Medium-Sized Project Brief

MEDIUM-SIZED PROJECT BRIEF PROJECT SUMMARY

PROJECT IDENTIFIERS 1. Project name: Mini-hydropower 2. GEF Implementing Agency: The Project World Bank 3. Country or countries in which the 4. Country eligibility: FYR Macedonia project is being implemented: Former signed the UNFCCC on January 28, 1998. Yugoslav Republic of Macedonia (FYR Macedonia) 5. GEF focal area: Climate change 6. Operational program/Short-term measure: Short-term Response Measure 7. Project linkage to national priorities, action plans, and programs: The proposed Project is linked to:

 the National Environmental Action Plan (NEAP). Completed in 1997 with Bank support, the NEAP identifies air pollution as the major environmental problem in the country and industries, power and heat generation plants, and the transport sector as its primary causes. In particular, heat and power generation are the main sources of greenhouse gas emissions (GHG), especially carbon dioxide. One of the recommendations of the NEAP for reducing air pollution is to “encourage the use of renewable energy resources including geothermal, solar and hydropower”. However, as the geothermal resource has yet to be assessed and the solar and wind potential is modest, Government has given priority to developing the country's relatively abundant hydropower potential.

 the long term investment plan for the country - Macedonia Investment Projects, October 96. The plan calls for the construction of both large and small hydropower plants to meet as much as possible of the projected growth in demand for electricity. the Power System Improvement Project (PSIP), financed by World Bank and the Government. PSIP supports the rehabilitation of the six largest hydropower plants in the country and creation of an enabling environment to facilitate the development of small hydropower plants by independent power producers. The proposed Project is fully consistent with the PSIP in that it support the development of mini-hydro sites by entities other than ESM, the national utility. Both projects also are aimed at developing hydropower, especially small hydropower plants, and reducing GHG emissions. 8 GEF national operational focal point and date of country endorsement: Mr. Mikhail Dimovski, Undersecretary, Ministry of Urban Planning and Environment Date of endorsement: November 3, 1998. The proposed Project was endorsed again by Mr. Tony Popovski , the Minister of Environment, March 19, 1999. 2

PROJECT OBJECTIVES AND ACTIVITIES 9. Project rationale and objectives: Indicators: (i) Reduce Macedonia’s emissions of (i) reduction in carbon dioxide emissions greenhouse gases (primarily carbon relative to the without project scenario. dioxide) by substituting hydropower for power generated by lignite-fired plants. (ii(a)) power purchase agreement signed.

(ii) Encourage the development of (ii)b)) additional proposals and/or independent power plants especially mini- expression of interests received for hydropower plants. developing new mini-hydro power plants. 10. Project outcomes: Indicators: (i) Installed hydro capacity and generation (i) installed hydro capacity increased by 1.2 increased MW

(ii) total hydro generation increased by about 8.8 GWh per year. 11. Project activities to achieve outcomes Indicators: (i) Project Implementation Unit ($160,000). (i) Staff and consultants appointed.

(ii) Debar mini-hydro power plant (ii) Plant constructed and unit ($440,000). commissioned.

(iii) Kavadarci mini-hydro power plant (iii) Plant constructed and all 5 units ($2,492,000). commissioned. 12. Estimated budget (in US$):

GEF: 750,000 Co-financing: Slovene Export Credits 1,177,000 Stopanska Bank 558,000 Equity ( utilities) 680,000 Bilateral Grant 100,000 Government/ESM 26,000 TOTAL (including IDC): 3,291,000 INFORMATION ON INSTITUTION SUBMITTING PROJECT BRIEF 13. Information on project proposer: Ministries of Economy and Environment of the FYR of Macedonia. 14. Information on proposed executing agency (if different from above): Ministry of Economy with PIU operated largely by personnel from national electric company (ESM) and foreign consultants. 15. Date of initial submission of project concept: 12/16/98 INFORMATION TO BE COMPLETED BY IMPLEMENTING AGENCY: 16. Project identification number: MK-GM-65996 (formerly MK-GE-44283) 17. Implementing Agency contact persons: Karin Shephardson, Regional Coordinator GEF Operations, Europe and Central Asia Region. Email: [email protected]; Tel: (202) 473-8954 3

James Moose, Principal Energy Economist, Europe and Central Asia Region. Email: [email protected]; Tel: (202) 473-3563. 18. Project linkage to Implementing Agency program(s): The proposed Project is an integral part of the World Bank Group's Country Assistance Strategy (CAS) for FYR Macedonia and supports two of its three key goals - those of encouraging private sector growth and increasing the efficiency of the state. Specifically, it supports the former by promoting the development of independent power plants (IPPs), which are a source of growth and employment, though a minor one. The IPPs, in turn, would provide benchmark competition to and serve as a vehicle for improving the efficiency of ESM, the state owned electric company. Largely because of these linkages, the proposed Project is specifically mentioned in the CAS.

As noted above, the proposed Project is also linked to the PSIP whose major goals are to increase the country’s hydropower capacity and generation as well as encourage the development of IPPs. Experience with this operation would provide the inputs needed to assess the likely future involvement of IPPs in the development of the country's relatively abundant large and small hydro potential and, ultimately, their implications for the structure of the sector. 4

FYR MACEDONIA - MINI-HYDROPOWER PROJECT

I. PROJECT DESCRIPTION

Background

1. FYR Macedonia emerged in 1991 as an independent nation following the break-up of the Yugoslav Federation. The country is landlocked with two primary ethnic groups, Macedonians (Slavs) and Albanians. Located on the Balkan Peninsula, it is a mountainous country of about 26,000 square kilometers and a population of about 2 million.

2. The country’s indigenous energy resources, consisting of lignite and hydropower, meet about 58% of its energy needs. The rest is imported, mainly in the form of crude oil, petroleum products and coke or coking coal. The bulk of lignite reserves are located in one large low-cost deposit at the Suvudol Mine. It is used primarily to generate electricity at the Bitola Power Plant, which supplies the majority of the electricity for the country. Typically, about 75-80% of the electricity is generated from lignite fired plants (mainly the Bitola Power Plant), 20% from hydropower plants and the remainder is imported.

3. Hydropower is the country's principal renewable energy resource, followed by geothermal, wind, solar and biomass. The geothermal resource has yet to be assessed and the potential for developing wind and solar is modest. As for biomass, the bulk of it is already being used, with limited prospects for increasing supplies.

4. FYR Macedonia's considerable hydropower potential is located at sites suitable for both large and small-scale plants. The Government’s plan calls for developing the larger hydropower potential to meet slowly rising electricity demand, but its implementation is likely to remain constrained by the availability of funds over the foreseeable future. The smaller hydropower potential is located at about 400 sites, spread throughout the country. The analysis carried out by the Government for the NEAP shows that these sites have the potential to produce around 1.1 TWh of electricity per year or about 20% of the country’s current requirements. However, so far only about 75 GWh per year or about 7% of the total potential has been developed, largely because of lack of experience with small hydropower plants, their high costs and, until recently, the relative low price of electricity. The proposed Project is, in part, designed to remedy this situation by encouraging the development of independent small-scale hydropower plants.

Objectives

5. The development objective of the proposed Project is to meet the country’s demand for electricity, while reducing air pollution. In support of this 5

objective, the proposed Project provides for initiating the development of the country’s relatively abundant mini-hydro power potential as a substitute for lignite, in electricity generation and accelerating the process of sector reform by establishing independent power producers (IPPs).

6. The global (GEF) objective of the proposed Project is to reduce FYR Macedonia’s emissions of carbon dioxide by substituting electricity generated by mini-hydropower plants for electricity generated from lignite-fired power plants. In the GEF context, this is a short term response measure and fully meets the eligibility criteria established by the GEF. First, the proposed Project would reduce carbon emissions for less than $10/ton of carbon. Second, the operation is low risk in that the technology, though not widely used in FYR Macedonia, is well known. Finally, expanding the use of hydropower, including mini-hydropower, is a part of FYR Macedonia’s longer term strategy for increasing electricity production and reducing pollution, including emissions of carbon dioxide. The strategy is an integral part of the NEAP and is made more concrete in the context of the country’s investment program, which lists a number of hydropower projects as top priorities for investment, including 15 small hydropower projects.

7. In addition to reducing carbon dioxide emissions, the proposed Project will promote the development of small hydropower plants by independent power producers (IPPs), the first such initiative in the country. Under the new Energy Law, ESM, the state owned electric company, is required to purchase electricity produced by IPPs. Also, a new power purchase system, aimed at providing incentives to IPPs, has been adopted, as agreed under the PSIP. It requires ESM to buy power from IPPs at only a 10%-15% discount (depending on voltage) to ESM’s household tariff, the highest tariff paid by any consumer category. The proposed Project will serve as a basis for demonstrating the adequacy of the incentive package, including the power purchase arrangements (price and off-take terms) with ESM, in attracting IPPs. As such it could serve as the basis for replicating similar projects in the future.

Description

8. The proposed Project involves installation of mini-hydropower plants on the municipal water supply pipes of the towns of Kavadarci and Debar. These were selected from among 400 potential small scale hydro sites in the country through a screening process carried out by Austrian consultants. First, all small hydro sites that in any way impeded the flow of water into neighboring countries were eliminated because FYR Macedonia does not have water sharing agreements with other riparians. This criteria eliminated most of the potential sites. Second, all sites sponsored by ESM, the national utility, also were eliminated as these could not be developed by IPPs. Finally, of the remaining sites only those for which the project design and preparation was fairly advanced and the costs and benefits could be determined were retained. After this screening only four possible sites were left. During preparation two 6

of these were recommended for inclusion in the proposed Project, both with good quality data on water flows.

9. By focusing on sites whose water flows are known, the proposed Project avoids the problems faced by the UNDP project - Optimizing the Development of Small Hydel Resources in Hilly Areas. Start-up of that project was substantially hindered owing to the poor quality of data on water flows.

10. Details relating to the three components of the proposed Project are presented below.

 Kavadarci, located in South Central Macedonia, has a relatively stable population of about 35,000, including a small ethnic minority. Economic activities are fairly diversified with the largest employers being a metals complex (ferro-nickel) and a winery and its accompanying vineyards. This component involves installing five hydropower plants on the existing water supply pipe for the town. The pipe starts on a mountain above the town and runs 19 km downhill, with a total head of about 600 m, to supply around 360 liters/second to Kavadarci, the immediate area around the town and the adjoining town of Negotino. The five small hydropower plants would be installed close to existing water chambers on the pipe. There is an asphalt road paralleling the pipe so that the necessary access to the site is simple. Also, there is a new 10-kV distribution line nearby so that the connection to the gird is also easy. The mini-hydropower plants will have a combined capacity of 1.04 MW and are expected to generate about 7.6 GWh per year.

JP Komunalec, an administratively autonomous company, owned by the town of Kavadarci will be responsible for implementing this component. JP Komunalec has 192 employees and is funded from user fees, with no subsidy. Fees are set such that it makes a small profit. The proposed GEF grant along with export credit financing and a bank loan will allow the company to fully fund the project without Government or city support. The cash flow from the sale of electricity would pay off the export credit and bank loan in about 7 years after production begins, based on conservative assumptions. (Details are presented in Annex 1).

 Debar is located in the far west of FYR Macedonia on the Albanian border. Including the surrounding area, it has a population of around 28,000 and the great majority of the population are of Albanian background. (Presently there also are a large number of refugees in Debar.) Unemployment is high and the main industry is light manufacturing. Water is supplied from the nearby mountains and the flow of water in to the water supply system is fairly constant at around 200-230 l/s. The portion of the supply pipe to be used as penstock for the mini-hydropower plant is 260 meters long, with a head of 76 meters. This component involves installing a 160 KW generating unit, producing about 1.2 GWh of electricity per year. The turbine and generating unit would be installed in a small building in a vacant lot close to the city reservoir. An asphalt road is adjacent to the lot and a 10KV line is close by. 7

JKP Standard, the city utility, will be responsible for implementing this component. The company is administratively and financially autonomous and employs 82 people. It is profitable, funded from fees, and does not receive any subsidy. The proposed GEF grant along with an export credit financing and a bank loan will fully fund the installation of the mini-hydropower plant without any subsidy from the town or central government. However, because of its lower state of development Debar may be eligible for a central government interest rate subsidy, though no subsidy is assumed in the analysis. All loans would be paid off in 6 years from starting production using conservative assumptions (Details are presented in Annex 1).

 Project Implementation Unit (PIU). The two city utilities which will undertake the installation and operation of the mini-hydropower plants are fairly experienced organizations and have used Macedonian Consultants for design and engineering work. However, neither the utilities nor the consultants are familiar with modern procurement methods, especially Bank procurement. It is proposed that a separate PIU, reporting to the Ministry of Economy (which oversees the electricity sector), be established to assist the city utilities in undertaking these projects. It would review the design and engineering work, but its primary function would be to assist the utilities with procurement. The PIU, in turn, would be assisted by the state electric utility, ESM, on the technical/operations side and by outside consultants on design and procurement. The services of the outside consultants would be financed in part by a bilateral grant from the Swiss Government.

Activities and Financial Inputs

11. The proposed Project, involving three main activities, would be implemented over a period of about three years period as follows:

 The first activity covers the creation of the PIU. The unit would be under the purview of the Ministry of Economy which is responsible for energy issues, with inputs from the Ministry of Environment. ESM would provide technical and administrative support. In order to assist the PIU with procurement, technical assistance would be provided by consultants funded by Switzerland. The cost of this PIU is estimated at about US$160,000. The proposed GEF grant would cover about US$34,000 of the total cost of consultancy services, Swiss bilateral grant about US$100,000 and the Macedonians about US$26,000. The PIU is expected to be fully operational within a few months of the GEF grant being made available.

 The second activity is construction of the single mini-hydropower plant in Debar. This would cost about US$440,000 with GEF contributing US$115,000, which is the incremental cost. GEF funding would be used primarily for civil works. The rest of the funding would be provided by an export credit for the equipment, a bank loan and Standard’s own funds. Construction of this mini-hydropower plant should be completed in about 2 years after project inauguration. 8

 The third component covers the five mini-hydropower plants in Kavadarci. The cost of this activity is about US$2.5 million. It is expected that GEF would contribute the incremental cost of about US$600,000 and that this would be used primarily to purchase equipment. The rest of the funding would come from an export credit, a bank loan and the company’s own contribution, which is likely to be mostly in kind. This component will take somewhat longer to complete since it is likely that the five units will be built in groups rather than all at once. In this case it may take up to about three years from project inauguration before all five units are operating.

12. In addition to these activities, the Bank would supervise the operation of the PIU, procurement under the GEF grant and the general implementation of the project by the contractors and the water companies of Kavadarci and Debar.

Sustainability and Risk

13. The proposed Project, once built, is totally sustainable. Hydropower plants have very long lives. For example, FYR Macedonia has hydropower plants which were built in the 1920s and 1930s and which are still operating. Thus, they have been operating 60 to 70 years, which is much longer than the operating lives of most thermal plants. Furthermore, there will be every incentive to operate these plants since they have very low operating costs due to the free fuel (water). The revenues generated by the plants will be much more than the cost of operating and maintaining them. Table below shows the most important risks both to the development objectives and the global objectives.

Major Risks Risk Risk Rating Risk Minimization Measure

Negative repercussions of war in Kosovo M Careful monitoring of all Bank activities (refugees, economic and political pressures) in the region. War is long over before project starts. Lack of cooperation between the Ethnic S The newly elected government has Communities initiated measures that are likely to increase cooperation between ethnic groups. Government Commitment to opening up the N The Government has shown commitment Sector to opening the sector and has agreed on conditionality under the PSIP which would assist this. Prices for Electricity significantly lower than N The Government strongly supports these anticipated after plants built mini-hydropower projects and has an Agreement ((PSIP)with the Bank which supports higher prices. Weak procurement capacity S The project will include a project implementation unit and consultants to sharply reduce this risk Overall Risk Rating M Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or low Risk) 9

Stakeholders and Social Assessment

14. The primary stakeholders are the Government of FYR Macedonia, the mayors, city councils, municipal utilities and, above all, the people of Debar and Kavadarci. The concept for the proposed Project came ultimately from the Government (Ministry of Economy) which is very concerned about developing the country's hydropower potential. They are particularly concerned about small hydropower sites which, despite their considerable potential, are unlikely to be of interest to ESM or other outside utilities. The Ministry of Environment has also been highly supportive since these mini-hydropower plants represent a means of reducing air pollution and greenhouse gas emissions. The details of the components were largely developed by the municipalities and the municipal utilities. The mayors and city councils of the municipalities were heavily involved in the decision to undertake the proposed Projects.

15. Secondary stakeholders include ESM, environmental NGOs and the Faculty of Engineering, University of Skopje, which has been acting as advisor to the cities on this project.

16. While social aspects of the proposed Project will be carefully monitored, no significant issues are known. The proposed Project will not lead to higher water or electricity tariffs for the local population. The city utilities own the water rights and because the flow of water is not effected by the units there are no riparian issues. The proposed Project will provide some local construction jobs and a very few jobs when the units are operational, which will benefit both ethnic groups. Because of the small size of the proposed Project and the lack of social issues, it was decided not to do a social assessment.

Implications of the War in Kosovo

17. The appropriate timing for launching the proposed Project was considered extensively in the light of the war in Kosovo, which has just ended. There are two reasons against further delaying the project processing. First, expediting the processing of the proposed Project would be consistent with the efforts of the international community including the Bank in assisting the recovery of FYR Macedonia. The Bank, for example, has an active program aimed at mobilizing additional financing for the country including, an emergency loan which has recently been appraised. Second, existing projects are moving ahead including the ongoing GEF Project on Lake Ohrid.

18. Transborder issues with Albania and Kosovo, in particular the transboundary refugee movements, and their implications on the project will be carefully monitored. At present, there are a number of Kosovar (ethnic Albanian) refugees in Debar, though apparently very few in Kavadarci. While the financial situation of the municipality of Debar could suffer in the short term, there should be no long-term impact on the proposed Project. If anything, higher demand for water should, in theory, lead to higher electricity output. 10

One can assume, however, that most of the refugees would have left Debar by the time the mini-hydropower plants are commissioned.

Lessons learned and reflected in proposed Project design

19. A key lesson learned from pilot phase projects in the Europe and Central Asia region is the need for fully integrating such projects in to local development initiatives. The proposed Project was designed and developed in collaboration with the Government and municipal stakeholders and builds on considerable work done by the Government in screening and identifying potential small hydropower sites. It also builds on the expressed demand of the two municipalities for developing their small hydropower potential as a source of additional income and employment generation.

20. The design of the proposed Project also takes into account the results of the "quality at entry" assessment conducted by the Bank's Quality Assurance Group. Of special relevance here are the results relating to the need to avoid unnecessary project complexity and to prepare an adequate economic analysis. Reflecting this concern the design has been kept simple and a detailed economic analysis has been undertaken. It clearly shows that, without the proposed GEF grant, the components are economically marginal.

21. Finally, the experience with the India mini-hydropower project also has been taken into account. First, the proposed Project focuses on demonstration, given that it yielded relatively high benefits in the case of India. Second, as noted above, by focusing on sites whose water flows are known, the proposed Project minimizes the risk of implementation delays such as those experienced in India.

II. INCREMENTAL COST ANALYSIS

Broad Development Goals and Baseline

22. Development Agenda: The broad development goals of FYR Macedonia, as outlined in the Government’s National Development Strategy, focus on the acceleration of recovery, the reduction in unemployment (the current unemployment rate is about 30% ) and the reversal of the rise in poverty (see the Bank’s Country Assistance Strategy for FYR Macedonia, report 18162- MK). Other goals include the promotion of private sector growth and enhancement of the efficiency of the state, both of which the proposed Project supports. The development goals for the power sector include the encouragement of independent power plants and the development of Macedonia’s hydropower resources, to the extent economically feasible, in order to increase supply security and improve local air quality.

23. Baseline: The baseline is defined as what would happen if the proposed mini- hydropower plants are not built. There are two aspects to this. First, the 11

electricity that would be produced annually by the mini-hydropower plants (about 8.8 GWh net of losses), is primarily, but not entirely, base load. The plants are base load plants having high capacity factors or utilization rates because they will run whenever water is used in the towns. The city utilities have every incentive to run the plants since the incremental cost of so doing is extremely low (no fuel costs) and the incremental revenues are quite attractive. Therefore, in the baseline case additional electricity would be supplied primarily by FYR Macedonia’s base load power plants, mainly the Bitola lignite fired plant which produces around 70% of the country’s electricity, but also the Oslomej lignite fired power plant which provides another 8-10% of the country’s electricity. This additional generation would not be a problem for Bitola except at peak when it is already at capacity.

24. This brings up the second aspect of the baseline. At peak periods the proposed mini-hydropower plants would provide additional generating capacity of 1.2 MW. If this capacity were not available Macedonia would have to import it or build additional generating units. In practice, since most of the surrounding countries have the same or a very similar peak, it is difficult to meet peak demand in the longer term from imports and additional construction of generation would be necessary. The cost of providing this additional capacity is usually measured by the long run marginal cost of generation and transmission (LRMC). This figure has not yet been estimated for Macedonia but a study of this issue is underway. However, approximate estimates are available and they range from about 4.5- 5.5 US cents/kWh, including investments to meet local air quality standards. Therefore, for this analysis the long run incremental cost of adding generating capacity in FYR Macedonia is estimated at about 5.0 US cents/kWh.

GEF Alternative

25. The alternative to the baseline case is the proposed Mini-hydropower Project. As mentioned above, it consists of the installation of 5 mini-hydropower plants on the water supply pipe for the town of Kavadarci and one unit on the water supply pipe for the town of Debar. Total capacity of these units is about 1.2 MW. The economic life is estimated at thirty years, which is conservative given that hydropower plants tend to be long-lived.

26. Emission Reduction: Base load electricity generation currently comes, and will continue to come, overwhelmingly from the Bitola Power Plant which emits about 1344 tons of carbon dioxide per GWh of electricity produced (367tC/GWh) and secondarily from the Oslomej Power Plant with similar emissions. At the margin, peak load electricity could come from a number of sources including new gas fired plants, coal plants or hydropower plants in FYR Macedonia or Serbian lignite fired peaking plants. Without the study mentioned above this will not be known. However, in any case peak electricity is a small part of the total. Thus, the baseline case electricity generation replaced by the proposed Project is overwhelmingly base load lignite fired generation, mainly from the Bitola Power Plant, but also from Oslomej. Once 12

the proposed mini-hydro plants are on line, they are expected to produce around 8.8 GWh of electricity per year, reducing some 3,200 tC per year, or 96,900 tC over the planning horizon of 30 years, as shown in Table 2.1.

Table 2.1 Carbon dioxide emission reductions (tC) Town Total 99 00 01 02 03 04-30/31 Kavadarci 83,700 0 0 0 2790 2,790 2,790 Debar 13,200 0 0 440 440 440 440 Total 96,900 0 0 440 3,230 3,230 3,230

Scope of Analysis

27. The system boundary was chosen to include the entire power sector of FYR Macedonia. However, as the capacity to be added by the proposed Project is relatively small, it is assumed that the project would not have a direct impact on the overall development of the sector. Sector effects can thus be measured through the long-run marginal cost (LRMC) of grid power.

Incremental Costs

28. The incremental costs calculated for this analysis consist of the difference in the present value of two life cycle cost streams. The first stream is the cost of the baseline case, which is assumed to be the long-run marginal cost of generating the same amount of electricity in a conventional way – that is 8.8 GWh per year at 5.0 US cents per kWh. The second stream is the alternative or the proposed Project and consists of the relatively large front-end investments in hydropower plants, followed by thirty years of quite low operating costs (insurance, maintenance, expected larger repairs, labor, no fuel). The investment costs for the mini-hydropower plants are shown in Table.2.2. The difference in the present value of the two cost streams is shown in Table 2.3 by component. In addition to electricity production, the proposed Project would yield several additional benefits to FYR Macedonia that are taken into account as follows:

 Local air quality improvements: these are captured in the analysis as the avoided costs of pollution abatement, which is incorporated in the LRMC estimate;  Job creation: to incorporate job creation benefits, labor costs were ‘shadow priced’ at 70% of actual costs (shown in Table 2.2) over the first 5 years of the project (assuming that the job market will have recovered at the end of 2003).  Energy security: this benefit was not measured as its importance and methodology for valuation are unclear. Table . 2.2 Capital costs of mini-hydro power plants (‘000 US$)

INVESTMENT CATEGORY KAVADARCI DEBAR ELECTROMECHANICAL EQUIPMENT 1500 275 13

CIVIL WORKS 572 55 GRID CONNECTIONS 200 45 OTHER COSTS AND SERVICES 220 65 TOTAL 2492 440

Table 2.3 Lifetime costs of baseline and alternative (US$ 000) Total 99 00 01 02 03 04 05-30/31 (PV) Domestic Benefits Kavadarci (GWh) 0.0 0.0 0.0 7.6 7.6 7.6 7.6 Debar (GWh) 0.0 0.0 1.2 1.2 1.2 1.2 1.2 Total (GWh) 0.0 0.0 1.2 8.8 8.8 8.8 8.8 Baseline costs Kavadarci 1,889 0 0 0 380 380 380 380 Debar 343 0 0 60 60 60 60 60 Total 2,232 0 0 60 440 440 440 440 Alternative Kavadarci 2,477 873 733 570 99 58 60 60 Debar 456 136 288 12 12 12 12 12 PIU 34 25 11 Total 2,967 1,033 1,032 582 111 70 73 73 Note: Figures may not add up due to rounding 29. Sensitivity Analysis: A sensitivity analysis was carried out to test the robustness of the above estimates with respect to key parameters. The results are shown in Table 2.4.

Table 2.4 Sensitivity Analysis Total Incremental Costs Parameter Absolute (US$000) Per unit (US$/tC) LRMC at 4.5 cents/kWh 959 9.9 LRMC at 5.5 cents/kWh 513 5.3 No shadow pricing of labor 808 8.3 High output (10.3 GWh/yr) 505 5.2 Low output (8.3 GWh/yr) 967 10.0

Summary 30. The results of the incremental cost analysis are summarized in Table 2.5.

Table 2.5 Incremental cost matrix

Baseline Alternative Increment Domestic benefits 8.8 GWh/yr. Of electricity 8.8 GWh/yr. of - from lignite-fired power electricity from mini- plant hydro 14

Global environment 96,900 tC 0 tC 96,900 tC benefit (3,200 tC/yr) (3,200 tC/yr)

PV Costs (US$000) - Kavadarci 1,889 2,477 588 - Debar 343 457 116 - Project management 0 34 34 Total 2,232 2,967 735 Per unit costs($/tC) - Kavadarci 7.0 - Debar 8.8 Total 7.6

III. BUDGET 31. The largest cost items for the project are the equipment (turbines, generators etc.) and the civil works (largely small buildings to house the generators). There are, however, also costs of connecting the generators to the grid and various miscellaneous costs such as land for small buildings, engineering etc. The cost of the PIU includes $100,000 for foreign consultants who would review the design work and, more importantly, help prepare the procurement documents.

Project Budget (US$ 000)

Component GEF Other Project total sources Equipment 601 1174 1775 Grid Connections 0 245 245 Civil Works 115 512 627 Other Costs and Services 0 285 285 PIU Operations 34 126 160 Project total 750 2342 3092

IV. IMPLEMENTATION PLAN

32. As noted above, a separate PIU, reporting to the Ministry of Economy, will be established to assist the two city utilities in implementing the proposed Project. Its primary function would be to assist the utilities with procurement. The PIU, in turn, would be assisted by ESM on the technical/operations side and by outside consultants on design and procurement. To keep the project simple, every effort will be made to ensure that there are no more than two GEF financed procurement packages for each component. These are likely to be primarily equipment in the case of Kavadarci and civil works in the case of Debar. The PIU will make available information on the project to other Macedonian and Balkan Utilities so as to encourage its replication (though this 15

is not the justification of the project which remains a short term response measure).

COMPONENT MONTHS 6 12 18 24 30 36 42

KAVADARCI

V. PUBLIC INVOLVEMENT PLAN

33. Stakeholders The major stakeholders are the Government of FYR Macedonia; and the mayors, city councils and municipal utilities and people of Debar and Kavadarci. The latter group will be the main beneficiaries since these plants they should provide: 1) the municipal utilities with an alternate source of income, thus perhaps holding down the increase in water tariffs; 2) a limited number of construction and operation jobs; as well as 3) increased security of electricity supply. The citizens of the whole country will, however, benefit from slightly lower emissions and a slight increase in security of supply.

34. Secondary stakeholders include the electric utility company, ESM, and the environmental NGOs. ESM has an interest in seeing that the mini-hydropower plants are reliable and provide inexpensive electricity since it will be the main customer for these plants and it is responsible for maintaining the integrity of the Macedonian Power System. The environmental NGOs are most interested in reducing pollution.

35. Stakeholder Participation The concept for the project came from the Government (Ministry of Economy) which is very concerned about developing the country’s hydropower potential. They are particularly concerned about small hydropower plants since they believe there is considerable potential in that area which is unlikely to be of interest to ESM or other utilities. The Ministry of Environment strongly endorsed this concept. The details of the components were largely developed by the municipalities and the municipal utilities. In each city the mini-hydropower projects were approved by the major and town council and then turned over the municipal water utilities for implementation. ESM ,as mentioned above, is interested in having the small hydropower capacity of the country developed but does not want to undertake this role itself since it would prefer to concentrate its own efforts on larger projects with higher rates of return. However, it has agreed to assist with the establishment and operation of the PIU since it is in its interest that the mini- 16

hydropower plants work well. The Ecologists Movement of Macedonia, the main environmental NGO, was consulted about this project which it endorsed.

36. Social and Participation Issues There are no known significant social issues. The project will not result in higher electricity or water tariffs and in fact in the long run may result in lower water prices for the towns of Debar and Kavadarci if the utilities use their small electricity profits to subsidize water. The water rights are already owned by the public utilities. There are no riparian issues as far as Bank policy is concerned since the project will in no way impact the existing flow of water, rather it will use some of the untapped energy involved in that flow to generate electricity. Furthermore, the project is ethnically balanced serving both ethnic communities. The citizens of both communities also participated in the selection of the projects through their democratically elected town councils and mayors.

VI. MONITORING AND EVALUATION PLAN

37. Reports: The PIU will provide quarterly reports on the status of the project. These reports would concentrate primarily on the status of implementation of the project. In this context they would focus on the major contracts and the status of physical implementation.

38. For the purpose of monitoring and verification the quarterly progress reports would include data on power generation and sales. These data would serve as the basis for estimating the reductions in carbon emissions.

39. Supervision: The project will be regularly supervised in conjunction with the PSIP, which also involves hydropower plants. It is expected that supervision would occur at least twice a year. It would involve not only meetings in Skopje with the Ministry of Economy and the PIU but also site visits to Kavadarci and Debar. (Fortunately these site visits could cover both the mini-hydropower plants and larger hydropower plants which are being rehabilitated under the PSIP; since both towns, Debar and Kavadarci, have major hydropower plants which will be undergoing rehabilitation in close proximity.) During these site visits, meetings would be held with the mayors of the towns and the management of the city utilities. Also the physical implementation of the work would be inspected. During supervision missions the local environmental NGOs will also be contacted.

40. The main purpose of these supervision missions is to make sure that the project is being implemented properly and that no unexpected issues are creating problems. Such issues are, unfortunately, common and most often involve procurement.

41. Mid-term Review: A mid term review would be undertaken along with the mid-term review for the PSIP. This is expected to occur no later than December 2000. Annex 1 Page 1 of 5

FYR Macedonia Mini-Hydropower Plants Project

Kavadarci

1. Company JP Komunalec , which will undertake this project, was established in 1968 along the lines of a German City Utility and is owned by the town. It supplies not only water and sewage services to the town of Kavadarci, but also it collects trash and repairs the streets. Altogether it employs 192 persons of whom 11 have college degrees, mostly engineers.

2. JP Komunalec’s balance sheet at the end of 1997, the last year for which data is available, was very solid with about $ 100,000 of cash and no significant long term debt including no bank debt. Equity including social capital and reserves, was about $ 2 Million. There were, however, significant accounts payable, similar in size to the accounts receivable after write-offs.

3. The company charges enough for its service to cover all costs and make a small profit. In 1997, the latest year for which data are available, the company had profits of a little over 1 million Dn. or about $20,000. In addition there was significant depreciation.

4. The project The water supply system for the cities of Kavadarci and the town of Negotino was constructed about 12 years ago.. The water supply pipeline is steel with a 4.5 mm width and 457.2 mm diameter. The pipeline is underground with a total length of 19.135 Km. The system capacity is 360-380 l/s. The total height of the system from water intake to final water chamber is 600 m. It is divided into six small water chambers for water energy dissipation and water pressure reduction.

5. The five mini-hydropower plants would be installed adjacent to the water chambers. These would be Francis turbines combined with small asynchronous generators. The first unit would have a capacity of 158 kW, the second 215 kW, the third 240 kW, the fourth 215 kW, and the fifth also 215 kW. Total generation would range from about 7 to 9 Gwh per year depending on the number of hours when the units would run and modest variations in water flow. For the purposes of this analysis, however, it was estimated that the units would produce 7.6 Gwh , which is a relatively conservative estimate. At this level of production the gross revenue from these mini-hydropower plants would be about $350,000 and again this is a conservative estimate.

6. The total cost of the Kavadarci mini-hydropower plants is estimated at about $2.49 Million dollars consisting primarily of the cost of equipment ($1.5 Million, primarily turbines and generators) and secondarily the cost of civil works ($570,000). Other costs include gird connections (to a close by 10 KV line) and various miscellaneous items. Annex 1 Page 2 of 5 7. The company has already invested or is investing $ 490,000 in the project. The remaining cost of the project is about $2.004 Million. This would be financed by the GEF Grant ($600,000), the company’s own funds (around $150,000 ), an export credit (up to $1.0 Million) and borrowing from commercial banks. The export credit financing would fund the purchase of three of the five units. The company is leaning strongly towards purchasing Slovene generators and turbines, from TurboInstitut Ljubljana. The Slovene export credit agency has been contacted though the Slovene Executive Directors Office to confirm that Slovene export credits are available. The GEF funding is likely also to be used to buy turbines and generators also though these would have to be purchased using International Competitive Bidding. The commercial banks would provide bridge financing to allow the export credit to be paid off more rapidly.( See Table 1-1).

8. New civil works will be fairly limited since the power houses will be built adjacent to the water chambers close to the pipeline. An asphalt road running parallel to the pipeline provides good access. The small power houses, which have been designed, will be 6X8 meters and located about 6 meters from the pipeline. One of the powerhouses has been completed by the city utility in an effort to accelerate the project.

9. The mini-hydropower plants will be remotely controlled. There will, however, be a need for regular maintenance (initially about once a year), occasional supervision, repairs in the later years and insurance. However, operating costs are quite low.

10. The design and specifications for the project were prepared by the city utility of Kavadarci, JP Komunalec, working with the faculty of engineering at the University of St. Ciril and Methodius in Skopje, the main University in FYR Macedonia. This design and the cost numbers were then confirmed by the Austrian Engineering and Environmental Consulting firm, KWI- which strongly supported the project. The design documentation is available in Macedonian.

11. The company JP Standard, which will undertake this project, is the city utility for the town of Debar with functions which are similar to those of JP Komunalec in Kavadarci. It employs 82 persons of whom 3 have college degrees, all engineers.

12. JP Standard’s balance sheet at the end of 1997, the last year for which data is available, was also fairly solid, though since it is a small company the orders of magnitude are modest. There was no bank or bond debt and the total value of equity including social capital and reserves was about $1 million.

13. The company charges enough to cover costs and has been profitable every year. In 1997, however, profits were depressed due to local economic conditions and were only about $2500 . However, depreciation was relatively more significant at about $30,000. Moreover, the company is anticipating substantial earnings in 1998 and 1999 from outside activities- primarily reconstruction work already undertaken for a German Company which has bought the main factory in the town. Annex 1 Page 3 of 5 14. The Project The water supply system for the town of Debar and smaller nearby settlements was constructed about 10 years ago. The water supply pipeline is steel with 4.5 mm width and 445 mm diameter. The system capacity is 200-250 l/s. The section of the pipeline on which the mini-hydropower plant would be located is 260 m with a head of 79 meters. The plant would actually be in a vacant lot in the city of Debar.

15. The unit is planned to be 160 kW in size. It would consist primarily of a Francis Turbine and an asynchronous generator. The output of the unit could vary somewhat depending on the number of hours it is in use and the flow of the water. The range is from about 1.1 Gwh to about 1.3 Gwh per year. The expected generation is about 1.2 Gwh per year.

16. The total cost of the Debar mini-hydropower plant is about $440,000 consisting primarily of the cost of equipment ($275,000, mostly the turbine and generator), civil works ($55,000), grid connection ($45,000) and other costs and services ($65,000). This includes contingencies. The company has invested so far about $75,000 in the project and anticipates further investments of close to $50,000 which would primarily come from its construction profits. The remaining funds would be from GEF ($115,000), export credits (up to $ 200,000) and bank financing. The export credit would be for the turbines and generators and as in Kavadarci, the city utility is leaning strongly towards using Slovene equipment, with which they are familiar. Again it has been confirmed that Slovene Export Credit financing is available. The commercial bank financing, which Stopanska Bank- the largest Macedonian Bank, has agreed to provide, would serve as a bridge loan to allow the export credit to be paid off earlier. The company could also make a larger equity contribution if required. ( See Table 1-2 below)

17. Civil works will again be somewhat limited consisting of the powerhouse for the generator, 4mX 5m, located about 3 meters from the pipeline and the connection to the power grid. The small powerhouse is already designed. The vacant lot on which the building will sit has a paved road adjacent and also a 10 kV power line with which the plant will be connected.

18. The mini-hydropower plant will be remotely controlled. There will, however, be a need for regular maintenance (initially about once a year), occasional supervision, repairs in later years and insurance. As a result, operating costs again will be quite low.

19. Again the design of the plant was prepared by the city utility, JP Standard, working with the faculty of engineering at the University of St. Ciril and Methodius. The design and cost numbers were confirmed by the Austrian Engineering and Environmental Consulting firm KWI, which supports the project. Annex 1 Page 4 of 5

Table 1-1

FINANCI NG PLAN Years 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Financing Required Investments 1106.0 756.0 588.0 42.0 Operating Costs 0 0 0 0 58.0 60.0 60.0 60.0 60.0 60.0 60.0 Total Operations 1106.0 756.0 588.0 42.0 58.0 60.0 60.0 60.0 60.0 60.0 60.0 Inter. +Guar. ECA 18.3 52.2 80.9 89.4 75.3 56.5 37.6 18.8 4.7 0.0 0.0 Repayment ECA 0 0 100.1 200.2 200.2 200.2 200.2 100.1 0.0 0 Interest Bank 12.7 27.1 50.4 71.1 59.3 61.9 62.7 61.2 57.0 37.4 1.7 Repayment Bank 90.8 0.0 32.2 150.6 275.0 12.8 Total Debt Service 31.1 79.4 131.3 351.4 334.7 318.6 300.5 312.4 312.4 312.4 14.5 Total 1137.1 835.4 719.3 393.4 392.7 378.6 360.5 372.4 372.4 372.4 74.5

Financing Provided Operating 0 0 372.4 372.4 372.4 372.4 372.4 372.4 372.4 372.4 Revenues GEF Grant 300.0 280.0 21.0 ECA Loan 390.4 330.3 280.3 0.0 Bank Loan 208.7 179.0 159.1 0.0 20.3 6.2 -11.9 Utility Funding 538.0 26.0 Total 1137.1 835.4 719.3 393.4 392.7 378.6 360.5 372.4 372.4 372.4 372.4

Loan Amounts ECA Loan Amount 390.4 720.7 1001.0 900.9 700.7 500.5 300.3 100.1 0.0 0 0 Bank Loan 208.7 387.7 546.8 456.0 476.3 482.5 470.6 438.4 287.8 12.8 0.0 Annex 1 Page 5 of 5

Table 1-2

FINANCI NG Years 1999 2000 2001 2002 2003 2004 2005 2006 Financing Required Investments 140.0 300.0 Operating Costs 0 0 12.3 12.3 12.3 12.3 12.3 12.3 Total Operations 140.0 300.0 12.3 12.3 12.3 12.3 12.3 12.3 Inter.+Guar. ECA 2.8 9.3 12.3 10.3 7.7 5.2 2.6 0.0 Repayment ECA 0 19.6 39.1 39.1 39.1 39.1 19.6 Interest Bank 1.4 3.0 1.5 2.1 2.4 2.4 2.1 Repayment Bank 2.4 16.0 Total Debt Service 2.8 10.7 34.8 50.9 48.9 46.6 46.5 37.7 Total 142.8 310.7 47.1 63.2 61.2 58.9 58.8 50.0

Financing Provided Operating 0 58.8 58.8 58.8 58.8 58.8 58.8 Revenues GEF Grant 115.0 ECA Loan 85.0 110.5 Bank Loan 23.2 4.4 2.4 0.1 Utility Funding 58.0 62.0 Total 143.0 310.7 58.8 63.2 61.2 58.9 58.8 58.8

Loan Amounts ECA Loan Amount 85.0 195.5 176.0 136.9 97.8 58.7 19.6 0.0 Bank Loan 23.2 11.5 15.9 18.3 18.5 16.0 0.0 Annex 2 Page 1 of 6

FYR Macedonia Mini-Hydropower Plants Project

STAP REVIEW AND

WORLD BANK’S RESPONSE TO STAP1 COMMENTS

STAP Review 6 November 1998 Re: Review of Proposed GEF Project "FYR Macedonia Development of Mini-Hydropower Plants"

Summary

This is a very interesting proposal. The proposed small scale hydroelectric projects would provide environmentally benign sources of power in an economically and socially distressed region, and would in a direct sense achieve an objective of the Global Environment Facility (GEF) by reducing carbon dioxide emissions. The proposal seeks to develop independent power production by supporting a government decision to back independent power projects.

The proposal, however, has one particular problem. It fails, in this reviewer's opinion, to make a case that the one-time demonstration would promote the diffusion of clean, independent power sources. The proposal indicates that the mini-hydro projects would have low internal rates of return (IRR) without a GEF grant. While the low IRRs may be consistent with GEF rules, they are inconsistent with the assumption that independent power producers, given a one-time boost, could replicate the GEF's introduction of a low- carbon power source. That is, there is no explanation for how the demonstration of the approach would transform the current situation into a sustainable market, at least for mini-hydro plants. If the GEF grant does not somehow change the underlying economic or financial context to create sustainable market conditions, including sufficiently high rates of return, the project will not be replicated.

If the expected benefit of the project is not so much the specific technology-mini-hydro power-but independent power production, then the proposal needs to make the case that independent power production will also be low-carbon power production. That case can sometimes be made, but it requires considerable elaboration.

The following specific comments may be useful to you.

Specific Questions About/Comments On the Proposal

1 Mr. William Chandler was STAP Reviewer of this project Annex 2 Page 2 of 6 C In section 1.d. you write, "It is expected that the project would reduce carbon dioxide emissions by about 670,000 metric tons." Over what period is that amount expected? Per year? Over the life of the project ?

C Also in section 1.d. you write, "First, the proposed grants by GEF are such that they would reduce carbon emissions for less than $lO/ton of carbon. "It is not clear to me that this is the incremental cost of carbon emissions reduction. It seems to be simply the project cost-which is not the incremental cost-divided by tons of carbon reduced.

C In section C:l. you write: "After this screening was carried out by Austrian Consultants, only four possible project components were left. Based on field visits to the sites by Bank Staff, it was recommended that three of these potential components be included in this GEF Project." This reviewer interprets this phrase as meaning that the potential for mini-hydro is very limited in the country, suggesting that this demonstration project might not, as claimed by the proposal, demonstrate the potential for expanding min-hydro power.

C In section C:l., you also write: "The insertion of the turbines into the water supply pipes, however, in no way impacts on the quality or the quantity of water supplied to these towns or other potential users." For this reviewer, this information was a very important indicator that environmental impact will indeed be minimal. The proposers may want to emphasize this aspect of the proposed project in the summary information.

C At various points in the proposal, it is argued that a major benefit of the project will be the introduction of independent power production. While the reviewer finds that a worthy economic and political goal, it may not be particularly compelling environmental goal. Brazil, for example, is moving rapidly away from state-sponsored power projects, which are mostly large-scale hydro projects, to independent, privately-owned power plants, which are likely to be coal-fired. Obviously, such a transition may have drawbacks for carbon emissions.

C In Section D:5., you write, "The mini-hydropower plants will cost around $2000 + per kW compared to around $600 or less for a natural gas fired plant. "This information suggests to this reviewer that the proposed GEF demonstration may be demonstrating a technology that is not sustainable in the market without GEF grants, and that the expected benefit of market replication of the project will not materialize.

C In Section E: 6.c., you write, "The project has minimal environmental impact since the facilities which will be built are small and attached to water supply systems which are under construction or existing." This reviewer finds this argument incomplete. While the proposal makes an adequate environmental case for the specific projects, the point of the project is presumably to open the way for multiple replication, which implies that tens even hundreds of mini-hydro facilities would be constructed. It is necessary to know something, at least in general terms, about the environmental impact of creating such a business (dam modification or construction, power line development), and to be able to compare those impacts with the alternative of using lignite. Annex 2 Page 3 of 6 C The table "Checklist of Bank Policies" in Section E is not understandable.

C In Annex I, in the table "Project Design Summary," you write, "Number of independent power plants should increase". The most serious criticism this reviewer has for the proposal is that this case has not been made. This reviewer finds evidence in the proposal that the demonstration will not, in fact, achieve this goal (the high capital costs and low IRRs cited formini-hydro), but not compelling reasons why it should achieve the goal. In the right column, "Critical assumptions," you write "The Government is committed to opening power generation to independent power plants and to the private sector( risk: 10~)~~. That assumption is fine, but there is another, unstated assumption that mini-hydro plants can be competitive in the market (or that independent power producers would develop some other low carbon source), and this assumption needs to be defended with some evidence. Would the post-grant, market find mini-hydro to be more profitable than other power investments?

C In Annex 2, FYR Macedonia Mini-Hydropower Project, Incremental Cost Analysis, you seem to indicate that no one knows the long run marginal cost of power for the country. That strikes me as a serious problem with a proposal that would make capital investments for power capacity....

C In the third line of "Costs" in Annex 2, there is a typo: "Kwh" should be kWh.

C Table A.3.1. "Mini-Hydro Power Plants Project Rates of Return" presents a very serious difficulty for this proposal. If the IRRs for these projects are only in the range of 11-17 percent, and many investments in the region are available with IRRs of 20+ percent, how will the stated objective of the project to create a sustainable independent power sector be achieved?

BANK 'S RESPONSE TO STAP REVIEW

1. Overall, the STAP’s comments are valid but for an OP6 operation rather than the proposed Project which is being prepared under the short-term response window.

2. According to the GEF Operational Strategy "The GEF may finance climate change projects that reduce greenhouse gases in the short-term. even if they are not part of an operational program. Such projects will be funded if they are country priorities , cost-effective in the short-term, and likely to succeed. The rationale for project support is primarily the expected reduction in greenhouse gases rather than its programmatic impact. .... Short-term projects may be of various types, including initiatives to seize unforeseen opportunities and to meet contingencies. Short term response projects may include, but are not limited to, mitigation in areas for which operational programs have not yet been developed.”

3. In the context of the above guidance, it is our view that replication is an ancilliary benefit and the proposed project can be justified without it. Also, the expected benefit of the project is not so much the specific technology - mini- Annex 2 Page 4 of 6 hydro power - but independent power production in general. In other words, IPP demonstration is the domestic and not the GEF objective. Of course, one needs to show that the development goal does not contradict the global environmental goal; i.e. that IPPs will not be more carbon intensive than the public sector power. We believe that this would be the case as the fuels utilized will the same, independent of ownership. But since low carbon IPPs is not the global environment benefit there would be no need for an elaborate analysis of this point.

RESPONSE TO SPECIFIC STAP COMMENTS

C In section 1.d. you write, "It is expected that the project would reduce carbon dioxide emissions by about 670,000 metric tons." Over what period is that amount expected? Per year? Over the life of the project ?

 It's the lifetime emissions in tons of CO2.

C Also in section 1.d. you write, "First, the proposed grants by GEF are such that they would reduce carbon emissions for less than $10/ton of carbon. "It is not clear to me that this is the incremental cost of carbon emissions reduction. It seems to be simply the project cost-which is not the incremental cost-divided by tons of carbon reduced.

 It is GEF contribution divided by carbon benefit: i.e. the agreed incremental cost. Since we cap at $10/ton in two of the three components the agreed IC are not quite the same as the analytic IC estimate.

C In section C:1. you write: "After this screening was carried out by Austrian Consultants, only four possible project components were left. Based on field visits to the sites by Bank Staff, it was recommended that three of these potential components be included in this GEF Project. "This reviewer interprets this phrase as meaning that the potential for mini-hydro is very limited in the country, suggesting that this demonstration project might not, as claimed by the proposal, demonstrate the potential for expanding min-hydro power.

 The screening was for components that can successfully demonstrate IPPs (and have positive IC). Hence, the criteria (i) no involvement by the state utility, and (ii) advanced preparation. After a successful demonstration those two criteria will no longer be as important and one can go back to those project. Presumably, the issue of riparian rights (the third criteria) may also be sorted out over time.

C In section C:1., you also write: "The insertion of the turbines into the water supply pipes, however, in no way impacts on the quality or the quantity of water supplied to these towns or other potential users." For this reviewer, this information was a very important indicator that environmental impact will indeed be minimal. The proposers may want to emphasize this aspect of the proposed project in the summary information.

 The relevant section will be expanded. Annex 2 Page 5 of 6

C At various points in the proposal, it is argued that a major benefit of the project will be the introduction of independent power production. While the reviewer finds that a worthy economic and political goal, it may not be particularly compelling environmental goal. Brazil, for example, is moving rapidly away from state-sponsored power projects, which are mostly large-scale hydro projects, to independent, privately-owned power plants, which are likely to be coal-fired. Obviously, such a transition may have drawbacks for carbon emissions.

 See para 3 above

C In Section D:5., you write, “The mini-hydropower plants will cost around $2000 + per kW compared to around $600 or less for a natural gas fired plant. ”This information suggests to this reviewer that the proposed GEF demonstration may be demonstrating a technology that is not sustainable in the market without GEF grants, and that the expected benefit of market replication of the project will not materialize.

 This is an STRM not an OP6 project, so replication is not essential . Obviously, it is desirable and constitutes an ancillary benefit, but the project can be justified without having to rely on replication.

C In Section E: 6.c., you write, “The project has minimal environmental impact since the facilities which will be built are small and attached to water supply systems which are under construction or existing.” This reviewer finds this argument incomplete. While the proposal makes an adequate environmental case for the specific projects, the point of the project is presumably to open the way for multiple replication, which implies that tens even hundreds of mini-hydro facilities would be constructed. It is necessary to know something, at least in general terms, about the environmental impact of creating such a business (dam modification or construction, power line development), and to be able to compare those impacts with the alternative of using lignite.

If there were to be replication, the follow-up operations will have to go through a standard environmental impact assessment. But again, replication is only a side benefit.

C The table “Checklist of Bank Policies” in Section E is not understandable.

 The format is part of the standard template.

C In Annex I, in the table “Project Design Summary,” you write, “Number of independent power plants should increase”. The most serious criticism this reviewer has for the proposal is that this case has not been made. This reviewer finds evidence in the proposal that the demonstration will not, in fact, achieve this goal (the high capital costs and low IRRs cited for mini-hydro), but not compelling reasons why it should achieve the goal. In the right column, “Critical assumptions,” you write “The Government is committed to opening power generation to independent power plants and to the private sector ( risk: low)”. That assumption is fine, but there is another, unstated assumption Annex 2 Page 6 of 6 that mini-hydro plants can be competitive in the market (or that independent power producers would develop some other low carbon source), and this assumption needs to be defended with some evidence. Would the post-grant market find mini-hydro to be more profitable than other power investments?

 Again, the operation is being processed under the STRM window.

C In Annex 2, FYR Macedonia Mini-Hydropower Project, Incremental Cost Analysis, you seem to indicate that no one knows the long run marginal cost of power for the country. That strikes me as a serious problem with a proposal that would make capital investments for power capacity….

 What is presented are first approximations. Which are sufficient for moving ahead at this point. But agree that better information is needed. The Study, about to be initiated, is expected to provide the data.

C In the third line of “Costs” in Annex 2, there is a typo: “Kwh” should be kWh.

 Thanks – noted.

C Table A.3.1. “Mini-Hydro Power Plants Project Rates of Return” presents a very serious difficulty for this proposal. If the IRRs for these projects are only in the range of 11-17 percent, and many investments in the region are available with IRRs of 20+ percent, how will the stated objective of the project to create a sustainable independent power sector be achieved?

 The table concerns the financial rate of return, and 20+% is probably also a financial rate of return. The economic rate of return will be better, especially once we consider (i) employment effects (shodow price labor); (ii) local environmental benefits, (iii) global environment benefits, etc. But, obviously even after all that we don’t meet the hurdle rate (what ever it is) we should not do it. Annex 3 Page 1 of 2 02/01/99 21:17 GEF SECRETFlRIAT + ENUGC NO.835 P0101012 DECEMBER 1998 INTERSESSIONAL WORK PROGRAM: COMMENTS FROM COUNCIL MEMBERS (reference to GEF/IS/S - December 16, 1998)

Macedonia, FYR: Development of Mini-Hydropower Plants (World Bank) GEF: $1.50 million, Total: S 6.4 million Comments from Switzerland 11/20/99) It should be noted that the inclusion of STAP technical reviews and IA responses as required annexes has proven to be very useful. The STAP reviewer should always be identified. STAP reviews should not be summarized by the IA, as in the case of Samoa, but included in their original form.

Commentss/rom France /l/20/99) Only one project is presented in the Climate Change category. It concerns the establishment of mini-hydropower plants in Macedonia (eight units between 0.1 and 1 .O MW, connected to the network and located in three zones). The GEF is asked for an amount of US$1.5 million on a total investment figure of US$6.4 million. The other sources of financing will be: export credits, USS3.4 million; and the Government, US% 1.4 million. In principle, the project meets GEF eligibility criteria, and is of significant interest: the introduction of small hydropower plants to replace thermal power plants is certainly feasible in the East and South regions if innovative methods of executing such projects are adopted.

This project warrants the following comments: The method used in calculating the GEF grant creates problems, in the sense that it leads to allocating most GEF grants to those projects that are least cost-effective. In this case, the calculation will be credible only if the arguments presented in the project documentation demonstrate that the GEF grant will help lower the costs of mini-hydropower plants in Macedonia, and that subsequent projects have a good chance of being financially viable without the GEF. The project documentation should also indicate the specific arenas in which opportunities for cost reduction are to be expected.

Details of the financial package should also be provided. The sharing of responsibilities and resources between public players and private operators needs to be clearer. (Since over 40% of project financing is to come from public sources-21% from the Government and 23% from the GEF-requirements in both the institutional and contractual spheres need to be spelled out.)

BANK'S RESPONSE TO COUNCIL'S COMMENTS

(1) Incremental Costs:

The project is proposed as a Short-Term Response Measure for which the GEF eligibility criteria is the reduction of carbon emissions for less than $10/ton of carbon, at low risk, and in accordance with country priorities. The proposed project is below the Annex 3 Page 2 of 2 cost effectiveness threshold ($7.6/tC); has a high likelihood of success since it is a well known technology and is of high priority for the country (it is linked to the NEAP; the Macedonian Long-term Investment Plan ands the World Bank Power System Improvement Project). The life cycle costs of the proposed mini-hydros have been reviewed and found reasonable (high front end capital cost offset by very low operating costs and long life). Alternative renewable sources of energy have been considered, however solar and wind are very limited and there is very little information about geothermal (which in FYR Macedonia is better for heating than power generation). Budget estimates are provided in the MSP Brief.

(2) Replicability and Cost Reduction Options:

As a Short Term Response Measure, replicability is not a requirement for GEF eligibility. However, some degree of replicability is expected as an additional benefit since the proposed project aim at promoting the development of small hydropower plants by independent power producers. The project will lead to lower costs for future mini- hydropower plants. The main arenas for cost reductions would be: 1) making the mini- hydropower technology in Macedonia better known so that in future certain projects (mainly municipal water projects) would be designed using this technology; and 2) establishing the process of obtaining operating licenses, agreeing on power purchase arrangements etc, which this project will pioneer.

(3) Other Council Comments:

For the comments on incremental cost calculation and cost reduction options, see first two items in this table. STAP Reviewer was Mr. William Chandler. His comments and the Bank’s response are attached to the MSP Brief. Information on the financial packages and responsibilities is provided and includes a detailed forecasts of financial flows. The financing is fairly simple and consists of four components: 1) equity contributed by the city utilities (21%); 2) GEF and bilateral grants (26%); 3) borrowing from export credit agencies (36%); and 4) Commercial bank loans (17%). All debts are paid off in about 6-7 years. Social aspects of the project will be monitored during implementation, However, no significant social issues, including transboundary issues with Albania and Kosovo, particularly related to refugee movements, are expected to affect the project by the time the plants are commissioned.

World Bank User Q:\Personal\Macedonia.doc 11/03/99 3:09 PM