisal and PAD documents for each tranche) will be clarified in terms of the calculated baseline and related milestones for each of the different phases at the time of submission for CEO approval and will be based on the following (with specific GEF related triggers presented in italics):

Triggers for Phase II

 Establishment of regulatory system, RE Fund, wheeling system and procedures, and a workable intermediation mechanism for commercial finance  Construction of renewable energy power generation facilities in the range of 20-25 MW, with a GEF share in total cost of about 20-25%, and the rest of the financing to come from a combination of Bank and commercial financing, but not from other external CDM-type sources;  Sales of solar pv systems: about 7,000-10,000 household systems and 125-175 institutional systems, with a GEF share in total cost of about 20-25%, and the rest of the financing from a combination of Bank and commercial financing (but not from external CDM-type sources);  Finalization of long-term renewable energy capacity building strategy and action plan, including financing of recurrent costs of renewable energy projects, and other evidence of Government commitment to renewable energy (to be discussed with Government)

Triggers for Phase III

Ttriggers for Phase III would be linked to the accomplishment of the objectives of Phase II. The Phase III triggers, with additional details to be developed during PAD preparation, represent many of the same factors as the Phase II triggers, but at a higher level of development (GEF related triggers are presented in italics):

 Fully operational regulatory system, RE Fund, wheeling system and procedures,  Fully functioning main grid rural extensification and independent grid system programs, and sales of solar pv systems,  Establishment of regional best practice level capacity to promote and undertake renewable energy development;  Construction of additional renewable energy power generation facilities in the range of 20- 25 MW, with a GEF share in total cost of about 15-20%, and the rest of the financing to come from a combination of Bank and commercial financing (but not from external CDM- type sources), with another about 10 MW not supported by GEF,  Sales of solar pv systems: about 50,000-75,000 household systems and 200-300 institutional systems, with a GEF share of about 15-20%, and the rest of the financing to come from a combination of Bank and commercial financing, but not from CDM-type sources)

2 1. Project components (Tranche 1): Indicative Bank- % of GEF- % of Component Sector Costs % of financing Bank- financing GEF- (US$M) Total (US$M) financing (US$M) financing Grid-based Energy 39 52 17 44 7 58 Distribution/Generation Independent Grid Systems Energy 28 37 8.6 30 0.5 4 Solar PV Systems Rural 2.5 3 1 40 1 8 Pilots Energy/Rural 0.5 1 0.4 90 Technical Assistance Energy/Rural/ 5 7 3 60 3.50 30 Financial Phase 1 Total 75 30 40 12 16

Project components (Tranches 2 and 3) Indicative Bank- % of GEF- % of Component Sector Costs % of financing Bank- financing GEF- (US$M) Total (US$M) financing (US$M) financing Grid-based Distribution/Generation Energy 9 50 Independent Grid Systems Energy 4 22 Solar PV Systems Rural 2 11 Pilots Energy/Rural Technical Assistance Energy/ 3 33 Rural/ Financial Phase 2 and 3 Total 300 120 18 6

These indicative targets will be confirmed during appraisal, and parallel WB targets for long- term operation of the APL. The baseline existing at the beginning of each trance will be clarified to the extent possible with this information incorporated into targets and triggers for the appropriate tranche. Because of the practical difficulties of forecasting 4-7 years in the future, and to retain the flexibility provided by the APL mechanisms, targets for tranches two and three may require some adjustment during appraisal. Similarly, additional details on co-financing will be developed during appraisal and PAD development for each tranche. Regardless of the ultimate source of such co-financing (World Bank, bi-lateral, private, or other), the objective will be to provide funds at the level closest to commercial terms as possible. Investments in the 2nd and 3rd tranches will also pursue financing from emerging Clean Development Mechanism (CDM) sources, but in no event will GEF funds be combined with CDM financing.

Specific GOU commitments (including agreements to provide specific policies related to RE), will be confirmed in a Letter of Development Policy to be developed during appraisal as the foundation of their objectives and agreements under the Adaptable Program Loan (APL) arrangement with the World Bank. This Letter will confirm the specific benchmarks for program progress at various stages of implementation required for release of subsequent tranches of funds (including GEF co-financing). Any significant deviation from these indicators will either require a delay in the release of the next tranche, or consideration by Council to approve significant changes in the targets, to be determined by the GEF CEO.

The calculated value of the cost of carbon of about $ 46 per ton carbon is based strictly on the supported investments, and does not take account of any multiplier effects or “programmatic

3 effect” which will occur, not just in Uganda but also in the neighboring countries of Tanzania, Kenya, Sudan and Democratic Republic of Congo, particularly from the solar PV component. As this is the first project in the region to support the systematic development of a number of renewable energy technologies, it is expected that the multiplier effect will be in the range of 2 or 3, resulting in a long-term GEF cost of $15-23 per ton of carbon. These multiplier effects will be considered as additional indicators related to tranche release and will be addressed to the degree possible in the relevant PAD document.

Consistency with Strategic Partnership Principles

This proposal, as the first project to be presented under the World Bank/GEF Strategic Partnership for Renewable Energy, represents a watershed for the GEF, WBG, and client country relationship in terms of initiating a variety of project modalities designed to encourage long-term renewable energy development pathways in the developing world. It is consistent with several of the Strategic Partnership modalities endorsed by the GEF Council at their May 1999 meeting:

A long-term programmatic approach focussed on sustainable private sector participation - The proposed project is targeted at building effective bridges to private sector market development and financing capabilities to ensure commercial sustainability. In contrast to the ex-ante definition of the entire project and a linear implementation path, this project is approached through an 10-year APL implemented in three tranches of approximately 3 years each, and combines long-term ‘stretch’ targets with a relatively high level of flexibility as a means to achieving credible programmatic goals. The APL approach provides phased and sustained implementation support on a scale and time capable of shifting sector direction rather than simply providing a technology demonstration, while providing multiple entry points for private sector players to encourage investment in market development and permit a logical maturation of commercial delivery and finance mechanisms. The proposed Uganda project proposes specific investment levels in a well defined set of first tranche sub-projects. Subsequent tranches propose indicative investment levels across an expanding set of similar sub- projects. The actual investment levels for subsequent tranches (and corresponding GEF co- financing) will be determined by continued progress in meeting targets for earlier tranches.

Increase in GEF resources with significant leveraging - The project proposes ambitious, long-term targets (with a GEF contribution proposed that is the highest for the World Bank’s operations in the sub- Saharan Africa region). It provides significant (over 11: 1) leveraging of GEF resources, particularly for the investment components, where the GEF incremental costs are expected to decline over time – this leveraging ratio is significantly higher than the range of 3:1 or 4:1 leveraging suggested in the WB/GEF Strategic Partnership proposal approved by Council. Program Co-financing Partners for financing include a number of bilateral donors, such as Denmark, Sweden, and Norway; in terms of preparation, they include a number of NGOs, such as ActionAid and Acord; and in terms of consultation, they include associations such as Uganda Renewable Energy Association and Uganda Manufacturers Association. By increasing the scale and tenure of projects to where they can be seen as contributing to a larger country- based rural development strategy, the APL approach is key to engaging the country government overall (not simply a subset of renewable energy ‘converts’) and in accessing significant co-financing from other bilateral donors.

Adherence to established principles of incremental costs – The project has a strong basis in strategic use of incremental cost financial support to overcome barriers to the programmatic use

4 of renewable energy technologies, using GEF support to build policy support and market activity over time to respond to sector needs and create new opportunities for systematic use of renewables. In the case of Uganda, this support will be delivered initially via ‘smart subsidies’ as a first step in stimulating private sector power entrepreneurs to invest in a wide spectrum of renewable energy sources – as opposed to diesel – to be provided to customers on a commercial basis. GEF support will be coupled with technical assistance for ‘light regulation’ that is more appropriate for these smaller private power operations and ongoing technical assistance to replicate lessons from initial applications further into the rural areas.

This project will demonstrate a practical context for rural energy and development efforts, ensuring a continued pace in rural energy services that unfortunately are often dealt a setback following initial utility privatization efforts. The use of GEF funds in this project reflects the fact that there is no single “quick-fix” but a continuum of efforts that will require less concessional incremental cost support over time, permitting a gradual transition from grant support through approaches such as non-grant contingent financing, ultimately resulting in the emergence of an RE sector on commercial par with conventional energy technologies.

For Uganda, the contrast with the baseline (which in the absence of this project will result in limited rural development and an off-grid energy path supported primarily by diesel generators) is striking. While there will be significant local benefits in terms of cleaner energy supply and local economic development, the GEF incremental cost element addresses only the additional cost of removing the initial investment risks related to shifting to renewable technologies; thus the incremental costs are those over and above the willingness of customers to pay for energy services.

Subsequent tranche investments will be formulated to minimize the GEF incremental cost element required to stimulate and maintain local entrepreneurial interest in pursuing RE projects. Non-grant financing options, including contingent arrangements or partial risk guarantees for renewable energy power generation will be considered and promoted in this context, and for the Uganda project are likely to be most relevant for mini-hydro, wind and geothermal resources. Such arrangements will be explored in view of the level of market, financial, perceived, and other risks that remain at the time when these future investments are considered. The overall viability of contingent financing and specific level of investment requirements that can be shifted to contingent arrangements will be a function of the pace of barrier removal efforts and the level of competition offered by other conventional energy sources in relation to prevailing Ugandan costs for RE sources. The final form and total cost of the contingent grant financing required to leverage adequate support from other financing sources will be determined through negotiations with private power entrants.

A Country Driven Process - Renewable energy is widely viewed in Uganda as a local, indigenous resource, a particularly important consideration for a land-locked country that is now heavily reliant on imported energy sources, transported long distances over land. To minimize the risks of supply interruptions and price volatility, Uganda recognizes that additional efforts are required to encourage development of indigenous energy resources where they are available and economic. For this reason, the Government has forcefully declined to consider thermal-based main-grid power generation, even in the current period when there is a severe shortage of power. Uganda has already taken the significant first step in their passage six months ago of private power legislation that will encourage rapid development of additional power resources. Further, in Uganda, key measures related to power sector reform, such as a

5 new Electricity Act, have already been enacted, and they provide a level playing field for renewable energy.

The project represents a true partnership with Uganda, providing a dedicated line of investment capital as targets continue to be met under a long-term performance-oriented framework. By integrating the renewable energy focus of the project so strongly with Uganda’s rural development objectives (and by association, with the WBG’s poverty alleviation agenda), the Partnership heightens the country’s commitment and facilitates a pursuit of global benefits that would otherwise not be economically possible. This project makes it clear that GEF resources should not be used simply to make a country client indifferent to the use of renewable energy, but should highlight the unique qualities that renewable energy technologies and markets can offer for inter-linked rural and commercial development. In subsequent tranches, the country role is expected to be more firmly established through the use of in- country intermediaries that can assist in the identification, appraisal, and implementation of sub-projects and work with the Rural Energy Fund to be established under the project to make continued investments.

Lessons for Continued Implementation of the WB/GEF Strategic Partnership

Preparation of the Uganda project has shown that it takes additional time and resources to complete the institutional and policy arrangements necessary to support larger and relatively complex project, and to forge relationships with a broader set of stakeholders. While this will likely continue to be true for additional Strategic Partnership proposals, the availability of GEF- approved model for a Strategic Partnership project will also provide significant opportunities to promote the Strategic Partnership concepts among client countries and World Bank task managers. At the same time, continued progress with the Uganda project will also provide GEF and the World Bank important practical experience on the development of and agreement on operational criteria and common program principles that will be required for future Strategic Partnership projects. These include:

 The use of APL performance triggers for release of subsequent tranches based on approval by the WB Regional Vice-President and the GEF CEO. Specific targets for later tranches for projects will be brought into closer focus during project appraisal, but due to the scale and time-frame of APL investments, some uncertainty on the pace of barrier removal and market development will always remain, and a re-assessment of incremental costs will have to be performed as early tranches reach conclusion and transition to the next. It is anticipated that initial Bank Board and GEF Council approval of Strategic Partnership projects will define the basic parameters of projects, permitting management approval on a practical and timely basis. Projects that take a slower than expected pace will simply not proceed to the next tranche. Additional review by Bank management or the GEF Council will only be required when project fundamentals change significantly or were not foreseen in initial project analysis.

 Development of comprehensive Monitoring and Evaluation plans specifically tailored to the larger scale of Strategic Partnership projects and some of the uncertainties introduced by multiple APL tranches plans will be required to: a) measure and verify forecasted benefits and impacts; b) guide the release of funding tranches based on performance, and c) promote widespread replication in other markets.

 In this (and most future) Strategic Partnership approaches, mainstream financing is expected to cover the bulk of investment costs, and verification of the long-term availability of such funding for long-term and widespread program replication will be expected in the preparation

6 and analysis of Strategic Partnership proposals. As part of barrier removal efforts, the increased initial transaction costs and economic costs of market aggregation may continue to be covered (as they are under current GEF operational procedures) as long as there are prospects for the activity to be economically viable by the end of the intervention. GEF may also help to facilitate the set-up dedicated credit lines, vendor financing, insurance and leasing programs and other mainstream financing mechanisms to enable access to finance. It is expected that GEF’s long term financing role of such projects may include sharing part of perceived technology performance and other risks through contingent financing arrangements (guarantees, loans, contingent grants), particularly in later tranches of programs where initial barrier removal efforts have been successful, and where contingent financing may be useful in facilitating a transition to commercial financing.

 Future projects will attempt to more clearly define the use of GEF resources in the context of "holistic" energy interventions and representing a high level of country commitment to promote ‘clean energy’ and simultaneously address other parameters such as energy efficiency, sector policy, etc. as part of the partnership approach.

Other important programmatic modalities envisioned for the Strategic Partnership, such as the use of long-term technology support tactics (such as the Non-fossil Fuel Obligation [NFFO], Energy Feed Law price support, or Renewable Energy Portfolio Standards) will likely be addressed through larger, country-based initiatives (such as the China Renewable Energy Market Expansion Program now being developed). The other specific approach suggested under the initial SP proposal, the Flexible Decision Authority envisioned for use by the International Finance Corporation (IFC), remains the subject of discussions between IFC and the GEF Secretariat.

Proposed Strategic Partnership Operations and Approval Approach

Assessment of APL projects will be based on GEF's usual standards, with each tranche viewed as separate but inter-linked projects. Approvals for continuing GEF support of an APL under the Strategic Partnership are proposed to be based on established procedures of delegated authority to the GEF CEO, and would be based on verification of compliance with agreed performance milestones. Specifically the following steps are proposed: a) Approval of tranche releases would be based on the project meeting minimum accomplishments and trigger points described on an indicative basis in the PCD and in greater detail in the Project Appraisal Document (PAD) developed for each tranche. The World Bank will keep the GEF Secretariat advised through upstream discussions during PAD development, and will provide a programmatic report to the Secretariat at the completion of each tranche. b) GEF approvals will parallel the rolling review process used by the WB for the APL. Based on the PAD approved by the WB Regional Vice-President for proceeding to the next tranche of the APL, the WB would request GEF CEO approval for GEF co-financing. b) On the basis of this information, the GEF CEO will determine the adequacy of accomplishments of the previous tranche and approve release of the next tranche. The CEO and

7 Secretariat may request clarification of performance indicators if required. d) The GEF CEO will provide an information document to Council based on these three elements, indicating to Council that program performance fell within acceptable margins and conformed with minimum indicators expressed (for that tranche), and signalling CEO approval of the next tranche. If there are significant deviations from originally agreed targets, Council would be invited to review the relevant PAD containing specific responses to the changing project circumstances that have caused the deviation before CEO endorsement.

8 A: Program Purpose and Project Development Objective 1. Program purpose and program phasing: (see Annex 1) While Uganda’s economy has consistently registered high economic performance, delivering an average annual increase in per capita income increase of 3.6 percent over the last decade, development in rural areas has lagged well behind urban areas. While the high growth performance has propelled rises in living standards – the population below the poverty line fell from 56 percent in 1992/93 to 44 percent in 1996/97 -- poverty remains pervasive and extensive. Much of Uganda’s rural population has not yet received or seen the benefits of commonplace modern goods and services, and local growth prospects are constrained by a lack of, inter alia, adequate physical infrastructure.

The purpose of the proposed long-term program is to develop Uganda’s rural energy sector so that it makes a due contribution to bringing about rural transformation, i.e., this sector facilitates a significant change in the quality of life of rural households as well as the productivity of rural enterprises. For this to happen, the rural energy sector would have to selectively build and exploit synergies between cross-sectoral assets, recognizing the significant linkages between such assets and therefore between the strategies to building and benefiting from them, (see section B3, Strategic choices), while avoiding unnecessary inter-sectoral linkages that may spread implementation difficulties in one sector to other sectors also.

Uganda is well-endowed with renewable energy resources, whose development could contribute to environmental protection as well as rural transformation, but little progress has been made so far in utilizing these resources (with the notable exception of large-scale hydroelectric power generation on the Nile). The global purpose of the proposed long-term program is to contribute to global environment protection by reducing greenhouse gas emissions; it is expected that the development of renewable energy would also make a significant contribution to rural transformation.

Phasing: It is proposed that the ten-year APL be divided into three tranches, roughly equal in terms of time. At present, Uganda lacks both the capacity and an appropriate institutional framework for the type of commercially oriented rural and renewable energy development envisaged in this APL, and upon which a large-scale program can be built. Hence, the overall approach is that the first phase would start small in terms of investment, while in parallel building the necessary capacity as well as the institutional and policy framework. The pace of investments would pick up in the second and third phases.

The phased approach of an APL provides an effective instrument to ensure that a robust policy and institutional foundation is in place, upon which a large scale program can be built, once the significant risks are dealt with. The phasing strategy to achieve the development objectives of the proposed program is:

 First phase: Development of requisite framework and limited investments

The central objective of the first phase is to put in place “on-the-ground” a functioning conducive environment for commercially oriented service delivery and small-scale renewable energy power generation by private enterprises, which can effectively support scale-up of

1 electricity access to underserved areas and on a sustainable basis. The focus would be to mitigate the main barriers, which relate to:

(i) regulation: plug the remaining gaps of a lack of detailed designs and implementation modalities of the applicable rules and procedures, consistent with the Electricity Act of 1999; agreement about this has been already reached with the Government (see section B2b),

(ii) financing: establish efficient and effective intermediation mechanisms for commercial financing (long-term debt, working capital) for private sector enterprises and for transfer of grants (Rural Electrification Fund – see section B2b), and

(iii) technical assistance and capacity building appropriately targeted to the relevant public sector institutions (central and local, including LC5 and LC3 levels), to commercial institutions, and business development services to private sector enterprises, in support of their respective roles in the policy setting, promotion, financing, regulation, service provision, and monitoring/evaluation of commercially-oriented rural electrification (see section B4).

While the above three barriers are also broadly applicable to renewable energy, some additional issues related mainly to renewable energy would also be covered in the first phase. In particular, a specific regulatory issue is the establishment of the contractual framework and rules/obligations for wheeling power over the main rid for third party sales, related pricing, penalties/remedies for non-performance, etc. (see section B2, Government strategy). The technical assistance and capacity building would be in line with the principles of the Global Environment facility (GEF)-World Bank Strategic Partnership for Renewable Energy: (i) develop a strategy and implementation plan for building the capacity of in-country intermediaries to identify, develop, appraise and move towards financial closure renewable energy investments, (ii) prepare a renewable energy resource information collection and dissemination system that provides reliable data that enables interested private sector investors to initiate their own assessment of potential projects; and (iii) activities to help reduce the gap in solar photovoltaic product prices, quality and range by moving Uganda in the direction of international best practices, as applicable to Uganda.

The first phase would start small in terms of investment, treating each sub-project on a case-by-case basis, to test (and refine, as necessary) and prove the readiness of business models and associated support systems for commercially oriented rural electrification and for meeting essential community needs, for scaled-up delivery in subsequent phases. In parallel, the first phase would begin awareness campaigns, especially at the regional (LC3) level about the program’s relevance to the communities and how they can participate.

Finally, the first phase of the APL will provide the opportunity of conducting a few and highly selective pilots with high likelihood of exploiting cross-sectoral synergies, with a view to getting them ready for increasing broader and deeper penetration in subsequent phases.

2  Second phase: Accelerating/building momentum for investment and continuing capacity building

The central objectives of the second phase1 would be to:

(i) accelerate investments and increase the regional coverage by shifting from the case-by-case approach of the first phase to processing sub-projects through the institutional framework, with continuing business development assistance, including making available generic packages, which individual entrepreneurs would tailor to their particular situation, of proven, low-cost technologies, workable financing modalities, and guidelines for community participation/acceptance developed in the first phase,

(ii) fine tune and strengthen the institutional framework in light of any difficulties encountered by sub-project developers, and increase the extent of decentralization in terms of responsibilities for program support and management, monitoring, and expansion,

(iii) Mainstreaming of successful pilots, with any necessary adjustments, undertaken in the first phase, and implement fresh pilots that reflect fresh opportunities as well as the experience with earlier pilots.

The activities specific to renewable energy would follow from those initiated in the first phase, and would consist of building in-country capabilities, resource data dissemination, and continuing dissemination and promotion of international best practices.

 Third phase: Rapid scale-up and consolidation of institution build-up

1 At this time, the details of the activities in the second third phases are less sharp than for the first phase, and would be further developed during the course of project preparation as well during the first and second phase of project implementation.

3 The central objective of the third phase would be to shift the focus to exponential growth in investments so as to reach the Government’s long-term targets for rural electrification and renewable energy development, with rural transformation f 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444444444 4444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444 444444444444444444444444444444444444444444444444444444444444444444444444444444

4 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555555555555555555555555555555555555555555555555555 555555555555555555555555555555P)2, which the Bank supports, fully integrates poverty issues in the national development strategy and obviates the need for a separate plan for the poor. The PEAP articulates the Government’s priorities for the purposes of resource allocation, and provides a framework for donors, including Bank support. The PEAP rests on two two key strategies, as follows:

 Increasing household income by facilitating rapid and labor-intensive economic expansion by development of requisite economic infrastructure including roads, electricity, rural market infrastructure and provision of rural credit and financial services, and maintenance of an enabling policy framework for private sector and community participation.

 Improving the quality of life of the poor through better access and quality of primary health care, water and sanitation, primary education, as well as preserving the environment.

The proposed ERT program is consistent with this strategy.

1b. GEF Operational Program addressed by the project:

The proposed project is one of the first to be proposed under the newly-established GEF/World Bank Strategic Partnership for Renewable Energy. The project is fully consistent with the GEF Operational Program 6: Promoting renewable energy by removing barriers and reducing implementation costs.

2. Main sector issues and Government strategy: Uganda faces three primary challenges in the energy sector.

2a. Power sector reforms and capacity additions on the main grid

Poor performance of power sector. At present, the power sector’s performance is poor. The Uganda Electricity Board (UEB),3 which no longer has a legal monopoly in the power sector 2 The Government, with the Bank’s assistance, is currently revising the PEAP. It is expected that the revised PEAP will constitute the Poverty Reduction Strategy Paper (PRSP) for Uganda. 3 UEB was established in 1948 as an independent institution charged with the responsibility to generate, transmit, distribute and supply electricity within Uganda and other countries in the region. UEB is a public

5 after the enactment of the Electricity Act of 1999, still continues to undertake generation, transmission and distribution activities in the country4. UEB suffers from poor financial performance, operating inefficiency, low productivity and inadequate funds for required investments.

By normal standards, UEB is close to insolvency. It has not been able to generate an adequate cash flow from its present average retail tariff of about 6.7 ¢/kWh. In 1998, it billed the equivalent of about $64 million for electricity consumption, but collected only $38 million.

Uganda is experiencing daily power shortages of around 80 MW, which is significant, given Uganda’s main grid installed capacity of about 180 MW. System losses, both technical and non-technical are currently estimated at around 35%. Poor collection is also a concern since revenues are collected on about 80% of electricity billed. This results in UEB realizing only around 50% of the value of all electricity generated in the system. UEB’s accounts receivables are currently equivalent to about nine months’ billings, but with 50% being due for more than one year. Though being addressed by the new management team, non-technical (or commercial) losses due to illegal connections and non-payment of utility bills continue to remain serious problems. Various factors such as an inadequate billing system inaccuracies and the existence of unmetered supply have exacerbated the problem. The public sector, which consumes roughly about 10% of the electricity, is a significant defaulter on its payment obligations to UEB.

Ongoing and planned reform efforts. The Government has embarked on a reform program for the sector which includes: (i) establishing new electricity legislation and an independent regulatory regime to promote a commercially oriented private sector-operated industry structure, (ii) unbundling generation, transmission and distribution activities, and (iii) creating incentives for competition and private sector investment. The reform program has been motivated by the critical need to improve the performance of the power sector and attract much needed investment.

In February 1999, the Bank Group brought together key decision-makers within the Government and its advisers to discuss the need for progress on implementing a comprehensive sector reform program5.

enterprise 100% owned by the Government of the Republic of Uganda, and is funded by government equity, debt and accumulated reserves. Its policies are determined by the Board of Directors, who are appointed by the Minister of Energy and Mineral Development. The day to day running of UEB is executed by the Managing Director (the chief executive officer) together with a management team appointed by the Board of Directors 4 These include the 180 MW Owen Falls Power Station and the 1 MW Maziba hydro power station, some isolated diesels, an interconnected 132 kV and 66 kV transmission network, a 33 kV sub-transmission network, and a distribution network at voltages of 11 kV and below. 5 This was done as part of the effort to support the IFC-sponsored Bujagali project.

6 Reform Event Reform Event: Revised Target Review London Economics Study & agree with WBG on Reform Agenda April 1999 (actual) Cabinet Approval of the Reform Agenda June 1999 (actual) Parliamentary Approval of Legal / Regulatory Framework (i.e., Electricity November 1999 (actual) Law) Hiring of Privatization Consultants February 2000 Appointment of Regulator April 2000 Request for Proposal for Privatization of Distribution October 2000 Successful Awarding of Concession for the Privatization of Distribution April 2001 Successful Private Sector operations in Distribution July 2001

Capacity additions. The UEB grid-connected electricity generation capacity is currently around 183 MW generating roughly 1,200 GWh. Most of this generation is through the 45-year old Owen Falls hydroelectric plant on the Victoria Nile with additional generation from a 1 MW hydro power station at Maziba and isolated diesel generators. The on-going Power III project provides for the civil works for Units 11 through 15 and 80MW (Units 11 & 12) generating capacity at the Owen Falls Extension facility which is expected to be commissioned in mid-2000 (total estimated cost of around $280 million). At the completion of the Power III project, based on reasonable long-term system planning expectations, both Owen Falls facilities together are expected to generate on an average around 240 MW of power and 1,600 GWh of energy. NORAD and SIDA are financing Unit 13 (40 MW) at the Owen Falls Extension. This unit is under construction and will be commissioned by end-2000.

The Government has expressed interest in an IDA-financed Power IV project under which one or two additional turbines (Units 14 and/or 15) would be installed at Owen Falls Extension. This would provide a further 40-80MW installed capacity that could be commissioned by end-2002, at the earliest. Under a run-of-river operation regime, the usefulness of Unit 14 has been established, while studies are underway for Unit 15.

The proposed Bujagali project would add an installed capacity of 200MW (with the option of an additional 50MW); upon commissioning, the Bujagali project will almost double the size of Uganda’s generation capacity. In view of the likelihood that there may be surplus generation capacity when Bujugali comes online, the Government is looking to secure additional electricity sales through incremental exports6 to Kenya and Tanzania. While the incremental 6 UEB currently exports 30 MW to Kenya, 7 MW to Tanzania and 1 MW to Rwanda. The Kenya power export contract (Kenya-Uganda Electricity Agreement) expired in mid-October 1999. However, exports have continued under the now-lapsed contract terms and a new export arrangement is expected to be completed soon. The Kenyan export sales contract provided for a guaranteed minimum supply of 10 MW during the ‘Day’ (5 AM to 6 PM) and a guaranteed minimum of 30 MW at ‘Night’ (11 PM to 5 AM) to Kenya. No supply was guaranteed

7 exports to Kenya will not require additional transmission infrastructure, exports to Tanzania will require a 300 km high-voltage transmission line; the concession to build this transmission line has already been awarded to an Ugandan entity that in turn has had preliminary discussions with AfDB on potential financing.

The table below summarizes the existing and planned generation expansion options in Uganda, and compares the installed capacity with estimated domestic requirements at the time of commissioning.

Planned Generation Expansion Options – Domestic Requirements Total Surplus/(Deficit) Project Source Year MW Sub-Total Low Base Existing Owen Falls + isolated 1999 183 (93) (93) Power III Owen Falls Extension 2000 80 Norad/Sida Owen Falls Extension 2000 40 303 (13) (87) Power IV + Bujagali Power IV Owen Falls Extension 2002 40* 343 (16) (74) Bujagali Bujagali Project 2005 200 543 119 18 * Unit 14 (40 MW) only.

2b. Low rural access to electricity. In Uganda today, with a population of about 22.6 million, an estimated 4.5 million households out of a total of about 4.7 million, remain “in the dark,” without access to electricity. The overwhelming majority of these unserved households are in the rural areas. Only an estimated 5% of the total population – and less than 1 percent of the rural population -- has access to grid supplied electricity; Uganda currently has one of the lowest per capita electricity consumption (44 kWh/year) in the world (India 300, China 580, USA 11,000 in 1996). About 72% of the total grid supplied electricity is consumed by 12% of the domestic population concentrated in the Kampala metropolitan area, and in the nearby towns of Entebbe and Jinja.

Adverse impact of poor performance and limited access Adverse impact of poor performance and limited access. Recent surveys indicate that the quality and adequacy of power supply is the perceived by urban enterprise managers as the most binding constraint to private investment.7 The rural areas are also seriously constrained by the lack of access to electricity; sustainable rural development and the accompanying benefits of increases in living standards will not occur without the provision of modern energy forms, and specially electricity. Yet, most rural households have little hope of getting such access, and even rural public institutions such as health and educational facilities are unable to provide essential services due to a lack of electricity.

Macro-economic growth is being seriously constrained. As Uganda is predominantly rural, rural and off-farm activities, led by small and medium enterprises, will have to be one of during peak hours (6 PM to 11 PM). Presently the bulk export tariffs to Kenya during the Day and Night are ¢8/kWh and ¢6/kWh, respectively. The governments of Kenya, Tanzania and Uganda envisage a partnership within the context of East African Co-operation for the development of electricity generation and transmission projects which is likely to further increase exports from Uganda. In total Uganda presently exports about 300 GWh with total export earnings in the order of $18-20 million, annually.

7 Reinikka, R. and J. Svennson, How Inadequate Provision of Public Infrastructure and Service Affects Private Investment, December 1999, World Bank , Policy Research Working Paper Number 2262. The survey revealed that in 1998 Ugandan private firms incurred on average about 89 days of power outages per year; as a result, as many as 77 percent of large firms, 4 percent of medium-sized firms, and 16 percent of small-sized firms owned back-up power generation facilities.

8 the main engines of rapid and broad-based economic growth. Yet, today, this potential growth is being seriously constrained by the lack of adequate investment for the provision of rural infrastructure services, of which electricity is a key component. This undermining of the growth potential of rural small and medium businesses and entrepreneurs directly constrains the generation of rural jobs and income.

Need for a paradigm shift.

Limited future impact of a restructured Uganda Electricity Board (UEB) in rural areas. UEB today has well under 200,000 customers, the majority of whom, about 128,000, are in the urban areas. At present, UEB connects well under an additional 10,000 customers per year, which implies that Uganda is losing the access race, as population growth at the rate of 2% per year which would add 90,000 or more new households per year.

Even under the best of circumstances, with a restructured UEB and its revitalized off- springs, as per present draft proposals for power sector restructuring and reform, the rural access picture is unlikely to improve perceptibly. For instance, under the optimistic assumption that the number of rural households connected to the main grid would increase at a sustained, compound annual growth rate of 15% over 2001-2010, the total number of rural households connected to the main grid would increase from about 30,000 in 2001 to about 125,000 in 2010. This would imply a rural access rate of about 3% based on the current rural population, and much lower once population growth and otherdomographic demographic changes are taken into account.

Need for a paradigm shift. The irony is that by various indicators of revealed preference, a substantial segment of the unserved rural firms and households are willing and able to pay significant sums for electricity. Some rural businesses have resorted to self-provision of electricity, at a unit cost that is far higher than would prevail in an organized, commercial delivery system. Most rural businesses and households simply make do without electricity or have devised make-shift arrangements, which are vastly inferior substitutes for electricity, again at high unit costs. It follows that a paradigm shift in the organization and approach used hitherto in rural electrification is needed to meet Uganda’s aspirations for off-farm led economic growth along with increases in the rural living standards.

Government strategy. The government has adopted, in consultation with the Bank, a commercially-oriented approach -- with the government playing the role of a market enabler -- towards rural electrification. A Rural Electrification Strategy Paper is currently under preparation by the Ministry of Energy and Mineral Development, and scheduled for submission to the Cabinet shortly. The main elements of this strategy are:

(i) Level playing field for private sector participants. This implies a market/sector structure that will:

. Permit private sector entry for supply of electricity – generation, transmission, distribution/retailing – from the interconnected grid system as well as stand-alone, independent mini-grid systems. (Already provided for in the Electricity Act of 1999).

9 . Ensure fair competition for all suppliers with respect to UEB and its successors, in particular, all necessary steps will be taken to ensure that UEB does not have an unfair advantage over potential private sector participants in competing for distribution/retailing of electricity purchased in bulk from the UEB-operated grid system. (To be implemented as part of power sector reforms).

(ii) Enabling regulatory framework. There is a need for a suitable regulatory framework that has:

. Clear separation of responsibilities of: (i) planning, monitoring, policy setting, licensing and permits, establishing/promulgating regulations, (ii) compliance (“regulator”), and (iii) conflict/resolution, arbitration, and adjudication in cases where an involved party wishes to appeal a finding of the regulator. (Already provided for in the Electricity Act of 1999)

. “Light-handed regulation” procedures and processes for small, stand-alone grid- based power system systems. (Already provided for in the Electricity Act of 1999, with details still to be developed).

(iii) Cost recovery and cost-based tariffs, to facilitate private entry and local initiatives, recognizing that this will imply that consumers in different parts of the country will pay different retail tariffs, and that the tariffs for some consumers will be significantly higher than for others, even after subsidies (see below) have been provided for. In particular, there is a need for:

. Regionally differentiated retail tariffs, for all suppliers, including UEB and its successors, which vary according to the cost of service delivery. Further, the benefits of the low-cost, big hydropower resources will be allocated on a national basis, and not restricted to main grid consumers only. (Already provided for in the Electricity Act of 1999, with details still to be developed)

. Bulk-supply tariffs based upon the cost of supply at the delivery point in the main grid system. (Already provided for in the Electricity Act of 1999, with details still to be developed)

. Non-discriminatory wheeling tariff (and access) to facilitate power transactions between distribution concessionaires and third-party generators. (Already provided for in the Electricity Act of 1999, with details still to be developed)

(iv) Subsidy transfer and financing mechanism, i.e., a Rural Electrification Fund to take account of regional and other considerations, with due consideration to efficiency and sustainability under a regime of cost-based regionally-differentiated tariffs and multiple service providers in the future. In particular, the Government will design subsidy schemes and allocation procedures that:

. Follow pre-established clear, explicit rules that

10  Are transparent, i.e., avoid implicit (and operating) subsidies that frequently lead to waste and non-accountability.

 Are linked to results, i.e., maintain the focus on expanding access by subsidizing the initial cost of investment rather than the cost of operation.

 Provide strong cost-minimization incentives, i.e., retain the commercial orientation to reduce costs even though subsidies are being provided.

. Ensure good governance, i.e., the institutional responsibility for policy and rule setting for the REF will be clearly separated from the administration of the Fund, and an independent entity will be responsible for requisite checks and balances, monitoring performance, and ensuring compliance. (Already provided for in the Electricity Act of 1999, but some key changes are required – see section C2).

2c. Renewable energy resource potential is under-utilized. Apart from large-scale hydropower schemes, only a small fraction of Uganda’s renewable energy resource potential – which includes (i) power generation from a variety of sources such as biomass residues, small hydro, wind, and geothermal and (ii) solar energy for stand-alone photovoltaic systems – has been tapped to date. While several small/mini-hydro and biomass projects have been proposed in the past several years, their development has been constrained by a number of factors including: i) a widely held belief that only UEB was permitted to sell power; ii) lack of access to long-term financing; iii) undeveloped local capacity for planning and implementing such projects. The prospects of utilizing solar energy have been given a boost by the ongoing UNDP-GEF Uganda Pilot Project for Photovoltaic Rural Electrification.

Government strategy. The government has adopted, in consultation with the Bank, a strategy to establish a regulatory and investment climate within Uganda that promotes private sector led, commercially-oriented development of these resources. In addition, the Government will seek financial support from various multilateral, primarily GEF and Clean Development Mechanism (CDM) sources, and bilateral agencies that are interested in supporting renewable energy.

3. Sector issues to be addressed by the project and strategic choices: The two sector issues to be directly addressed by the project are the low rural electricity access and the under-utilization of the renewable energy resource potential. In general, the key design features and details of this project would be coordinated with the activities and policies related to power sector reforms and capacity additions; in particular, there are three links that would have to be closely coordinated:

 UEB operates several isolated systems in rural areas, based on local generation, that are not connected to the main grid. Many of these systems are unlikely to be attractive to potential private sector firms that would otherwise be interested in becoming distribution concessionaires, once the restructuring of UEB is complete. Hence, the disposition of these rural UEB assets and the continued provision of power in these areas will be coordinated with the overall sector reform process.

11  The addition of any renewable energy based power generation capacity on the main grid would be coordinated with the overall planned capacity expansion plan. In particular, while there is a generation capacity shortage at present, this may turn into a surplus when Bujugali comes online, and any capacity additions must take account of this.

 The design and details of the Rural Electrification Fund (REF) would be coordinated with the overall sector reform process, for two reasons. One, some of the resources for the REF would come from levies imposed on the main grid. Second, it is vital to have a clear and transparent specification of the geographical areas that would qualify for subsidies from the REF.

Strategic choices. The first strategic choice made by this project is to stretch the project’s boundaries to focus on rural transformation, rather than the energy sector itself, and, further, set ambitious targets within this context. In particular, the proposed project will establish links with (i) physical capital, via investment sectors, such as telecommunications/computers/Internet,8 water9, and small and medium enterprises (see section D3, Lessons learned), and (ii) human capital, via social sectors such as health (see below) and education to enhance the quality and effectiveness of their service delivery. The basis for these links will be their need for and efficient use of adequate and reliable supplies of energy; most of these links will be tested in the form of pilots in the first phase of the APL. The alternative of a less ambitious, internally-focused rural electrification project does not offer good prospects of a significant development impact, at a time when it is clear that, in the past, even successful projects, particularly rural electrification projects10, have often failed to make a noticeable difference in rural lives. For instance, while it will take a considerable, sustained effort on a number of fronts to reach the project’s targets, they are not ambitious to the extent that at the end of the project, the vast majority of the rural population would still be left without the benefits of electricity.

8 An initial field visit in which a telecommunications mission joined the project team has already led to plans to establish a Multipurpose Community Telecenter (MCT) -- at Kisizi (see Annex 3) where expanded power supply is proposed to be made available under this project -- that would provide communications, information, multimedia, and computing functions at a common center to help address a variety of community problems and needs. Given the urgent needs of this community for improved communications, immediate steps are being undertaken to integrate this site into the larger satellite-based communications network being piloted by the Ministry of Education in cooperation with the World Links for Development Program, as well as a range of potential international and private sector partners. The plans are that the grant-financed pilot MCT would become operational independent of and even prior to the finalization of this project. Based on the experience with this and another pilot in the first phase, a strategy for scale-up and implementation would be developed. 9 Discussions have been initiated with the proponents of a successful Development Marketplace 2000 proposal related to a low-cost method of disinfecting water at the household level in rural areas; this method requires a reliable power supply. The proposal includes a pilot in Latin America; it is now being explored whether a pilot (based on this and/or other suitable technologies) could be tested in Uganda. This would fit in well with one if the findings of the Uganda Participatory Poverty Assessment: “In discussions concerning water, local people focused predominantly on the need for clean drinking water for people and livestock, although rivers, lakes and swamps were also seen as important.”

10 “The overall record of rural electrification (R.E.) has been satisfactory. Nevertheless, the reestimated economic returns have proven considerably lower than planned and a whole range of expected indirect and external benefits have not materialized, especially with respect to industrial growth.” Rural Electrification in Asia: A Review of Bank Experience, OED, World Bank, June 30, 1994, Report No. 13291.

12 A second strategic choice is to promote rural electrification in a commercially-oriented manner, under which the investment, operational and consumption decisions at the margin -- “the last dollar”-- are made on an unsubsidized basis, while affordability and equity considerations are tackled by an appropriate subsidy transfer and financing mechanism (see section B2b, points (iii) and (iv) of Government strategy). This is the only option that offers good prospects of meeting the project’s targets. The alternative of State-led rural electrification with subsidies provided through a national uniform tariff has proved to be non-workable in most countries, and is a non-starter in Uganda, given UEB’s poor past and current performance. On the other hand, the option of totally commercial rural electrification, i.e., with no subsidies, would be unlikely to attract potential service providers, given the risks and high initial costs arising from the lack of any experience with such an endeavor, and would be unlikely to accelerate rural electricity access significantly, given the limited affordability.

A third strategic choice is neutrality and flexibility with respect to regional location, business models, supply modalities and technology. In particular, the project will be national in scope, support multiple business models, including public-private joint ventures, and utilize a broad set of supply options, ranging from relatively large (for rural areas) stand-alone mini-grids to small solar photovoltaic systems11. While this does increase the complexity of project design and implementation, a narrower range of supply options would be unlikely to accelerate and scale-up rural electricity access, thus reducing the impact of the project. At the same time, the project’s approach will be to look for and define workable entry points and growth trajectories for each option in order to mitigate implementation difficulties. A fourth strategic choice is to explicitly focus on the needs of rural enterprises and public institutions, and not just on rural households. In particular, the program would determine, in conjunction with health and education sector authorities, the energy needs, as well as the priority attached to them, of rural health and educational facilities, and formulate plans to meet them in a cost-effective manner, so that the poorer segments of the rural population are able to receive some indirect benefits from this program. For instance, in Uganda, rural trading centers (see below) include clusters of enterprises, many of which wish to improve their productivity, that have an ability to pay significant amounts for electricity, and can form the critical mass of demand required for setting up an independent grid, which could then serve nearby households and public institutions on relatively affordable terms.

11 While the program will not directly support battery-charging stations to serve individual household who use automotive batteries to power some lights and/or radio/TV, it is expected that such enterprises will spring up around trading centers and other clusters that become electrified.

13 In most cases, rural public institutions would be unable to pay the full cost of energy supplies; particularly, the user fees they collect are often inadequate to cover even their essential operating costs. At the same time, the commercial orientation of this program requires that the energy providers recover their costs, and do not provide energy to any consumers at reduced prices with implicit cross-subsidies. This “affordability gap” would be covered by devising sustainable financing plans consisting of local contributions, government funds, and grant support from bilateral donors.

An unelectrified trading center in Uganda; the bulk of Uganda’s estimated 2,000 trading centers – whose numbers are rising with economic growth – are unelectrified.

A fifth strategic choice adopted by this project is to work in partnership with other donors. This is not only consistent with the Comprehensive Development Framework (CDF) approach but also has particular relevance for Uganda, where bilateral and multilateral donors have been and are planning to provide significant support to the energy sector, including for rural electrification. The alternative arrangement of the Bank and the donors functioning essentially independently of each other, even with some amount of coordination, offers little beyond a slowly evolving status quo with limited development impact.

A sixth strategic choice is to promote rural energy and renewable energy in tandem. While it is possible, in principle, to separate the two12, in Uganda there are significant linkages between renewable energy and rural transformation. To start with, the promotion of solar photovoltaic systems for rural areas is now a well-established practice in projects sponsored by the Bank as well as other agencies, and in Uganda, the ongoing UNDP-GEF project has already made a start in this direction. Further, many rural areas of Uganda have mini-hydro, coffee hulls, wind and other renewable resources that could be used to generate the power for independent mini-grid systems. The proposed project is expected to be one of the first under (i) the GEF/World Bank Renewable Energy Strategic Partnership, under which GEF would use the APL instrument, and (ii) Clean Development Mechanism (CDM) sources as international trade in greenhouse gas emissions develops.

Finally, the project’s activities will be coordinated with the national strategy to combat HIV/AIDS, which is now viewed as a national problem, and not just as a health sector problem. Discussions have been initiated with the Ministry of Health and the National AIDS Commission regarding the manner in which this project, which is expected to have a significant rural outreach, can serve as an agent of the

12 This separation has been done in some of the Bank’s projects in Asia.

14 national HIV/AIDS strategy. At this point, apart from the strengthening of rural health and educational facilities by providing them with energy services, there appear to be two channels for cooperation. First, the project teams could act as the “arms/legs and eyes/ears” for the national strategy13, spreading the messages and materials provided by the national authorities during the course of meetings and discussions in the rural areas as well as at headquarters, while providing feedback about reactions and suggestions. Second, the service providers participating in this project could as act as channels for disseminating HIV/AIDS materials provided by the national authorities.

Risk implication of strategic choices. A risk implication of these strategic choices is that the proposed project may be too large and too complex, given Uganda’s limited absorptive capacity, particularly in this sector, and may face above-average implementation problems and delays for the project. This issue is discussed later in section F Sustainability and Risks.

4. Program description and performance triggers for subsequent loans:

The program will consist of two broad components: capacity building/technical assistance and investment.

The overall objective of the capacity building/technical assistance component will be the creation and/or strengthening of the organizations and institutions involved in the implementation of the project to operate these facilities and resources in a sustainable manner, beyond project completion. The capacity areas covered would be the policy setting, promotion, financing, regulation, service provision, and monitoring/evaluation of commercially-oriented rural electrification and renewable energy development; the agencies covered would include central and local authorities, private sector enterprises, including rural small and medium enterprises, and NGOs/CBOs.

To this end, while the project will make full use of national resources and strengthen them as necessary, it is also recognized that external financial and human resources would also have a key role to play in this component, particularly in the first two phases of the APL, within the framework of a long-term capacity development plan that will serve as an operational roadmap for sustainability. The scope and magnitude of this component will be determined by: (i) an overall assessment of capacity needs, and (ii) formulation of the overall approach of the capacity building plan; these activities will be initiated during pre-appraisal and which will determine the scope and magnitude of investments for this purpose. These efforts will take account of the concepts embodied in the rapidly growing literature related to social capital theory, which will be particularly relevant in the context of increased networking and transparency within the communities benefiting from the project, and on account of the links between the communities and the outside world by way of communication and information.

The capacity assessment will be instrumental in setting the scope, objectives and targets for capacity development. It will indicate what benchmarks are to be used in planning the strengthening of institutional capacities and what level of resources (including TA) are required

13 An initial effort on this account by mission members did not encounter any negative reactions or resistance. Further, the management of one of the sugar mills planning to participate in the ERT program accepted the suggestion enthusiastically, and is planning to display official HIV/AIDS posters in not only the participating sugar mill but also all other facilities that they manage.

15 to attain such benchmarks. These would specified in the context of local management implementation plans, to be developed by the producers, regulators, managers and users of the new energy sources. The monitoring and evaluation plan will also assess cross-sectoral outcomes and synergies resulting from the availability of new services ( e.g. health, education, training, income generation , etc).

The preliminary indications, based on field visits by Bank energy sector missions, are that:

 Some of the technical assistance would take the form of introducing and mainstreaming suitable international best practices, particularly those that would reduce the cost of service provision and improving the quality of service offered;

 A significant effort is required to increase the capacity of district and lower level authorities, particularly with respect to “light-handed” regulation and promotion of this project, and that these activities should be coordinated with other planned or ongoing district-level capacity building programs.

 There will a specific focus on capacity building for renewable energy, as called for in the GEF/World Bank Strategic Partnership for Renewable Energy.

The investment program would consist of four sub-components:

Sub-component 1: Main grid related power distribution and generation. The power distribution would be to presently unserved rural areas that would be connected to the main grid, with the power supply to come from the large-scale hydropower plants. It is expected that the private sector distribution concession areas, arising from sector reforms, would be narrowly defined in terms of the physical distance from the existing grid. Thus, the extension of the main grid to rural areas and the consumers would be supported under this sub- component. In keeping with the objective of renewable energy development, there would be additional power generation from small, renewable energy resources, such as sugar mills, that are close, or already connected, to the main grid. In the long run, the sale of this power would be to third-party customers via wheeling through the main grid, i.e., in the long run, there would be no power purchase agreement between the generator and the main grid, which would merely serve, for a fee, as the “highway” over which power is transported from the generator to a third-party customer. However, in the short run until the Bujugali project comes online, there would likely be a power purchase agreement between the main grid and the renewable energy power generators; further, after Bujugali comes online, there would likely be a transition period during which the renewable energy generators would have some assurance of the sales of their power, after which the long run wheeling mechanism would be utilized.

Sub-component 2: Independent grid systems for relatively concentrated isolated areas with a potential for the use of electricity by rural enterprises. This sub-component would support relatively larger systems that may require some transmission (such as in the West Nile region) and smaller systems, such as those located in rural trading centers, that require only generation and distribution facilities. It is expected that a significant part of the power generation would be

16 from renewable energy resources.

Sub-component 3: Individual/institutional solar PV systems, for relatively dispersed areas where even small independent grid systems are not viable.

Sub-component 4: Pilots for scale up in later tranches. In the first phase, this would include: (i) energy efficiency in use of traditional woodfuels by rural SMEs and public institutions for which a pilot would be prepared in conjunction with ongoing research sponsored by the U.K. Department for International Development (DFID), (ii) provision of telecommunications and connectivity, for which one pilot may be implemented outside this project, and one within the first tranche of this project, and (iii) low-cost household water disinfecting, which requires adequate supplies of electricity, based on a winning proposal in the Development Marketplace 2000 and/or other similar technologies.

The first tranche of the APL would include investments in all of the above sub-components. The various sub-projects identified so far on a preliminary basis for inclusion in the first tranche are described in Annex 3.

Triggers for Phase II

The overall approach is that the triggers for Phase II would be linked to the accomplishment of the objectives of Phase I (see section A1). The triggers, with the details to be developed during project preparation, would be based on (GEF related triggers are presented in italics):

 Establishment of regulatory system, RE Fund, wheeling system and procedures, and a workable intermediation mechanism for commercial finance  Construction of renewable energy power generation facilities in the range of 20-25 MW, with a GEF share in total cost of about 20-25%, and the rest of the financing to come from a combination of Bank and commercial financing.  Sales of solar pv systems: about 7,000-10,000 household systems and 125-175 institutional systems, with a GEF share in total cost of about 20-25%, and the rest of the financing to come from a combination of Bank and commercial financing.  Finalization of long-term renewable energy capacity building strategy and action plan, including financing of recurrent costs of renewable energy projects and institutional arrangements, and other evidence of Government commitment to renewable energy (to be discussed with Government)

The triggers for Phase II and III, and the quantitative and qualitative indicators described on pages 3 and 4 will be clarified in terms of the calculated baseline and related milestones for each of the different phases at the time of submission for CEO approval.

Triggers for Phase III

The overall approach is that the triggers for Phase II would be linked to the accomplishment of the objectives of Phase II (see section A1). The Phase III triggers, with the

17 details to be developed during project preparation, would represent basically the same factors as the Phase II triggers, but at a higher level of development (GEF related triggers are presented in italics):  Fully operational regulatory system, RE Fund, wheeling system and procedures,  Successful implementation and/or functioning of main grid rural extensification and independent grid systems, and sales of solar pv systems  Establishment of regional best practice level capacity to promote and undertake renewable energy development;  Construction of additional renewable energy power generation facilities in the range of 20-25 MW, with a GEF share in total cost of about 15-20%, and the rest of the financing to come from a combination of Bank and commercial financing, with about 10 MW not supported by GEF,  Sales of solar pv systems: about 50,000-75,000 household systems and 200-300 institutional systems, with a GEF share in total cost of about 15-20%, and the rest of the financing to come from a combination of Bank and commercial financing.

C: Project Description Summary

1. Project components (Phase 1): (see Annex 1) Indicative % of Bank- % of GEF- % of GEF- Component Sector Costs Total financing Bank- financing financing (US$M) (US$M) financing (US$M) Grid-based Distribution/ Energy 39 52 17 44 7 58 Generation Isolated Independent Grid Energy 28 37 8.6 30 0.5 4 Systems Solar PV Systems Rural 2.5 3 1 40 1 8 Pilots Energy/Rural 0.5 1 0.4 90 Technical Assistance Energy/ 5 7 3 60 3.50 30 Rural/ Financial Phase 1 Total 75 30 40 12 16

Project components (Phases 2 and 3) Indicative Bank- % of Bank- GEF- % of GEF- Component Sector Costs % of financing financing financing financing (US$M) Total (US$M) (US$M) Grid-based Distribution/Generation Energy 9 50 Independent Grid Systems Energy 4 22 Solar PV Systems Rural 2 11 Pilots Energy/Rural Technical Assistance Energy/ 3 33 Rural/ Financial Phase 2 and 3 Total 300 120 18 6

2. Key policy and institutional reforms to be sought: The key policy and institutional changes sought relate to power sector reforms, with which the activities of this project will coordinated, keeping in mind this project, with its focus on rural

18 areas, is not the main vehicle for the policy dialog or financing related to these reforms. A conditionality for this project, as for other power Bank group supported power sector projects is that the power sector reform process move forward as agreed, in particular that concessions for the privatization of distribution be awarded by April, 2001.

Most of the key policy and institutional reforms related to this project have already been incorporated into the Electricity Act of 1999. At this stage, the bulk of the remaining job is to finalize the details of regulations and other (“secondary legislation”) that are needed to be able to implement the new provisions of the Act. Specifically, the following reforms related to the objectives of this project will be sought:

 Detailing of the following provisions already provided for in the 1999 Electricity Act (to be done in coordination with overall power sector reforms).

. “Light-handed regulation” procedures and processes for small, stand-alone grid- based power system systems.

. Regionally differentiated retail tariffs, for all suppliers, including UEB and its successors, which vary according to the cost of service delivery.

. Bulk-supply tariffs based upon the cost of supply at the delivery point in the main grid system.

. Non-discriminatory wheeling tariff (and access) to facilitate power transactions between distribution concessionaires and third-party generators.

 Changes related to the transfer of incremental cost grants and financing mechanism (to be done in coordination with overall power sector reforms). While the provisions in the 1999 Electricity Act do provide some degree of autonomy for the Rural Electrification Fund, the Fund is under the control of the Minister, with the trustees of the Fund to be appointed by and accountable to the Minister. The implication is that the Fund, as currently designed, is under the Government’s control and may lack adequate autonomy, leading to fears that this Fund may face hard-to- resist political pressures, which may ultimately lead to financial difficulties and lack of transparency. Changes will be sought to ensure greater autonomy for the Fund, including by means of appropriate secondary legislation without any changes in the primary legislation. Acceptable changes in this regard will be a condition of negotiations for this project. 3. Benefits and target population: The benefits of the project are:

 Improvements in the quality of life of rural households that directly get electricity access, or indirectly via rural public institutions such as health clinics and schools, and from synergistic developments in other sectors such as telecommunications and water;

19  Increases in the productivity of small and medium rural enterprises who introduce electricity into their operations or whose use of traditional fuels becomes more energy-efficient; and

 Reductions in greenhouse gases, which has global environmental benefits.

Since this is a national program, the target population would be distributed over various parts of Uganda, While a conscious effort will be made to promote regional equity, it is likely that all sub-components of the program will not be equally appropriate for the different regions. 4. Institutional and implementation arrangements: The overall responsibility for program management, promotion, provision of business development assistance, and monitoring and evaluation will be with the Steering Committee for Rural Electrification and Renewable Energy – already set up by the Government of Uganda in consultation with the Bank – which would report to the Minister of Minerals & Energy Development (MEMD). This inter-agency forum, which includes government officials from the MEMD and the Ministries of Local Government (MOLG) and Finance, as well as non-official members, would also advise the Government on policy formulation with respect to rural electrification and renewable energy development. Since the Steering Committee is expected to comprise of high level officials and non-officials members, day-to-day matters would be handled by a small Rural Electrification Program Group/Unit in MEMD.

On account of the weak capacity, it is expected that a Lead Consultant reporting to the Rural Electrification Steering Committee would be contracted under the TA component to carry out the day-to-day responsibilities of program management and in this process also build the capacity of Rural Electrification Program Group/Unit over time to take on the full range of functions required.

Program promotion. Apart from MEMD, MOLG would also have a key role in the promotion of the concepts to rural communities, given MOLG’s strong outreach at the district and lower levels as part of its role in Uganda’s decentralization process. In addition, the Uganda Local Authorities Association (ULAA), which is an apex body of district-level authorities, will also be a channel for disseminating information to its members and stimulating interest/action in taking advantage of the opportunities/assistance offered under the project. At the district level, the LC5 Chairs and districts councils will be involved in dissemination of information; below the district level, the LC3 level authorities will also have a critical role in disseminating information as well as encouraging local communities to think about and develop project proposals. However, government officials ,including the LC5 and LC3 level officials, will not be generally involved in the formulation and/or approval of specific sub-projects, which will be the responsibility of the private sector, except in their role as part of the regulatory system. A key element of program promotion would be social intermediation by NGOs and community-based organizations (CBOs), as appropriate, to facilitate community participation and buy-in for sub- projects.

Sub-project preparation. To assist some potential developers, who may not have experience with commercially oriented rural electrification and renewable energy development, business development assistance – financial, technical, and legal – will be provided to help

20 develop these proposals. Consultants for this purpose have already been begun preliminary work with some of the sub-projects tentatively identified for the first phase (see Annex 3). Early on in the program, especially during the first phase, it is expected that the Lead Consultant would need to play a significant role in back stopping the local private sector business development support providers because of weak capacity.

Monitoring and evaluation. The responsibility for this task will lie with the Steering Committee for Rural Electrification and Renewable Energy. The monitoring and evaluation system will linked to the two elements – rural transformation and environmental protection – of the overall program purpose, as well the objectives, outputs and triggers for each of the phases. During the course of project preparation, baseline levels will be established with the assistance of academic experts --preliminary discussions and initial agreements have already taken place with the Oxford Centre for African Studies and Imperial College, London. It is expected that the monitoring and evaluation system would use participatory as well as quantitative techniques.

Approvals and regulation. The process of approvals and regulation will be within the overall power sector regulatory framework, which provides for “light-handed” regulation for smaller systems.

Sub-project appraisal, financing and implementation. The implementation of the investment components of this project will be undertaken primarily by private sector firms and NGOs, who may form partnerships with local government authorities and/or the community concerned. The appraisal and financing of the sub-projects will be on the basis of commercial financial intermediation by commercial banks, and possibly other financing agents, to enable access by sub-project developers for long-term financing --at market terms and commercial discipline-- as well as working for capital for dealers. End-users may be able to access micro- finance for their needs.

Subsidy intermediation. (Rural Electrification Fund) to buy down a portion of the investment cost in a competitive and transparent manner for private sector led business proposals evaluated against clearly defined selection criteria. The RE Fund would be independently operated but, will work in parallel and be closely coordinated with the commercial intermediation channels --without commingling funds-- since most schemes will necessarily involve sub-project developers having to put up equity and pass commercial appraisal for securing debt financing. The RE Fund would likely also need to provide partial risk cover for the commercial debt financing portion of sub-project investments.

Under the Electricity Act of 1999, overall responsibility for establishing the Rural Electrification Fund, and operating rules and administering the Fund, is delegated to the Minister of Mineral & Energy Development. A major activity in project preparation will be to develop a detailed design of the operation and management of this Fund --pre-established, clear and explicit rules for sub-project eligibility, screening process procedures and rules for evaluation of “business plans” submitted by potential service providers and communities, criteria for determining subsidy levels, conditions to be associated with the subsidy/grants provided, etc,-- acceptable to the Government and the Bank. In this context, a key issue will be the setting up of this Fund to ensure transparency and good governance, i.e., set up wherein the responsibility for

21 policy and rule setting for the Rural Electrification Fund is separated from responsibility for day- to-day management of the Fund, with provision for independent checks for performance monitoring and ensuring compliance, acceptable to the Bank and bilateral financiers of the Rural Electrification Fund.

Implementation of the technical assistance and capacity building components will be managed through MEMD and MOLG, and other institutions such as the Private Sector Foundation , as appropriate. A significant part of the capacity building will be aimed at the district level, private sector and NGOs, and will be undertaken by private sector and NGO/CBOs.

D: Project Rationale 1. Project alternatives considered and reasons for rejection: Most of the key issues related to project alternatives considered and rejected have already been discussed under the section related to strategic choices (see section B3). Hence, the only issue considered here is the choice of an APL as the lending instrument. The alternatives considered were (i) a conventional project (SIL), and (ii) a LIL, followed by a SIL.

Both rural electrification and the development of renewable energy in Uganda would benefit from a long-term approach that retains flexibility for changes as conditions evolve over time. Given the current low levels of rural energy access, negligible utilization of renewable energy, and the lack of experience with commercially-oriented approaches, the approach adopted under this project is to start small and accelerate scale-up over time. However, a conventional project, with a short-term horizon, is not well-suited for this purpose, as it would not make an adequate impact during its course, nor would it be suited for building the framework required for later scale-up. Hence, a conventional project was rejected.

While the first tranche of the proposed APL does have some elements of learning, the scale of the first tranche is much larger than that of a LIL, and the type of learning involved is that associated with any project, and not of the type generally targeted under LILs. Further, a LIL would have almost no measurable impact on rural energy access or renewable energy development, thus delaying the scale-up. Thus, the alternative of a LIL followed by a SIL was also rejected.

22 2. Major related projects financed by the Bank and/or other development agencies: (completed, ongoing and planned)

Sector issue Project Latest Supervision (Form 590) Ratings (Bank-financed projects only) Implementation Development/ Progress (IP) Global Objective (DO) Bank-financed Grid-based rural electrification Uganda Power III S S Ethiopia Rural Electrification Under preparation Ghana National Electrification (P000953) S S Vietnam Rural Electrification Under preparation Independent mini-grids Mozambique Urban Household Energy (P 001793) S S Sri Lanka Energy Service Delivery (P010498) S S Laos Southern Province Rural Energy (P044973) S U Solar pv India Renewable Energy Development I Indonesia Solar Home Systems (P035544) (planned to be phased out) Sri Lanka Energy Service Delivery (P010498) S S China Renewable Energy (P046829) S S Togo-Benin Rural Energy (P057881) Under preparation Argentina – Renewable Energy Rural Markets (P006043) S S Mexico – Offgrid Rural Electrification (P064848) Under preparation Cape Verde – Energy/Water (P040990) S S Cape Verde – Renewable Energy (P042054) S PV Market Transformation Initiative (IFC project) Vietnam – PV project. (IFC project)

Other development agencies Solar pv Zimbabwe Solar PV Project (UNDP/GEF) Uganda Pilot Photovoltaic Project (UNDP/GEF) Zambia Solar PV (SIDA) Mozambique – PV systems for rural health clinics (NORAD) IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

23 3. Lessons learned and reflected in proposed project design:

Choice of APL

Experience with APLs has been satisfactory. A draft review14 of 40 APLs approved in FY98, FY 99 and first quarter of FY00 found that “the quality of these operations has met Bank standards and the perception of Bank staff and borrowers seems to be that these instruments are likely to be achieve their expected development objectives. Among those who have used them borrower understanding and satisfaction with these instruments is high.” QAG’s quality-at-entry review of APLs approved in FY98rated 75% of these APLs as “satisfactory or better.”

Triggers in APLs need careful consideration. The review also found that in most instances where issues/concerns were raised for an APL operation – Board member, QAG – these centered around the emphasis on the need for clarity and specificity regarding benchmarks and indicators (“triggers”) for moving from one phase to the next, which in fact argues for the importance of clear and specific delineation in objectives of subsequent phases of the program, as well as paying special attention to the quality of the monitoring and evaluation in place.

Grid-based rural electrification

An OED review15 of Asian Rural Electrification Programs noted that most have cost more and yielded fewer benefits than expected. The review recommended that in order to reduce costs, “project appraisal needs to focus more attention on identifying the economic limits of extensions to the grid and on the economic potential of alternative energy sources, particularly solar energy.” The project design fully incorporates this approach to cost reduction, in addition to the introduction of lower-cost technologies and processes.

The review also found that “RE reduces rural poverty only through a general rise in income obtained by productive uses.” This project’s focus on rural enterprises is consistent with this conclusion. Further, instead of merely facilitating the supply of electricity, this project will be on both sides of the meter, i.e., providing technical assistance to rural enterprises to switch over to electricity when it becomes available, using an approach similar to that of the Indonesia Second Rural Electrification Project, which, under its Rural Business Services (RBS) Program trained and deployed local NGOs to assist over 60,000 rural enterprises in enhancing productivity and incomes by switching over to electricity.

The OED review found that “implicit subsidies of RE programs can significantly depress a utility’s financial performance … a rational system of cost recovery is a key policy ingredient of any RE project.” Consistent with this conclusion, the project calls for a system of transparent and explicit subsidies along with an emphasis on cost recovery via commercially-oriented rural electrification.

14 Operational Core Services Network, Adaptable Lending: Review of Experience after Two Years, February 2000. 15 Rural electrification in Asia: A Review of Bank Experience, June 30, 1994, Report No. 13291, and Rural Electrification: A Hard Look at Costs and Benefits, OED Precis No. 90, May 1995.

24 Subsequent to the OED review of Asia, more recent reviews and reports16 of selected country experiences with rural electrification – Thailand, Costa Rica, Indonesia, Chile, Mexico, Cote d’ Ivoire, South Africa, the Philippines, and Bangladesh –provides a broader and more diverse base for analyzing the critical success and impeding factors in achieving a high level of rural household electricity access. While the various countries used a variety of institutional models and approaches, and there are no fixed blueprints to follow, the lessons of the common experience suggest several closely related guiding principles:

 Conducive macroeconomic conditions, genuine Government commitment and follow through, with significant decentralization of decision-making  To ensure sustainability, rural electrification needs to be set up on a commercially viable basis  Address affordability through aggressive deployment of low-cost equipment as well as construction and O&M systems, including utilization of alternative technologies, based on least-cost criteria  Demand-driven selection criteria for service expansion rather than top-down “RE Master Plans” so as to maintain emphasis on cost recovery  Some subsidies are generally required, but recurrent cost subsidies undermine sustainability and development impact.  Development impact can be increased by subsidizing access, (i.e., low connection charges instead of consumption), cost-recovery based tariffs, and working with rural enterprises to enhance their productivity.

At present, the only ongoing Bank-financed grid-based rural electrification project in Africa is the Ghana National Electrification Project, which is expected to meet its target of 97,000 new customers in 13 district capitals, 33 towns and several townships, along with privatization of distribution. The use of transmission line “shield wire” technology for rural distribution has led to as much as 50% cost reduction in this aspect; while this particular technique is not applicable to Uganda, the broader lesson is that significant cost reductions can be brought about by technical innovations.

Independent grids

There has been only limited experience with independent grids; overall, the early results are encouraging. Two independent grids were financed under a recently completed project in Mozambique, which is the only Bank-supported project in Africa to feature such grids. These grids are working well, cost recovery is high, and the Government has recently contracted out their management, following a bid process, to private sector firms. Bank-supported projects in Sri Lanka and Lao PDR also include village-level independent grids. These systems are

16 Douglas Barnes and Gerald Foley: Rural Electrification in the Developing World: Lessons from Successful Programs. Nov. 1998 (draft), Wolfgang Mostert, ESMAP report on Cote d’ Ivoire, Alejandro Jadrente, Case Study: Subsidies for Rural Electrification in Chile, paper prepared for the National Energy Commission, Santiago, Chile, January 2000, Implementation Completion Report, Indonesia Rural Electrification Project, Implementation Completion Report, Indonesia Second Rural Electrification Project, under preparation, Mexico Village Power98 presentation, October 1998, A. Sanghvi Discussions with key ESKOM management and staff responsible for South Africa’s National Rural Electrification Program, January 2000.

25 characterized by local-level ownership and operation which is a key element of long-term sustainability. In general, these systems are far from urban centers, which highlights the critical importance of local ownership and operation. In Sri Lanka, this is done through village cooperatives. In Lao, private entrepreneurs have taken this role. However in both cases design and implementation have been highly participatory. This emerges as a key lesson to enhance sustainability of the independent grids. The other key lesson from these efforts is that even remote communities generally have a strong interest in obtaining electricity, but their capacity to implement a successful system is limited. A targeted program to provide the needed support and capacity building is therefore critical to the scale-up of access through independent grids.

Outside the Bank, there is some experience with local mini-grids, both in terms of technical implementation, management, and collective management, in Nepal and Tanzania. The project team has close links and good working relationships with the key individuals and entities (SIDA, NRECA) involved in these projects, and will continue to review with them any lessons applicable for the Uganda project.

26 Solar PV

A draft review17 of the Bank’s experience with solar home systems projects derives some lessons from the early implementation experience.

 Initially, the pace of implementation is likely to slow, as it takes time to develop and fine tune effective business models (operations, servicing and financing) for operating a solar pv business in rural areas.

 Some of the ways to accelerate implementation are to: (i) provide flexibility in project design in terms of delivery mechanisms/model and technical specifications about size and nature of systems supported, (ii) focus initially on cash sales, as credit collection can be costly and risky, (iii) introduce systems of various sizes, so that consumers have a choice of models, (iv) and provide business development assistance to solar pv dealers.

 Adequate after-sales service, including consumer education in proper maintenance and operating procedures, is important for consumer satisfaction, minimizing maintenance costs and enhancing overall system reliability.

 While marketing campaigns are important, in order to enlarge the market, consumer awareness must be combined with other factors such as affordability, demonstrations, opinions of neighbors, and service presence. The nature of marketing campaigns should be carefully tailored to the local conditions, but, in any case, should be sure to include potential consumers, and not just local leaders or business developers.

Outside the Bank, the experience of Kenya with solar pv is particularly relevant. The growth of the photovoltaic solar home system market in Kenya has been both dramatic, and provides a number of important ongoing lessons.18 In brief, Kenya has an active solar home systems (SHSs) market, with cumulative sales in excess of 100,000 units and current sales of about 20,000 systems per year. There are more than 40 independent manufacturers, vendors, installers, and after-sales providers to serve this demand.

When the SHSs market emerged in the mid-1980s, typical systems used crystalline (x-Si) modules of 40 Wp. However, in 1989, 10 Wp amorphous silicon (a-Si) modules entered the market, capturing the majority of SHSs sales within five years. Since then, total solar pv module sales in Kenya have increased dramatically, from 10 kWp in 1989 to 270 kWp in 1998.

Most solar pv modules sold in Kenya go into SHSs, and a substantial majority of all SHSs use a-Si modules—though most a-Si SHSs in Kenya hardly qualify as formal systems. In one typical pattern, families simply tie a module to their roof and directly wire it to a car battery 17 Eric Martinot, Anil Cabraal, and Subodh Mathur, World Bank Solar Home Systems Projects: Experiences and Lessons Learned 1993-2000. The review has been financed by the Climate Change and Rural & Renewable Energy Thematic Groups and the Africa Rural and Renewable Energy Initiative.

18 A report on this topic will soon be published by ESMAP, World Bank.

27 that they already own and charge in town. Among other system design issues, the lack of a charge controller raises concerns about battery longevity; however, the critical advantage of this approach is that it reduces the cost of “going solar” to as little as US$70. This has made PV accessible on a fully commercial basis to thousands of Kenyan households that otherwise would not have been able to afford it. At the same time, important issues about consumer education, resources available to large and (in particular) small-scale commercial enterprises, and training opportunities all exist. Each of these issues could impact the future sustainability of the industry.

4. Indications of borrower commitment and ownership:

There are three strong indications of borrower commitment and ownership. First, the Government amended the draft Electricity Act to reflect the Bank’s views about the policy framework for commercially-oriented rural electrification, and the Electricity Act of 1999, as passed, includes most of these changes. This is a clear indication that the Government is committed to this project.

Second, there was a one-day workshop on June 25, 199 in Entebbe, hosted by the Ministry of Energy and Mineral Development (MEMD), the Ministry of Local Government (MOLG), the Uganda Local Authorities Association (ULAA), and the World Bank. The purpose of the workshop was to enable key stakeholders to discuss the principles and approach underlying this project. The workshop attracted approximately 150 participants, including the Ministers and senior officials from MEMD and MOLG; a Minister from the Prime Minister’s Office; Chairpersons of district councils (LC5s); Members of Parliament; NGO representatives; local banks and credit organizations; local businesses; and bilateral donors. The following key themes emerged from this participatory workshop:

 Strong endorsement of ERT concepts and goals by all workshop participants, and especially by ministers, MPs and local leaders.

 Cost recovery with smart subsidies should be the guiding principle for service provision although issues of affordability must be addressed. To be sustainable, electricity must be provided on a commercial basis. However, expansion of electricity access supported by the program must reach as deeply as possible to maximize the program’s impact on rural development. “Smart subsidies” from a Rural Electrification fund were endorsed as an appropriate tool for achieving this balance.

 Broad-based consultation was welcomed, and more was requested. Local participation in all aspects of the program will be essential to its success. Consultation must be continued with all stakeholders, and local authorities and businesses must be involved in the regulating, operating, and investing in electricity supply.

 Productive uses should be the focus of rural electrification, as there are strong links between rural electrification and rural social and economic development – in particular, to the modernization of agriculture, and to facilitating opportunities for economic and human development beyond subsistence levels.

 Donor co-ordination in financing and capacity-building was requested to maximize the

28 development impact of the scarce funds available.

 Constraints imposed by the financial sector were acknowledged, and action urged. Effective financial intermediation between program funds and both suppliers and consumers of electricity will be vital – at present, appropriate financial institutions are scarce.

Third, field missions have been warmly received by district and lower level authorities, local leaders and communities have enthusiastically supported the ERT approach, and quickly collected and provided the data requested. Many of them have urged visiting missions to begin the ERT program as soon as possible; the Minister of Energy has also requested the Bank to accelerate preparation of this program. The main reasons for this support were: (i) a realization that UEB-based main grid power supply would not reach even potential key economic growth areas such as trading centers, let alone the bulk of the rural areas, within any reasonable time, (iii) a sense of frustration that local entrepreneurship and non-farm income generation opportunities in their region were being choked off, the provision of essential services such as health and education was being restricted, and local households were being left in the dark by the present and foreseeable power supply situation under the prevailing UEB approach, and (iii) an experience of frequent outages, unreliable supply, and rigid attitudes from UEB in the areas where the main grid had reached – in the words of one district LC5 chairman “power supply is more absent than present.”

Commitment to renewable energy development. Renewable energy is widely viewed in Uganda as a local, indigenous resource, a particularly important consideration for a land- locked country that is now heavily reliant on imported energy sources, imported long distances over land. To minimize these risks of supply interruptions and price volatility, Uganda recognizes that additional efforts are required to encourage development of indigenous energy resources where they are available and economic. For this reason, the Government has forcefully declined to consider thermal-based main-grid power generation, even in the current period when there is a severe shortage of power. The Government’s vision, including its commitment, will be spelled out in a Letter of Sector Development Policy, which will be ready by appraisal, and will be included in the Project Appraisal Document.

Uganda has already taken the significant first step in their passage six months ago private power legislation that will encourage rapid development of additional power resources. Further, in Uganda, key measures related to power sector reform, such as a new Electricity Act, have already been enacted, and they provide a level playing field for renewable energy. What remains to be worked out are the details of how the broad measures will actually be implemented. As such, there are no government policies in place that are explicitly or implicitly discriminate against renewable energy investments in any meaningful way; instead, the barriers to renewable energy development lie elsewhere.

The GOU is committed to establishing and maintaining specific incentives/commitments to encourage renewable energy sources and to create and maintain a ‘level playing field’ that will permit RE technologies to compete with conventional energy sources. To fulfill this commitment, Uganda fully accepts the need for the institution of sufficient policy measures to

29 provide and sustain a level playing field for renewable energy. In this context, the key barrier to renewable energy that the Government can act upon is the lack of indigenous capacity. For this reason, the release of GEF tranches will be linked to the development of local capacity to promote and undertake renewable energy investments – which is also in keeping with the principles of the Bank-GEF Strategic Partnership for Renewable Energy. The proposed triggers for Phase III specifically include renewable energy capacity building.

5. Value added of Bank and GEF support in this project: Overall, the Bank’s relationship with Uganda continues to be strong and productive, and Uganda sees the Bank as its major strategic partner in development. This project, with its focus on rural transformation, is a an important element of this partnership. Within the energy sector, Uganda is working in close partnership with the Bank to design and implement power sector reforms and UEB restructuring; it is important for the Bank support the Government’s plans for rural electrification and renewable energy development, so that the Bank’s support is not limited to only those who can be served by the main grid.

One of the main contributions of the Bank to this project is its ability to function as a “knowledge bank” that brings to Uganda fresh approaches to solving its problems, taking account of Uganda’s current situation and growth potential, while incorporating the experience of and key lessons learned in other countries. This knowledge-bank function is valuable in all of the technical assistance and investment sub-components; for example, reductions in unit costs of access, critical to the sustainability and scale-up of rural electrification, will come from introduction of technologies and approaches already proven in other parts of the world. Similarly, the Bank has helped the Government to shift its sense of rural electrification from the “poles, wires and solar panels” aspects to a focus on rural transformation, including the exploitation of cross-sectoral synergies.

A second major contribution of the Bank would be to work with the various donors in Uganda in relation to rural electrification and renewable energy development. Based on preliminary discussions and expressions of interest, it is expected that bilateral donors will provide grant funds for a number of the activities envisaged under this project, including the Rural Electrification Fund, for which discussions have already been initiated with a number of bilateral donors. Bilateral donors have already provided significant support for this project in the form of grants for the Bank’s Africa Rural and Renewable Energy Initiative (AFFREI), which has financed, and will continue to finance, the bulk of the higher-than-average project preparation costs.

For renewable energy development, this project expects grant support from the Global Environment Facility (GEF) which will pave the way for future Clean Development Mechanism (CDM) sources to be accessed later in the project, though there will be no commingling of GEF and CDM funds. Use of such resources is anticipated to be an important part of the sustainable transition to commercial replication and sustainability. When combined with TA and capacity building and the long-term tenure of the project, such CDM-related investments (which recognize and place value on the GHG mitigation elements of RE while providing an additional resource flows that can help RE sources compete against more conventional energy alternatives) will serve to effect this transition.

30 GEF support for this project will follow and build on the ongoing UNDP-GEF Uganda Pilot Project for Photovoltaic Rural Electrification, which is limited to solar pv. Thus, in this project, GEF will broaden its support to other aspects of renewable energy, including power generation for sale via the main grid. While the GEF has supported phased projects in other instances, this project is the first Bank operation that will support renewable energy development in an APL format; this is also one of the first projects under the Bank-GEF Strategic Partnership for Renewable Energy. As a result, GEF resources will be allocated on the basis of agreed long- term renewable energy development plans, shifting from single transactions to more continuous strategic development of the most promising technology and market opportunities, and targeted at building effective bridges to private sector market development and financing.

Leverage of GEF Resources. The principle of significant leverage of GEF resources with other financial resources, combined with the decline in the need for concessional financing requirements over time and the transition to a fully functioning commercial RE market is one of the key objectives of the World Bank-GEF Strategic Partnership for Renewable Energy and is applicable to this project.

In terms of investments, the GEF supported activities fall into two groups: renewable energy power generation for the main grid and for independent grids, and standalone solar pv systems. In the first phase of the APL, a large part of the GEF support will be for sugar mill power cogeneration; it is expected that the GEF share of the total costs will be of the order of 20%. For solar pv, and power generation for isolated grids, the GEF share is expected to be of the order of 20-25%. These leverage levels are believed to be at the margin of what can be effectively achieved given current RE market barriers in Uganda, and the level of financial leverage is expected to increase over the three tranches. Actual leveraging will depend upon decisions of private sector investors who have not yet finalized their business plans, at this stage it is possible to give only indicative assessments of the leveraging and project costs.

Within the total project costs, it is expected that costs for the renewable energy investments and corresponding GEF support will be about $ 135 million (GEF $ 23.5 million) overall, broken down as:

Tranche 1: $ 40 million (GEF $ 8.5 million) Tranche 2: $ 45 million (GEF $ 8 million) Tranche 3: $ 50 million (GEF $ 7 million)

It is expected that the GEF supported investments will lead to additional renewable energy investments, which will not be supported by GEF grants (multiplier effects). GEF investments will generally be in support of power generation capacity only. Costs for ancillary investments in transmission and distribution (which are potentially significant) and could be considered as leverage on investments, are not included in the above leverage indications as they would be required regardless of whether the power was from conventional or renewable sources.

31 E: Issues Requiring Special Attention 1. Economic [x] Summarize issues below (e.g., fiscal impact, pricing distortions) [ ] To be defined (indicate how issues will be identified) [ ] None One economic issue is the extent to which the project will have a significant and sustainable development impact in terms of rural transformation. The two-fold approach adopted by this project to increase the impact is to: (i) promote rural electrification and rural energy development on a commercially-oriented basis, and (ii) stretch the project’s boundaries beyond, while remaining firmly rooted within, the energy sector, initially in the form of pilots. Since both of these prongs involve some elements of innovation in Uganda, there is, correspondingly, some risk and uncertainty about the outcome. This issue is discussed further in section F Sustainability and Risks. A second issue is the role of renewable small power generation in the capacity expansion plan for the main grid. It is clear that in the short-term there is a shortage of generation capacity, and any power made available from sugar mill biomass cogeneration would mitigate this problem. However, in the medium run, it is expected that there will be a sharp upward spike in the generation capacity when a 200 MW hydro power plant at Bujugali Falls come online (see section B2a), and there are indication that there may be a temporary capacity excess at that time. If, at present, the potential private sector renewable energy power developers do not have assurance that there will be some takers for their power at that time, then they may find the project too risky, and may choose not to undertake the project in the first place. The failure to undertake the project would have adverse economic and environmental effects. The sugar mill biomass cogeneration projects are expected increase the domestic supply of sugar, which is still imported to some extent in Uganda, and provide significant benefits for the small-lot cane outgrowers who would provide the additional cane to the sugar mills. On the environmental side, the sugar mills are already burning excess bagasse in open fields, and this would be exacerbated if the mills’ cane crushing capacity increases unless the excess bagasse is used to generate power. Given the short-term need for additional power, as well as the adverse effects of not undertaking sugar mill cogeneration projects, it is expected that the capacity expansion plan and the institutional framework for sale of power from the sugar mills would include provisions to mitigate the concerns of the potential developers. Economic evaluation methodology: [x] Cost benefit [ ] Cost effectiveness [x] Other [specify] Incremental Cost

2. Financial [x] Summarize issues below (e.g., cost recovery, tariff policies, financial controls and accountability) [ ] To be defined (indicate how issues will be identified) [ ] None The long-term viability of the commercially-oriented approach towards rural electrification requires the availability of commercial financing, i.e., a functioning capital market that provides financing, debt in particular, on standard terms and conditions. At present, in Uganda, financial intermediation for rural electrification faces a major obstacle. While there are a number of financially viable commercial banks and financial institutions that could be intermediaries for World Bank funds, they are mainly focused on the urban sector, do not do much term lending, and are not focused on medium-size loans (thousands or at most hundreds of thousands of dollars). Since the intent would be to finance the producers of energy services, and

32 not the end-users, micro-finance institutions (which typically offer credits of hundreds of dollars for working capital for relatively short periods of time) are unlikely to offer a suitable channel for financial intermediation.

This issue lie outside the energy sector, and can only be addressed in the medium/long run by programs designed to broaden and strengthen the financial sector. However, for the near future, the implication is that private sector led rural electrification may have a slower start than warranted by other considerations. To avoid unnecessary delays, one of the options would be to set up an earmarked facility through one of the local banks, who would have to be brought into the project early on, and adequately trained and compensated.

A second financial issue is the extent to which cost-recovery based tariffs will be successfully implemented. While the Government has agreed to permit such tariffs and local communities have said that they are willing to pay, it still remains to be seen what the reactions will be when the tariffs have to be actually paid. One source of concern is that rural borrowers have shown a lack of discipline in the repayment of loans. Default rates are frequently high, with a 15% default rate considered a success. This would be directly of concern to suppliers of individual based solar pv systems who wish to make credit sales; it would also be of concern to grid-based private providers who would be worried about their ability to collect monthly payments from their consumers.

3. Technical [x] Summarize issues below (e.g., appropriate technology, costing) [ ] To be defined (indicate how issues will be identified) [ ] None The main technical issue is the introduction and mainstreaming of low-cost designs and procedures. Given that there is a large pool of tested innovations available from the experience of other countries, and the private sector’s interest in cutting costs, this is not expected to encounter any difficulties.

33 4. Institutional [x] Summarize issues below (e.g., project management, M&E capacity, administrative regulations) [ ] To be defined (indicate how issues will be identified) [ ] None The main issue relate to the establishment and efficient functioning of “light-handed” regulation and the RE Fund; since both of these are innovative institutions for Uganda, there is some risk and uncertainty as to how they will actually function. While all efforts will be made to minimize this risk by introducing tested designs, providing technical assistance, and building the capacities of the responsible functionaries, at this stage it is not possible to rule out the concern that one or both of these institutions will not function effectively, either because of mismanagement, parochial interests or some other factors. Since these institutions are key elements of the framework for commercially oriented rural electrification in Uganda, ineffective functioning of these institutions will have a significant adverse impact on the project’s ability to meet its targets. 5. Social [x] Summarize issues below (e.g., significant social risks, ability to target low income and other vulnerable groups) [ ] To be defined (indicate how issues will be identified) [ ] None The main social issue is the acceptance by communities of the concepts of commercially oriented rural electrification. In particular, in the past, the expectation was that the Government and UEB were responsible for service provision, and that the tariffs charged in the rural areas would be no higher than in the urban areas. While these expectations are now changing, particularly with decentralization, there may still be some resentment in the rural areas at having to pay higher tariffs. Further, there may be some resentment among the poorer sections of the rural population, who would not be able to afford the high tariffs.

These concerns would be mitigated by a program of promotion and social intermediation (see section C4). Further, the provision of services to rural health and educational facilities would provide some indirect benefits for those who are not able to get direct benefits.

6. Environmental a. Environmental issues: [x] Summarize issues below (distinguish between major issues and less important ones) [ ] To be defined (indicate how issues will be identified) [ ] None There are no major negative environmental issues. However, the project can be expected to contribute to environmental improvement in several ways:

 Use of renewable energy (sugar mill cogeneration, small & mini-hydro, coffee-husk gasification, solar PV, possibly geothermal and wind) will displace generation which otherwise would have been fossil-fuel based. This would result in local and global environmental benefits from reduction of atmospheric emissions of SOx, NOx, particulates, and carbon.

34  Widespread use of solar home systems should markedly reduce indoor use of kerosene and other lighting fuels, improving the indoor environment.

 Increased efficiency in use of traditional fuels should lead to a reduction in biomass pageharvesting, which is currently at unsustainable levels at least in some regions.

However, there some concerns:

 Construction and operation of generation plants (small hydro, bagasse cogeneration, biomass gasification, diesel) as well as electricity distribution systems (poles and wires) will have some potential for adverse environmental impacts.

 Management, recycling, disposal, and of batteries for PV systems requires attention, particularly when the industry growth accelerate over time. Regional recycling, education, and buy-back plans are the options that will be investigated to mitigate this concern. b. Environmental category: [ ] A [x] B [ ] C c. Justification/Rationale for category rating: There are no major negative environmental issues anticipated for the project, however, some in- vestments have some potential for adverse environmental impacts. Therefore, the project is given a “B” rating. d. Status of Category A assessment: EA start-up date: Date of first EA draft: Current status: e. Proposed Actions:

These investments will be subject to Uganda’s existing National Environment Statute (1995) as implemented by the National Environment Management Authority (NEMA). It is proposed that project investments follow the existing Environmental Impact Assessment (EIA) process, which includes partici- pation of the appropriate Lead Agency – in this case the Ministry of Energy and Mineral Development (MEMD). The need for capacity building for MEMD to improve its ability to support this process will be considered during project preparation. In addition, an Environmental Analysis will be started in March 2000, will be conducted in compliance with Ugandan and WBG requirements and will be submitted through the borrower to the Bank's approval before appraisal. f. Status of any other environmental studies: None g. Local groups and NGOs consulted (list names): h. Resettlement [x] Summarize issues below (e.g., resettlement planning, compensation) [ ] To be defined (indicate how issues will be identified) [ ] None

35 No major resettlement issues are anticipated for this program. However, there could be small land takings, of a temporary or permanent nature in some of the investments. Brief descriptions of cur- rent site use and construction access for any investment that will entail land takings will be provided for further review. i. Borrower permission to release EA: [ ] Yes [ ] No [x] N/A j. Other remarks:

7. Participatory Approach: a. Primary beneficiaries and other affected groups: [x] Name and describe groups (how involved, and what they have influenced or may influence.)

The primary beneficiaries are rural households, SMEs, health and education facilities, energy service providers, and renewable energy small scale power generators. During field trips, the Bank missions have met with and discussed the main elements of the proposed project with them in public meetings, and taken account of their interests and concerns in preparing the project concept; a participation specialist consultant was involved in many of these meetings. Further, the findings and concerns expressed in the Uganda Participatory Poverty Assessment have also been taken into account.

Apart from direct meetings at the individual level, there have also been discussions with representatives of the beneficiaries (see below). Given the importance of community acceptance of commercially-oriented rural electrification (see section E5), extended participation is essential, and will continue throughout project preparation as well as implementation.

[ ] Not applicable (describe why participatory approach not applicable with these groups) b. Other key stakeholders: [x] Name and describe groups (how involved, and what they have influenced.)

Apart from the Ministry of Minerals and Energy Development, this project will work closely with a number of other agencies: the Ministries of Local Government and Health, the Uganda Local Authorities Association, Uganda Renewable Energy Association, and ActionAid, an NGO. All of them have contributed to project design, and will continue to do in project preparation. Further, they will also be in involved in the promotion of the project, once implementation begins.

[ ] Not applicable (describe why participatory approach not applicable with these groups)

36 8. Checklist of Bank Policies a. Safeguard Policies (check applicable items):

Policy Risk of Non-Compliance (H, M, L) x Environmental Assessment (OD 4.01) Low Natural Habitats (OP/BP/GP 4.04) Forestry (OP 4.36) Pest Management (OP 4.09) Cultural Property (OPN 11.03) Indigenous Peoples (OD 4.20) x Involuntary Resettlement (OP 4.30) Low Safety of Dams (OP 4.37) Projects on International Waterways (OP 7.50) Projects in Disputed Areas (OP 7.60) b. Business Policies (check applicable items): Financing of recurrent costs (OMS 10.02) Cost sharing above country 3-yr average (OP/BP/GP 6.30) Retroactive financing above normal limit (OP/GP/BP 12.10) x Financial management (OP/BP 10.02) x Involvement of NGO’s (GP 14.70) Other (provide necessary details) c. Describe issue(s) involved, not already discussed above: None

F: Sustainability and Risks 1. Sustainability: The main concern about sustainability is whether the project is too large and too complex, given Uganda’s limited absorptive capacity (see section B3). Since none of the sub- components of this project is particularly complex and/or risky on its own, the “complexity” concern arises from the (i) number of sub-components, which represent different service delivery modes, included in the project, and (ii) stretching of the project’s boundaries to exploit cross- sectoral synergies. In other words, “complexity” and scale are linked together, and both arise directly from the project’s objective of a significant development impact in terms of rural transformation.

The project design incorporates several features to mitigate this sustainability risk. First, it is clear that the risk implications of the complexity are the greatest in Phase I of the APL, in which a number of innovative concepts and procedures will be introduced, and that the risks will be reduced over time as the familiarity increases. In recognition of this, within Phase I the cross- sectoral links, a significant source of the complexity, are present in the form of pilots only in order to keep the risks manageable, and further, the investment scale is the smallest of the three

37 phases. Correspondingly, in Phases II and III, as the familiarity with the various sub-components increases, and the concomitant risks reduce, the investment scale increases in an exponential manner. In short, complexity and investment scale have been counter-balanced in the three phases.

Second, the outcomes of the various investment sub-components are not inter-linked, so that the sub-components can proceed at their own pace, and there is no concern that delays and/or difficulties in any one investment sub-component would adversely affect any other sub- component. In particular, adverse outcome in the pilots would have no bearing on the pace and success of implementation in any other sub-component.

Third, while there are a number of entities – private sector, financial institutions, NGOs, local governments --involved in project implementation, all of them will play a “natural” role that is within the scope of their usual activities. This arrangement does not overstretch the capabilities of any particular entity, nor does it require any entity to take on functions that are outside its customary ambit.

Fourth, it is recognized that this project will require above-average human and financial resources to prepare and supervise, particularly in Phase I. Bilateral donors have already made available significant funds for this purpose in the form of support to the Africa Rural and Renewable Energy Initiative (AFRREI), and it is expected that this support will continue.

A second concern relates to the sustainability of the various sub-projects supported under this project. In particular, it is important that the individual sub-projects continue to provide adequate and reliable service over the years, meeting the demand as it grows over time, and that renewable energy development continue even after GEF grants are no longer available.

The basic approach to ensuring sustainability is to root service provision along commercial lines and introduce low cost technologies and processes, so that the incentive and ability to make profits makes it worthwhile for the service provider to continue in business. In addition, business development assistance would be provided not just in the initial stages of service provision, but also at critical growth junctures, so that increasing demand would not overwhelm the service providers.

A third concern is sustainability for renewable energy after the project, when GEF grants would not longer be available. The overall approach is that, over time, sustainability will come from barrier removal, cost reductions, rising incomes, and declining GEF grants. For renewable energy power generation, the key to sustainability will be barrier removal and declining costs, as familiarity with the technologies and institutional framework increases, and the GEF grant per unit is slated to decline over time. For solar pv systems, the decline in costs will come from: (i) economies of scale –which are often realized when a credible expectation of a large market has been created, (ii) formation of links to suppliers in Asia, where are prices of high-quality systems are much lower than in Africa, and (iii) rising incomes, which would increase the affordability of the systems. Further, the GEF grant per unit for solar pv systems is also slated to decline over time.

38 A fourth concern is the absorptive capacity of the emerging Uganda renewable energy market. The issue of absorptive capacity is considered separately for solar pv and renewable energy power generation. For solar pv, the absorptive capacity depends heavily upon (i) the price and nature of the pv systems to be sold to households, and (ii) the ability to put together financing packages (over and above the GEF incremental cost-based support) that make it possible for rural public institutions such as health facilities and schools to purchase these systems. It is recognized that exponential sales growth rates will be required for the Ugandan market to reach the ERT project targets; such rates are achievable when the initial base is small, with clear possibilities of significant price reductions. Though the Kenyan situation is not directly applicable to Uganda, the exponential sales growth achieved there, even in the absence of any form of subsidies and grants, indicates that the absorptive capacity is present in East Africa.

For renewable energy power generation for the main grid, the main issue is the absorptive capacity after large-scale hydropower capacity additions (Bujugali), at which time there may be a surplus of generating capacity for a period of time. While the Government of Uganda is firmly of the view that there will be no excess capacity (i.e.; that there will be sufficient absorptive capacity), they have already initiated discussions with neighboring countries for power sales to ensure a market for power produced in Uganda. This issue has to be seen in the context of the transition in Uganda from a “single-buyer” model, under which the market could be ascertained with a high degree of certainty, particularly as the single buyer was a Government agency, to a “multiple-buyer, multiple-seller” model, under which the normal market risks present for any commodity are also applicable to the power sector, including renewable energy power generation.

For renewable energy power generation for independent grids, there are few concerns about absorptive capacity, as the grids will be set up in areas of high demand near vibrant trading centers.

2. Critical Risks: (reflecting assumptions in the fourth column of Annex 1) Risk From Outputs to Objective 1. Electricity may not be priority for the target beneficiary group 2. Anticipated cost reductions may not take place.

From Components to Outputs 1. The regulatory system and RE Fund may not function effectively 2. Private sector participants and financial institutions may choose not to participate 3. Cost recovery based tariffs may prove difficult to implement Overall Risk Rating: S Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk)

39 G: Project Preparation and Processing 1. Has a project preparation plan been agreed with the borrower: (see Annex 2 to this form) [ ] Yes, date submitted: [ x] No, date expected: A draft plan is attached as Annex 2. This has been discussed with the borrower, but may require modification depending on the outcome of the PCD review meeting. The preparation plan will be finalized shortly after the PCD is approved. 2. Advice/consultation outside country department: [x] Within the Bank: EASEG, Africa Connection, EMTTI [x] Other development agencies: Danida, SIDA, Dutch, DFID, SIDA 3. Composition of Task Team see Annex 2 4. Quality Assurance Arrangements The Quality Assurance Team consists of Messrs. Karl Jechoutek (Advisor, EMTDR – to be confirmed), William Steel (Lead Specialist, micro finance and SMEs, AFTP1), Ernesto Terrado (Principal Renewable Energy Specialist, LCSFE), Louis Pouliquen (former-Bank Director of Infrastructure, consultant), and Peter Scherer (former Bank Division Chief for Telecommunications and Energy, consultant).

In addition to access to the Quality Assurance Team on an ongoing basis throughout project preparation for advice and vetting of key design issues, the team will seek a QAG Quality Enhancement Review early in the preparation process. 5. Management Decisions: Issue Action/Decision Responsibility

Total Preparation Budget: US$ 650,000 Bank Budget: (US$000)US$ 250,000 Trust Fund: US$ 400,000 Cost to Date: US$ 250,000

In view of the Government of Uganda’s current budgetary revenue shortfalls, and the corresponding lack of local funds, additional funds will be mobilized by the project team on behalf of the Government.

[ ] GO [ ] NO GO Further Review

(signature)

40 Team Leader: Arun P. Sanghvi

(signature) Sector Manager/Director: Mark D. Tomlinson

(signature) Country Manager/Director: James W. Adams

41 Annex 1: Project Design Summary

Uganda: Energy for Rural Transformation

Hierarchy of Key Performance Monitoring and Critical Assumptions Objectives Indicators Evaluation Sector-related CAS Goal: Sector Indicators: Sector / Country Reports: (from Goal to Bank Mission) Increase electricity To be developed in course PEAP, PRSP Economic growth and service coverage and of PEAP and PRSP rural transformation revitalize rural report finalization reduce poverty development, while according due priority to Renewable energy capacity building and the investments protect the environment environment by reducing greenhouse gas emissions GEF Operational Program: Promote renewable energy by removing barriers and reducing implementation costs

Program Purpose: End-of-program Indicators: Program Reports: (from Purpose to Goal) Make energy sector’s due Percentage of rural Availability of modern contribution to rural households with direct Supervision mission forms of energy facilitates transformation, in access to electricity reports rural development. association with other sectors. Percentage of Mid-term review reports communities /public institutions with access to GEF Purpose: Monitoring and Barrier removal is an electricity Remove barriers and evaluation report utilizing effective way of reduce implementation qualitative and promoting renewable Employment/economic costs of renewable energy participatory approaches energy gain in SME participation in the project Phase completion reports

GHG emission abated

In-country capacity to Program Phases promote and undertake Phase I: Development of renewable energy requisite framework and investments limited investment Phase II: Acceleration/building momentum for investment and advancing capacity building Phase III: Rapid scale-up and consolidation of institution build up. A1-- 1 Project Development Objective: Outcome / Impact Indicators: Project Reports: (from Objective to Purpose) Improve the quality of life Increase in the percentage Supervision mission A high priority in rural of rural households and of the rural population reports transformation is communities and enhance with access to improved productivity of the productivity and conventional power Mid-term review enterprises and benefits income of rural area and/or stand alone solar of modern lighting, enterprises PV systems Phase completion reports media, connectivity directly through Increase in the percentage electricity and indirectly of rural non-farm by linkages with other enterprises that benefit sectors. from increased electricity access or more efficient Barriers to renewable use of traditional fuels energy have been correctly identified and Increase in the percentage targeted of rural public institutions with access to electricity and/or more efficient use of traditional fuels

Price reduction in solar PV product market, product quality aspects and range of product availability GEF Objective: Development of stand- Increase in the power alone solar PV systems generated from renewable and power generation energy sources (excluding from renewable energy large scale resources hydroelectricity)

Increase in consumption levels (kWh) per connection

Synergistic development linkages with other rural sectors

A1-- 2 Output from each component: Output Indicators: Project Reports: (from Outputs to Objective) 1a. connections from Number of rural Supervision mission Electricity is a priority main-grid systems households, firms, and reports institutions connected Mid-term review 1b. Renewable energy MW installed; MWh Familiarity increases and power generation produced Phase completion reports costs are reduced

Number of rural 2. Connections from households, firms, and Electricity is a priority independent grid systems institutions connected

Number of systems 3. Solar pv systems installed; number of Familiarity increases and customers served costs are reduced

4. Pilots Evaluation of pilot performance and 5. Technical assistance formulation of strategy and capacity building and plan of mainstreaming

Completion of TA supported outputs such as key studies, rules and regulations, number of new private sector business proposal preparation supported, number of LC3 and LC5 engaged in relevant capacity building Project Components/Sub- Inputs: (Project cost for each Project Reports: (from Components to Outputs) components: component) Regulation and RE Fund Supervision mission are operational 1a. grid extension $125 reports Sufficient number of 1b. renewable power project sponsors generation $92 Disbursement reports participate 2. isolated grids $65 Local bank(s) interested 3. solar pv $65 Audit reports in participating systems $3 Acceptable tariff policies 4. pilots 5. $25 technical $375 assistance/ capacity building

A1-- 3 Annex 2

Uganda: Energy for Rural Transformation Program Project Preparation Plan February 2000

Background

The Government of Uganda has proposed an Energy for Rural Transformation Program for World Bank assistance. As part of this identification task, the Government in discussion with the Bank, has prepared this Project Preparation Plan. The proposed Energy for Rural Transformation program would have the following objectives:

 Improve the rural quality of life and facilitate significant rural non-farm income by accelerating rural electrification, including from solar PV systems, with a tentative target of increasing rural electricity access from about 1% at present to about 10% by 2010;

 Promote development and use of Uganda’s indigenous, renewable energy resources on a cost-effective basis, with a tentative target of about 70 MW of power generation from small renewable energy resources by 2010, and development of a traditional fuels program to improve efficiency in production and use of commercial woody biomass.

Phase I of the Energy for Rural Transformation Program would have the following investment components:

 Component 1: Main grid related power distribution and generation. The power distribution would be to presently unserved rural areas that would be connected to the main grid, with the power supply to come from the large-scale hydropower plants. It is expected that the private sector distribution concession areas, arising from sector reforms, would be narrowly defined in terms of the physical distance from the existing grid. Thus, the extension of the main grid to rural areas and the consumers would be supported under this component. In keeping with the objective of renewable energy development, there would be additional power generation from small, renewable energy resources, such as sugar mills, that are close, or already connected, to the main grid. It is proposed that the sale of this power would be to third-party customers via wheeling through the main grid, i.e., there would be no power purchase agreement between the generator and the main grid, which would merely serve, for a fee, as the “highway” over which power is transported from the generator to a third-party customer. However, discussions about this sale modality are still ongoing between the Bank/IFC, the Government and some of the private sector developers, which may lead to some changes.

 Component 2: Independent grid systems for relatively concentrated isolated areas with a potential for the use of electricity by rural enterprises. This component would support relatively larger systems that may require some transmission (such as in the West Nile

A2-1 region) and smaller systems, such as those located in rural trading centers that require only generation and distribution facilities. It is expected that a significant part of the power generation would be from renewable energy resources.

 Component 3: Individual/institutional solar PV systems, for relatively dispersed areas where even small independent grid systems are not viable.

 Component 4: Pilots for scale up in later tranches. In the first phase, this would include: (i) energy efficiency in use of traditional woodfuels by rural SMEs and public institutions for which a pilot would be prepared in conjunction with ongoing research sponsored by the U.K. Department for International Development (DFID), (ii) provision of telecommunications and connectivity, for which one pilot may be implemented outside this project, and one within the first tranche of this project, and (iii) low-cost household water disinfecting, which requires adequate supplies of electricity, based on a winning proposal in the Development Marketplace 2000 and/or other similar technologies.

In addition, Phase I would include technical assistance and capacity building, including:

 Assistance in start-up of the Rural Electrification Fund and implementation of decentralized, light-handed regulation for smaller scale systems  Establishment of local capability for promotion, identification, development, and implementation of rural energy investments

Program Preparation Team/ Government support

Preparation of this programme will require significant efforts on the part of government. Dedicated staff and resources will be needed to ensure that preparation activities remain in line with the evolving project concept. Therefore, the government has put in place a Rural Electrification Technical Committee whose main responsibility is to ensure that programme preparation is well executed and timely. Within the RE Technical Committee, there has been created a core team with individuals drawn from the main sectors/stakeholders, whose primary responsibilities are to coordinate the activities of their sectors and carry out project preparation. This core team will be drawn from the following institutions: MEMD, MOLG, ULAA, UEB and Private Sector Foundation. Each institution will be represented by one member. The core team will regularly report on progress achieved to the RE Technical Committee, which will provide the necessary guidance for further progress. The officer representing MEMD will also have the responsibility of coordinating the core team. He will report directly to the Chairman/Leader of the RE Technical Committee, who will ensure that programme preparation is proceeding according to plan.

The members of the core team shall devote approximately 20 weeks of effort during the calendar year 2000 to the programme. In addition, MEMD will develop a budget to present to MFPED to support Government’s project preparation activities. Members of the RE Technical Committee and Bank teams are given in Appendix 1, Table A along with their responsibilities.

Program Preparation Activities

A2-2 The Energy for Rural Transformation program is innovative in nature. Also, both the Government and the Bank attach a high priority to rapid implementation of the program. For these reasons, program preparation activities are extensive, and the planning timetable is aggressive. Key outputs for preparation are given in Appendix 1, Table B. Some of these activities already are under way. Terms of Reference for these activities, as well as Draft Terms of Reference for consultant support needed for many of the other activities also have been prepared.

Program Preparation Schedule

While Table B in Appendix 1 focuses mainly on the government’s project preparation, the Bank’s processing steps, and the proposed schedule for this program, are given in Appendix 2.

It should be noted that Table B shows a range of target dates for several key outputs, primarily the business plans of the subprojects. These outputs are critical for project appraisal, and will require a considerable amount of effort, coordination among stakeholders (e.g. business developers, equipment suppliers, customers, local government, UEB and its successors, financial institutions, Rural Electrification Fund, and the proposed power sector regulator) and innovation in an area completely new to rural Uganda. In addition, this preparation schedule coincides with sweeping changes in the power sector – UEB unbundling, creation of the commercial distribution concessions, establishment of the regulator and RE Fund, etc. These add an element of uncertainty in many areas important to the commercial electricity business development central to the program. For these reasons there is a high possibility of schedule slippage unless all stakeholders proceed according to plan, without delay, in good faith, and in coordination with one another. Also, delays would be likely from any deterioration in the business environment. In addition, business plan development is entirely dependent on the response of the private sector. Delays in business plan preparation will inevitably result in slippage in appraisal and further processing steps, as shown in the ranges given in Table B as well as Appendix 2. The RE Technical Committee and its core team will play a key role in maintaining the momentum of program preparation, and in holding the preparation schedule to a minimum.

A2-3 Appendix 1: Project Preparation Plan Uganda: Energy for Rural Transformation A. Project Preparation Team Name Bank Unit Borrower Agency Role/Responsibility RE Technical Committee Godfrey Turyahikayo Ministry of Energy and Mineral Development Chairman and Leading Rural Electrification Technical Group & coordinating energy policy James Baanabe * Ministry of Energy and Mineral Development Coordinating the core team Paul Mubiru Ministry of Energy and Mineral Development Stand in for Chairman Kahuka Kusemerera Ministry of Local Government Coordinator of local governments Baker Akantambira * Ministry of Local Government Coordinator of local governments John Behangaana * Local Authorities Association of Uganda Liaison with local authorities, raising awareness, lobbying, & building capacity Ministry of Finance Arranging financing Godfrey Kagolobya Uganda Electricity Board Technical and institutional advice Anthony Ngororano* Private Sector Foundation Developing local business Charles Busunge NGO – ACTIONAID, Kampala Local participation specialist Arun Sanghvi AFTG1 Team Leader Mac Cosgrove-Davies AFTG1 Project coordinator, renewable energy, isolated mini-grids Subodh Mathur Consultant Economist, project concept and design Robert Chronowski Consultant Renewable Energy Specialist James Finucane Consultant Business Development and Financing Specialist Robert Schware EMTTI Telecom and connectivity specialist Philip Gowers AFTH1 Health sector specialist Claude Salem AFTI2 Capacity building specialist Supporting Team Members Sten Bergman AFTG1 Low cost network design, liaison with bilateral donors Trine Refsbaek AFTG1 Energy in health and education, productive use of biomass in rural SME Joseph Kizito AFMUG Financial Management Specialist Roguti Kayani AFTQK Procurement Specialist Hanne Nielsen Consultant Participation Specialist Wolfgang Mostert Consultant Rural Electrification Policy/Regulatory Analyst Mike Bess Consultant Rural Electrification Specialist Mr. Bagonza Urban Authorities Association of Uganda Liaison with urban authorities Sarah Nalumansi Uganda Manufacturers Association Organizer and promoter of Ugandan manufacturers Josh Mabonga Uganda Renewable Energy Association Promoter of renewable energy businesses and NGOs Uganda Banker’s Association Coordinator of local banks Coordinator of local micro-finance institutions * Core team member

2-1 B. Project Preparation Activities Key Outputs Prepared by Responsibi Consultant Appraisal Requirement Target lity Financing Date Source (cost) Rural Electrification Policy and Strategy MEMD with MEMD PPIAF Cabinet approval of policy 4/30/00 consultant assistance ($40,000) acceptable to Bank Designs for Low-Cost Distribution Consultant Bank UK/AFRREI Designs and costing suitable for 4/30/00 Grid Systems ($25,000) main-grid and mini-grid systems acceptable to MEMD and Bank 5 Electrification Business Plans Entrepreneurs/ Entrepreneurs/ Not identified Final Report/MOU with 9/31/00- (West Nile, Kagadi, Kisizi, Investors with Investors ($200,000) donors/Serious discussion with 11/30/00 Lwamaggwa and Mbale) at $40,000 consultant assistance local bank each Sugar Mill Cogeneration Expansion Entrepreneurs/ Entrepreneurs/ Not identified Final Report/MOU with donors 9/31/00- Business Plan(s) Investors with Investors ($50,000) /Serious discussion with local bank 11/30/00 consultant assistance Solar PV Business Plans – Three (3) Entrepreneurs/ Entrepreneurs/ Not identified Final Report/ Serious discussion 9/31/00- businesses Investors with Investors ($50,000) with local bank 11/30/00 consultant assistance Commercial woody biomass energy Project developers MEMD, Feasibility Final Report/ Serious discussion 8/31/00 supply feasibility studies, business with consultants and MOLG, studies and with developers, investors, micro- plans MEMD, MOLG and ULAA, rural local finance institutions, local ULAA assistance Project authorities authorities (e.g., LC5, LC3) and developers framework – donors DFID KAR Project, AFRREI Project Implementation Plan (PIP) MEMD/MOLG MEMD/ - Complete report 6/30/00- MOLG 11/30/00

2-2 Environmental Review MEMD/ Not identified 6/30/00 NEMA/Bank ($10,000) Social Assessment MOLG/Bank - 6/30/00 Institutional Assessment MOF/Bank - 6/30/00 Economic/financial impacts MOF/Bank - 6/30/00 Financial Management Review MOF/Bank - 6/30/00 Monitoring and evaluation Plan Consultative - 6/30/00 Working Group/Bank Principles for Light-Handed, MEMD/MOLG/MOJ MEMD Norad Draft principles acceptable to local 9/30/00 Decentralized Regulation /Norad with inputs ($50,000) authorities, potential investors, and from W. Mostert Bank (and members of Regulatory Authority if identified by target date) Capacity building plan at local level for MEMD with MEMD Not identified Initial activities undertaken in 9/30/99 decentralized regulation to be consultant assistance ($40,000) some districts, plan for full implemented in phase 1 and inputs from implementation complete Wolfgang Mostert Pricing and contracting framework MEMD/UEB/ MEMD/Bank Netherlands? Initial draft framework 5/15/00 for SPP’s consultant ($50,000) 2nd draft framework 7/31/00 Rural Electrification Fund Operating RE Technical RE Technical not identified Guidelines, procedures and criteria 5/15/00 Guidelines, procedures, and financial Committee with Committee ($75,000) adopted, acceptable to Bank support criteria consultant assistance Fund and inputs from Wolfgang Mostert

2-3 Appendix 2: World Bank Processing Steps and Schedule

Uganda: Energy for Rural Transformation

Key Dates Phase Timetable step Plan Actual LENP Concept Review Meeting 3/3/00 LENP RVP/ROC/OC Sign off 11/1/00 LENP PID to PIC date 12/1/00 LENP Depart Preappraisal 5/1/00 LENP Decision Meeting 10/1/00 LENA Authorize Appraisal/Negotiation 11/1/00 LENA Update PID to PIC 11/1/00 LENA EA received date 12/1/00 LENA Depart Appraisal 1/1/01 LENN Invitation to Negotiate 3/1/01 LENN Start Negotiations 3/15/01 LENN Board Presentation 5/1/01 Completion Note

World Bank User M:\RAMON\WP3-2000\WB\Urganda Energy final.doc 04/07/00 5:06 PM

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