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Report No. PID8399 Project Name Bosnia and Herzegovina-Third Electric (@+) Power Reconstruction Project Region Europe and Central Asia Region Sector Distribution & Transmission Public Disclosure Authorized Project ID BAPE58521 Borrower(s) Bosnia and Herzegovina Implementing Agency Address EPBIH, EPM AND EPRS Address: See below. Environment Category B Date PID Prepared March 20, 2000 Projected Appraisal Date March 28, 2000 Public Disclosure Authorized Projected Board Date May 30, 2000 1. Country and Sector Background (i) Reconstructing the power system. In 1990, BiH produced 12,900 Gigawatt hours (GWh) of electricity from generating plants located on its territory. Electricity consumption was 11,822 GWh. The system comprised 13 hydropower plants with a total capacity of 2,034 megawatts (MW) and an average output of 6,922 GWh/year, and 12 thermal power plants with a total capacity of 1,957 MW and an output of 9,252 GWh in 1990. The thermal power plants were brown coal and lignite fired, with the fuel coming from mines within BiH. BiH was responsible for operating its own system and meeting local demand. However, being part of the former Yugoslav network, the 400 kilovolt (kV) power grid in BiH was controlled by the Yugoslav Electric Power Industry's (JUGEL) dispatching center in Belgrade. Power Public Disclosure Authorized exchanges were also controlled by JUGEL.At the beginning of 1996, more than half of generating capacity had been put out of operation because of direct damages, destroyed transmission lines or lack of coal. Most plants had also suffered from lack of maintenance during the war. About 60% of the transmission network and control system in the Federation was seriously damaged, including transmission facilities and interconnection lines to neighboring countries. The transmission network and control system in RS were also heavily damaged, particularly in those areas located close to confrontation lines. The 400 kV system in BiH was almost completely out of operation (the main exception was the Trebinje-Podgorica 400 kV transmission line). Many distribution networks were badly damaged in both the Federation and RS as a result of fighting and lack of maintenance. Many transformer stations, buildings, telecommunications and maintenance facilities and equipment were also either seriously damaged or destroyed.Rehabilitation enabled total generation to reach 11,423 GWh in Public Disclosure Authorized 1999 (89% of the 1990 level) and consumption within BiH to reach 9,533 GWh in 1999 (83% of the 1990 level). However, despite these achievements, the remaining needs are still very large and many facilities remain to be reconstructed. Investments are also needed to improve reliability, safety and environmental protection. The Federation and RS governments place high priority on continued reconstruction of the power system as one of the primary means to relaunch economic activity. IDA and other international donors have been supporting this reconstruction, mainly through the Emergency Electric Power Reconstruction Project (Cr. No. 2903) (Power 1) and the Second Electric Power Reconstruction Project (Cr. No. 3071) (Power 2). Further investments are needed to continue the post-war reconstruction program. (ii) Improving cost recovery. All three power enterprises were severely affected during the war by revenue constraints arising from the inability of households as well as commercial and industrial enterprises to pay for their electricity consumption. Revenue collection during the war dropped to as low as 25% of invoiced amounts, leading to severe cash deficits. Since the Dayton peace accord, the revenue situation of the three enterprises, both in terms of tariff levels as well as collection performance, has improved, particularly for EPBiH. In 1999, revenue collection by EPBiH, EPM and EPRS reached 99%, 80% and 75% respectively of the amounts billed. The collected revenue is estimated to have covered 137%, 1309 and 1069 respectively of cash expenses. In 1999, total distribution losses were reduced to 12% of electricity entering the distribution network for EPBiH and 26% for EPM and EPRS. Of these amounts technical losses were 12 percentage points or fewer. The rest consisted of non-technical losses, that is unbilled consumption due to such factors as lack of meters, meter tampering or bypassing. An adverse factor is that operating costs appear to be excessively high because of overstaffing and possible overestimation of depreciation. Cash operating costs of EPM have also been growing rapidly, by over 30% in 1999. The Elektroprivredas need to make further progress to reach full cost recovery, including coverage of appropriate depreciation charges. This will require progress in: (i) increasing billing and collection, (ii) improving cost efficiency, (iii) reducing distribution losses; and, if necessary, (iv) increasing tariff levels. There is also a need for asset revaluation in order to ensure realistic depreciation charges necessary for asset replacement. All three Elektroprivredas have been implementing recommendations for improving billing and collection and reducing distribution losses made by a recently completed electricity tariff study.(iii) Improving tariff structures. In 1999, the average industrial electricity tariff rate of about US$ 0.06/kWh (kilowatt hour) in BiH was close to the average in OECD Europe of US$ 0.07/kWh. By contrast, the household rates of about US$ 0.05/kWh was much lower than the OECD Europe average of US$ 0.13/kWh. The tariff study recommended large rate increases, mainly for households, phased in over the period 1999-2003. It also recommended the establishment of a three-block tariff structure for households, under which the high-priced third block would compensate for the low-priced "lifeline" first block, and a system of vouchers to allow targeted low income consumers to pay for their lifeline consumption of electricity. On October 1, 1999, the RS Government raised tariff rates to about the level recommended by the study, and gave each municipality the authority to designate 6.7% of collected electricity revenue for the reduction of arrears on previous electricity bills of specified consumer groups. The Federation Government is expected to raise tariff rates for EPBiH and EPM in 2000, with the increases being concentrated on household consumers. The strategy of the Federation and RS Governments expected to be set out in their Power Sector Policy Papers is to gradually remove the distortion between household and other tariff rates, introduce lifeline tariff rates, and possibly establish further direct assistance to needy groups. (iv) Improving power co-ordination between EPBiH, EPM and EPRS. Since the war, power exchanges between the different parts of BiH have been restricted because of the -2 - breakdown of many transmission lines and the existence of three separate vertically-integrated power enterprises. Where before the war there was one dispatch center for BiH, each EP has subsequently been dispatching its own power stations for the benefit of its own consumers. For purposes of frequency control, EPRS is synchronized with the power system of FRY, while EPBiH and EPM are synchronized with the power system of Croatia. However, EPBiH provides some ancillary services free-of-charge to both EPM and EPRS. Both frequency regulation and reserve for the EPM service areas in Central Bosnia are provided by EPBiH by means of the Jablanica hydropower station. Similarly Jablanica provides frequency regulation for the EPRS service areas around Prijedor, Modrica and Derventa, as well as power supply when EPRS cannot supply itself. Initially electricity exchanges between the Elektroprivredas were in kind and constrained so that net trade between any pair of Elektroprivredas was always zero or close to it (e.g., exports from one company to a service area with a power deficit of another company were offset by imports of the same amount from a power surplus area of the other company). The development of commercial trade was also hindered by difficulties in making payments because of a poorly functioning banking system. More recently, commercial exchanges have been initiated on a limited scale. Enhancement of power exchanges would: (i) permit surplus power of one company to be used to alleviate shortages of another company (caused by inadequate generation capacity or by outages of large generating units or surges in power demand); (ii) reduce transmission costs by allowing the most direct routes to be used, regardless of whether these routes cross the territories of the other companies; and (iii) reduce generating costs by permitting the lowest cost generating units in the country to be used at each time of day and year. A Joint Power Co-ordinating Center (ZEKC) was established in March 1999 to co-ordinate the operation of the BiH power system in a safe, effective and efficient manner. Further progress towards improved power exchanges would be demonstrated by the establishment of more commercial trade contracts between the three companies, and a readiness by the companies to help each other out in emergencies, and to accept the power dispatch recommendations of ZEKC. These improvements are expected to occur. All three Elektroprivredas have declared their support for BiH to rejoin the European Union for the Co-ordination of Transmission of Electricity (UCTE). (v) Power sector reform. Prior to the war, BiH had a single vertically-integrated socially-owned power company. There are currently three vertically-integrated