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INTEGRATED SAFEGUARDS DATASHEET APPRAISAL STAGE I. Basic Information Date prepared/updated: 04/25/2005 Report No.: AC1384 Public Disclosure Authorized 1. Project Statistics Country: Ukraine Project ID: P083702 Project Name: ENERGY SECT REF Task Team Leader: Dejan R. Ostojic Estimated Appraisal Date: March 31, 2005 Estimated Board Date: June 16, 2005 Managing Unit: ECSIE Lending Instrument: Specific Investment Loan Sector: Power (100%) Theme: Regional integration (P);Regulation and competition policy (P) IBRD Amount (US$m.): 100.00 IDA Amount (US$m.): 0.00 GEF Amount (US$m.): 0.00 Public Disclosure Authorized PCF Amount (US$m.): 0.00 Other financing amounts by source: BORROWER 0.00 BORROWING AGENCY 620.00 Financing Gap 150.00 770.00 Environmental Category: B - Partial Assessment Simplified Processing Simple [] Repeater [] Is this project processed under OP 8.50 (Emergency Recovery) Yes [ ] No [X] 2. Project Objectives Public Disclosure Authorized The main objective of the Hydropower Rehabilitation Project is to improve operational stability and reliability of power supply by increasing regulating capacity, efficiency and safety of hydroelectric plants, and, therefore, facilitate unimpeded operation and opening up of the electricity market. Additional objective is to support the Ministry of Fuel and Energy (MFE) and the National Energy Regulatory Commission (NERC) in updating and implementing the Energy Sector Reform and Development Program, including implementing Wholesale Electricity Market (WEM) concept. Key performance indicators that will be used to assess fulfillment of the Hydropower Rehabilitation Project in terms of results and outcomes by the end of the project and in comparison to parameters in the year 2004, are: - Increased production of hydroelectric energy by 360 GWh; - Increased (winter firm) hydropower capacity by 250 MW; Public Disclosure Authorized - Reduced O&M costs in rehabilitated hydropower plants by 20%; and - Reduced emissions from thermal power plants, including emission reduction of 1,300,000 tonns of CO2 equivalent, due to the increased production of hydroelectric energy. The Hydropower Rehabilitation Project is the first specific investment project within the Energy Sector Reform and Development Program (Energy Program) proposed by the Government of Ukraine. The overall program objective is to improve the security, reliability and quality of energy supply, and, therefore, facilitate unimpeded operation of the energy market, both domestically and internationally. Also, the proposed Energy Program would support Ukraine?s aspirations with regard to legal, institutional, regulatory and technical harmonization and increasing energy trade with the EU Internal Energy Market. If successful, the Energy Program would support sustainable economic growth through the consolidation of energy sector reforms, improved security, reliability and quality of energy supply and growing energy trade in the domestic and international energy markets. Reform and sustainable development of the energy sector is one of the highest priorities in restoring Ukraine? macroeconomic fundamentals, improving the investment climate and integrating the county into the global economy. Addressing emerging fiscal imbalances and inflationary pressures in Ukraine requires hardening budget constraints, including strengthening financial discipline in the energy sector and timely payment of energy bills and taxes to the budget. The Energy Program would help bring energy companies to financial solvency and eliminate further accumulation of tax and other payment obligations to the budget. It will also help reduce quasi-fiscal deficit in the energy sector through gradual elimination of price distortions, reduction of technical and commercial losses, and increase in cash collections. Advancing energy sector reform and ensuring sustainable provision of reliable, affordable and environmentally acceptable energy services is crucial for improving the investment climate in Ukraine, which has a high concentration of production and exports in energy intensive industries. From this point of view, key aspects of the proposed Energy Program are: (i) resolution of large debts accumulated in the energy sector; (ii) reduction and ultimate elimination of subsidies in the sector both explicit (for coal) and implicit (for gas and electricity); (iii) improvement of financial solvency and corporate governance of state-owned energy enterprises; (iv) strengthening the independence of NERC; (v) improvement of security, reliability and quality of the energy supply; and (vi) capacity building in MFE and NERC. Ukraine?s location on the main corridor for energy trade between Russia and the EU and the country?s large energy resources and infrastructure make energy sector reform and sustainable development essential for integrating Ukraine into the global economy, including its membership in WTO. The proposed Energy Program would support Ukraine?s aspirations with regard to legal and technical harmonization and increasing integration of its energy market with the EU Internal Energy Market. Strengthening energy interconnections and opening access to the EU electricity market will improve energy security and the reliability of energy supply in the whole region and result in significant economic benefits for all market participants. Furthermore, the proposed Energy Program would help Ukraine benefit from its large surplus of GHG emission reductions under the Kyoto Protocol. This would also help other countries (i.e. developed countries) meet their obligations under the Protocol and jointly mitigate the impacts of the growing energy demand on the global climate. 3. Project Description Eligible program components. Recent sector notes prepared by the Bank concluded that significant investments in aging energy infrastructure are required for a well-functioning energy market. The following priority investments and technical assistance would be eligible for financing under the proposed Energy Program in order to help the Ukraine energy market to better meet increasing demand in a secure, reliable and environmentally friendly manner, while converging toward legal, regulatory and technical standards of the EU Internal Energy Market. - Investments to increase operational capacity and flexibility of hydropower plants which play key role in providing load following, frequency control and other ancillary services in the Ukraine power grid, and, therefore, are critical for opening up the electricity market and meeting technical requirements of the EU power grid (UCTE); - Investments to upgrade the capabilities of transmission system operator, UkrEnergo, so that it can implement policy decisions to assure security and reliability of power supply, including: (a) removing critical bottlenecks in transmission networks and sub-stations; (b) improving operational stability of power grid; (c) upgrading load dispatch and system control capabilities; and (d) upgrading infrastructure and systems for electricity market administration; - Investment to retrofit critical energy facilities and networks to help improve their environmental compliance and reduce losses; - Investments in metering and/or telecommunications programs designed to improve billing and collections and/or coordination and communications capabilities of distribution utilities so that they can more effectively participate in the energy market; and - A wide range of technical assistance, for institutional development and program/ project preparation and implementation, to support implementation of the WEM (as detailed in Annex 4); and to fund engineering/ environmental services for the preparation and implementation of investment projects (including but not limited to projects financed by the Bank under the Energy Program) necessary for a functioning energy market. Hydropower Rehabilitation Project comprises five components: Component A: Rehabilitation of hydroelectric plants. This component includes refurbishment of 46 hydroelectric units and associated plant equipment at nine hydroelectric plants. It also includes modernization of nine hydropower plants and refurbishment of high voltage equipment in nine switchyards connected to these plants. Component B: Dam Safety. This component includes rehabilitation and upgrade of the existing, as well as installation of new dam safety monitoring systems and rehabilitation of drainage facilities and spillway gates on seven dams on the Dnipro river and one dam on the Dnister river. Component C: UHE Institutional Development. This component includes establishment of a corporate-wide Management Information System (MIS) in UHE. This component also includes provision of technical assistance to UHE in improving financial management, enhancing dam safety, optimal scheduling of the multi-purpose cascade of hydropower plants, capacity building in procurement and project management and training for the UHE staff in dam safety. Component D: MFE Institutional Development. This component includes provision to the MFE of advisory services and consultant assistance in developing and implementing: (i) an action plan for legal and technical harmonization of the Borrower?s energy market with the European Union Internal Energy Market; and (ii) a program of priority investments and technical assistance in the energy sector. Component E: Implementation of the WEM Concept. This component includes provision of technical assistance to NERC in implementing the WEM concept, as required for (i) clarifying market