Document of The World Bank Public Disclosure Authorized

Report No. 17170-ET

PROJECT APPRAISALDOCUMENT Public Disclosure Authorized FEDERAL DEMOCRATIC REPUBLIC OF ETHIOPIA

ENERGY 11 PROJECT Public Disclosure Authorized

November 13, 1997

Energy Team Africa Region Public Disclosure Authorized CURRENCY EQUIVALENTS

Currency Unit = Ethiopian Birr (ETB) US$1.00 = Birr6.801 as of November 1997 SDR 1.0 = US$1.37 as of October 1997

FISCAL YEAR

July 1 - June 30

WEIGHTS AND MEASURES

I kilometer = 0.621 miles 1 square kilometer (km2 ) = 0.386 square miles 1 kilovolt (kV) = 1,000 volts 1 megawatt (MW) = 1,000 kilowatts 1 megavolt ampere (MVA) = 1,000 kilovolt amperes 1 gigawatt hour (GWh) = 1 million kilowatt hours 1 ton of oil equivalent (toe) = 10,500,000 kilocalories

Vice President: Callisto Madavo Country Director: Oey Astra Meesook Technical Manager: Mark Tomlinson Task Manager: Alfred Gulstone ABBREVIATIONSAND ACRONYMS

AfDB AfricanDevelopment Bank BOT Build, Operate and Transfer DANIDA Danish InternationalDevelopment Agency DCA DevelopmentCredit Agreement EELPA EthiopianElectric Power and Light Authority EEPCO EthiopianElectric Power Corporation EESRC EthiopianEnergy Studiesand ResearchCenter EIA EnvironmentalImpact Assessment ERR EconomicRate of Return ESMAP Energy Sector ManagementAssistance Program GOE Governmentof Ethiopia ICR ImplementationCompletion Report ICS InterconnectedSystem IDA InternationalDevelopment Association LRMC Long RunMarginal Cost MME Ministryof Mines and Energy MOA Ministryof Agriculture NGO Non GovernmentalAgency NORAD Nordic DevelopmentAgency NPV Net PresentValue PA Project Agreement PAD Project AppraisalDocument PAP Project AffectedPopulation PMU Project ManagementUnit PPF Project PreparationFacility SCS Self ContainedSystem Sida SwedishInternational Development Agency STD SexuallyTransmitted Diseases

ETHIOPIA ENERGY II PROJECT

PROJECTAPPRAISAL DOCUMENT

CONTENTS Page No.

Project Financing Data ...... 1I

BLOCK 1:

ProjectDescription ...... 2 1. Project DevelopmentObjectives ...... 2 2. Project Components...... 2 3. Benefits and Target Population...... 2 4. Institutionaland ImplementationArrangements ...... 3

BLOCK 2:

ProjectRationale ...... 3 5. CAS ObjectivesSupported by the Project...... 3 6. Main Sector Issues and GovernmentStrategy ...... 3 7. SectorIssues to be addressedby the Project and StrategicChoices ...... 5 8. Project AlternativesConsidered and Reasonsfor Rejection...... 6 9. Major RelatedProjects Financedby the Bank and/or Other DevelopmentAgencies ...... 6 10. LessonsLearned and Reflectedin the Project Design...... 6 11. Indicationsof BorrowerCommitment and ownership...... 7 12. Value Added of Bank Support...... 7

BLOCK 3:

SummaryProject Assessments ...... 7 13. EconomicAssessment ...... 7 14. FinancialAssessment ...... 8 15. TechnicalAssessment ...... 9 16. InstitutionalAssessment ...... 10 17. Social Assessment...... 1.1 18. EnvironmentalAssessment ...... I 1 19. ParticipatoryApproach ...... 12 20. Sustainability...... 12 21. Critical Risks...... 12 22. PossibleControversial Aspects ...... 12 - ii -

BLOCK 4:

Main Loan Conditions ...... 13 23. EffectivenessConditions ...... 13 24. Assurances...... 13

BLOCK 5:

Compliance with Bank Policies...... 14

Annexes

1. ProjectDesign Summary...... 15 2. Detailed Project Description...... 18 3. EstimatedProject Costs...... 23 4. Cost BenefitAnalysis Summary...... 24 4A. FinancialAnalysis Summary...... 28 5. EEPCOPast and CurrentFinancial Performance: FY90/91-95/96 .30 6. Procurementand DisbursementArrangements .37 7. Project ProcessingBudget and Schedule.44 8. Documentsin the Project File.45 9. Status of Bank Group Operationsin Ethiopia.46 10. Ethiopiaat a Glance.47

Map:

Ethiopia - IBRD No. 28768 INTERNATIONALBANK FOR RECONSTRUCTIONAND DEVELOPMENT INTERNATIONALDEVELOPMENT AsSOcIATIoN

AFRICA REGIONAL OFFICE AFC06

Project Appraisal Document

ETHIOPIA ENERGY II PROJECT Date: November 13, 1997 [] Draft [X] Final Task Manager: Alfred Gulstone CountryDirector: Oey Astra Meesook Project ID: 736 Sector: Energy Lending Instrument: Sector Investment and Maintenance PTI: [ ] Yes [X] No Loan

Project FinancingData [ Loan [X] Credit [ Guarantee [] Other [Specify)

For Loans/Credits/Others:

Amount(US$mlSDRm): US$200.0 million/SDR 146.1 million Proposed Terms: [] Multicurrency [ Singlecurrency Grace period (years): 10 years [] Standard [X] Fixed [] LIBOR-based Variable Years to maturity: 40 years Commitmentfee: 0% Service charge: 0.75%

Financing plan (US$m): Source Local Foreign Total

Government 24.64 24.29 48.93 Cofinanciers: EuropeanInvestment Bank 9.65 32.46 42.11 Nordic DevelopmentFund 0.00 4.85 4.85 IDA 42.93 157.07 200.00 Total 77.22 218.67 295.89

Borrower: Federal DemocraticRepublic of Ethiopia Guarantor: Responsibleagencies: (i) Ministry of Mines and Energy (MME); (ii) Ethiopian Electric Power Corporation(EEPCO); and (iii) Ministry of Agriculture(MOA).

Estimateddisbursements (Bank FY/US$M): 1998 1999 2000 2001 2002 2003 2004 Annual 2.29 21.49 39.88 51.01 50.44 27.50 7.39 Cumulative 2.29 23.78 63.66 114.67 165.11 192.61 200.00 Page2 ProjectAppraisal Document Ethiopia:Energy II Project

For Guarantees: [] Partial Credit [ ] Partial risk Proposed coverage: Project sponsor: Nature of underlying financing: Terms of financing: Principal amount (US$) Final maturity Amortization profile Financing available without guarantee?: [] Yes [] No If yes, estimated cost or maturity: Estimated financing cost or maturity with guarantee:

Expected effectivenessdate: January 31, 1998 Closing date: January 31, 2004

Block 1: Project Description

1. Project developmentobjectives (see Annex 1 for key performanceindicators): The project objectives are: (a) to increasethe efficiency and sustainabilityof Ethiopia's power sector, and to increaseelectricity use for economic growth and improvedquality of life; and (b) to improve utilization efficiency of rural renewableenergy. Progress on these objectiveswill be measuredby Ethiopia achieving by the end of 2002: (i) total system failures of no more than 3 per year (ii) capacity to connect 250,000 new customersto the grid as the distribution networkis rehabilitated and expanded (under a separateproject); (iii) 100% of new industrial applicants for power connectionswill be satisfied; and (iv) inventoryof biomass stock in Northern regions. 2. Project components(see Annex 2 for a detailed descriptionand Annex 3 for a detailed cost breakdown):

Component Category Cost Incl. % of Total Contingencies(US$M) (I) Gilgel Gibe Hydroelectric Plant Physical 281.88 95 (ii) Rural Energy Development Physical/Institution 5.08 2 Building (iii)PowerSector Reform: Legal and Regulatory Reform Institution Building 0.53 Restructuring of EEPCO Institution Building 8.73 3 Total 295.89 100 3. Benefits and target population: The benefits of power sector reform include relievingthe financial burden on the treasury by charging adequate prices, reducing costs, improving quality of service, and by eventuallyattracting private capital for system expansion as needed. A more appropriatecapital structure and better working capital managementwould reduce the cost of capital to EEPCO. The benefit of the Gilgel Gibe hydroelectricplant will result from energy generated and used by consumers during the useful life of the plant, (valued at $330 million). The benefits from the rural energy development component will result from reduced degradation of the rural ecosystem. ProjectAppraisal Document Page3 Ethiopia:Energy II Project

4. Institutionaland implementationarrangements: Implementationperiod: Six years, 1998-2003

Executing agencies: (i) EEPCO for constructionof the Gilgel Gibe HydroelectricPlant and restructuring program of EEPCO; (ii) the Ministry of Agriculturefor the Woody Biomass Inventory; and (iii) MME for the power sector reform program and institutional strengtheningfor rural energy.

Project coordination:(i) EEPCO has appointedproject managementconsultants for Gilgel Gibe; EEPCO's planning unit will be responsiblefor the restructuringprogram; the Ministry of Agriculture will establish a project implementationteam with a project manager for the Woody Biomass Inventory; and (iii) MME, with the help of short- term consultants,as needed, will implementthe power sector reform and the institutional strengtheningfor rural components. Quarterlyprogress reports will be submittedby each of the implementingagencies; because they each have sufficient capacity, there is no need for an overall coordinatingunit.

Accounting,financial reporting and auditing arrangements: EEPCO will have its accounts, including its financial statements, special account, and statements of expenditureaudited by an independentauditor acceptable to IDA. MME will establish a project account and a special account for the power sector reform componentsand the rural institutionaldevelopment. It will have this account, its specialaccount, and statementsof expenditure audited by the Audit Service Corporationor any independentauditor acceptableto IDA. MOA will establish a project account and a special account for the Woody Biomass survey component. It will have these accounts audited by the Audit Service Corporationor any auditor acceptableto IDA. EEPCO will send its audited accounts along with the corresponding audit reports to IDA within six months after the closing of its fiscal year, except for FY97 and FY98 when it will submit these reports nine months after the close of the fiscal year. MME and MOA will send their audited accounts and the correspondingaudit reports to IDA within six months of the close of their fiscal year.

Block 2: Project Rationale

5. CAS objective(s)supported by the Documentnumber and dateof latestCAS discussion: Report No. 17009dated August project 19,1997,discussed by the ExecutiveDirectors on September9, 1997. Ethiopia's major developmentobjective is sustainedpoverty reduction. The Bank's assistance strategy aims to reduce poverty both directly and by promoting sustained economicgrowth, notably by creating an environment conducive to rapid private sector and export development. This will be achievedthrough four clusters of activities: (i) policy and capacity; (ii) infrastructure;(iii) sources of growth; and (iv) poverty and human development. To sustain the Government's GDP growth target of 7-8% per year, as well as to alleviate poverty more directly, a major effort is needed to ease the severe infrastructuralconstraints. As noted in the CAS, per capita electricity consumption in Ethiopia is only one-half that in Mozambiqueand one-sixth that in Kenya, and the shortageof electricity is a major impedimentto industrial growth. The Bank/ESMAP's Energy SectorAssessment (April 1995)provides options and strategies for energy developmentin Ethiopia and provides an analyticalbase for lending. The proposed project supportsthe Government's policy of increasingelectricity use for economic growth and improvedquality of life. The Government recently raised tariffs and proposes, under the proposedproject, to raise them again to commerciallyviable levels. It has also taken measures to commercializethe electric utility (EEPCO), and has acceptedthe need, in principle, for private sector investment,although it is moving cautiouslyto define how this might best be achieved. 6. Main sector issues and Governmentstrategy:

Main Sector Issues:

Electricity operationsrepresent a growing burden on the treasury. Over the past severalyears, the Government Page 4 ProjectAppraisal Document Ethiopia:Energy II Project has maintained electricity tariffs below cost for social welfare reasons. EEPCO has been provided with increasingly large subsidies,both by relinquishingdebt servicingand by direct grants for investment. With vigorous economic growth fueling demand, the treasury can no longer sustain the subsidiesat levels to cover the growing investmentneeds.

Service coverage and quality are low. Only about 5% of Ethiopia's populationhas access to electricity. Where electricity is supplied,the quality of the electricity service is becominginadequate to meet the needs of a growing economythat is becoming increasinglysophisticated. Low access is a result of very low investment in power system expansion over the past several years, especially in the distribution systems that make the final connection to the customer. More recently, and largely as a result of demand growth in existing customers and poor rainfall, Ethiopia went through a period of power rationing. Althoughthe Government minimizedthe impact by instituting a well organized and transparent plan for the rationing,the outages had a dampeningeffect on economic growth; as a result, increasing generationcapacity has become the first priority.

EEPCO's day to day operations need major changes to improve efficiency. EEPCO's day to day operations have been constrained by a lack of managementautonomy and by a shortageof cash resulting from Government policies to keep tariff levels low. Although EEPCO managed to maintain relativelyhigh service continuityto its customers, the institutional frameworkhad few incentives for efficiency and relied on the dedication of individual staff. Also, the managementculture was one that was more concernedabout providing an essential service than operating the utility accordingto commercial principles. Some of the items that must be addressedto improve efficiency are: (a) Improved financial management. Basic operating and managementsystems (such as accountingand customer billing), required to facilitate prompt financial managementdecisions, must be upgraded. (b) The present capital structure cannot sustain long-term investmentsfor growth and must be aligned with that of a commerciallybased electric utility. (c) Receivables must be reduced to the lowest feasible level. (d) Total losses, of about 18%, must be reduced. This implies that investing in distribution system strengtheningwill yield high returns.

Low efficiency in the use of traditional energy sources. Biomass is the only form of energy available to most of Ethiopia's population. A growing populationand drought in some areas has resulted in rapid depletion of biomass resources, for example, 100 years ago about 40% of Ethiopiawas forested; today only 3% is forested. The depletion of biomass resources is exacerbated by inefficientuse. Not only does the inefficientuse deplete the biomass more rapidly, it leads to drudgery for women who have to walk several kilometers every day to collect enough fuel for cooking. Also the inefficientuse of biomass leads to larger volumes of smoke being inhaled by the population and this results in health problems.

Government Strategy:

After ESMAP prepared an Energy Assessmentin 1994,the Governmentmade several changes in the power sector and continues to make more changes. The Governmenthas stated that it intends EEPCO to operate commercially (so that poor people in the countrysideare not subsidizingthe more affluent users of electricity in the urban areas). The specificchanges the Governmenthas made or plans to make are embodiedin two parallel efforts: to design and enact a new legal and regulatoryframework; and to corporatizeand commercializeEEPCO. In the first category, the Government has issued a Proclamation (no.86/1997). The proclamationpromotes private participation; establishes a regulatory authority responsible, among other things, for recommendingtariffs; and establishthe principle of third party accessto the grid (which makes competitionpossible in the future). Regardingprivate investment,the Governmenthas made a proclamationthat Ethiopian citizens can invest in power plants of up to 25 MW.

In the second category, the Council of Ministers has issued a Regulation (no.86/1997)establishing EELPA as a corporationto be named the Ethiopian Electric Power Corporation(EEPCO) under the Public Enterprises Proclamation No. 25/1992. The Corporationis governed by a ManagementBoard. The powers and duties of the Board and of the ProjectAppraisal Document Page5 Ethiopia:Energy H Project

General Manager of the Corporationare clearly indicated in the Public EnterprisesProclamation. Meanwhile,a Task Force within EEPCO has designed an internal restructuringof the utility including giving more autonomy and accountabilityto the seven regionalmanagers, separatingand creating separate accountingfor the non-core activities of the utility, such as constructionand transportmaintenance, decentralizing the accounting and billing systems, introducing a program of human resource development,and improving operations planning.

The Governmenthas announcedan electricity pricing policy to complementthe changes in the managementand structure of EEPCO. The policy includes the eliminationof all subsidiesto EEPCO. Towards this end, the Govermnent has proposedtariff increases in several steps. The Government implementedthe first increase from the previous level of US$ 0.034/kWhequivalent to US$ 0.0476/kWhequivalent in April 1997. At that time, the Government announceda second increase, affecting domestic customers only, to be implementedin 12 months (April 1998). Based on a joint assessment by EEPCO and the Bank of EEPCO's financial needs, the Governmenthas agreed to raise tariffs again by July 1, 1999,to move EEPCO closer to commercialoperation.

In keeping with its new mandate to operate commerciallyand make a profit, Governmenthas announced a new capital structure for EEPCO with authorized capital of 6.1 billion Birr (US$ 924 million), of which about one-third is paid. EEPCO will be subjectto taxation and the payment of dividends.

In addition to supportingimprovements in the use of traditional fuels, the Government is finalizing its policy to extend electricity services to rural areas by (i) networkextensions; and (ii) decentralized systems based on renewable energy (micro-hydro,PV, and wind). In all cases, communityparticipation and ownershipwill be emphasized. A senior official of the Ministry of Energy recently has been on a study tour of UK and USA to study policy options to support renewableenergy resources and technology development. 7. Sector issues to be addressedby the project and strategic choices: Most of the constraints in the Ethiopian power sector, (inadequateinvestment, low efficiency, and extremely low customer access to electricity) can be removed by restructuringthe Sector to promote private investment,competition, and clear and transparent regulation in cases where competition is not possible. The Bank's strategy, in this respect, is based on recommendationsembodied in the report of sector work undertaken by ESMAP in 1994 (ref. EthiopiaEnergy Assessment:Report 179/96issued in February, 1996)

The proposed project will be the Bank's first lending operation in the Ethiopian power sector for about ten years. The project seeks to address two aspects of the necessary evolution of the sector: First, it builds on changes the Government already has made to restructurethe sector and helps establish a continuingdialog with the Government regardingthe other changes it proposes;these changes will further promote private investment. Second,the project addressesmany of the short term issues that constrainefficient operation; it seeks to improve EEPCO's cash flow to permit regular maintenanceand expansion. Also, the project provides the tools required for effective financial managementand full restructuringof the sector, such as decentralizedaccounting and billing systems; these systems will bring immediate efficiency improvementsto EEPCO and could promote private investmentin the Sector. One of the studies included in the project, the generation expansion study, will considerthe economicsof all feasible options for expansion,including the use of natural gas.

The project supports developmentof a hydroelectricgenerating plant, that is part of the least cost generating expansion sequence. Its development will help ensure that the present robust economic growth is not choked off prematurelyby power shortages. A planned follow-up project would strengthenthe distribution infrastructure,another prerequisite for sustaining economic growth. Private investmentin the generatingplant was not feasible at present because of the urgency of the capacity additionand the lack of a precedent for very large private investments.

The second dimension of the project is its focus on rural energy. Since 95% of the population has no access to Page6 ProjectAppraisal Document Ethiopia:Energy II Project electricity at present, it is important to start addressingthe energy needs of this large segment of the population. The biomass information system, that utilizes satellite imagery, helps locate areas where interventionin rural energy is needed and helps in the selection of appropriateintervention methods. The institutionalstrengthening associated with this componentwill help the Government prepare for more focused rural development. A follow-up project is being designed to use various types of renewabletechnologies and new institutionalstructures to help address the rural energy need in a multi-facetedapproach.

During project preparation, the project team attempted,as much as possible, to seek areas of common understandingwith the Government and strengthen and support the Government's actions. In return, the Government has sought the Bank's opinion on most of the actions it has taken, and proposesto take to restructurethe sector. This cooperativeapproach has lead to much more progress than would have been expected in a short time and, if continued, will lead to rapid changes that will improve the performanceof the sector.

Some of the detailed activities that will help support the strategicchoices outlined above are: (a) a study tour, by senior Governmentofficials, of countries where electricity reforn has taken place; (b) a revaluation of fixed assets to help establish EEPCO's revenue requirements;and (c) a tariff study to determine an appropriatetariff structure and rates, and to determine the cost of service at various voltage levels and at various geographic locations in the power system. 8. Project alternatives considered and reasons for rejection: The major choice was between Private-Publicinvestment. The alternativeapproach that was considered by the Project Team was whether to go the " private sector route" for the constructionof Gilgel Gibe HydroelectricPlant including a Build, Operate and Transfer (BOT) option. But initial investigationshowed that private sector interest in such a project in Ethiopia is weak at this stage. The project team, therefore,felt that it would be better to undertake the hydroelectricproject with public sector investmentand vigorouslyto help EEPCO commercializeand decentralize,with cost/profitcenters created both geographicallyand for generation,transmission and distribution. Other options such as managementcontract for all or selected operations of EEPCO were considered,but it was decided by the project team that changes that would promote private investmentare more important at this stage. Regardingother alternatives for power generation(thermal or hydroelectric)please see Annex 4, and the economic assessment in the project files. These documentspresent a discussionon the Gilgel Gibe project as the least cost optionto satisfy electricity demand in the Ethiopian interconnectedsystem up to the year 2000. For a discussion of alternative project designs, please see the Gilgel Gibe feasibility study in the project files. 9. Major related projects financed by the Bank and/orother developmentagencies (completed,ongoing and planned): The Bank has financed four completed projects in the Energy sector,going back to the early seventies; in general, performanceof these projects has been satisfactory. Implementationof the on-going Calub Gas Development Project has been delayed; the Government has formed a high level committeeto prepare for selling the companyto the private sector.

Several donors (NORAD,the Netherlands,Austria, Japan, Switzerlandand AfDB/ADF)are currently financing EEPCO projects. EESRC has received funds from DANIDA,the Netherlands, Sida, UK and USAID; the UK and Germany are planning studies on renewable and wind energy. 10. Lessons learned and reflected in the project design: One of the important lessons that arose from Finchaa HydroelectricProject, which was closed in 1975, was the importance of reasonableload forecastingbefore undertaking a major hydro project, given the time lag requirement,to make sure that the investment is not premature. As a result, for the proposedproject, the project team has sought to ensure that the master plan, of which the Gilgel Gibe is a part, is based on a realistic load forecast. Another major lesson emerging from previous projects is that unless EEPCO is fully commercializedit would be difficult to improve supply efficiency. The relationship of MME and EEPCO is being streamlinedso that their responsibilities and accountabilities will become transparent and clear. EEPCO will be made autonomousand accountable to supply electricity in an efficient ProjectAppraisal Document Page7 Ethiopia:Energy H Project

and business like manner. As it becomes feasible, the Governmentwill continue to promote private investment in the sector. Also, a predeterminedtariff setting mechanismwill facilitate commercialoperation of EEPCO and encourage private sector participation in the sector. 11. Indicationsof borrowercommitment and ownership: The proposed project is being undertaken at the explicit request of the Government.The Government's commitmentto the project is further illustrated by the fact that it has already acted upon several of the Bank's recommendationsfor policy change in the sector. For example,the Governmenthas already enacted a new Electricity Law and the Council of Ministers' Regulationfor convertingEEPCO from an Authority to a for-profit corporation has been issued. Also, the Governmenthas approved a tariff increaseof 39% and agreed to two further increasesby mid- 1999. It has also agreed to undertake a Tariff Study for developing a tariff policy and structure (see also section 6). Under the Electricity Law, the Governmenthas established a RegulatoryAgency under MME. 12. Value added of Bank support: This is a sector which is rapidly being reformed. Until private investment is forthcomingin the power sector in Ethiopia, the Bank, which has been a significantplayer in this sector,needs to provide financing for the least cost solution to electricity supply necessary for economic development. Also, Ethiopiansneed assistance in learning about other countries' experience in reform efforts in the energy sector, and the Bank is well positioned to provide such assistance. The Bank is also playing a leading coordinationand catalyst role with other donors for ensuring a coherent strategy in this important sector.

Block 3: Summary Project Assessments (Detailed assessments are in the project file. See Annex 8)

13. Economic [x] Cost-BenefitAnalysis: NPV=US$35.6million [] Cost Effectiveness [ Other Assessment at 10%;ERR= 11.7% Analysis: [Specify] (see Annex 4): The benefits of the project are: (1) The benefits from the Gilgel Gibe plant resulting from energy generated and used by consumersduring the useful life of the project; (2) the benefits from the rural energy development component resulting from reduced degradation of the rural ecosystem,which has a positive impact on the poor (primarily women) who are the fuelwood gatherers;and (3) the benefits from the power sector reform which will relieve the financial burden on the treasury by charging adequateprices, reducing costs, improving quality of service, and eventually attracting private capital for system expansion as needed.

The major project component,the Gilgel Gibe HydroelectricPlant, which has quantifiable benefits, has been evaluatedby cost-benefit analysis as discussed in Annex 4. The Gilgel Gibe HydroelectricPlant is the least cost option, in the sequenceof studied and feasible alternatives,to satisfy the power demand by the year 2003 when the plant will start its operations. The unit cost of firm energy of the Gilgel Gibe Plant is US$0.067is the lowest comparedto other feasible hydroelectricor thermal power generation options. Environmentaland social costs have been taken into account, including the full cost of relocation, resettlement and mitigation in the project costs (approximatelyUS$19 million including physical contingencies).

The project is economicallyviable, with an economicrate of return of 11.7% and sensitivity analyses show that the economic returns are robust. The sensitivityanalysis (see details in Annex 4) shows that the major risks to achieving the expected economic benefits of the project are: (i) an increasein total project costs (12% increaseof both investment and operations and maintenancecosts makes the NPV nil); (ii) a reduction in Gilgel Gibe's output (13% reduction in the plant's output every year makes the NPV nil); and (iii) delays in commissioningof the Gilgel Gibe plant (a 2 year delay makesthe NPV negative). These risks are mitigated by the fact that EEPCO has been responsiblefor implementing several hydroelectricprojects and will have the support of an experiencedinternational consulting firm for project implementation. Close Bank supervisionand a mid-term review will also mitigatethese risks. The probabilitythat the ERR will be below 10% is negligible. Page8 ProjectAppraisal Document Ethiopia:Energy II Project

Fiscal impact:

The project will have a positive effect on governmentfinances since EEPCO is being commercializedand its current burden on Governmentfinance will be stopped. Furthermore,EEPCO will pay taxes, related to the Gilgel Gibe plant's production,to the Government of Ethiopia (GOE) estimatedat a present value of US$58 million during the life of the project. Estimated dividends paid by EEPCO to the GOE as shareholderamount, at present value, to US$16 million. If tariffs are increasedto commercial levels but no (or limited) dividends are paid by EEPCO to the Govermuent,then the burden on govermnent finances as a result of the project will be limited to expecteddividends on the equity contribution or the opportunity cost of those funds (e.g., if the funds were invested in other Govermnent programs). Covenantsto reduce this risk and to guaranteethe commercializationof EEPCO have been included in the project. The amount of the IDA credit does not have a negative effect on Govermmentfinances since it will be on-lent to EEPCO at adequaterates. The fnancing of EEPCO through the Governmentcould, however, indirectlyaffect the funding of other future priority public sector projects due to the project's contributionto Ethiopia's debt ratio.

Given that the project is a hydro project, it has the advantagethat it will not require petroleum imports (as a thermal project would) and will therefore have a positive impact on balance of payments. Furthermore, given the high cost of power shortages and load shedding,the project will contribute to the overall growth of the economy. 14. FinancialAssessment (see Annexes 4-A & 5 for financial rates of return) Detailed analysis of EEPCO's past and current financial performance,tariff issues and future financial projections are included in Annex 5. Financial rate of return analysis of the Gilgel Gibe component and EEPCO is included in Annex 4-A. 1. EEPCO's Past and Current Financial Performance: EEPCO's electricity sales and revenues have been steadilyincreasing during FY9 1-FY96;however, its profitabilityhas been very low due to low level of tariff and devaluationof the currency.EEPCO's profitability is still overstated since its annual depreciationcharges do not fully reflect the impact of the currency devaluation and the intrinsic value of its fixed assets. EEPCO's capital structure is characterizedby a large outstandingbalance of accountsreceivable and accounts payable partly due to problems with billing and collection. EEPCO intends to reduce its electricity sales debts by improving its billing and collection operations and maintain the balance lower than two months' equivalent of its sales revenue after the end of 1998. EEPCO has financed its investments,debt service and working capital requirementsmainly by long-term loans, grants and contributionssince its internal cash generationhas been inadequateto meet its cashflow requirements. EEPCO will gradually increase its internal cash generationup to 25% of its capital expenditures. While EEPCO's debts to debt plus equity ratio remained in a reasonable level of some 40%, it will need to leverageits capital structure further to meet large investmentrequirements while maintainingthe optimal capital structure.

2. EEPCO's Tariff: EEPCO has sufferedfrom a low level of averagetariffs and long delays in revision. EE'PCOhas not been able to carry out proper maintenanceof its assets or generate sufficientcash from operations. The Government has recently changed its sectorpolicy: EEPCO will be required to operate as a financially independent commercialentity. EEPCO will no longer receive free budgetary contributionexcept for some activities to be taken up by EEPCO due to past policy failures or for social purposes. EEPCO will be able to maintain its tariff at the level that its revenues will be able to cover its operation and maintenanceexpenses, financialand administrative charges, an appropriatereturn on equity and income tax. The Governmentwill require an appropriatereturn on its equity share holding in EEPCO with a premium over the cost of EEPCO's long-term loans. EEPCO will be required to maintain an optimal capital structure to minimize its cost of capital. A tariff revision was approved on April 7, 1997:the average energy tariff was increased by 39 percent to 4.76 US cents. Another increasefor domestic users to be implementedin April 1998 has already been approved. The Governmentand EEPCO have further agreed that the average energy tariff will be increased to by July 1, 1999. Also, major changes in input prices such as fuel prices and currency fluctuation will be automaticallyadjusted in accordance with an agreed price adjustmentformula. There is a need for further review of ProjectAppraisal Document Page9 Ethiopia:Energy II Project

EEPCO's economic LRMC estimates; various studies estimate LRMC in the range between 4 and 12 US cents due to different assumptionsof load forecasts, asset values and investmentcosts. In order to establish an optimal tariff level and structure,in which price distortion is minimized and financial requirementsare appropriatelyaddressed, the Government agreed to carry out a power system expansionstudy, an asset revaluationstudy and a full tariff study.

3. EEPCO's FinancialPerformance Projections: EEPCO plans to meet load demands for FY98-FY2008 period by implementingits investmentand rehabilitationprogram of Birr 9.0 billion. EEPCO would finance its total investments by long-term loans (44%), internal cash generation(20%), equity finance (25%) and grants and contributions (11%). Electricity sales are estimatedto gradually increaseover the Project implementationperiod. Sales revenue is projected to grow by an annual average compoundrate of 15%until FY08. The after tax return on total net assets will increaseto 4.9% by FY08. The return on equity will increaseto 10.3%by FY08 and EEPCO's capital structure will remain sound. The ratio of its long-term loans to total liabilities and equity will remain less than 50% during FY98 - FY08. Its cashflow is estimatedto remain sound. It will generatecash from operations no less than to 25% of its annual capital expenditures in FY2000 and the followingyears. Workingcapital requirementswill also be met during FY98- FY08.

15. Technical Assessment: After diverse alternative design conceptsfor the Gilgel Gibe project and its elements were consideredduring the project's gestation period, the final concept was approved by the Panel of Experts in December 1996. The proposed design consists of a 40-m high, curved rockfill dam, a 9 km long power tunnel, a surge shaft, an undergroundpower house with three generatingunits, a tailrace tunnel, a cable shaft, and an outdoor switchyard.However, at the same time that it approved the design concept, the Panel of Experts also requestedthat a campaignof additional geological investigations be carried out to serve as a basis for (a) deciding whether an earthfill dam would not be more adapted to the relatively soft terrain on which the dam will be founded; and (b) to permit optimizingthe location of the undergroundpowerhouse (having as much of its volume as possible to be in good quality rock). A meeting of the Panel in July 1997 concludedthat the rockfill dam is appropriate. Also, the geological investigationshave helped locate an appropriate block of rock for the constructionof the undergroundpowerhouse. The plant will be equipped with three Francis turbines driving three 61.3 MW generators for a total installed capacity of 184 MW. Average annual potential generationwill be 770 GWh, while the firm energy capacity will be 640 GWh/year.Three step-up transformers located in the outdoor switchyardwill raise the generated voltage to the 220 kV transmissionlevel. The transmission line that will link Gilgel Gibe with the Sabatha substationnear Addis Ababa is already built but needs some rehabilitation. Somesubstation rehabilitationand two short transmission links are required to completethe system. The total cost of the Gilgel Gibe component is estimatedat US$281.9million, includingphysical and price contingencies,but excludingtaxes. The Consultantshave prepared very detailed cost estimates that were discussedwith the project team, during its pre-appraisalmission, and the Chairmanof the Panel of Experts in May 1997. The Bank found the cost estimates, as well as the assumptionson which they are based, to be reasonable. The contingency allowanceswere found to be adequate, given the currentknowledge of the geology. For the purposes of procurement,the project has been divided into 9 lots, which will each be the object of a separatecontract: (1) power tunnel; (2) preliminaryworks for the powerhouse;(3) ancillary works for the powerhouse;(4) undergroundpowerhouse, shafts, tailrace tunnel and switchyard;(5) dam and appurtenant structures; (6) turbines and inlet valves; (7) generators and balance of plant; (8) penstockand gates; and (9) transmission line and substationrehabilitation and expansion. Lots 1, 4, and 5 require prequalificationof contractors.Prequalification for lots 1 and 4 is already underway.All procurementto be financed by IDA will follow WorldBank procedures. Page 10 ProjectAppraisal Document Ethiopia:Energy II Project

The construction schedule,which was also reviewed during the World Bank mission of May 1997, and found to be reasonable, shows that the first generatingunit would begin operation in March 2002, followedby the other two units at intervals of two months each. To advise it on all technical matters relating to project design and construction,EEPCO has appointed a four- memberPanel of Experts, currently being financed from an advance for project preparationfacility (PPF). The project will continue to finance the services of the panel until completionof the works.

To support adequate operation once the plant is commissioned,the project will financetechnical assistance for setting up a modem system for maintenancemanagement, as well as the organization and resources for dam safety. The project will also finance technical assistance and training for EEPCO's System OperationsDivision, to provide an operationsplanning model for optimizing reservoir management. 16. InstitutionalAssessment: A. Executing 4gencies:The main executing agencywill be the EthiopianElectric Power Corporation(EEPCO). EEPCO was previously the Ethiopian Electric Light and Power Authority which was set up in 1956 as a statutory agency wholly owned by the Ethiopian Governmentto generate,transmit and distribute electricity. In April 1997, the Cabinet approved its conversionfrom a statutory agency to a Corporationunder the Public Enterprise Act of 1992. EEPCO currently operates two systems, namely the InterconnectedSystem (ICS) and the Self Contained System (SCS). The ICS has a total installed capacity of 380.6 MW and serves the major towns and industrial centers. ThleSCS has a total installed capacity of 38.2 MW and services isolated supply centers throughdiesel generators. By EEPCO's own assessment, while it attempted to develop a reasonabletechnical and managerial competence,it was not able to complement it adequately with effective support services due to lack of sufficient financialbacking and material support which a utility business demands. A study task force for the restructuringof EEPCO was established in May 1995, and its December 1996 Report was commentedon by Bank staff. Its main recommendations,which will be implementedsoon and supportedunder this project, include commercializationof EEPCO's activities, completeautonomy of operations under a ManagementBoard, and decentralizationof responsibilitiesto the nine Regions. EEPCO has executedseveral projects funded by the Bank and I other donors, includingthe recently completed Energy I Project.

B. Project Managementwill be undertakenby:

(a) The Ministry of Mines and Energy (MME), for the SectorReform Program.

(b) EEPCO will be responsible for constructionof the Gilgel Gibe project, as well as the utility's Restructuring Reform Program. For project execution, EEPCO has established in Addis Ababa a project office under an experienced project manager. The Gilgel Gibe Project Officereports directly to EEPCO's General Manager, and acts as a liaison with various agencies and governmentbodies associatedwith the project. The Project Office also maintains technical staff on the site for carrying out and/or coordinatingfield investigationsand other preparatoryworks. Under the terms of its contract with EEPCO, a Consultant is responsiblefor setting up the project organizationat site, and for supervisingall aspects of project implementation.The Consultantwill assure the liaison between the contractors, the suppliers, and EEPCO through the Project Office. Two camps, includinghousing, office facilities, and warehousesalready exist at the site. The Consultant is required to assume full responsibilityfor the project at the site, and will assign a Resident Engineer (Site Manager), as well as other staff as required for effective supervisionof the works. The Project Office will also assign EEPCO's engineers, technicians and other personnel to the project site, to work under the direct supervision of the Consultant. The Gilgel Gibe Project Manager will also be responsiblefor coordinatingwith the Oromia and other Regional Governmentson resettlement activities and the environmentalmitigation plan.

(c) MME will implementthe Rural Energy InstitutionalDevelopment component. It has sufficient trained and experiencedstaff to undertake the project with the help of specializedconsultants. ProjectAppraisal Document Page 11 Ethiopia:Energy II Project

(d) The Ministry of Agriculture will managethe WoodyBiomass inventorythrough its Woody Biomass office. This office is adequately managed and staffed to implementthe componentwith the help of specializedconsultants.

C. Procurement capability: 6fordetails on procurementand disbursementarrangements, see annex 6)

(a) EEPCO has executed a Bank project in the past and consultantswill assist in civil works and supply/erect contracts. MOA's portion will be executedby the woody biomassgroup and they will employ consultants. They also have experience from the implementationof the Energy I Project. The MME component is small and they will hire a consultant if necessary. 17. Social Assessment: The resettlementplan has been prepared by EEPCO in collaborationwith the Oromia Regional Governmenton whose territory the project site and the resettlementarea are located. About 2,000 households(12,000 people) will be resettled. The selected resettlement site of 8,000 hectares used to be a military training ground, now left in fallow. The area is not only large enoughto provide land for the project affected population(PAPs), its soils are similar to those soils currently cultivatedby the PAPs. The Oromia Regional Governmenthas transformedthe resettlement action plan to a development project, and this will enhancethe livelihood of the PAPs. The plan prepared is consistent with World Bank Operational Directives on InvoluntaryResettlement. About 1,000 squattersare living under the transmission line from Gilgel Gibe to Addis Ababa. The line was built about 12 years ago and remained unenergized. These people will be asked to move and will be compensatedfor the loss of their houses.

Through communication,consultation, and participative decision making, the various stakeholders have taken part in the planning of the project. For example,every householdhas receiveda visit in their homes, from project staff planning the resettlement.

In June this year, the resettlementplanning had a delay of six months,but the work is now progressing well. Six extension agents have been in the field revisitingthe familiesto be resettled in order to make a last check of the number of people and amenities to be taken into account. The houses will be self-built, followingthe local building tradition but with the building material supplied by the project. The project office in Addis Ababa is not only functional but has created an enabling environment. Project staff there, project staff in the field and the Regional Council of Oromia are well prepared and committedto the project. Funds are set aside for the continuationof the implementation.

The project planning is satisfactory. The institutionalcommitment is strong and likewise the institutional capacity. There is, however, a need for temporarytargeted capacity building activities. 18. EnvironmentalAssessment: Environmental [x] A [] B [] C Category A satisfactoryEnvironmental Assessment (EA) report has been submittedby the government and was available to the public in Ethiopia from May, 1997.

Major environmentalissues include loss of 300 ha of riparian forest for wildlife, altered downstream flows for 16 km of the Gilgel Gibe River, increased habitat for water-bornedisease vectors of bilharzia and malaria, increase in transmission of sexuallytransmitted diseases(STDs), including HIV/AIDS,and potential increase in alcohol abuse.

Minor environmentalissues includetemporary noise, dust and safety concerns from construction,influx of laborers for construction,increase in costs of basic commodities in the local economy.

Proposed Actions: The Project area has been enlarged to provide a 2,600 ha buffer zone around the reservoir free from human habitation and intensive use. The buffer zone will provide wildlife habitat, reduce sedimentation,and reduce transmission of water borne diseases. An amenity flow will provide water throughoutthe year for the stretch of river Page 12 Project Appraisal Document Ethiopia:Energy 11 Project between the dam and the powerhouse.A vigorous sex and health education campaign will be carried out for the work force and the local community. EEPCO will have an on-site environmentalunit to manage and monitor environmental conditions during construction.

NGOs Consulted: Peasant Associationsin the affected areas and the resettlement areas have actively participated in the project planning. 19. ParticipatoryApproach: Identification/Preparation Implementation Operation Beneficiaries/communitygroups CON CON IS IntermediaryNGOs CON CON IS Academic institutions CON IS IS Local government COL COL iS Other donors COL COL IS Other (specify)) Other (specify)) Other (specify)) Other (specify))

Defiition: CON= consultation COL= collaboration IS informationsharing 20. Sustainability: Essential factors critical for sustainabilityof project benefits are: (i) a reliable tariff-setting mechanism to be in place; (ii) corporatizationof EEPCO; and (iii) reform of the power sector. 21. CriticalRisks (see fourth column of Annex 1):

Risk Risk Risk Minimization Measure Ratin! Government long-term commitmentto Moderate Since Governmentlong-term commitment to reform is critical, power sector reform may falter ensure that a reasonablenumber of steps towards sector reforms are undertaken during project preparation. Several steps have been taken.

Governmentfinds that increasingtariffs to Moderate The first tariff adjustmentof 39% has already been made. commercial levels (higher of LRMC or Another one in 12 months' time (April 1998) has been officially financial)is politically too costly announced. The Governmenthas also agreed to another increase on July 1, 1999.

Overall project risk rating Moderate EEPCO has been responsiblefor implementingseveral hydro- electric projects. On the reform side, the Government's commitment seems firm.

22. Possible ControversialAspects: There are no serious negative factors or potentialcontroversies expected to affect the Project. Kenya, as a riparian of the Omo River, (the project will be constructedon its tributary Gilgel Gibe river) has given its No Objection to the Riparian Notice sent by the Bank on behalf of the EthiopianGovernment. Ethiopia already has six hydroelectricplants; constructionof all of these went smoothly as they were acceptableto civil society and the NGO community. The settlementplan has been widely discussedand consultationshave taken place with each one of the affected households and the NGO community. The rate of compensationis consideredreasonable and adequate. Project Appraisal Document Page 13 Ethiopia: Energy II Project

Block 4: Main Loan Conditions

23. EffectivenessConditions Prior to credit effectiveness,(i) EEPCO will establish a Project ManagementUnit (PMU)with a competent Project Manager;(ii) the Governmentwill establish a PMU within MME headed by a competent coordinator; and (iii) the Governmentwill establish a PMU within MOA headed by a competent coordinator. EEPCO's PMU and the units within MME and MOA would: (a) coordinateexecution of the project; (b) communicatewith IDA and other financiers on various componentsof the project; and (c) deal with all correspondence,procurement activities, financial reporting and progress. Also, a subsidiary loan agreement will be executed between the Borrower and EEPCO. 24. Assurances During negotiations,the Governmentand EEPCO gave assuranceson the following:

Sector Reform and EEPCO Restructuring

1. No later than June 30, 2000, EEPCOwill have developed and installed a decentralizedaccounting system, and providedthe necessary training to its staff. 2. No later than June 30, 1999, EEPCO will have adopted a plan to decentralizepart of its billing and collection system (as a pilot scheme), and no later than June 30, 2000, it will have installedthe system and trained its staff in its use. 3. No later than June 30, 1999, EEPCO will prepare and submit to IDA a Human Resource DevelopmentPlan, and, on receipt of IDA's comments, promptly implementthe plan. 4. No later than August 31, 1999, EEPCOwill have completeda power system expansion study which will includeconsideration of all feasible generatingoptions. On completionof the study, provide IDA with a copy for comments. No later than November 30, 1999,EEPCO will have adopted a plan based on the findings of the study acceptable to IDA. 5. No later than November 30, 1999,EEPCO will have completed an evaluation of its fixed assets and will have revalued its fixed assets based on the evaluationby June 30, 2000.

Tariffs

1. No later than July 1, 1999, EEPCO will increasethe averagetariff. 2. No later than April 30, 2001, EEPCO will have carried out a full tariff study utilizing information from the power system expansion study and the valuation of assets, and no later than November30, 2001, will adopt an action plan, includinga tariff escalation forrnula,for the implementationof the recommendationsof the tariff study. 3. Beginning in July 1998,EEPCO will review the level of its tariffs at least every six months for inflation and foreign exchange rate changes and adjust the tariff level accordingto an agreed formula. 4. Until the Project completion,the Borrower shall ensure that electricity prices allow EEPCO to cover its operatingcosts, earn adequatereturn on invested funds, meet its financial obligationsand make a reasonablecontribution to future investment.

Financial

1. Except as IDA shall otherwise agree, EEPCO shall (a) produce funds from its internal sources equivalent to no less than 10% for FY98, 20% for FY99 and 25% for FY2000 onwards,of the average annual capital expendituresto be incurred for the next three year period; (b) not incur any debt unless it is able to maintain, each fiscal year during the terms of debt to be incurred,a ratio of cash generatedfrom operationsto debt servicerequirements of no less than 1.3; and (c) maintaina ratio of long-term loans to total sum of all liabilities and equity of no more than 50%. The ratio of EEPCO's current assets to current liabilities shall be greater than one. 2. By adopting a detailed plan of action for the recovery of overdue accounts by June 30, 1998, EEPCO shall, by Page 14 Project Appraisal Document Etiiopia: Energy II Project

March 31, 1998, reduce its accounts receivable to no more than 60 days of sales and maintain it at less than that level thereafter. 3. Except as IDA shall otherwise agree, the Government shall not provide EEPCO with grant contributions except: (a) a one-time contribution to EEPCO's rehabilitation projects in generation, transmission and distribution included in its FY96-06 investment program to compensate for maintenance that was deferred because low tariffs; and (b) to undertake, at the Government's request, any investment program for social purposes.

4. Unless IDA shall otherwise agree, EEPCO shall not undertake any investment exceeding by more than five percent of the project investment program costs (Birr 9.0 billion) for 1997-2006.

Safety and Environment

1. EEPCO shall continue to employ competent consultants to manage construction and commissioning of the Gilgel Gibe Hydroelectric Plant, and shall continue to employ a competent Panel of Experts for the duration of the implementation period. 2. No later than six months before the expected completion of the dam and structures, EEPCO shall provide IDA with details of its arrangements for regular inspection and maintenance of the dam and associated structures. 3. No later than June 30, 1998, EEPCO will (a) establish an environmental unit at the Gilgel Gibe site, and implement the environmental mitigation plan; and (b) submit to IDA the first progress report on the resettlement plan for the population at the project site. 4. No later than June 30, 1998 EEPCO shall carry out a social study and prepare a detailed plan for the resettlement of the population in the right of way of the transmission line from Gilgel Gibe to Addis Ababa. 5. No later than December 31,. 2000, EEPCO shall implement the resettlement plan for the population in the right of way of the transmission line from Gilgel Gilbe to Addis Ababa.

Annual Review

1. No later than October 31 of each year, commencing on October 31, 1998, the Govemment shall undertake with IDA and EEPCO ajoint annual review on all matters relating to the progress of the Project.

Mid-term Review

1. On or about 30 months after the effectiveness date, the Government shall carry out, jointly with IDA and EEPCO, a mid-term review of progress made in carrying out the project.

Block 5: Compliance with Bank Policies

[x ] This project complies with all applicable Bank policies.

Tasi'Manager: Coitry Director: Annex 1

Ethiopia - Energy II Project Project Design Summary

Narrative Summary Key PerformanceIndicators' Monitoringand Supervision Critical Assumptionsand Risks

CAS Objective To reduce poverty both By 2003, supply 222 GWh per Confirm from EEPCO records Economicgrowth is directly and by promoting year electricity to industrial that the additional consumers broadbased leading to sustained economicgrowth, consumers, and 323 GWh to have been connected. increasedpower requirements throughfour clusters of residential/commercial at approximatelevels assumed activities,among them, a major consumers(from Gilgel Gibe). for power load growth. effort to ease the severe infrastructuralconstraints.

ProjectDevelopment Objectives 1. Improved power sector By 2002, Ethiopia achieves: Supervisionof the project Critical assumption is that the efficiency and sustainability, -capacityreserves of 10% in componentswill ensure the Governmentwill successfully and increasedelectricity terms of frmnenergy, and of achievementof the restructureEEPCO and generationcapacity for 30% in terms of installed performance indicators:bi- improve its operating economicgrowth and power; annual field supervisionand efficiency. improvedquality of life of -Total system failure of no close contact with the Ethiopians. more than 3 per year; implementingagencies will be -100% new industrial required to ensure timely connectionsrequested be met; completion,and improvement -Installed capacity for in operations;also review and generationincreased by 180 monitor: MW at Gilgel Gibe with no -audited EEPCO accounts; cost ovenun; 2 -power system operation statistics; -statistics on no. of consumers and processing of new connections. 2. Improvedutilization of -Complete inventoryof -Annualreview of statistics -None. rural renewableenergy. biomass resources in Northern from Ministriesof Agriculture Ethiopia. and Energy. -Help establish agencyto deal with Rural Energy.

I Baselineand targeted values shouldbe shown,with the latterdivided into valuesexpected at mid-term,end of projectand full impact. 2 Expectedinvestments in distribution(including a possible FY99 project financed by IDA) will allow output of the generators to be supplied to customers. Page 16 Annex I Ethiopia: Energy II Project

Narrative Summary Key PerformanceIndicators' Monitoring and Supervision Critical Assumptionsand Risks ProjectOutputs 1. Restructuredpower sector: -By the end of 1997, the -Bi-Annualsupervision -Government's long-term (a) Promote private sector following is in place: rules missions. Close collaboration commitmentto reform is participation;(b) with correct facilitatingprivate participation with MME and EEPCO critical. pricing system; and (c) in the power sector: a providing them any reform strengthened,commercialized regulatoryagency (by end- informationneeded from other EEPCO. 1997);an adequate pricing successfulreformers. system; third party access to the grid; and EEPCO convertedinto a for-profit corporationby end-1997.

2. Increasedelectricity -EEPCO's dependablecapacity -Bi-Annualvisit to the Dam -None. The constructionwill generationcapacity. increasedby 194 MW at Gilgel site to review construction be contractedout to contractors Gibe by 2003 with no cost progress. Receive and study of internationalrepute with overrun, increasingEthiopia's progress reports of the project adequate guarantees in the firm generation capacityby constructionon a quarterly contract for finishingon time 644 GWh per year. basis (review computerized and within budget. Project MonitoringSystem Reports). Collaborateclosely with the project managementat all times.

3. Completedata on biomass -Completionof resource -Bi-Annualreview of latest -None. The implementing resources in NorthernEthiopia. Atlases and formulationof inventory information. agency has good experience. strategic plans for 6 regions.

4. Establishmenta capabilityto - Rural Energy group - Bi-annual review of Rural -Government's commitmentto deal with Rural Energy. establishedby June 30, 1999. Energy program. rural energy developmentis critical.

Components: 1. Support of power sector reform program: (a) - Study tours for policy - Study tours completedby -Task force reports. Little risk as Government task makers. June 1998. forces have sufficientlyclear objectives and enough - Assistance for implementing - New ElectricityProclamation -Review of successivedrafts understandingof issues to a regulatory framework. in place by end-1997. of legal documents. design a regulatorysystem for the power sector, creating incentives for private mvestment. (b) -ElectricityTariff Study -Tariff study completed by -Review of draft /final report - Parliamentapproves the April 30, 2001. proposed new tariff structure - Trainingfor Regulatoryand - Training completed by end- - Trainingreports. without major changes. Agency staff. 1999. Project Appraisal Document Ethiopia: Energy 11Project Page 17

Narrative Summary Key PerformanceIndicators' Monitoringand Supervision Critical Assumptionsand Risks (c)___ _ - Restructuringand strengtheningof EEPCO: (i) assistancefor - Utility incorporatedas for- - Review of EEPCO's program - Government is committedto corporatization& profit enterpriseby end-1997. on restructuring. commercializingthe utility but reorganization; we have to monitor progress.

(ii) assistance for asset - Assetsrevalued by - ReviewDraft and final EEPCO must incorporate revaluation; November 30, 1999. reports. results in its accounts.

(iii) assistance,training, and IT - Utility's commercial - Close review of Utility's for decentralizingbilling & operations and accounting ManagementInformation accounting; systems decentralizedby mid- System. 2000 (TA & training).

(iv) manpowerdevelopment; - Training program. - Trainingreports.

(v) assistanceand Information - Operationsplanning model - Model documentation. Technologyto improve installedand in use by mid Operationsplanning reports. operations planning; 1999.

(vi) system expansion study. - expansionstudy completed by August 31, 1999.

2. Constructionof Gilgel Gibe - Gilgel Gibe commissionedby -Regular supervision. Low risk. EEPCO has good hydroelectricplant (180 MW). mid 2002 with no cost overrun experience in supervisingthe project management consultants who will monitor 3. Improvementof rural energy construction. efficiencyand data base: (a) woody biomass survey; - Survey completedby 2002. -Regular supervision. (b) assistance in establishing -Rural group fully functioning group to deal with rural by 2000. Energy. Annex 2

Ethiopia - Energy II Project

Detailed Project Description

The project comprisesthe followingcomponents:_

* Decentralizationof EEPCO's Accountingsystem; * Decentralizationof part of EEPCO's Billing systemas a pilot; * Manpowerdevelopment to supportEEPCO's restructuring; * Constructionof the Gilgel Gibe hydroelectricplant; * Developmentof a Rural Energycapability; * Completionof the WoodyBiomass inventory in the North of the country; * Studiesincluding sector restructuringstudy, a generationexpansion study, a tariff study,and a valuationof fixed assets; * Assistancewith Sector Restructuring.

T;hefollowing is a descriptionof the components:

Decentralizationof EEPCO's Accountingsystem

The intention is to provideEEPCO's sevenRegional managers and, in the case of Addis Ababa, its four Zonal managerswith a fully computerizedaccounting capability. Decentralizingthe accountingresponsibility would reduce the time taken to close accounts at the end of the year and would have a beneficialimpact on security becauseseparate audits of the Regionsand Zones would quickly identifythe source of any irregularities.

The procedurefor implementingthe system would be one in which a competentaccounting firm would managethe update of EEPCO's accounts,taking care to preservethe audit trail. The firm would select a comprehensivesuite of accountingsoftware, arrange for any hardwareneeded and transfer the accounts in stages to the new system. The consultantwould be responsiblefor training EEPCO's staff to ensurethat they are fully familiarwith the system. Anothertask that must be performedis to change the mode of operationof the present data processingdepartment from data processingto providingdata security and maintenanceof softwareand hardware.

Decentralizationof EEPCO's Billingsystem

At present all bill calculationsare done by EEPCO's main computerin Addis. This involves reading the meters all over the countryand physicallytransporting the readingsto Addis where they are processedin batches. The batches of bills are then redistributedfor local distributionto customers. Under this procedure,EEPCO assumes that there will be a delay in collectionof bills of 60 days after the electricityis actually used. In practicethe delay-averages105 days.

EEPCOis working on a short term solutionthat involvesthe installationof workstationsat regional offices linked by communicationlines to the main computerin Addis. This would shift the responsibilityfor enteringthe customerreadings and printingthe bills to the Regionaloffices, ProjectAppraisal Document Page19 Ethiopia:Energy II Project but the processingwould continueto be done in a batchedmode by the main computerin Addis. Under this plan, there would be no change in the billing cycle exceptthat the bill calculation would occur one week earlier.

The proposalto decentralizethe billing systemenvisages a distributedcomputing environment, where the Branch offices would be fully equippedto calculatetheir own bills and managetheir customers,thus givingthe managerthe appropriatetools and correspondingresponsibility. With the distributedsystem, the lag betweenmeter reading and bill preparationcan be reduced to two to three days, giving EEPCOsignificant cash flow benefits. EEPCOis cautiousabout quickly changingthe entire operationto distributedcomputing in the Branch offices because of concerns about securityand the capabilityof the present staff. EEPCOhas agreed to implementthe new systemin three Branch offices and, if it is satisfiedthat there is improvementwithout security problems,to continueto implementthe system for all of its Branchoffices.

The decentralizationwould require the following:

* renovationof the branch offices; * the installationof computers,power conditioningequipment, printersand magnetic storage equipment. * the installationof suitablecomputer software; * extensivetraining of staff (this can be reduced somewhatif the interface of the softwareis very well designed); * consultingservices to plan and managethe installationand training.

The pilot projectof three offices can be completedin nine to twelve months.

ManpowerDevelopment

EEPCO plansto reorganizeto give more authorityto Regionalmanagement, and to establish non-core functionssuch as the constructiondepartment, workshops and garages as separatecost centers , eventuallymoving to have them competewith outside contractorsfor work. The purpose of the manpowerdevelopment component is to providethe managementtraining and technicalskills to EEPCO's managementthat would help them performthese new functions. EEPCOwill prepare a detailed list of its requirementswith the help of consultantsas necessary.

Gilgel Gibe HydroelectricPlant

The Gilgel Gibe hydroelectricplant, scheduledto be commissionedin 2002, will have a capacity of 180MW, and will increaseEthiopia's firm generationcapacity by 640 GWh per year, and its averagegenerating capacity by 770 GWh per year.

The proposed Project, as originallyconceived, consisted of two power stations in cascade,each with two units of 45 MW each for a total capacity of 180 MW. After extensivestudies of the geologyin the area, the scheme was recentlychanged to a design consistingof single undergroundpowerhouse with three units of 61.3 MW each.

Teams from North Korea carried out the initial studiesfor the project. These studies included extensivefield investigations,with borehole drillingat the dam site, along the tunnel route, and at the originalpowerhouse location. Work has been started on the diversionchannel, the upstream Page 20 Annex 2 Ethiopia: EnergyII Project and downstream headings and an adit of the tunnel. Both temporary and permanent housing for personnel is practically completed, although some upgrading will be needed to meet international contractors' standards. Construction equipment including aggregate processing plants, a concrete batching plant and some movable construction machinery is at site. Most access roads have been constructed. The transmission system to connect the power stations to the Ethiopian Interconnected system has been built; only local connections to the Gilgel Gibe substation and substation in Addis Ababa are still to be done. Also, some of the substations must be upgraded.

The Project is located about 260 km South-West of Addis Ababa on the main highway from Addis Ababa to Jimma. The Gilgel Gibe scheme includes a regulating reservoir with Full Storage Level (FSL) at Elev. 1669 m created by a 40.0 m high, curved rockfill dam, with a crest length of 1600 m, sealed with a bituminous upstream facing. The Project would develop a 230 meter gross head on the Gilgel Gibe River, a tributary of the Omo River. The Omo River flows into Lake Turkana which is partially in Ethiopia and partially in Kenya. The river's catchment area, at the dam site, covers 4,225 square km. Gross storage capacity is computed at 803 million cubic meters of live storage. The water surface area of the reservoir at FSL would be 48 square km. Long term average inflow is estimated at 52.9 cubic meters per second while usable regulated discharge is 39 cubic meters per second, or a 74% regulation. With the revised design, water would be taken from the reservoir to the turbines by a 5.5 meter diameter, concrete-lined, headrace tunnel, 9.0 km long, and three 250 meter, steel penstocks of various diameters. A surge shaft, 16m in diameter towards the downstream end of the tunnel would project the tunnel from hydraulic hammer surges. Three 61.3 MW vertical, Francis turbines generators would be installed at the powerhouse.

Commissioning of the Project would be expected by the year 2002. EEPCO hired Messrs. Electroconsult and Messrs. ENEL of Italy to review and complete the design of the scheme, and to supervise its construction. Given the size and complexity of the project's structures, particularly the dam, in accordance with World Bank guidelines, EEPCO has hired a Panel of Experts (POE) to review the design and construction of the project. The POE consists of independent, internationally known engineers with particular knowledge of the technical disciplines involved in the Project

EEPCO's current estimate shows the cost of completing the project to be US$ 281.8 million including physical and price contingencies or about US$ 1500 per kW.

Except for the dam, the structures proposed for the Project are straightforward and will be located in relatively competent geology, mainly massive basalt. A significant portion of the dam, about 700 meters of its total length of 1.7 km would be sited over competent basalt. The balance of one km would be sited over tuffaceous clay interbedded by volcanic ash with traces of burnt wood. The tuffaceous clay shows relatively low permeability but high compressibility, as much as 6% to 10%. The volcanic ash layers exhibit high permeability. The current design to control leakage under the dam, involves the use of a grout curtain cutoff done from a gallery at the foot of the dam, where the asphaltic concrete mask would be tied in.

Dam Safety, Maintenance Management System and Optimization of Water Use

The project includes a component to provide consulting services, training and the appropriate software to: establish a dam safety unit in EEPCO, establish a systematic maintenance management system for the Gilgel Gibe plant; and establish a group in the operations center to ProjectAppraisal Document Page 21 Ethiopia: Energy 11Project optimize the use of all the reservoirs. These systems will improve the efficiency of EEPCO's generation operations and help raise the profile of dam safety activities.

Rural Energy Development.

The component consists of two sub-projects: (i) Woody Biomass Inventory and Development Project; and (ii) the strengthening of the Government's capability to deal with rural energy. A brief description of each of these projects is given below.

* Woody Biomass Inventory and Development Project. There will be woody biomass inventory data collection and survey in Tigray, Amhara, Harer and Dire Dawa, Benishangul- Gumuz, Afar and Somali Regions. In all 658,000 square kilometers will be surveyed. On completion of the survey work, detailed Atlas and preparation of strategic plans for rational planning and management of forestry resources in these six regional states will be done. Also, a survey will be undertaken at a scale of 1:250,000 using high resolution panchromatic satellite imagery in nine regions. The survey will indicate the extent and productivity of grazing lands, and undertake a livestock carrying capacity analysis. In addition, 12 persons will be trained overseas and locally in woody biomass inventory studies and remote sensing. * Strengthening of Rural Energy Capability. This component will provide the means for the strengthening of a group to deal with rural energy and to support the Government's decentralization objective. This group will undertake technology development work and its main focus will be adapting technology for use in Ethiopia. There will also be training of research personnel overseas in various energy research fields.

Institutional Development

The government is in the process of designing a program to reform Ethiopia's power sector with the objectives of ensuring the long-term sustainability and economic efficiency of electricity supply, and of relieving the financial burden the sector currently imposes on the Treasury.

The program is proceeding along two parallel tracks. In the first place, a Task Force coordinated from the Prime Minister's office is working on the definition of a new legal and regulatory framework, to be embodied in an Electricity Proclamation (Electricity Law) together with secondary laws and regulations. The new legal framework promotes private participation in the power sector, and creates a regulatory authority. The new framework will also include the definition of an efficient electricity pricing system, and would establish conditions to make competition possible in the future. The project will finance a study tour for policy makers, and will provide specialist services to assist in the design of the new sector structure and the corresponding legal and regulatory systems. The project would also finance training for the regulatory agency's staff, as well as information-technology equipment and services required to set up the agency, and expert assistance during an initial period. The project will finance a tariff study to implement the pricing system.

The second aspect of the reform program is the restructuring of the state-owned utility (EEPCO) to convert it into a for-profit corporation operating on a commercial basis. The restructuring would also decentralize the utility's operations. An essential element consists of increasing the utility's management autonomy and accountability. The project will finance specialist services for (i) designing a new Financial and Accounting System; (ii) billing and Page22 Annex2 Ethiopia:Energy II Project customer servicing systems;and (iii) human resourcedevelopment, including executive managementdevelopment training. It will also financehardware and software,as well as training.As a basis for the tariff studymentioned in the previousparagraph, the project will finance consultingservices for assetrevaluation and for updating the utility's power system expansionplan. Finally,the projectwill financetechnical assistance and informationtechnology to improve operationsplanning (hydro-thermal operations optimization). Annex 3

Ethiopia - Energy II Project

Estimated Project Costs

Project Component Local Foreign Total ------US $ million------

Gilgel Gibe Hydroelectric Plant 70.13 175.22 245.35 Rural Energy 0.25 4.59 4.84 Institutional Development:

- Legal and Regulatory Reform -0- 0.50 0.50 Restructuring of EEPCO 0.30 8.07 8.37 Subtotal,Institutional Development 0.30 8.57 8.87 Total Baseline Cost 70.68 188.38 259.06

Physical Contingencies 6.83 15.00 21.83 Price Contingencies -0.30 15.30 15.00

Total Project Cost 77.21 218.68 295.89 Annex 4

Ethiopia - Energy II Project

Cost Benefit Analysis Summary For the Gilgel Gibe Hydroelectric Plant Component (Currency: US$, Units: Million, and Base year: 1997)

Present Value of Flows Fiscal Impact Economic Financial Analysis Analysis' Taxes Subsidies Benefits 330.0 See Annex 4-a

Costs 295.9

Net Benefits: 35.6 154 (EEPCO) 69 (EEPCO)3 ERR: 11.7% 58 (Gilgel Nil (Gilgel Gibe) Gibe) Dividends:2 212 (EEPCO) 16 (Gilgel Gibe)

Economic Analysis (see details in Economic Assessment Report in the Project File): In order to evaluate the economic viability of the Gilgel Gibe hydroelectric plant, an economic rate of return (ERR) has been calculated on the basis of the incremental cost and benefit streams associated with the Gilgel Gibe project component. Benefits will result from energy generated and used by consumers during the useful life of the plant. Benefits are valued in terms of the incremental demand that can be served under the project compared to the lower level of demand that could be served if no new supply capacity were added to Ethiopia's Inter-connected System (ICS). The costs are the costs for generation (the cost of the Gilgel Gibe hydro plant) and transmission and distribution needed for delivering the extra energy generated by the plant.

The Gilgel Gibe Hydroelectric Plant (194 MW of dependable capacity) is the least cost option to satisfy the electricity demand in the ICS by the year 2003 when the plant will start its operations. In terms of least cost for the medium to short term, the first candidate is Tis Abay II followed by Gilgel Gibe. Tis Abay II (a 73 MW run-of-the-river hydro plant) is under construction now and

'The differencebetween the present value of financialand economicflows is due to the fact that economic valuesare estimatedtaking intoaccount the consumers'surplus derived from the electricityconsumed that will substituteexisting energy methods(kerosene, fuelwood, diesel) by electricityfrom the Gilgel Gibe Hydroplant, whilefinancial analysis is based on the currentand expectedtariff levels. 2 This is the presentvalue of dividends,at 10%discount rate, which are paid by EEPCOto the GOE as shareholderuntil FY2025. 3 EEPCO'soperations and maintenanceare not subsidized.The low tariffsthat were chargedby EEPCOin the past are being progressivelyraised so that EEPCOwill be able to operate and maintainits plant adequately.This amount is the present value of grants fromthe Governmentto EEPCOto fund rehabilitationand expansioninvestments only during FY98-2006,to compensatefor the insufficient expansionand rehabilitationprovided earlier due to lackof funds. ProjectAppraisal Document Page25 Ethiopia:Energy II Project its constructionis scheduledto start in 1998 and be completedin 1999. The unit cost of firm energyof the Gilgel Gibe Plant is US$0.067(including transmission upgrading), which is the lowestcompared to other already studiedand feasiblehydroelectric or thermal options. Tekeze (184MW),although apparently less expensivethan Gilgel Gibe at a per unit energycost of US$0.06,is still at feasibilitystage of preparation. Other hydro plants have per unit energy costs in the US$0.08to US$0.10 range. Gilgel Gibe is also the least-costoption comparedto thermal power generation,since thermal's energy cost, when used on base-loadduty, rangesfrom US$0.08to US$0.11,due to fuel transportationcosts which are high in Ethiopia due to the long distancefrom the port. Thermal power generationalso has the disadvantageof using imported fuel which requires scarce foreign exchange. Regardinggeothermal power generation,the most advancedstudy of the geothermalresources is for the Langano-Alutofield in the Lakes District which would provide 30 MW of capacitywith a unit cost of base load energy supplyestimated at US$0.07/kWh,which is higher than Gilgel Gibe. Other geothermalfields with larger unit sizes, which might have significantlylower cost - US$0.045/kWh- have not been exploredyet. Indigenousgas resources- Calub gas field in the Ogaden- could becomea good alternative,but would not be availablein the near future since only a smallgas utilizationproject, financed by IDA, is now being implemented.

A load forecastfor Ethiopia's ICS was done by an internationalconsulting firm in 1993 and updated in 1995. EEPCOlater revisedthose estimates in May 1996and April 1997 to reflect recent economicdevelopments. An internationalconsulting firm reviewedEEPCO's load forecast in August 1997. EEPCO's forecast is based on detailedassessments and projectionsfor the main customer categories. For the existingcustomers, this forecast estimatesenergy demand from relationshipsbetween power demandand economicgrowth and energy prices. For new load, the expectedadditional load from waitlistedcustomers, transfers from the SCS to the ICS, as well as new towns underthe rural electrificationprogram has been estimated.

Total benefits are estimatedby each class of customer(domestic, commercial, and industrial). Benefits for domesticconsumers arise from the consumers' surplus derived from the electricity consumedthat will substituteexisting methods of lighting(kerosene lanterns) and cooking (fuelwoodinjera stoves) by electric lightingand cooking. The consumers' welfare is derived from the power consumedat a lower price fromthe switch from non-electricalmethod of lightingand cookingto electricforms. Similarly,benefits for commercialconsumers arise from the consumers' surplus derived from electricityconsumed that will substituteexisting methods of lightingby electricity lightingat a lower price. Benefits for industrialconsumers arise from the consumers' surplusderived from electricityconsumed that will substituteexisting methods of electricitygeneration (installing and operatingdiesel-based generators) by electricityfrom the ICS. For the estimationof consumers' surplus demand is assumedto be linear. The per kWh equivalentprice of Kerosenefor lightingfor domesticconsumers is US$0.19and of fuelwoodfor cooking is US$0.12. The per kWh equivalentprice of Kerosenefor lightingfor commercial consumersis US$0.15. The per kWh price of self-generatedelectricity (diesel) for industrial consumersis US$0.17. Environmentaland economicbenefits due to improvedenvironmental managementand enhancedresources in the project area have not been quantifiedand are thereforenot includedin monetaryvalue as part of the benefits.

Costs are incremental(investment and operationsand maintenance)as comparedto the "without project" scenario in whichnone of the investmentswould have been made. Investmentcosts are calculatedby adding physical contingencies(which vary from 4-20% for various projectsub- components)to the base costs. Costs are expressedin 1997 prices net of taxes and duties. Page 26 Annex4 Ethiopia:Energy II Project

Environmentaland social costs have been taken into accountby includingthe full cost of relocation,resettlement and mitigationin the project costs (approximatelyUS$19 million includingphysical contingencies). One indirectenvironmental cost is the reductionin about 15 Gwh/ per year of energy productionaimed at keeping an amenityflow in the river), which could provide a consumerbenefit estimatedat about US$1.6million per year. A shadowexchange rate of ETB7=US$1 has been used to reflect the opportunitycost of foreign exchange. Labor costs are estimated usingmarket rates, thereforeno opportunitycost adjustmentshave been made. Cost of capital is estimatedat an opportunitycost of 10%. Investmentcosts includethe costs of the Gilgel Gibe Hydro plant and the necessaryinvestments in transmissionand distributionto deliverthat electricityto the consumers. Operationsand maintenancecosts are the O&M costs of the Gilgel Gibe plant plus the incrementalO&M associatedto transmissionand distribution necessaryto deliverthe incrementalelectricity generated by Gilgel Gibe to the consumers.

Net benefits from the Gilgel Gibe plant are estimatedby subtractingthe incrementalcosts associatedto the Gilgel Gibe componentfrom the incrementalbenefits. This results in US$35.6 million of net present benefits discountedat 10%. The ERR is 11.7%.

Main Assumptions(See details in EconomicAssessment Report in the Project File): Discountrate: 10% Averagegrowth in electricitydemand: 13.7%per year (1997-2002) Growth in GDP: 7.5% per year Real exchangerate: Constant at ETB7=US$1 Growth in real prices of output: See Annex 4A. Price elasticityof demand is assumedto be negligible,however, since currentlythere is a large demand for electricitywhich is unservedand there are limitedopportunities for substitutiongiven the higher price and limitedavailability of alternativeenergy sources. Costrecovery: EEPCO's tariff will be adjustedto allow for financial sustainability(See Annex 4a) Technicaland Non TechnicalLosses: Graduallydecrease from 18% in 1997to 16% in 2002

Nature of Benefits: Consumers'surplus derived from additionalpower generatedand consumedduring the useful life of the plant

Main beneficiaries: Domestic,commercial and industrialconsumers that will have a readilyavailable source of energy at lowerprice

Switchingvalues of critical items: Total Project Costs: If both investment(which alreadyinclude physical contingencies)and operationsand maintenancecosts increaseby 12%,the NPV becomes nil EnergyOutput: If Gilgel Gibe's output is reduced every year by approximately13%, the NPV becomes nil Constructiontime: If Gilgel Gibe is commissionedone year later (with no other cost increase),the ERR dropsto 10.4%. If there is a 2 year delay, the ERR drops to 9.5% and the NPV becomes negative ProjectAppraisal Document Page27 Ethiopia:Energy II Project

Demand: If demand grows slowerand only 65% of Gilgel Gibe's output could be utilized, and Gilgel Gibe cannot be fully utilized until the year 2007, the NPV becomesnil Technicaland Non-TechnicalLosses: If losses are not reducedfrom 18%to 16% in 2002 and are kept at 18%, the ERR drops to 11.1%. If losses increaseto approximately25%, the NPV becomesml

This sensitivityanalysis showsthat the major risks to achievingthe expectedeconomic benefits of the projectare: (i) an increasein total projectcosts; (ii) a reductionin Gilgel Gibe's output; and (iii) delays in commissioningof the Gilgel gibe plant. These risks are mitigatedby the fact that EEPCOhas been responsiblefor implementingseveral hydroelectric projects and will have the support of an experiencedinternational consulting firm for project implementation.Close Bank supervisionand a mid-tern reviewwill also mitigatethese risks.

Risk Analysis: Probabilistic(Monte Carlo) risk analysiswas carried out to assessthe impacton the project's ERR of the uncertaintyin key variables,particularly the energy output, projectcosts, construction time, demandforecast and technicaland non-technicallosses. A commerciallyavailable softwarewas used. The risk analysis showsthat the base case ERR varies from 10.0%to 13.5%, with a negligibleprobability of being less than 10%.

Figure 1: ProbabilityDistribution for ERR

Forecast: 031 10,000 Trials FrequencyChart 6 Outliers .025 252

.01918

.01312

'-.006 6

.000 10 10.0% 10.9% 11.8% 12.6% 13.5% Annex 4-A Ethiopia - Energy II Project

FinancialAnalysis Sunmmary EEPCOCorporate Financial Return and Gilgel Gibe HydroelectricPower Plant ComponentReturn (Currency;US$ million:and Base Year; 1997)

EEPCO CorporateReturn Instruments FinancialRate of Return

Long-termDebts 5.0-6.9 % (FY2000- FY2008)

Equity 9.7-14.7%(FY2000- FY2008)

Gilgel Gibe Hydro Instruments PresentValue Rate of Component Return (with 10%) Long-termDebts Costs 164.9 (annual interest: Return 141.8 8%) Net Return -23.1 8.5% Equity Costs 13.8 Return 45.4 =______==______= XNetReturn 31.6 50.3%

1. FinancialRate of Return Analysis: The financial rate of return analysiswas conducted for EEPCO's corporatefinancial return and the Gilgel Gibe Hydropowercomponent. The returns are calculatedfor specificcategory of investorsand debt holders since the investmentrisk of each stakeholderis different. The rates of return are all on the basis of ex-tax (35%) returns.Major assumptionsare summarizedin the paragraph7 of this Annex. The detailed data are availablein the Project File.

Financial Rate of Return

2. EEPCOCorporate Financial Return: EEPCO's debt holders' average return will be in the range of 5.0% and 6.9% during FY2000-FY2008.The existingdebt holders' averagereturn is around4.5% and new debt holders' return is estimatedat 8%. The return for equity investors is estimatedat in the range of 9.7% and 14.7%during FY2000-FY2008since the tariff is set to produce,on average,12% return on equity investments.

3. Gilgel Gibe Hydro ComponentFinancial Rate of Return : Debt holdersfor the Gilgel Gibe HydropowerPlant componentwill earn 8.5% return on its cashflows. The difference between the assumed8% interestrate on debts and actual return of 8.5% arises from the interest roll-upduring the repaymentgrace period. The equity investorswill earn a return of 51.6%from this componentsince the averageenergy tariff is to be set basedon the EEPCO's system-wide cost of capital and operations,rather than the long-runmarginal cost of capital and operations specificto the Gilgel Gibe component. The weightedaverage cost of capital for EEPCO's total systemis estimatedat some 6-8% duringFY98-FY08 period, while the weightedaverage cost of ProjectAppraisal Document Page29 Ethiopia:Energy II Project capital of Gilgel Gibe component is estimated at 8.3%. The average unit cost of generation of the Gilgel Gibe power plant is roughly estimatedat US 6.7 cents per kWh, excluding transmission and distributioncosts.

Sensitivity Analysis

4. A switchingvalue analysis, using 10%discount rate, was conducted. The financial rates of return for debt holders are not the dependentvariables of input factors such as tariffs, demand growth, cost overrun, and constructiondelays unless these affect the debt holders' investment risk or credit worthiness of EEPCO: therefore,the switching values are estimated only for the equity holders. Returns on equity are sensitive to tariff changes and demand growth: but, not so sensitive to cost overrun or construction delays.

5. Tariff: If the level of energy tariff is eroded to 4.4 US cents equivalent due to inflation, currency devaluationor delays in tariff revision throughoutFY99-FY08, the EEPCO's corporate wide return on equity is estimatedto drop to around 0% towards FY2006. The net present value of the return on equity for Gilgel Gibe would decrease to 0 if the average tariff is eroded to 6.0 US cents equivalent throughoutFY99-FY08.

6. Growth Scenario: The equity return for Gilgel Gibe component would have negativenet present value if the demand growth goes down to 9.6% during FY98-FY03 and 6% during FY04- FY08, comparedto 13.5% during FY98-03 and 7.5% during FY04-08. Under the same assumptions,the rates of return on EEPCO would be reduced to same 7% from 10%during FY04-08.

Main Assumptions

7. Discount rate: 10%

Average growth in electricity consumption 13.5 per annum on average during FY98-02 and 7.5% per annum on averageduring FY03-08.

Average EEPCO energy tariff: Birr 0.3141 (US$0.0476)for FY97. The average tariff will be set to meet the financial objectives.

Terms of long-termdebts: 8% interest with 5-year grace for principal repaymentswith 20-year installments

Resettlementand relocation costs: the costs are born by the Government

Finance for the Gilgel Gibe component: Long-term debt US$234 million (93%) Equity US$19 million (7%)

Finance for the FY97-FY06EEPCO program: Long-term debt US$594million (44%) Equity US$346 million (25%) Cash from OperationsUS$273 million (20%) Grants US$154 million (11%) Annex 5

Ethiopia - Energy II Project

I. EEPCO Past and Current Financial Performance: FY90/91-95/96

1. The past sevenyears have been an extraordinaryperiod for EEPCO:there was a major managementchange after the end of Civil War in 1991,the EthiopianBirr was devaluedby 142 % from Birr 2.07 per US$ to Birr 5.00 per US$ in 1992and Eritrea became independentin 1993. The devaluationof the currency,especially, had a significantnegative impact on EEPCO's profitabilityand its service capacity to its debt obligations.

2. EEPCO's historical financialperformance during FY91 -FY96 is summarizedin Table 5.1 below, and the detailed financial statementsare includedin the Project File.

Table 5.1: EEPCO's FinancialPerformance, FY91-96

CY9I CY92 CY93 CY94 CY9s CY9B Exdlge FRate (Average.) USS1.00=ET Bff 2.07 2.81 5.00 5.09 8.15 6.15 Conawner FPricIncrease (%) 35.7 10.5 3.5 7.6 10.0 10.0

EELPAKey FinancialPerbmwnce Inicators FY9O/91 FY91/92 FY9293 FY93J94 FY94/96 FY95i96 (ST '000 u slested oihew) I_ Instled Capaity I( 367.1 367.1 367.1 367.1 380.0 412.1 Sale (March96 report)(GW) 945.3 995.0 1,035.3 1,133.9 1,178.4 1,284.5

Impid Aveae Twif (ETrKVVh) 0.202 0.198 0.204 0.202 0.238 0.265 Impld AverapeT2iff (U 6) 0.098 0.070 0.041 0.040 0.039 0.041

Total OperatingnRevenue 200,502 207,872 232,787 252,097 289,484 382,484 OepratingMatrgin | = B60,251 57,416 64,627 75.263 105,732 148,732 ProfitLoss befm Appropriton 16,144 (24,490 (85,301) (57.327) 16,132 44,627

Tota Cnret Assets I 511,451 568,368 630,770 712,685 926,681 1.342.564 Tote FiuedAssets 1,936,682 2,052,126 2,636,316 2,904,529 3,019,882 2,993,390 TotalAssets 2.448,132 2,620,494 3,259,068 3,617,214 3,946,543 4,335,954 Tot CremLntiabibties 4 355,773 510,143 . 709,548 829,567 1,045,717 969,053 Total Long-termLoans 694,507 753,730 1,245,486 1,465,945 1,448,112 1,780,485 Total Equity I I. 1,397,853 1,358.621 1,314,053 1,321,702 1,454,715 1,609,414 Total Liatattiand Equity I _= 2,448,132 2,620,494 3,269,086 3,617,214 3,948,543 4,335,952

Tota: Funds tom Operations _ 56,057 3,293 (18,548) 11,176 110.179 174,435 Tot: Fundsfrom Ohr Sources 180,311 120,602 534,489 288,232 128.,29 440,528 Tobl: Sourceof Funds 236,368 123,895 515,941 299,409 238,609 614,963 Tot Applicat of Funds 216,141 221,347 652,944 337,513 240,982 327,428 Total:Wobldng Capitalrcea (Deease) _12.881 (121,959) (147,657) (148.332) (96,048) 195,279 MovementinCash = i -| 7,345 24,607 10,654 110,238 93,874 92.256 Annual Rnue Growth(%) |ToWtOpwn Revee Prev.Yer 22% 3.7% 1Z0% 8.3% 14.8% 25.2% Operatin Marn (%) Opeatn MargirTotAl Rnuev | j 30% 28%9 28% 30% 37% 41% Potm Margin(%) Froh/Lossbefore AppTrot Revenue 8% -12% -37% -23% 6% 12% Ratum on Total Assets(%) PrclttiLossbore App EndTotal Assets 0.7% -0.9% -2.8% -1.E% 0.4% 1.0% CueoriraeboCies) z rntAsset wreLabilihiesa 1.4 1.1 0.9 0.9 0.9 1.4 Long-termDebtsDebs+Equi1y (%) 28% 29% 38% 41% 37% 41% SalesNdsldn Capital(Tlme) i 1.3 3.6 -3.0 -2.2 -2.4 1.0 AccomutReceivable (Ds) iDebtorfrotal Revenue36S 394 427 447 329 342 595 CasMowfromOperertioCurrent UsabOites(Utmes) 0.2 0.0 (0.0) 0.0 0.1 0.2 CsflwfrfommOperatios/nteres Charges+Loaneayents (ie)12 0.1 (0.7)1 0.3 1.6 0.7

Revenues and Profitability

3. EEPCO's electricitysales and revenueshave been steadilyincreasing during FY91- FY96. Its electricity sales have been increasingby an averageannual compoundrate of 6.3% from 945GWhin FY91to 1,285 GWh in FY96. Its salesrevenue has been increasingby an averageannual compoundrate of 12.2%from Birr 191 million in FY91 to Birr 340 million in FY96. ProjectAppraisal Document Page31 Ethiopia:Energy II Project

4. Despitethe steady growth in electricitysales and revenue, EEPCO's profitabilityhas been very low mainlydue to delays in tariff revision and devaluationof the currency. Its profit margin remainednegative during FY92-FY94and increasedonly to 14% in FY96. Its net profit returns on total assets were negligibleor negativethroughout FY91-FY96: it remainedin the range from[-]2.6%to 1.1%.

S. EEPCO's profitabilityis overstatedsince its annual depreciationcharges do not fully reflect the impactof the currencydevaluation and the intrinsicvalue of its fixed assets. After the devaluationof the currencyin 1992,only the increasein value of its fixed assets financedby the long-termloans was incorporatedinto its balancesheets. Its fixed assets have not been revalued since 1989. Under the proposedProject, an asset revaluationstudy will be conductedand its outcomewill be incorporatedin the accountsand used in the follow-ontariff study.

Capital Structure and Finance

6. EEPCO's capital structureis characterizedby a large outstandingbalance of accounts receivableand accountspayable partly due to inefficientbilling and collectionand a dispute between the Ministryof Finance and EEPCOregarding the debt service obligationsof its existing non-multilateralloans. Its outstandingbalance of electricitysales debts during at the end of FY96 was Birr 154 million or about 5.4 months equivalentof its annual sales revenue. Its creditor's outstandingbalance increasedcontinuously from Birrl68 million in FY91to Birr 540 million in FY96,equivalent to some 19-monthworth of its total revenue, since EEPCOdid not serviced its debt obligationsof non-multilateralloans to the Ministryof Finance due to disagreementas to who bears the debt service obligations.

7. EEPCOintends to reduce its electricity sales debts by improvingits billingand collection operations. A more efficient and decentralizedbilling and collectionsystem will be introduced on a pilot basis under the proposedProject and additional2% of outstandingbalance of electricity sales debts will be written off as provisionfor bad debts. EEPCOwill maintainthe outstanding balanceof electricitysales debts equivalentto two monthsof its annual electricitysales revenue after end-1998. As for the outstandingbalance of accountpayable, the dispute betweenthe Ministryof Finance and EEPCOon debt service obligationswill be resolvedby end-1998.

8. EEPCOfinances its investments,debt service requirementsand working capital requirementsmainly by long-termloans, grantsand contributionssince its internal cash generationis inadequateto provide significantportion of its cashflowrequirements. It is estimatedthat EEPCO's accumulatedcashflow from operationsprovided only 15% of its accumulatedcashflow requirements during FY91-96:the accumulatedcash generationfrom operationduring FY91-96 amounted only to Birr 337 million (half of which was generatedin FY96 alone), comparedto the accumulatedfund requirementsof someBirr 2,270 million during the period. The rest of requirementswere met by long-termdebts of Birr 1,208million (53%), grants and contributionsof Birr 462 million(20%), and working capital charge of Birr 306 million(12 %).

9. While EEPCO's debts to debt plus equity ratio remained in a reasonablelevel of some 40%, it will need to leverage its capital structure furtherto meet large investmentrequirements and, at the same time, to maintainan optimal capital structure. During the Project period, EEPCOwill graduallyincrease its contributionfrom internalcash generationto the capital Page32 Annex5 Ethiopia:Energy II Project expenditureup to 25% while it will maintainthe debts to debt plus equity ratio under 50%. The Governmentwill make equity investmentsand will require appropriatereturn on investments.

EEPCO's Compliance with Financial Covenants under IDA Credit 1704-ET

10. A loan of US$45 million was providedto EEPCOduring 1986-1995under IDA Credit 1704-ET for rehabilitationof its infrastructurein generation,transmission, substations, distributionand other operationalassets. Under the Credit, amongothers, the followingfinancial covenantsin Table 5.2 were agreed to; however,they were not compliedwith by GOE or EEPCO during most of the Project period. The major factors that affectedthe Borrower and the implementingagency's financialperformance were the civil unrest and the change in govermnent. The new governmenthas made remarkableprogress in stabilizingthe economy and has introduceda sector reform program. It has recentlyestablished the electric utility as a corporationand has shown its commitmentto the sustainabledevelopment of the sector and the efficiencyimprovement.

Table 5.2: Compliancewith FinancialCovenants under Credit 1704-ET

Covenants Status Credit Local CurrencyInvestment Requirements: GOE shall - Partiallycomplied with. 3.04 take all measuresnecessary to ensurethat EEPCOshall - GOE provided grantsand timely have at its disposalsufficient funds to meet the budgetarycontributions to local currencyrequirements of EEPCO's investment EEPCO. I program Credit Tariff Revision: GOE shall take or cause to be taken - Not compliedwith. 4.02 all measuresrequired to enableEEPCO to adjust its - There was no tariff revision tariffs and meet its obligationsunder Project during FY90-95to catch up Agreement with inflationand currency devaluation. Project AccountReceivable: EEPCOshall have reduced its - Not compliedwith. 3.04 accountsreceivable to no more than 90 days of sales - Its outstandingbalance of by July 7, 1987 accountreceivable remained at around 7-10 months equivalent. Project Intemal Cash Generation: EEPCOshall produce funds - Not compliedwith. 4.02(a) from its intemal sourcesequivalent to not less than - EEPCO's internal cash 15%for FY88,29% for FY89 and 25% thereafter of generationcovered less than EEPCO's averageannual capital expenditures 10% of its capital investments during Project period. Project Debt Ceiling: EEPCOshall not incur any debt without - Not compliedwith PA4.03 IDA's agreementunless the 12 month net revenueprior - The ratios were less than to incurringthe new debt covers at least 1.5 times one most of the project future maximumdebt service includingthe new debt. period. Project InvestmentCeiling: EEPCOshall not until the - Compliedwith. 4.4 completionof the project undertakeany major projects - EEPCOhas not taken on which shall exceed 1.5% of EEPCO's gross revalued any major new investments assets in operationand which is not includedin the duringFY90-95 due to Power Sector InvestmentProgram agreed with GOE. managementtransition. ProjectAppraisal Document Page33 Ethiopia:Energy II Project

II. EEPCOTariff

1. EEPCOhas sufferedfrom low averagetariffs and long delays in revisingtariffs. The level of the averagetariff has been so low that EEPCOhas not been able to carry out proper maintenanceof its assets and it has not been able to providefrom its cash for operationsany more than 10% of its capital expendituresuntil FY96. Tariff revisionshave been implementedonly five times since 1960,with insufficientincreases after a long delays. As a result, EEPCOhas been heavilydependent on budgetarycontribution and grantsfrom the Government.

2. The Governmenthas recentlychanged its sector and pricingpolicy: it has improvedthe tariff policy to ensure that EEPCOwill be able to operateas a financiallyindependent commercialentity. EEPCOhas been transformedto a limitedliability company as set forth in the proclamationNo.25/1992. The Governmenthas set up a sinkingfund up to Birr 2.7 billion to be used for its equity investmentsand contributionsto EEPCO.

FinancialAspects of New Tariff Policy

3. Under the new sector policy, EEPCOwill no longer receivefree budgetarycontributions exceptfor someactivities to be taken up by EEPCOdue to past policy failures or for social purposes. EEPCOwill be able to maintain the averagelevel of tariff so that its revenueswill be able to cover its operationand maintenanceexpenses, financial and administrativecharges, an appropriatereturn on equity and incometax obligations. The Governmentwill require an appropriatereturn on its equity share holdingin EEPCOwith an appropriatepremium over the cost of EEPCO's long-termloans. EEPCOwill be requiredto maintainan optimal capital structure to minimizeits cost of capital.

4. Under the new sector policy, a recenttariff revisionwas approvedon April 7, 1997. The averageenergy tariff was increased by 39 percentfrom Birr 0.2254 (3.42 US cents) to Birr 0.3141 (4.76 US cents). Another increasefor domesticusers to be implementedin April 1998 has alreadybeen approved. Furthermore,the Governmenthas agreed to raise tariff levels again in July 1999to maintainEEPCO's profitability. EEPCO's currentlyapproved energy tariffs and other charges are includedin the Project File.

5. Major changes in input prices such as fuel prices and currencyfluctuation will be automaticallyadjusted in accordancewith an agreed price adjustmentformula, after the tariffs are adjustedstructurally based on the analysis in the proposedtariff study.

6. The detailed financial requirementsand tariff calculationsare includedin the Project File. Its financialimplication for EEPCO's future financialperformance is presented in Section III.

RemainingIssues

7. Whileseveral attemptshave been made in the past to estimateeconomic long-run marginal cost (LRMC)of EEPCO's operation,there is a need for further reviewof EEPCO's economicLRMC estimate. EEPCO's tariff study in 1992estimated its economicLRMC at around 5 US cents, on the basis of the preliminaryGilgel Gibe hydropowerplant development program. ESMAPstudy in 1993estimated the economicLRMC at some 7-8 US cents based on Page 34 Annex 5 Ethiopia: Energy 11Project

the preliminaryAleltu hydropowerplant developmentplan. EEPCO's power systemplanning study in 1996 estimated its LRMCin the range of 7-12 US cents based on varioushydropower plant expansionplans.

8. The variancesin various estimateswere caused by difference in crucial assumptionssuch as load forecasts,asset values, and required investmentcosts. These factors would require fiurtherreview since the economicenvironment is drasticallychanging. In order to establish an optimal tariff level and structure in which price distortionis minimizedand financial requirementsare appropriatelyaddressed, the Governmentagreed to carry out a power system expansionstudy, an asset revaluationstudy and a full tariff study. The power system expansion studywill be completedby August 31, 1999, and the asset revaluationstudy will be completedby November30, 1999. The full tariff studywill be initiatedshortly after the abovetwo studies in orderto incorporatethe outcomesof the studiesand the outcomesof whichwill be implemented from November30, 2001.

m. EEPCOInvestment and FinanceStrategy and FinancialPerformance Projections

EEPCOInvestment Program: FY97-FY2006

i. EEPCOplans to meet load demandsfor FY98-FY2006period by expansionand rehabilitationof generation,transmission and distributionassets and improvementsof its operationalefficiency. The total cost of investmentsis estimatedat Birr 9.0 billion for the period. The investmentprogram for FY98-FY2006is summarizedin Table 5.3 below and details are includedin the Project File.

Table 5.3: EEPCOInvestment Program FY97-FY2002

Project costC (Birr mio) l Completion(CY) Generation Tana BelesRegulation 27.1 1997 Rehabilitation FinchaPenstock Rehabilitation 10.0 1997 FinchaGenerator & TurbineRehab. 18.5 1999 Koka Rehabilitation 2.0 1999 AwashII & III Rehabilitation 69.1 1999 Tis Abay Rehabilitation 2.0 1999 Generation Aluto LanganoGeothermal Plant (7.3 MW&62.7GWh) 111.3 1998 Expansion MediumSpeed Diesel Power Plant (21 MW &179 GWh) 103.9 1998 GilgelGibe Hydro Power Plant (180 MW & 642GWh) 1,736.2 2002 TisAbay II HydroPower Plant (73 MW& 331GWh) 504.0 1999 Fincha4th Unit Expansion (33.3 MW & 137GWh) 135.0 2000 Tekeze(203.3 MW & 981Gwh) 2,456.8 2002 Gojeb(102.0 MW & 364Gwh) 1,616.0 2006 Transmission Rehabilitationand Expansion 1,403.0 2005 andSubstation Distribution DistributionRehabilitation and Expansion,and Rural 824.0 2005 Electrification RehabilitationTotal 317.7 ExpansionTotal 8,700.8 Total 9,018.5 ProjectAppraisal Document Page35 Ethiopia:Energy II Project

EEPCOFinance Plan: FY97-FY2006

2. In order to maintainan optimal capital structure,EEPCO intends to financeits total investmentsby long-termloans (44%), internalcash generation(20%), equityfinance (25%) and grants and contributions(11%). Grantand contributionswill cover rehabilitationcosts since the long overduerehabilitation work is caused by the past sector policy that did not allow EEPCOto carry out propermaintenance. The plan for FY97-FY2006is summarizedin Table 5.4 belowand detailsare includedin the Project File.

Table 5.4: EEPCO Finance Plan FY97-FY2006

FY97 FY98 FY99 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 TOTAL

Loan 304 724 539 713 698 495 240 208 - 3,921 Equity 76 181 162 238 233 371 240 208 459 2,281 2,281

ICG 51 121 216 396 388 310 172 149 - - 1,801

Grants 76 181 162 238 233 62 34 30 = - 1,015 Total 506 1,206 1,078 1,584 1,552 1,238 686 595 459 113 9,019 LTL/L+E 38% 43% 45% 46% 46% 45% 44% 43% 40% 38%

3. Under the new sector policy, EEPCO's revenue will cover its operating and maintenance expenses,financial and administrativecharges, appropriate return on equity and incometax. The major assumptionsare as follows:average cost of existinglong-term loans is 4.5 %; average cost of new loans is 8%; and return on equity is 12%,or 4% premium over the average costs of new long-term loans. The average cost of capital is estimated remain below 7% throughout FY2008.

EEPCO Financial Performance Projections: FY98-FY2008

4. Projections of EEPCO's financial performance are made based on the above assumptions and the summary is presented in Table5.5 below. Detailed assumptions and financial projections are included in the Project File. Page36 Annex5 Ethiopia:Energy II Project

Table 5.5: EEPCO'sFinancial Performance Projections (FY98-08)

NW______097/38 0/ 02000 00/01 01/02 02/03 jO3/04 04/0 0/06/S 06/07 M7/0 (1997Constart Birr MiDin) . ICGSup (GWh) 1,368.4 1,477.0 1,670.0 1,933.0 2,130.0 2,455.0 2,696.0 2,925.0 3,147.0 3,383.0 3,832.0 3,862.0

hncome _ _t______Revenue _ 418.8 494.2 661.3 947.2 1,043.7 1,203.0 1,321.0 1,433.3 1,542.0 1,057.7 1,779.7 1,892.4 Opeat MaigIn 196.6 241.4 370.4 601.9 652.1 759.8 846.3 925.3 1,004.2 1,095.6 1,194.3 1,285.5 ProfitaftwTax 72.4 104.4 188.3 339.4 380.4 430.7 437.1 4532 457.6 470.8 505.1 554.2 Reaned Eaw, after Div. 72.4 104.4 186.3 270.0 213.7 219.4 197.1 188.1 137.4 137.0 171.3 220.4 inttnal CaahGeneatn Actl IGCAvalio _ 117.9 178.6 258.9 379.6 356.4 377.6 346.1 331.3 264.0 238.7 249.7 281.6 Ann4mlInvest Req.(AIR) 506.4 1,206.0 1,078.0 1,584.3 1,551.8 1,238.0 666.3 595.3 459.2 113.2 ActualIGC/AIR 13% 14% 18% 26% 31% 45% 60% N.A. N.A N.A NA. NA PlannedIGCOAIR 10% 10% 20% 25% 25% 25% 25% N.A. N.A. NA N.A. NA. iBalanceShee_t CuentAssts _ 1,052 979 792 545 553 609 770 841 991 1,224 1,377 1.627 NetFbcad Asets 3,430 4,536 5,492 6,922 8,289 9,318 9.781 10,141 10,358 10.223 9.976 9.730 TotaAuset 4,482 5,515 6.284 7,467 8,842 9,927 10,551 10,982 11,347 11,447 11.353 11.357

CurrentLiabilites 1,000 900 700 500 570 589 606 525 441 467 400 400 LTLoa I 1.692 2,359 2,818 3,456 4,082 4,495 4,631 4,717 4,566 4,393 4,194 3,978 Dev.Reaeve. 566 568 566 56 566 566 556 566 568 566 56 566 Grant 776 957 1.118 1,356f 1,589 1,851 1,685 1,715 1,715 1.715 1,715 1,715 RetalnedEarnngsl (128) (23) 163 433 6476 86W 1t,063 1.251 1,389 1,526 1,697 1,918 CoawnonShae I__ 576 757 919 1,156 1.389 1,760 2,001 2,209 2,668 2,781 2,781 2,781 Totl L&E I4.482 5.515 8,284 7.487 8,842 9,927 10,551 10,982 11,347 11,447 11,353 11,357

FIFnancialPenrfomnce IndIcator. .. I .,= CntRego 1.05 1.09 1.13 1.09 0.97 1.03 1.27 1.60 2.25 2.62 3.44 4.07 ROA(ProlttaltertaxbeforeDlv.) 1.6% 1.9% 3.0% 4.6% 4.3% 4.3% 4.1% 4.1% 4.0% 4.1% 44% 4.9% ROE(DRt+RE+CS) _ 7.1% 8.0% 11.3% 15.7% 14.6%, 13.5% 12.0% 11.3% 9.9% 9.7% 10.0% 10.5% Op.MargIn _____ 47% 49% 56% 64% 62% 63% 64% 65% 65% 66% 7% 68% LTDe E __T _ 38% 43% 45% 46% 46% 45%1 44% 43% 40% 38% 37% 35% Caeh pnOettServ. 2.08 2.79 3.10 4.94 6.29 2.92 2.43 2.13 2.01 2.01

5. The electricity sales is estimatedto graduallyincrease from 1366GWh in FY97to 2244 GWh in FY03. EEPCO's sales is projectedto grow by an annual compoundrate of 14% from Birr 494 million in FY98to Biff 1,892 million in FY2008.

6. The operatingmargin is estimatedto improve from 47% in FY97 to 68% in FY08. Profit after incometax will increasefrom Biff 72.4 million in FY97 to Birr 104.4 million in FY98 and then will graduallyincrease to Birr 554 million in FY08. The after tax return on total net assets will increasefrom 1.9% in FY98 to 4.9 % in FY08. The return on equity will increasefrom 8.0% in FY98to 10.5% in FY08, which is close to the target return for equity used for the tariff calculation.

7. EEPCO's capital structurewill remain sound. The ratio of its long-termloans to total liabilities and equity will remain less than 50% throughout the period FY97 - FY08. Its current ratio is estimatedto increasefrom 1.05 in FY97 to 4.07 in FY08.

8. EEPCO's cashflowis estimatedto remainsound. EEPCOwill meet target ratio of internallygenerated cash to annual capital expenditure(IGC ratio) throughoutFY03: its target IGC ratio would be 10% in FY98, 20% in FY99, 25% in FY2000and 25% in FYO1,as compared to the targets of 10% for FY98, 20% for FY99,25% for FY2000onward. Its working capital requirementswill also be met throughoutthe period FY98-FY08. Annex 6 Ethiopia- Energy II Project Procurementand DisbursementArrangements

Procurement Procurementmethods (see Table Al, A2, A3 and A4)

Only USS 12.6 million of the goods and services financedby IDA will not be procured by InternationalCompetitive Bidding (ICB). These consist of:

(a) US$ 9.3 million worth of consulting servicesthat will be procured using the Bank's Guidelines for Selectionand Employmentof Consultants;

(b) USS 1A.19 million worth, in severalcontracts, of specializedservices and training relating to institutionaldevelopment that will be procured by direct contracting;

(c) USS 348,000worth of specializedequipment that will be procured through InternationalShopping;

(d) US$ 761,000 worth of vehicles, consistingof several differenttypes of vehicles for the three implementingagencies involved in the project, that will be procured throughthe UN system (IAPSO);and

(e) USS 737,000worth of computer equipmentin severalcontracts, for the three agencies implementingthe project, that will be procured through National CompetitiveBidding

ICB contractsrepresent about 94 % of the procurementfinanced by IDA. The Borrower'sNCB procedures are acceptable. A schedule of procurementactions is includedin the Project ImplementationPlans.

The implementingagency responsiblefor most of the procurement,EEPCO, has executeda Bank project in the past and is capable of managingthe procurement. It has engageda consultantto assist with the large Civil Works contracts. The MOA has also implementedBank project similar to this one and it still has the staff that managedthe procurementfor that project. The MME componentis small and they have staff qualifiedto managethe procurement. They will engage consultants for specialized items.

Prior review thresholds (see Table B)

Disbursement Allocation of loan proceeds (see Table C)

Use of statementsof expenses (SOEs): Contractsfor goods, works and consultancyfirms valued at less than US$100,000;consultancy services with individualsvalued at less than US$50,000;and training. Documentsverifying expendituresunder SOE procedures should be retained for review by IDA supervisionmissions. Special accounts: There will be three Special Accounts,as follows:

SpecialAccount "A" for Gilgel Gibe HydroelectricPlant: US$1,000,000 SpecialAccount "B" for institutionalcomponents (MME): US$100,000 SpecialAccount "C" for woody biomass component(MOA): US$100,000

Estimated IDA Disbursements: FY98 FY99 FY00 FY01 FY02 FY03 FY04 Annual 2.29 21.49 39.88 51.01 50.44 27.50 7.39 Cumulative 2.29 23.78 63.66 114.67 165.11 192.61 200.00 ETHIOPIA- ENERGY 2

TableA-1: PROCUREMENTARRANGEMENTS -All ImplementingAgencies Go

ProcurementMethod (USS '000) International National Competitive Competitive Intemational Direct From U.N. Consulting Bidding Bidding Shopping Contractinga/ Agencies Services N.B.F. Total A. CIVIL WORKS 156,302.36 * 49,341.86 205,644.22 (149,040.04) (149,040.04) B. SUPPLYAND ERECT EQUIPMENT 47,568.16 ------47,568.16 (33,364.36) (33,364.36) C. GOODS 1. Vehicles 372.52 - - - 761.80 - 79.66 1,213.98 (372.52) (761.80) (1,134.32) 2. Equipment 3,934.96 737.25 348.34 - - 492.33 5,512.87 (3,934.96) (737.25) (348.34) (5,020.55) 3. Materials 685.81 - 685.81 (685.81) (685.81) 0. SERVICES 1. Studies - - - - 3,193.69 - 3,193.69 (3,193.69) (3,193.69) 2. Training - - - 445.93 - 475.74 104.20 1,025.87 (445.93) (475.74) (921.67) 3. EngineeringServices. - - - - 5,649.42 24,207.64 29,857.06 (5,649.42) (5,649.42) 4. OtherServices - - - 973.96 - - - 973.96 (973.96) (973.96) E. PPF REFINANCING - - - - - 0.61 - 0.61 (0.61) (0.61) F. OPERATINGCOSTS ------197.51 197.51

TOTAL 208,863.81 737.25 348.34 1,419.88 761.80 9,319.47 74,423.18 295,873.73 (187,397.69) (737.25) (348.34) (1,419.88) (761.80) (9,319.47) - (199,984.43)

Note:Figures in parenthesis are the respectiveamounts financed by IDA a/ 'Training"includes several short-term courses for specificskills. "OtherServices" includes satellite imagery and rental of helicopterfor WoodyBiomass surveys.

Pa _.

a_4 ETHIOPIA- ENERGY2 ,

TableA-2: PROCUREMENTARRANGEMENTS - EEPCO >

ProcurementMethod (US$ '000) International National Competitive Competitive International Direct From U.N. Consulting Bidding Bidding Shopping Contract.a/ Agencies Services N.B.F. Total ,3

A. CIVIL WORKS 156,302.36 - 49,341.86 205,644.22 (149,040.04) (149,040.04) B. SUPPLYAND ERECT EQUIPMENT 47,568.16 ------47,568.16 (33,364.36) (33,364.36) C. GOODS 1. Vehicles 372.52 - - - 200.49 - 79.66 652.66 (372.52) (200.49) (573.00) 2. Equipment 3,934.96 92.55 192.13 - - - 492.33 4,711.97 (3,934.96) (92.55) (192.13) (4,219.64) 3. Materials 685.81 ------685.81 (685.81) (685.81) D. SERVICES 1. Studies - - - - - 2,878.98 - 2,878.98 (2,878.98) (2,878.98) 2. Training - - - 103.48 - 475.74 104.20 683.41 (103.48) (475.74) (579.22) 3. EngineeringServices - - - - - 3,460.21 24,207.64 27,667.85 (3,460.21) (3,460.21) 4. OtherServices - - - - -

E. PPF REFINANCING - - - - - 0.61 - 0.61 (0.61) (0.61) F. OPERATINGCOSTS ------

TOTAL 208,863.81 92.55 192.13 103.48 200.49 6,815.54 74,225.68 290,493.66 (187,397.69) (92.55) (192.13) (103.48) (200.49) (6,815.54) ' (194,801.87)

Note:Figures in parenthesisare the respectiveamounts financed by IDA a! Training"includes several short-term courses for specificskills. ETHIOPIA- ENERGY 2

TableA-3: PROCUREMENTARRANGEMENTS - MME

ProcurementMethod (US$ 000) National Competitive Direct From U.N. Consulting Bidding Contract.a/ Agencies Services N.B.F. Total A. CIVIL WORKS

B. SUPPLYAND ERECT EQUIPMENT - - - - -

C. GOODS 1. Vehicles - - 163.04 - - 163.04 (163.04) (163.04) 2. Equipment 326.08 - - - - 326.08 (326.08) (326.08) 3. Materials -

D. SERVICES 1. Studies - - 314.71 - 314.71 (314.71) (314.71) 2. Training - 155.28 - - - 155.28 (155.28) (155.28) 3. EngineeringServices - - - 310.55 - 310.55 (310.55) (310.55) 4. Other Services

E. PPF REFINANCING - - - .

F. OPERATINGCOSTS - - - -

TOTAL 326.08 155.28 163.04 625.27 - 1,269.67 (326.08) (155.28) (163.04) (625.27) - (1,269.67)

Note:Figures in parenthesisare the respectiveamounts financed by IDA a! Training"includes several short-term courses for specificskills.

5.B

a0 ETHIOPIA- ENERGY 2 R

Table A-4: PROCUREMENTARRANGEMENTS - MOA ', z

ProcurementMethod (USS '000) National Competitive International Direct From U.N. Consulting -U Bidding Shopping Contractinga/ Agencies Services N.B.F. Total 00

A. CIVIL WORKS - -

B. SUPPLYAND ERECT EQUIPMENT ------

C. GOODS 1. Vehicles - - - 398.28 - - 398.28 (398.28) (398.28) 2. Equipment 318.62 156.20 - - - - 474.83 (318.62) (156.20) (474.83) 3. Materials - -

D. SERVICES 1. Studies - -

2. Training - - 187.18 - - - 187.18 (187.18) (187.18) 3. EngineeringServices - - - - 1,878.66 - 1,878.66 (1,878.66) (1,878.66) 4. Other Services - - 973.96 - - - 973.96 (973.96) (973.96) E. PPF REFINANCING - - - - -

F. OPERATINGCOSTS - - - - - 197.51 197.51

TOTAL 318.62 156.20 1,161.13 398.28 1,878.66 197.51 4,110.40 (318.62) (156.20) (1,161.13) (398.28) (1,878.66) - (3,912.90)

Note:Figures in parenthesisare the respective amounts financed by IDA al "OtherServices" includes satellite imagery and rental of helicopterfor Woody Biomass surveys.

P0 Page 42 Annex 6 Ethiopia Energy II Project

Table B: Thresholds for Procurement Methods and Prior Review

Expenditure ContractValue Procurement Contracts Subject to Category (Threshold) Method Prior Review

1. Works $500,000 and above ICB $200,000 and above

2. Goods $250,000 and above ICB $200,000and above $50,000-$250,000 NCB $200,000 and above Below $100,000 IAPSO N.A. Below $50,000 IS N.A.

3. Services $100,000 and above QCBS $100,000 and above for QBS firms*

Less than $50,000 Individual $50,000 and above for individuals*

Less than $50,000 Single Source All

$200,000and above for applicationof sub-para. two of para. 2(a) of Appendix I of the Guidelines

*Termsof Referencefor all consultantcontracts, as well as all singlesource appointments, irrespective of dollaramounts, are subjectto priorreview.

ICB = InternationalCompetitive Bidding NCB = NationalCompetitive Bidding IS = InternationalShopping QCBS= Quality and CostBased Selection QBS= QualityBased Selection Project Appraisal Document Page 43 Ethiopia Energy II Project

Table C: Allocation of Loan Proceeds

ExpenditureCategory Amount in US$ million Financing Percentage

EEPCO:

Civil Works 134,118,000 100%of foreign expendituresand 85% of local expenditures

Equipment and Installation 27,371,000 100%of foreign expendituresand .______85% of local expenditures.

Vehicles and Materials 4,106,000 100%of foreign expendituresand 95% of local expenditures.

Equipment,Vehicles and 100%of foreign expendituresand Materials 1,081,000 95% of local expenditures

Trainn g 588,000 100%

ConsultantsServices 7,199,000 100%

NMM

Equipment Vehicles and 100% of foreign expendituresand Materials 821,000 95% of local expenditures

Training 55,000 100%/0

ConsultantsServices 630,000 100%

MOA ______

Equipment Vehicles and 100% of foreign expendituresand Materials 1,834,000 95% of local expenditures

Training 192,000 100%

ConsultantsServices 1,875,000 100%

Refunding of Project Preparation Advance 600,000

Unallocated 19,530,000

Total 200,000,000 Annex 7

Ethiopia - Energy II Project

Project Processing Budget and Schedule

A. Project Budget (US$000) Planned Actual (At final PCD stage) 374,400 336,100

B. Project Schedule Planned Actual (At final PCD stage) Time taken to prepare the project (months) 12 months 12 months First Bank mission (identification) 06/15/96 06/15/96 Appraisal mission departure 05/05/1997 05/05/1997 Negotiations 05/27/97 10/09/97 Planned Date of Effectiveness 10/15/97 01/31/98

Prepared by: EEPCO, MME and MOA

Preparation assistance: PPF of US$600,000

Bank staff who worked on the project included: Alfred Gulstone (Task Team Leader and Principal Power Engineer); Fauzia Najm (Principal Financial Analyst); Angel Baide (Power Engineer); Takuya Kamata (Sr. Financial Analyst); Keta Ruiz (Economist); Gus Tillman (Sr. Env. Specialist); Antoine Lema (Resettlement Specialist); Max Wilton (Energy Specialist); Yuriko Sakairi (Financial Analyst/Economist); Charlotte Jones (Operations Analyst); David Phan (Task Assistant); Negede Lewi (Infrastructure Operations Officer in the Resident Mission); and Helen Berhe (Task Assistant in the Resident Mission). The Quality Reviewers were Karen Rasmussen (Sr. Financial Analyst); Joseph Gilling (Sr. Energy Economist); and Peter Cordukes (Principal Financial Analyst). Annex 8

Ethiopia - Energy II Project

Documents in the Project File*

A. Project Implementation Plan EEPCO's ProjectImplementation Plan Woody BiomassProject Implementation Plan

B. Bank Staff Assessments EconomicAssessment* FinancialAssessment* Project CostTables

C. Other EnvironmentalAssessment, EEPCO, August 1997 ResettlementPlan, EEPCO,April 1997 Load Forecastand InvestmentPlan, Applied Energy Group,October 1997 Aleltu HydroelectricProject Feasibility Study, Power System Planning Study, Acres InternationalLtd., July 1993(Draft) Gilgel Gibe HydroelectricProject, FeasibilityStudy, EELPA and Electroconsult/ENEL,May 8, 1997 EthiopiaEnergy Assessment, ESMAP, Report No. 179/96,February 1996 The Woody BiomassInventory and DevelopmentProject, Phase II: ProjectDocument, November 1996 Termsof Referencefor ConsultancyServices of GilgelGibe HydroelectricProject, EELPA,April 1997

*Including electronicfiles. Annex 9 Ethiopia - Energy II Project

STATUSOF BANKGROUP OPERATIONS IN ETHIOPIA STATEMENTOF BANKLOANS AND IDA CREDITS As of September30, 1997 (US$millions)

(Less Cancellations) Loan or Fiscal Undis- CreditNo. Year Borrower Purpose Bank IDA bursed

Twelve(12) Loans and forty-eight(48) Creditsclosed. 108.60 1334.88 12.96 of which SAL, SECALor ProgramLoan/Credit: (250.67)

Cr.18730 1988 Ethiopia EducationVII 64.06 14.58 Cr.19130 1988 Ethiopia FamilyHealth 33.00 8.42 Cr.21030 1990 Ethiopia Market TownsDev. 40.20 16.43 Cr.21610 1990 Ethiopia SecondAddis Urban Dev. 35.00 20.66 Cr.24380 1993 Ethiopia Road Rehabilitation 96.00 60.24 Cr.25880 1994 Ethiopia CalubEnergy Dev. Pr. 74.31 67.53 Cr.27400 1995 Ethiopia Nat. FertilizerProject 120.00 85.85 Cr.27410 1995 Ethiopia NationalSeeds Project 22.00 19.17 Cr.28410 1996 Ethiopia ESRF I 120.00 103.11 Cr.28420 1996 Ethiopia WaterSupply Dev. & Rehab. 35.73 31.73

Total ** 108.60 1975.18 427.72 of whichrepaid 108.60 93.71

Total held by Bank& IDA DM0 181A.

Amountsold 6.04 of whichrepaid 6.04

TotalUndisbursed 449.6

** Total approved,repayments, and outstandingbalance representboth activeand inactiveLoans and Credits. Annex 10 EthiopiaEnergy II Project Ethiopia at a glance 8/28/97

Sub- POVERTYand SOCIAL Saharan Low- Ethiopia Africa income Developmentdlamond

Populationmid-1996 (millions) 58.1 600 3,229 GNP per capita 1996 (US$) 110 490 500 Life expectancy GNP 1996 (billions US$) 6.4 294 1,601 Averageannual growth,199046 Population(%/6) 2.1 2.7 1.7 GNP Gross Labor force (%l) 2.3 2.6 1.7 per prmary Most recent estimate (latestyear availablesince 1989) capita enrollment Poverty:headcount index (% of population) Urbanpopulation (%of total population) 13 31 29 Life expectancyat birth (years) 49 52 63 Infant mortality (per 1,000live births) 112 92 69 Access to safe water Child malnutrition(% Ofchildren under 5) 47 Access to safe water (% of population) 27 47 53 illiteracy (% of populationage 15+) 65 43 34 Ethiopia Gross primaryenrollment (% of school-agepopulation) 27 72 105 Male 33 78 112 Low-incomegroup Female 21 65 98

KEY ECONOMICRATIOS and LONG-TERMTRENDS 1975 1985 1995 1996 Economicratios' GDP (billions US$) 6.7 5.4 6.1 Gross domesticinvestment/GDP .. 9.0 16.3 20.5 O of Exportsof goodsand services/GDP .. 8.2 14.4 12.8 penness economy Gross domesticsavings/GDP .. 1.0 6.8 7.6 Gross national savings/GDP .. 3.4 14.0 14.2 Currentaccount balance/GDP .. -5.6 -1.6 -7.5 / I InterestpaymentslGDP .. 0.6 1.1 1.4 Savings Investment Total debt/GDP .. 30.3 95.9 82.6 Total debt servicelexports 7.3 28.4 19.1 33.7 Presentvalue of debtlGDP .. .. 63.1 Presentvalue of debtlexports .. .. 425.0 .. Indebtedness

1975-85 1986-96 1995 1996 199745 (averageannua/ growth) Ethiopia GDP .. 2.3 5.4 12.4 5.9 GNP per capita .. -0.3 3.1 9.5 2.9 Low-income group Exports of goodsand services .. -2.2 10.2 8.9 8.8

STRUCTUREof the ECONOMY 1975 1985 1995 1996 (% of GDP) Growthrates of output and Investment(%) Agriculture . 53.2 .. .. 100 Industry . 12.7 .. Manufacturing .. 7.2 .. .. Services .. 34.1 o- 92 93 94 95 93 Private consumption .. 84.6 82.4 81.1 .so. General govemmentconsumption .. 14.4 10.8 11.3 GDI GDP Importsof goodsand services .. 16.2 23.9 25.7

1975-85 1986-96 1995 1996 (averageannual growth) Growthrates of exportsand Imports(%) Agriculture .. 2.5 3.4 17.5 100. Industry .. -2.6 8.1 8.5 80 Manufacturnng .. -3.1 9.0 9.2 40 Services .. 5.4 7.2 7.1 20 Private consumpton .. 2.9 3.9 9.0 0 093 95 9 General govemmentconsumpton .. -4.9 2.7 17.9 -40 Gross domesticinvestment .. 6.0 13.8 41.2 -s0 Importsof goodsand services .. 0.5 6.9 29.0 Gross national product .. 2.2 6.0 12.9 Exports -mports

Note: 1996 data are preliminaryestimates. The diamondsshow four key indicators in the country (in bold) comparedwith its income-groupaverage. If data are missing, the diamondwill be incomplete. Annex 10 Ethiopia Energy II Project Ethiopia

PRICES and GOVERNMENTFINANCE 1975 1985 1995 1996 Domestic pres Inlaon (%) (% change) 30 - Consumerprices 6.6 19.1 13.4 0.9 20 Implicit GDPmp deflator .. 29.5 14.0 1.3 Govemment finance 10 (% of GDP) 0 Currentrevenue .. 16.8 17.1 17.6 91 92 93 94 95 9s Currentbudget balance . -2.7 1.5 1.0 -GDPdef. --O-CPI Overallsurplus/deficit . -11.3 -8.1 -8.3 G

TRADE 1975 1985 1995 1996 (millions US$) Exportand Import levels (mill. USS) Total exports (fob) 230 359 454 410 1,500 Commodity1: Coffee ,. 225 288 273 Commodity2: Leather and leatherproducts .. 46 60 49 Manufactures .. 100 Totalimports (cif) 276 975 1,064 1,413 Food .. 283 181 215 Soo Fueland energy .. 186 169 215 Capitalgoods .. 249 334 460 0C

Export priceindex (1987=100) .. 96 116 96 90 91 92 93 94 95 9o Import priceindex (1987=100) .. 101 105 109 n xports Isimports Terms of trade (1987=100) .. 95 110 88

BALANCE o PAYMENTS 1975 1985 1995 1996 (millions US$) Current account balanceto GDPratio (%) Exports of goods and services 330 549 784 783 o Imports of goodsand services 409 1,082 1,273 1,646 9 91 9239 94 9 96 Resource balance -79 -533 -488 -863 Net income -17 -33 -60 43 _ Net current transfers 45 193 459 446 Currentaccount balance, beforeofficial capitaltransfers -52 -373 -90 -460 ^ -. Financingitems (net) 45 420 146 515 Changesin net reserves 7 -48 -56 -55 -. Memo: Reservesincluding gold (mill.US$) 315 216 550 878 Conversionrate (lbcal/US$) - 2.1 6.3 6.3

EXTERNAL DEBT and RESOURCEFLOWS 1975 1985 1995 1996 (millions US$) Composition of total debt, 1996(mill. USS) Total debt outstandingand disbursed 344 2,027 5,221 5,059 G IBRD 69 49 0 0 G9 IDA 73 437 1,470 1,555 330 Total debt service 25 159 155 278 B55 IBRD 9 7 4 0 IDA 1 6 23 25 Compositionof net resourceflows Official grants 35 514 475 E Official creditors 65 276 194 165 2E21 Private creditors -3 59 -49 -70 20,21 Foreign direct investment 19 0 7 0 D Portfolio equity 0 0 0 0 964 World Bank program Commitments 71 32 142 156 A - IBRD E- Bilateral Disbursements 26 50 84 142 B -IDA D- Othermultilateral F - Private Principalrepayments 4 7 12 14 C- IMF G - Short-term Netflows 22 43 72 127 _ Interest payments 6 7 11 11 Nettransfers 16 36 61 116

DevelopmentEconomics 8128/97 Note: The debt data excludes a substantialamount of ruble-denominatedmilitary debt. IBRD28768

ETHIOPIA ENERGY11 PROJECT TAbaba LOCATION OF GILGELGIBE HYDROELECTRICPLANT 235km

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