Document of
The World Bank
FOR OFFICIAL USE ONLY Public Disclosure Authorized Report No. P-7274-GE
REPORT AND RECOMMENDATION
OF THE
PRESIDENT OF THE
INTERNATIONAL DEVELOPMENT ASSOCIATION Public Disclosure Authorized TO THE
EXECUTIVE DIRECTORS
ON A
PROPOSED ENERGY SECTOR
ADJUSTMENT CREDIT
IN AN AMOUNT OF SDR 18.1 MILLION (US$25 MILLION EQUIVALENT) Public Disclosure Authorized To
GEORGIA
JUNE 4, 1999
Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. GEORGIA Energy Sector Adjustment Credit
Currency Equivalents
(as of end April 1999) Currency Unit = Larl 2.39 Laris = US $ 1.00 1.00 Lari = 100 tetri
Weights and Measures
Metric System
ABBREVIATIONS AND ACRONYMS
BCM - Billion Cubic Meters CAS - Country Assistance Strategy EBRD - European Bank for Reconstruction and Development ESAF - Enhanced Structural Adjustment Facility GDP - Gross Domestic Product GIC - Gas International Corporation of Georgia GNERC - Georgian National Electricity Regulatory 'Commission IBRD - International Bank for Reconstruction and Development IDA - International Development Association IMF - Intenational Monetary Fund KFW Kreditanstaft fur Wiederaufbau KWH - Kilowatt Hours MW - Megawatts OECF - Overseas Economic Cooperation Find SAC - Structural Adjustment Credit SDR - Special Drawing Right
Georgia's Fiscal Year
January I - December 31
Vice President: Johannes Linn, ECA Country Director: Judy O'Connor, ECCO3 Energy Sector Leader: David Craig, ECSEG Team Leader: Jonathan Walters, ECSEG FOR OFFICIALUSE ONLY
GEORGIA
ENERGY SECTOR ADJUSTMENT CREDIT
CREDIT SUMMARY
Borrower: Georgia Government Amount: SDR 18.1 million (US$25 million equivalent) Terms: Standard IDA, with 10 years grace and 35 years maturity Commitment Fee: A variable rate between 0.0 - 0.5% of the undisbursed credit balance, set annually by the Executive Directors of IDA.
Objectives and Description: The proposed credit would maintain the momentum of energy sector reform in Georgia, and help mitigate its social costs. The energy sector reform program aims to enhance financial management, combat corruption, increase the availability of energy on a sustainable basis, catalyze private investment, realize Georgia's pipeline transit potential, and upgrade environmental management.
Benefits: Energy sector reform will improve service quality, reduce environmental damage, and enhance the prospects for private participation in energy infrastructure. By removing a source of soft financing for the economy, it will force more rapid structural adjustment. Similarly, eliminating this quasi-fiscal role of the energy sector will remove the threat of such a role being thrust back on the Government budget, thereby undermining fiscal sustainability. Relieving energy shortages will remove a major constraint to private sector development and employment generation.
Risks: The reform program is ambitious in the face of huge problems in the sector. The reforms may face stiff resistance from vested interests determined to preserve rent-seeking opportunities. The
This documenthas a restricteddistribution and may be used by recipients only in the performanceof theirofficial duties. Its contentsmay not otherwisebe disclosedwithout WorldBank authorization. political will to proceed with energy reform may dissipate in the face of a sociopolitical reaction. In the winter of 1999/2000, electricity supply may be no greater than in the previous winter; this could lead to a backlash against electricity privatization. Implementation capacity of state agencies wilLbe sbtetched, which can be only partially offset by technical assistance. Declining appetite for emerging market risk rmaydeter private investment in spite of the attractive policy framework. Broader stabilization and structural reform programs rnay break down in the face of political resistance, inadequate external financing, or a further sharp deterioration in the economies of ma jor trading partners.
These risks are substantially mitigated by a widespread perception in Government and Parliament that there is no alternative to the proposed energy reform program. The collapse in services has been so great and the ability o f the State to overcome the problems of the sector has proved to be so limited, that attracting private investment is perceived as an overwhelming imperative. In addition, the need to attract private investment in transit pipelines through Georgia in the face of few perceived alternative sources of growth and economic independence, serves to bolster political support for energy sector reform.
Poverty Category: Poverty-focused. The proposed credit and program would support the provision of social benefits targeted to vulnerable groups.
Project ID Number: GE-PE-64094 GEORGIA Energy SectorAdjustment Credit
CONTENTS
PART I. COUNTRY CONTEXT...... 1
PART II. GEORGIA'S ENERGY SECTOR ADJUSTMENT PROGRAM ...... 2
A. The Power Sector ...... 2 B. Natural Gas Transmission and Distribution ...... 5 C. Oil and Gas Exploration and Production ...... 7 D. Oil and Gas Transit Pipelines...... 7 E. Energy and the Environment ...... 8
PART III. THE PROPOSED ADJUSTMENT CREDIT...... 8
A. Rationale for the Credit ...... 8 B. Link to the CAS and other Bank Group Operations ...... 9 C. Benefits and Risks of the Proposed Program and Credit ...... 10 D. Poverty Impact ...... 11 E. Environmental Impact ...... 12 F. Prior Actions, Effectiveness and Second Tranche Conditions ...... 13 G. Credit Amount and Disbursement Procedures ...... 15 H. Program Implementation Arrangements ...... 15
PART IV. RECOMMENDATION OF THE PRESIDENT...... 16
Annexes Annex 1 Georgia - Key Economic Indicators Annex 2 Government of Georgia: Letter of Energy Sector Policy Annex 3 Policy Matrix Annex 4 Timetable of Key processing Events Annex 5 Status of Bank Group Operations in Georgia - Operations Portfolio Annex 6 Georgia - Statement of IFC's Committed and Disbursed Portfolio Annex 7 Georgia at a Glance
Maps Map 1 Georgia Gas Network -IBRD27432 Map 2 Georgia Power System - 1BRD 27433 Map 3 Georgia Oil Fields, Processing & Transportation Facilities -IBRD 30236 REPORT AND RECOMMENDATION OF THE PRESIDENT OF IDA TO THE EXECUTIVE DIRECTORS ON A PROPOSED ENERGY SECTOR ADJUSTMENT CREDIT TO GEORGIA
1. I submit for your approval the following report and recommendation on a proposed credit to Georgia for SDR 18.1 million (US$ 25 million equivalent). The proposed credit would be on standard IDA terms with a maturity of 35 years, including a grace period of 10 years.
2. The proposed credit is a key element of IDA's Country Assistance Strategy (the last CAS was discussed by the Executive Board in September 1997). It has been prepared in parallel to a proposed Third Structural Adjustment Credit. Georgia's stabilization and adjustment program is supported by the International Monetary Fund through a three-year Enhanced Structural Adjustment Facility (the third annual arrangement was approved on July 27, 1998).
3. Georgia became a member of IBRD in August 1992, of MIGA in December 1992, and of IFC in June 1995. Georgia became eligible for IDA terms in August 1993.
PART I. COUNTRY CONTEXT
4. Georgia is a country of 5.4 million people, bounded by Armenia, Azerbaijan, the Russian Federation, Turkey, and the Black Sea. It is strategically located as a transit corridor in the Caucasus, between Europe and Asia, Russia and the Middle East. The country became independent in 1991 upon the dissolution of the former Soviet Union. The Georgian economy was highly integrated in the Soviet economy.
5. The breakup of the former Soviet Union, and civil conflict involving separatist tendencies in Abkhazia and South Ossetia, led to the collapse of the Georgian economy. Conflicts elsewhere in the region (Nagorno Karabakh, Chechnya), and consequent border closures, also contributed to economic decline in Georgia. Disappearing markets, disruptions in production, and a huge adverse terms of trade shock (due in large part to rapidly rising energy prices), caused GDP to fall by more than 70 percent in the 1991-94 period. External arrears accumulated, mainly for natural gas, and lax fiscal and monetary policies led to hyperinflation. Infrastructure fell into a state of extreme disrepair. The building of new state institutions took place in extremely unfavorable circumstances.
6. From 1994, after the cessation of civil conflict in Georgia, the Government embarked on a comprehensive program of macroeconomic stabilization and structural reform. Results have been impressive: a national currency was introduced, GDP has grown strongly since 1995, inflation has been brought down to single digits, fiscal and external deficits have been reduced, and broad stability in the exchange rate has been achieved. -2-
7. However, macroeconomic stability is still fragile and a substantial structural End institutional reform agenda remains to be implemented. In addition, the regional economic outlook continues to be uncertain in the Caucasus, since conflicts have not yet been fully resolved, and important transport, electricity and gas connections therefore remain blocked. The fiscal position is extremely weak in Georgia, due to very poor tax collection, and Government service provision is consequently highly inadequate (particularly in the social sectors). External deficits are growing, particularly in the wake of the economic crisis in Russia, and the real appreciation of the lari against the ruble. On the structural reform side, enterprise budget constraints have not hardened sufficiently to catalyze the degree of restructuring required, obstacles remain to private sector development, and the climate for private participation in infrastructure is not yet favorable enough to attract the large amounts of capital needed for rehabilitation and upgrading. An intensification of stabilization and structural reform is clearly needed.
PART II. GEORGIA'S ENERGY SECTOR ADJUSTMENT PROGRAM
8. Reform of the Georgian energy sector has faced the twin challenges of a Soviet heritage of negligible prices for energy services and a collapse of the economy since the dissolution of the Soviet Union and civil war in Georgia. Against this background, sector reform has so far proceeded gradually. Cost recovery has improved in the power secltor, with increases in both tariffs and collections, but revenues still remain well below costs. Gas supply to households was cut in 1995 in the face of mounting external arrears, but the investmnentclimate in the sector is still unfavorable and the investment necessary to restore supply to paying customers therefore remains limited. Gas transmission has been reorganized but losses remain very high. The oil sector has attracted significanit foreign investment, but development has been retarded by an uncertain legal and regulatory framework. Oil and gas pipeline transit has attracted considerable attention and some investment, but much needs to be done to mitigate investor risk and enhance environmental management.
9. The Government and Parliament now recognize that energy sector reforms need to be accelerated. Economic growth is highly constrained by the unreliable energy supply, and popular discontent with poor service and with corruption in the energy sector is growing. At the same time, grasping the economic and political opportunity presented by the potential transit through Georgia of Caspian oil and gas also requires sector reform. In consequence, the Government has elaborated a series of energy sector reforms to be taken in 1999, which are reflected in a Letter of Energy Sector Policy (see Annex 2).
A. The Power Sector
10. The Georgian power sector has been drastically affected by economic crisis. Disrepair, civil war damage, financial collapse, and improper operation have all taken their toll. Today, only 15-30 percent of the sector's 5,090 MW of nameplate generation capacity is operational, the main constraint being a severe lack of working capital due to -3- poor cost recovery. Although tariffs and collections have been allowed to rise, the sector's financial deficit is equivalent to about two percent of GDP, and serious blackouts occur as a result. In the winter of 1998/99, Tbilisi had only 4-6 hours of electricity per day, and the rest of the country averaged 3-4 hours (with some parts of the country receiving only negligible amounts). In combination with the near-suspension of gas supply to all but large users (see para. 21), these shortages cause severe hardship and economic dislocation. Sustainable economic growth is severely undermined by the lack of electricity supply.
11. The sector's financial performance has been improving gradually since 1994. End-user tariffs have increased by about 200 percent to their present level of about 4.5 US cents per kwh. Collections have increased over the period from about 20 percent of billings to about 65 percent, but appear to have stagnated at that level. The obstacles to further improvement are a combination of political interference (particularly at the municipal level), corruption, weak management, inadequate metering, inefficient billings/collections systems, and limited financial accountability.
12. The track record in reorganizing the sector has been mixed. On one hand, the sector has been unbundled, with generation, transmission, dispatch, and distribution handled by different entities to permit greater transparency and to lay the foundation for eventual competition.1 On the other hand, the distribution sector has broken up into more than 70 municipally-owned companies, mostly of uneconomic size and suffering considerable political interference.
13. However, the regulatory framework for the sector has been considerably strengthened by the 1997 passage of the Electricity Law, which created the independent Georgian National Electricity Regulatory Commission (GNERC). GNERC has progressively strengthened its technical capacity and is becoming independent of Government budget funding (both essential prerequisites for political independence). GNERC has adopted a transparent tariff methodology2 and issued licenses to sector enterprises.
14. The Government has recognized that radical measures are needed to redress the disastrous situation in the power sector, and has launched a comprehensive privatization
l Generation is divided between (i) small plants which have been privatized (which represent 2 percent of capacity); (ii) plants leased to employees (4 percent); (iii) state-owned corporatized plants representing 51 percent of capacity (including Tbilsresi which owns and operates the Gardabani Thermal Power Plant); (iv) Sakenergogeneratsia (which owns and operates 3 plants in Abkhazia representing 38 percent of capacity, and manages all the corporatized plants except for Gardabani ); and (v) idle plants which have not been corporatized, come under the authority of Sakenergogeneratsia, and represent 4 percent of capacity. Transmission is handled by Electrogadatsema, except for import/export which is handled by Sakrusenergo, a Georgia-Russia joint venture. Sakenergo is responsible for dispatch, as well as purchasing and selling wholesale power pending establishment of the Wholesale Electricity Market.
2 The tariff methodology calculates maximun tariffs on a cost-of-service-basis, but allows conversion to a price-cap methodology at a later stage, once regulatory capacity is sufficiently developed. -4-
program, to attract strategic investors with substantial capital and operating experience into the sector. In the Government's view, privatization offers the only sustairnable solution to financial mismanagement of the power sector, given the endemic wAeaknessof state institutions. Merrill Lynch, an internationally-experienced and reputable investment bank, has been engaged to assist in the privatization transactions.
15. The first enterprise to be offered was Telasi, the Tbilisi distribution cornpany, which was sold in December 1998 to AES, an American utility investor experienced in the region and elsewhere.3 Since Telasi accounts for more than half the total distribution load in Georgia, and distribution is at the front end of the nonpayments chain, this privatization should contribute much to the financial soundness of the sector. The successful sale of Telasi - even in the midst of declining investor interest in emerging markets - has galvanized the power privatization process in Georgia.
16. The Government has decided to offer the rest of electricity distribution and generation for privatization (transmission will be privatized later). The distribution companies have been offered in two packages, East and West Georgia. In both cases, 75 percent of the shares have been offered to strategic investors. If those packages should not prove sufficiently attractive to investors, they will be reconfigured. In the generation sector, all plants have been offered either for sale of a majority stake or for long-term concession (at least 25 years) with full control to the concessionaire. A debt commission has been formed comprising the Ministries of Finance, Fuel and Energy, and State Property Management to restructure the debt of sector enterprises immediately prior to privatization, where necessary. In those enterprises where privatization may take some time, financial control systems will be reviewed and international accounting/auditing standards will be introduced in order to upgrade financial management as soon as possible. Debts of those enterprises will be restructured only after overall sector privatization is well-advanced.
17. Privatization and other measures to increase cost recovery in the power sector make it necessary to protect the most vulnerable sections of the population. Although severe budgetary constraints limit the amounts that can be provided to such groups, the Government has decided to increase the poverty benefit targeted to poor single pensioners, which has been identified as a particularly vulnerable group. The benefit levels established for 1999 are intended to bring the beneficiaries just to the poverty line (which the Bank estimates on the basis of household surveys at 52 lari per month for a one-person household and 80 lari per month for a two-person household).
18. As a key element of the power sector reform program, the foundations of a competitive wholesale electricity market will be laid. This market will be estab lished in a gradualist manner given the organizational, financial, and infrastructural constraints. In the first phase, to be introduced in July 1999, generators will sell power to the rnarket at regulated prices set by GNERC periodically. Prices will cover average generation cost
3 Georgiais thus only the secondcountry in the former SovietUnion to sell an electricitydistribution companyto a strategicinvestor (after Kazakhstan). -5-
(comprising an energy charge based on the variable costs of actual supply, and a capacity charge to cover fixed costs based on capacity made available in case of need). Each generator will receive a tariff reflecting its own costs, and the market will supply distribution companies and large industrial customers at a weighted average tariff, with dispatch being on a least-cost basis. Some direct contracting between generators and customers (distribution companies and industries) will be permitted, with charges for transmission and ancillary services being set by GNERC.
19. In essence, the first phase will create the transparent institutional framework necessary for the settlement of debts and for the later development of a true market. A major benefit of the first phase is that stakeholders will be represented in market management (in contrast to the current situation, in which Sakenergo plays a dominant role).
20. In the second phase of establishment of the market, generators will all receive the same price, which will reflect the marginal cost of supply in the system (i.e. the cost of supply from the highest cost plant) determined on an hourly basis. The introduction of hourly marginal cost pricing will allow dispatch and consumption to be continuously on an economic basis as demand varies over each 24 hour period. The second phase can only be introduced after the necessary investment in bulk metering and control systems has been made to allow accurate determination of hourly marginal cost. In the third phase, generators will actually bid for supply to the market. This phase will be introduced once a sufficient number of private operators are participating in the market to make competitive bidding meaningful. Direct contracting will continue to be allowed during the second and third phases.
B. Natural Gas Transmission and Distribution
21. The gas sector in Georgia has been particularly hard hit by the contraction in the economy. In 1990, the country consumed approximately 5.45 billion cubic meters (BCM) of natural gas, of which 5.4 BCM was imported. By 1995, owing largely to the accumulation of large external debts (primarily to Turkmenistan) and the consequent reduction in access to gas supplies, domestic consumption had dropped to approximately 0.9 BCM, and fell further to 0.8 BCM in 1997 - all of it imported from Russia. Most of the gas received is used for power generation, and by a few large industries. Supply to households and commercial customers in the cities has been reduced to very low levels, since a lack of investment in metering and billing/collections systems has made commercial operation of gas distribution very difficult. Technical losses in transmission remain very high. Domestic production is negligible, and any associated gas is being flared. While some of the oil producers suggest that there are commercially viable gas resources available, they are unwilling to invest in development of those resources in the absence of viable markets and access to those markets.
22. Gas transmission and distribution in Georgia is organized into a state-owned transmission operator company, Saktransgasmretsvi, about 30 gas distribution companies, a number of wholesale suppliers, and a single supplier at the Russian border. -6-
The transmission network itself is owned by the state-owned Gas International Corporation of Georgia (GIC), which was established to negotiate gas transit joint ventures. Six of the distribution companies were privatized during 1998. However, the privatization process was conducted in a less than fully competitive manner, and the new companies may not be adequately capitalized. One of the new owners also holds a contract for managing the State's shares in Saktransgasmretsvi.4
23. The gas sector reform program seeks to establish a framework in which private operation and investment will be encouraged to restore gas supply to consumers, while protecting those consumers from abuse of monopoly power. The authority of the Georgian National Electricity Regulatory Commission has been extended, through amendments to the 1997 Electricity Law, to include regulation of monopolistic components of gas supply through the transmission and distribution network (it will not regulate exploration and production).
24. The Comnmissionwill adopt a transparent methodology for setting tariffs for monopoly services, including gas purchase/resale (until competitive markets can be established), transmission, and distribution. The tariff-setting procedures will ensure that regulated enterprises can recover prudently incurred costs of service, while at the same time promoting efficiency in gas supply and energy consumption, and protecting consumers from monopolistic pricing practices. The Commission will also adopt dispute resolution procedures (applicable also to electricity sector enterprises).
25. The Commission will develop terms and conditions for commercial licenses which address the rights and responsibilities of sector enterprises, and will issue licenses to participants in the supply chain. The amended Electricity Law gives the Commission the authority to prevent a given participant in the gas sector from holding more than one license. This will allow the Commission to induce greater competition in the sector.
26. Once the new gas regulatory framework is firmly established, the remaining 23 municipal gas distribution companies will be privatized. For those gas distribution companies already privatized, the Ministry of State Property Management will ensure that the new owners meet their commitments with respect to extending supply to financially viable markets within their service areas. If necessary, the Ministry will require the new owners to bring in additional partners with adequate capital. Given that the government proposes to seek strategic investors to participate in the upgrading of the high-pressure transmission network for transit purposes, the transmission operating company, Saktransgasmretsvi, will not be privatized until transit potential is clarified. However, in order to facilitate regulation and improve performance, financial management of the company will be upgraded through the introduction of international accounting standards, appointment of international auditors, and a review of financial control procedures.
4 The single gas supplierat the borderis Itera Russia,an affiliateof RAO Gaspromof Russia. Itera Russia is also a shareholderin the newly-privatizedgas distributioncompanies, along with affiliatecompanies, Itera Georgiaand SakgasiGeorgia. Sa.kgasiholds the managementcontract for managingthe State's sharesin Saktransgasmretsvi,and is also activein the wholesalesupply of gas. -7-
C. Oil and Gas Exploration and Production
27. The Georgian oil sector has seen modest amounts of foreign investment by international standards (about US$ 60 million) since Independence. While Georgia's oil and gas potential is not large, development has been retarded by lack of security in the legal framework. The new Oil and Gas Law, adopted in May 1999, is expected to catalyze investment in exploration and production of oil and natural gas by establishing a one-stop regulatory authority for the sector, and by consolidating the legal foundation for existing operations (each of which is currently governed by a presidential decree). The Oil and Gas Law will also facilitate pipeline access for Georgian oil and gas (where access is not constrained by international agreement). In parallel, regulation of the gas sector by the Electricity and Gas Regulatory Commission to facilitate competitive supply should stimulate development of Georgian gas potential, and eliminate the current practice of flaring gas (which will be of environmental benefit).
28. Under the new Oil and Gas Law, the state-owned Georgian Oil Company (Saknaftobi) will focus on its commercial activities and will cease to play a regulatory role, to avoid conflict of interest. During 1999, Saknaftobi will be prepared for privatization, to ensure that maximum revenues from existing production sharing agreements accrue to the State (Saknaftobi disposes of the State's profit oil under the production sharing agreements).
D. Oil and Gas Transit Pipelines
29. Georgia's geographic location and positive investment climate create substantial potential for the transit of crude oil and natural gas from the Caspian basin. Already the "Early Oil" pipeline is transporting oil from fields off the Azeri coast to the Black Sea terminal of Supsa. Crude oil is being transported (so far by boat and rail) from the Tenghiz field in Kazakhstan and from Turkmenistan to the Georgian port of Batumi, and pipeline options are being considered. Gas transit is to date limited to transport of about 1.5 b.c.m. per year from Russia (and formerly Turkmenistan) to Armenia, but prospects for much larger volumes of Russian, Azeri, or East Caspian gas transiting through Georgia to Turkey (and beyond) are being actively explored. However, for both oil and gas pipelines, Georgia is in competition with a number of other transit options (through Russia, Iran, Armenia, under the Black Sea, or eastwards from the Caspian).
30. Georgia's ratification of the Energy Charter Treaty could contribute substantially to realizing the country's pipeline transit potential, through enhancing security for the large volumes of private capital that will be required. The attraction of private investment into oil and gas transit pipelines in Georgia will be facilitated by the adoption of legislation on eminent domain, which will permit land access in exchange for fair compensation, where that access is for an investment in the public interest.
5 This pipeline involvesan investment(from international oil companies)of about US$ 590 million, divided approximately equally between Georgia and Azerbaijan. -8-
31. Pipelines involve large infrastructure investments of long gestation and payback periods, with very limited alternative uses once constructed. They will therefore require long-term predictability in the tax regime. The Government will achieve this through legislating tax stabilization, while avoiding any discretionary tax exemptions or concessions on a case-by-case basis. The attractiveness of the investment climnatefor pipelines will also be enhanced by the conclusion of double taxation agreements with major home country governments. In this manner, oil and gas pipelines could become a major source of tax revenue and other economic benefits for Georgia, while providing a fair return to private investment and mitigating investor risk. Internationally-experienced advisors have been recruited to assist in commercial negotiations with potential foreign investors in oil and gas pipelines.
E. Energy and the Environment
32. During the past two years, a broad legal framework to govern environrnental management has been put in place in Georgia, reflecting the high priority the Government and Parliament place on this issue. However, further legislation and regulation is necessary to give full effect to the broader legal framework, particularly in the energy sector. Strengthening the legal framework should both enhance environmental management and reduce negative perceptions of investment in the environmentally-risky energy sector, thereby improving the investment climate.
33. The energy privatization due diligence process should include appropriate environmental audits to ensure that the responsibility for environmental mitigation can be clearly assigned post-privatization, and the Privatization Law will be amended during 1999 to achieve this. Legislation to clarify environmental liability in the energy sector will be adopted. Operational standards and permitting procedures applicable to oil and gas pipelines will be developed to enhance pipeline safety. In addition, Georgia will ratify international conventions related to marine oil pollution damage and adopt the requisite enabling legislation. Existing insurance arrangements to cover the costs of oil spill clean-up will be reviewed and, if necessary, legislation will be adopted to require compulsory insurance in the oil sector. These measures will help ensure that the risk of oil spills is minimized, and that an effective emergency response facility will be in place to mitigate any spills which do occur.
PART III. THE PROPOSED ADJUSTMENT CREDIT
A. Rationale for the Credit
34. Georgia urgently needs adjustment financing. Restructuring of the economy after the dissolution of the Soviet Union and the civil war in Georgia is still underway, and serious fiscal, quasi-fiscal, and external imbalances remain. In recent months, these imbalances have been compounded by the impact of the crisis in the Russian Federation on the Georgian economy. -9-
35. These imbalances originate in part from energy sector policies, and in part from broader macroeconomic policy. In particular, the energy sector has been used as a source of quasi-fiscal financing for the population and the economy, resulting in very poor service and high capital consumption. Weak fiscal management and insufficient structural reform have made it difficult to remove this quasi-fiscal role.
36. The proposed Energy Sector Adjustment Credit has therefore been designed in parallel with stabilization and structural reform programs supported by the IMF's ESAF and by the Bank's structural adjustment lending. The proposed credit is intended to allow the implementation of the energy sector reform program, with adequate funding of social sector expenditures to mitigate the impact of the program on the most vulnerable groups. The combined funding from the proposed ESAF and the Bank's adjustment lending is intended to provide an appropriate blend of financing and structural adjustment.
B. Link to the CAS and other Bank Group Operations
37. The proposed program and credit will support all four objectives of the CAS (I 7000-GE). It will strengthen public finances by removing the continued threat to the Government budget, which is posed by the unsustainable deficits in the electricity sector, by complementing public investment with private capital, and by transforming the energy sector into a major taxpayer. Sources of growth will be deepened and diversified as opportunities for private participation in the energy sector develop, and as the improved availability of energy removes a key obstacle to private sector development throughout the economy (which will also serve to strengthen the taxbase). The objectives of poverty reduction and environmental protection will be pursued as described below (paras. 46-49 and 50-51).
38. The proposed credit and the associated energy sector reform program are closely related to a number of Bank activities in Georgia. Structural adjustment lending, and the associated technical assistance credits,6 have directly supported energy sector reform in Georgia. Moreover, the structural adjustment program serves to improve social safety net provision, underpin fiscal adjustment, and create hard budget constraints for enterprises; all these measures should improve payments discipline amongst customers of the energy sector. Correspondingly, measures to improve energy sector financial management, taken under the proposed credit, will themselves harden budget constraints and thereby stimulate structural adjustment. They should also reduce corruption in a notoriously corrupt sector, thus mitigating popular opposition to economic reform.
39. In the energy sector itself, the Power Rehabilitation Credit (Credit 2958-GE) aims to rehabilitate, physically and financially, a 300 MW unit (No. 10) of the country's main
6 Relatedstructural adjustment and technicalassistance credits include the SecondStructural Adjustment Credit (Credit2983-GE), the proposedThird StructuralAdjustment Credit, the First and Second Structural AdjustmentTechnical Assistance Credits (Credit2848-GE and Credit2984-GE), and the proposed StructuralReform SupportCredit. In essence,the proposedEnergy Sector Adjustment Credit reflectsthe energy policy component of the Third Structural Adjustment Credit proposed in the CAS. -10- thermal power plant (Tbilsresi's plant at Gardabani). This project is part of a program of rehabilitation of generation plants funded by the Government of Georgia, sector enterprises, IDA, EBRD, KFW, OECF, and the Government of Switzerland. The electricity sector reform program supported by the proposed credit will be essential to the realization of Tbilsresi's financial rehabilitation. The program will also pave the way for preparation of an Electricity Market Support project. This would undertake limited rehabilitation of transmission and dispatch, and provide bulk metering and other information technology necessary for the functioning of a competitive wholesale electricity market. A Power Privatization Report (No. 17152-GE) helped to clarify the strategy for privatization and the creation of a competitive market. IFC is actively seeking investment opportunities in the electricity sector.
40. The oil and gas pipeline measures under the proposed credit are closely integrated with the technical assistance provided to the sector by the Oil Institution Building Credit (Credit 2944-GE) and the structural adjustment technical assistance credits. IFC has already made investments in the Early Oil pipeline and the Ninotsminda oil field.
41. The electricity privatization program supported by the proposed credit is the first major infrastructure privatization program in Georgia. As such, it should help to stimulate privatization initiatives in the water and transport sectors which are supported by Bank projects. The enviromnental initiatives to be taken with the support of'the proposed credit will be complementary to the Integrated Coastal Management P'roject (Credit No. 31560) and the proposed IDF for Environment Legislation (which will focus on capacity building for implementing such legislation).
C. Benefits and Risks of the Proposed Program and Credit
42. The proposed credit would maintain the momentum of energy sector reform in Georgia, and help mitigate its social costs. Energy sector reform will improve service quality, reduce environmental damage, and enhance the prospects for private participation in energy infrastructure. By removing a source of soft financing for the economy, it will force more rapid structural adjustment. Similarly, eliminating this quasi-fiscal role of the energy sector will remove the threat of such a role being thrust back on the Government budget, thereby undernining fiscal sustainability. Relieving energy shortages will remove a major constraint to private sector development and employment generation. Thus, energy sector reform is essential to macroeconomnic stabilization, sustainable economic growth, and poverty alleviation in Georgia.
43. However, the credit is a high-risk operation. The reform program is ambitious in the face of huge problems in the sector. The reforms may face stiff resistance from vested interests determined to preserve rent-seeking opportunities. The political will to proceed with energy reform may dissipate in the face of a sociopolitical reaction against cost recovery and foreign investment, and of parliamentary elections in November 1999 and presidential elections in April 2000. In the winter of 1999/2000, electricity supply may be no greater than in the previous winter, because drought has diminished hydropower reserves and poor financial management has starved the system of working -11- capital to buy fuel. This could lead to a backlash against electricity privatization (and against infrastructure privatization in general), yet the reform agenda depends heavily on privatization.
44. Implementation capacity of state agencies will be stretched, particularly as regards complex legal/regulatory reform, environmental management, and overall program coordination. This can be only partially offset by technical assistance. Declining appetite for emerging market risk may deter private investment in spite of the attractive policy framework. Broader stabilization and structural reform programs may break down in the face of political resistance, inadequate external financing, or a further sharp deterioration in the economies of major trading partners.
45. These risks are substantially mitigated by a widespread perception in Government and Parliament that there is no alternative to the proposed energy reform program. The collapse in services has been so great and the ability of the State to overcome the problems of the sector has proved to be so limited, that attracting private investment is perceived as an overwhelming imperative. In addition, the need to attract private investment in transit pipelines through Georgia in the face of few perceived alternative sources of growth and economic independence, serves to bolster political support for energy sector reform. However, the political risks of the proposed program and supporting adjustment credit remain significant.
D. Poverty Impact
46. Privatization and other measures to increase cost-recovery in the power sector can potentially have a large social impact. On the one hand, these measures are expected to bring about a sustained improvement in the availability and reliability of electricity, with a very favorable impact on the living standards of Georgian households (both directly by allowing households to use electricity rather than more expensive heating fuels, and indirectly through the revitalization of the economy, and the consequent generation of jobs and incomes). On the other hand, the combination of increased payment discipline and expected increase in electricity tariffs over the medium term, could place a large additional burden on already over-stretched household economies. The poorest and most vulnerable households are those most at risk.
47. According to the quarterly Household Expenditure Survey, the average Georgian household spends 14.7 lari per month on energy and fuel (about 5% of total household monthly expenditures). Approximately 60% of this figure is spending on relatively expensive heating fuels (kerosene and wood), with only 24% of the energy bill representing outlays on electricity, and less than 5% spending on natural gas (due to the lack of supply). Hence, the average family is spending some 3.5 lari per month on electricity, or the equivalent to 60 kWh at current retail tariffs. However, given significant non-payment by the population and the proliferation of illegal connections, actual electricity usage, for those receiving supply, is likely to be much higher. Assuming that average household usage, post privatization, is around 150 kWh per -12- month,7 expected monthly outlays at current tariffs and 100% collections, would reach some 9 lari per month. For the average Georgian household, this would represent approximately 3% of total monthly expenditures-not an unreasonable burden. Moreover, there is potential for these households to reduce their overall energy bills by shifting spending from kerosene and wood towards cheaper electricity and gas, once these services are provided on a reliable basis.
48. For the poor, however, the financial impact of increased cost-recovery will be much larger. Total monthly expenditures for the average poor family amount to only 80 lari per month, of which currently some 4 lari per month are spent on all forns of energy (heating fuels plus electricity). An increase in electricity payments to 9 lari per month, even if it were to allow an elimination of all spending on other sources of heating, would represent a significant fraction of their monthly spending (about 11%). For some particularly vulnerable groups, such as poor single pensioners, whose monthly expenditures amount to only 38 lari, the impact of increased cost recovery could be even more formidable.
49. In this context, it will be essential to protect these especially vulnerable groups from the impact of increased cost-recovery. Although severe budget constraints limit the amounts that can be provided to vulnerable households, the Government has increased the poverty benefit targeted to poor single pensioners, who are among the poorest identifiable groups in society, and whose incomes will not improve significantly with growth, at least in the short term. The authorities will monitor the impact of increased cost-recovery in the energy sector on poor families, using the continuous Georgian Household Income and Expenditures Survey. A parallel beneficiary assessment will be carried out to monitor the actual receipt of the poverty benefit.
E. Environmental Impact
50. The sector adjustment program supported by the proposed credit is expected to yield significant environmental benefits. Increased cost-recovery in the electricity sector will encourage conservation by enterprises and households. The restoration of natural gas supply will allow substitution for environmentally-harmful wood and oil products, and will reduce the wasteful transformation of gas into electricity. Improved market access for Georgian gas should eliminate gas flaring.
51. The adoption of legislation to clarify environmental liability is expected to improve the environmental management practices of energy enterprises, particularly in the oil sector. Amending the Privatization Law to require environmental audits will facilitate the disclosure of pre-privatization environmental damage, as well as enhancing the enforceability of environmental liability legislation. The legislation on environmental liability will be complemented by the adoption of minimum operational standardis for
7 It is not possibleto determinereliably actual average monthly consumption of electricityby householdsin Georgia. It is even more difficultto predictusage once electricitybecomes available on a 24-hourbasis. However,a comparisonwith neighboringcountries suggests that an averageof 150 kWhper monthis a reasonableestimate.
8 "Single" is defined in Georgianlaw to representpensioners with no relativesof workingage. -13- pipelines to help prevent onshore oil spills. Ratification by Georgia of international conventions related to marine oil pollution damage will also serve to mitigate environmental damage to the marine environment from the oil industry, as will ensuring that oil companies are adequately covered by insurance against oil-spill risks.
F. Prior Actions, Effectiveness and Second Tranche Conditions
52. A set of prior actions were taken before presentation of the proposed credit to the Board. These prior actions were:
* sale of Telasi;
* offering for privatization of all remaining electricity distribution companies and generation plants9;
* increase in electricity tariffs (by an average 45%);
* inclusion the 1999 Consolidated Budget of 14.3 million lari for the poverty benefit targeted to poor single pensioners, and approve an increase in the benefit was increased to 18 lari for an individual recipient and 29 lari for two recipients in the same household (from 9 and 14.4 lari respectively);'0
* inclusion in the 1999 Consolidated Budget of 10 million lari to compensate for unpaid electricity supplied by Inguri Hydro Power Plant (to Abkhazia)' 1;
* adoption of detailed electricity market rules;
* parliamentary adoption of Oil and Gas Law (governing exploration and production);
* parliamentary adoption of amendments to the Electricity Law to authorize GNERC to regulate gas marketing, distribution and transmission.
A satisfactory macroeconomic framework (ESAF and SAC programs on track) is an effectiveness condition.
53. The conditions of second tranche release are12:
9 The generation plants in Abkhazia will only be privatized once the Government of Georgia regains sufficient control over that region.
10 The individual benefit levels bring the beneficiaries just up to the Bank-estimated poverty line.
1' The Inguri Hydro Power Plant is located just inside Abkhazia, but is controlled by the Government of Georgia (an agreement reached as part of the cease-fire in the hostilities over Abkhazia). Abkhaz consumers of electricity, who are supplied from Inguri, do not pay for electricity to any significant extent. The cost of this supply is therefore a financial leakage from the Georgian power sector, borne by the transmission and generation companies. It thus represents a serious obstacle to financial rehabilitation and to privatization. However, providing for budget funds to cover this leakage is obviously not a long-term solution. -14-
* satisfactory progress on power privatization 13;
* actual expenditures on the poverty benefit for poor single pensioners to fully reflect the 14.3 million lari total budgetary allocation (i.e. no arrears) and individuaLlbenefit levels specified, and abolish direct transfers to Sakenergo in respect of pensioners, civil servants, and refugees in privatized distribution areas14;
• actual expenditures in compensation for electricity supplied by Inguri Hydro Power Plant to fully reflect the budgetary allocation;
* continued implementation of the electricity tariff methodology adopted by GNERC on July 1, 1998;
* adoption of a gas tariff methodology by GNERC and licenses to have been issued to all privatized gas distribution companies, the gas transmission company, and all gas purchasers/resellers;
* Parliamentary adoption of legislation on eminent domain;
* Parliamentary adoption of legislation on environmental liability;
* Sakenergo, Energotransmission, Sakenergogeneratsia, Tbilsresi and Saktransgasmretsvi to adopt a Chart of Accounts according to Intemnational Accounting Standards, and appointment of international auditors to audit the 1999 financial statements of those enterprises;
* satisfactory overall performance on the Government's energy refonn prograrn as stated in the Letter of Energy Sector Policy;
* satisfactory macroeconomic framework (ESAF and SAC programs on track).
12 These actions are expected to be completed by end - 1999.
13Progress will be measured against the target that by Fall 1999 (i) bids for Gardabani Thermal P'ower Plant should have closed; (ii) at least 10 percent of state-owned generation capacity (other than Gardabarii or plants in Abkhazia), i.e. about 130 MW, should have been sold (majority stake) or long-term concessions awarded (at least 25 years) through a competitive process; and (iii) offers for the two packages of distribution companies should have been evaluated, or if no eligible offers are received, the packages should have been reconfigured and offered for sale again.
14 These direct transfers were introduced in 1997 to provide Sakenergo with urgently-needed working capital, which was failing to flow from the distribution companies due to non-enforcement of payments from consumers and to theft. The transfers are fnanced by a defacto withholding tax from pensions, civil service salaries, and refugee allowances. As such, they represent a forced consumption of electricity and should be abolished once distribution privatization removes the reason for which they were introduced. -15-
G. Credit Amount and Disbursement Procedures
54. The proposed credit of SDR 18.1million (US$25 million equivalent) will be made to Georgia, represented by the Ministry of Finance, which will be responsible for credit administration. Disbursements will be made in two tranches, each of SDR9.05 million (US$ 12.5 million equivalent), against submission by the Borrower of a simplified withdrawal application. The first tranche will be disbursed immediately upon credit effectiveness; the second on completion of the second tranche conditions outlined above (para. 53). Disbursements will be made to an account (the "Deposit Account") of the Ministry of Finance established at the Georgian central bank (National Bank of Georgia) for that purpose (upon Board approval of the proposed credit).
55. The credit will be disbursed according to the Bank's simplified disbursement procedures for adjustment operations. Thus disbursements will not be linked to specific purchases and there will be no procurement requirements. If the proceeds of the credit are used for ineligible purposes as defined in the credit agreement (i.e. to finance items imported from non-member countries, or good and services on the Bank's standard negative list), IDA will require the Borrower to either (a) return that amount to the deposit account for use for eligible purposes; or (b) refund the amount directly to IDA, in which case IDA will cancel an equivalent undisbursed amount of the credit. Although routine audits of the deposit account will not be routinely required, the Bank reserves the right to require audits at any time.
H. Program Implementation Arrangements
56. The program has been designed in a context of strong ownership by individual government agencies, but of weak coordination between them. Coordination under the program will be provided primarily by oversight from a Government interministerial working group, which is chaired by the State Minister. IDA will monitor implementation through frequent review missions, periodic reporting by individual implementing agencies, and by continuous involvement of the Resident Mission.
57. The technical capacity to implement complex privatization transactions and legal/regulatory reform is still evolving in Georgia. As such, extensive technical support will be provided through consultancy advice and training programs, financed principally by USAID and by IDA's Structural Adjustment Technical Assistance credits (Credit 2848-GE and Credit 2984-GE) and the proposed Structural Reform Support Credit.
58. USAID is proposing to provide technical support for (i) development of the wholesale electricity market; (ii) upgrading accounting, auditing, and financial controls of energy sector enterprises; (iii) capacity-building of GNERC in both electricity and gas regulation; (iv) capacity-building for the Competent Authority under the Oil and Gas Law; and (v) development of legislation on environmental liability and eminent domain. IDA will finance (i) negotiation advisors for oil and gas pipelines; (ii) power and gas privatization advisors; and (iii) support to GNERC and the Electricity Market Administration. -16-
PART IV. RECOMMENDATION OF THE PRESIDENT
59. I am satisfied that the proposed credit would comply with the Articles of Agreement of IDA and I recommend that the Executive Directors approve it.
James D. Wolfensohn President
By Sven Sandstrom
Attachments Washington, D.C. June 4, 1999 b1dbr"U)3M1b MMan3660 PRESIDENT OF GEORGIA
Mr. James D. Wolfensohn President Intffational Bank for Reconstuction and Development Washington,20433
June 2, 1999
Dear M4r.Wolfensohn:
Ile attached Letter of Energy Sector Policy outlinesthe energy reform progm of Georgia. We request the World Bank to support this prgram with an Energy Sector Adjustnent Credit.
The program of measues in the Letter is intended to enhance financial muanagementin the energy sector and catalyzepnrvate investnent in electricity, gas and oil. The program places particular emphasis on strengthening environmcntal managementand on providing social protection. We consider this program to be essential to the restructring of the Georgian economy and attainment of a sustinable growth in the living stndards of our population.
Yourssincerely,
Eduard Shevardnadze ,2'r Annex 2 Page 1 of I
ANNEX 2 GOVERNMENT OF GEORGIA: LETTER OF ENERGY SECTOR POLICY
The Government of Georgia has embarked upon a program of reform to restructure the country's energy sector. The primary objective of this program is to transform the sectlorfrom one drained of resources and providing unreliable service to one capable of promoting economric growth, environmentally-sustainable development, and the realization of Georgia's considerable transit potential. This letter outlines the measures to be taken in the energy sector during 1998 and 1999 in pursuit of that objective. The Govermmentbelieves that the success of these measures will depend on the sustained implementation of macroeconomic stabilization and broad structural reform.
In the electricity sector, a series of measures are being taken to enhance financial management, combat corruption, and protect the most vulnerable sections of the population. The sector is being progressively privatized through a transparent and competitive process to bring new capital and commercial management techniques into the country's power enterprises. This is being achieved by offering majority shares (or very long-term concessions) in major sector enterprises to strategic investors with capital and expertise, in combination with minority shares to be sold on the Georgian capital market or offered to employees. The involvement of an internationally-reputable investment bank is critical to the success of this process.
Efficiency gains from privatization will be enhanced by the gradual introduction of a competitive wholesale electricity market to ensure the dispatch of electricity on a least-cost basis. Market institutions and regulations are being developed in this regard, and the market will be launched in July 1999. The Government will focus its limited budgetary and donor resources on removing systemic constraints to sector privatization (for example, by upgrading transmission and dispatch services and building market infrastructure) and undertaking urgent rehabilitation in advance of privatization.
Private ownership and competitive market relations are expected to substantially enhance payments discipline, greatly improve cost recovery, and stimulate investment in the sector. This will be of major benefit to the majority of the Georgian population after years of receiving an extremely low-quality service from a sector deprived of working capital and operating extremely dilapidated plant and equipment. The adverse social effects on the poorest sections of the population of cost recovery in the power sector will be mitigated by the provision of targeted social benefit payments from the State budget. The Government will ensure that these benefits are disbursed on a timely basis.
In parallel to the restructuring and privatization process, the Georgian National Electricity Regulatory Commission's capacity to regulate monopoly practices is being strengthened through training and legal reform. The Government will ensure the continued independence of the Commission in accordance with the Electricity Law. The tariff methodology adopted onIJuly 1, 1998 will continue to be applied to protect consumers from monopoly practices while providing an adequate return to investment. This will be essential to ensuring that the power sector in Georgia is rehabilitated and upgraded to provide reliable electricity to the population and the economy. Annex 2 Page 2 of 2
Sector enterprises remaining in state ownership will face a considerable challenge to improve their financial management practices. For enterprises where privatization may commence only in a later phase (dispatch company, transmission company, generation plants in Abkhazia), financial management will be enhanced by the conduct of audits to international standards (which will be published) and through systematic reform of internal financial controls. International auditors will be appointed for those companies by June 1999. International accounting standards will become mandatory for all sector enterprises by June 1999. The Government will closely monitor the financial performance of the power sector, and will accelerate privatization and financial management reforms if performance improves less than projected.
In the natural gas sector, a similar program of sector reform is under way with a view to creating a suitable climate for investment and improving the efficiency of gas supply. The restoration of gas supply to the population will reduce energy costs and replace energy products which are environmentally harmful (particularly wood and oil products). The authority of the Georgian National Electricity Commission is being extended, through amendments to the 1997 Electricity Law, to include regulation of monopolistic components of gas supply. The Commission will, by June 1999, adopt a transparent methodology for setting tariffs for monopoly services, including gas supply (until competitive markets can be established), transmission, and distribution. The tariff-setting procedures will ensure that regulated enterprises can recover prudently incurred costs of service, while at the same time promoting efficiency in gas supply and energy consumption, and protecting consumers from monopolistic pricing practices. The Commission will develop terms and conditions for commercial licenses which address the rights and responsibilities of sector enterprises and will by June 1999 issue licenses to all major participants in the supply chain, including at a minimum the transmission company, the privatized distribution companies, and gas purchasers/resellers. The Commission will also establish clear dispute-resolution procedures (applicable also to electricity sector enterprises).
Once the new gas regulatory framework is firmly established, the remaining municipal gas distribution companies will be privatized. For those gas distribution companies already privatized, the Ministry of State Property Management will ensure that the new owners meet their investment and service commitments with respect to extending supply to financially viable markets within their service areas. If necessary, the Ministry will require the new owners to bring in additional strategic partners. Given that the government proposes to seek strategic investors to participate in the upgrading of the high-pressure transmission network, the transmission operating company, Saktransgasmretsvi, will not be privatized at the present time. However, in order to facilitate regulation and improve performance, financial management of the company will be upgraded through the introduction of international accounting standards, appointment of international auditors, and a review of financial control procedures (by June 1999).
In the Georgian oil sector, the new Oil and Gas Law is expected to catalyze investment in exploration and production of oil and natural gas by establishing a one-stop regulatory authority for the sector, and by consolidating the legal foundation for existing operations. The Law will also facilitate pipeline access for Georgian oil and gas. The Georgian Oil Company (Saknaftobi) will focus on its commercial activities and will play no regulatory role. During 1999, Saknaftobi will be prepared for privatization, to ensure that maximum revenues from existing production sharing agreements accrue to the State. In parallel, regulation of the gas sector by the Electricity and Gas Regulatory Commission to facilitate competitive supply should stimulate development of Georgian gas potential. Annex 2 Page 3 of 3
The Government places a high priority on environmental management, particularly in the energy sector. The energy privatization due diligence process should include appropriate environmental audits to ensure that the responsibility for environmental mitigation can be clearly assigned post-privatization, and the Privatization Law will be amended during 1999 to achieve this. Legislation to clarify environmental liability in the energy sector will be adopted by June 1999. Operational standards applicable to oil and gas pipelines will be developed. In addition, Georgia will ratify all international conventions related to marine oil spill prevention and mitigation by March 1999, and adopt the requisite enabling legislation. Existing insurance arrangements to cover the costs of oil spill clean-up will be reviewed and, if necessary, legislation will be adopted to require compulsory insurance in the oil sector.
Georgia's location and positive investment climate create enormous potential for the pipeline transit of crude oil and natural gas, which will be financed largely by private capital. Georgia's ratification of the Energy Charter Treaty will contribute substantially to realizing that potential. The attraction of private investment into oil and gas transit pipelines in Georgia will be facilitated by the adoption by June 1999 of legislation on eminent domain in order to permit land access in exchange for fair compensation. Pipeline investment will also require predictability in the tax regime; this will be achieved through legislated tax stabilization, while avoiding any discretionary tax exemptions or concessions on a case-by-case basis. The attractiveness of the investment climate for pipelines will also be enhanced by the conclusion of double taxation agreements. In this manner, oil and gas pipelines could become a major source of tax revenue and other economic benefits for Georgia, while providing a fair return to private investment and mitigating investor risk. Internationally-experienced advisors will be recruited by January 1999 to assist in negotiations with potential foreign investors in oil and gas pipelines.
The Government expects this program of measures to stimulate investment in Georgia's energy resources and to steadily improve the provision of services. Greater efficiency in the energy sector will have a positive effect on the external balance of payments and on the State budget. Overall, energy sector reform will bring a major improvement in the living standards of the Georgian people and in the country's ability to realize its considerable economic potential. Annex 3 Page 1 of 1
ANNEX 3 GEORGIA: ENERGY SECTOR ADJUSTMENT CREDIT - POLICY MATRIX Note: Core conditions in bold OBJ:ECTIVES CURRENT STATUS MEASURtESIN THE LESP
POWER SECTOR
Enhance financial management Telasi privatized Progress on privatization satisfactory to IDA
Remove threat to Government budget from Rest of distribution and generation Continued implementation of electricity tariff quasi-fiscal deficit in the power sector offered for sale or long-term concession methodology adopted July 1, 1998 by GNERC
Promote private investment Electricity Law adopted, which creates Sakenergo, Energotransmission, independent regulatory commission Sakenergogeneratsia, and Tbilsresi to adopt Regulate monopoly power and promote (GNERC) IAS chart of accounts, appoint international competition auditors, and review internal financial controls Electricity tariffs increased Harden budget constraints on enterprises Public investment resources to focus on removing consuming power Debt commission formed to restructure systemic constraints to sector privatization and debt at point of privatization undertaking urgent rehabilitation Improve social protection Consolidated budget for 1999 Actual expenditures on Abkhazia compensates for part of leakage to compensation to reflect budget allocation Abkhazia Wholesale market commences first phase of Wholesale market rules adopted operation
Consolidated budget for 1999 provides Actual expenditures on poverty benefit to increased poverty benefit to reflect budget allocation and continuous compensate poorest for increased cost monitoring of poverty impact of cost recovery recovery and of actual receipt of the poverty benefit to take place. Annex 3 Page 2 of 2
OBJECTIVES __CURRENT STATUS MEASURES IN THE LESP
NATURALI GAS 'IRANSMCiSS0N AND DISTRIBU'[ION
Enhance financial managerment Some gas distribution companies pnrvatized Remaining gas distribution companies to be privatized Restore gas supply to paying Electricity Law amended to authorize GNERC to customers regulate gas marketing, distribution and Miniistry of State Property Management to transmission enforce investment and service commitments of Promote private investment new owners of gas distribution companies
Regulate monopoly power and GNERC to adopt gas tariff methodology promote competition GNERC to license sector enterprises Improve social protection Saktransgasmretsvi to adopt IAS chart of accounts, appoint international auditors, and review internal financial controls
GNIERCto adopt dispute-resolution procedures (applicable also to electricity enterprises). OIL AND GAS EXPLORATION AND PRODUCTION
Catalyze private investment on Oil and Gas Law adopted to create one-stop Saknaftobi to be prepared for privatization. terms beneficial to Georgia competent authority to regulate oil and gas exploration and production, and negotiate production sharing agreements Annex 3 Page 3 of 3
OBJECTIVES |CURRENT STATUS |MEASURES IN THE LESP
OIL AND GAS TRANSIT PIPELINES
Catalyze private investmett Energy Charter ratified Legislation on eminent domain to be adopted realize Georgia's transit potential Early oil pipeline in operation; other oil and gas Legislation to be adopted to stabilize tax regime transit pipelines under discussion applicable to pipelines; no discretionary tax concessions to be granted GIOC (oil) and GIC (gas) established to liaise with potential pipeline investors Double taxation agreements to be concluded with major investors' home countries Recruitment of internationally-experienced advisors for pipeline negotiations Annex 3 Page 4 of 4
OBJECTIVES CURRENT STATUS MEASURES IN THE LESP
ENERGY AND THE ENVIRONMENT
Enhance environment Broad legal framework for environmental Adopt legislation on environmental liability management in the energy sector management has been adopted. Amend Privatization Law to require appropriate environmental audits
Develop operational and permitting standards for pipelines
Georgia to ratify all international conventions related to oil spill and to adopt requisite enabling legislation
Oil spill insurance arrangements to be reviewed, and legislation on compulsory insurance to be adopted if necessary Annex 4 Page 1 of 1
ANNEX 4 GEORGIA ENERGY SECTOR ADJUSTMENT CREDIT
Timetable of Key Processing Events
1. Time taken to prepare: 12 months
2. Prepared by: Government of Georgia in collaboration with World Bank staff and consultants*
3. Preparation missions: June 1998, October 1998
4. Negotiations: December 1998 (and subsequent communications)
5. Planned Board presentation: June 1999
6. Planned date of effectiveness: August 1999
7. Expected program completion: June 2000
* Messrs./Mmes.:Arpad Bajkay, PrivatizationSpecialist David Craig, SectorLeader ManuelDussan, Regulatory Specialist Zurab Javakhishvili,Project Officer VakhtangKvekvetsia, Financial Analyst William Onorato,Petroleum Lawyer Ana Revenga,Sr. CountryEconomist Allan Rotman,Environmental Specialist Ralf Schwimmbeck,Pipeline Engineer Peter Thomson,Oil and Gas SectorLeader VladislavVucetic, Power Engineer JonathanWalters, Task Team Leader/SeniorEconomist Peggy Wilson,Energy Economist SalmanZaheer, Energy Economist Annex 5 Page I of 1
ANNEX 5 Status of Bank Group Operations in Georgia Operations Portfolio
Difference b/t expected & Last PSR Original Amount in US$ Millions actual Supervisio Fiscal disbursements a! n Rating b/ Project Year Borrower Purpose IBRD IDA Cancel Undisb. Orig Frm Dev Imp ID Rev'd Obj Prog Number of Closed Projects: 5 Active Projects GE-PE- 1995 Gov't of Georgia Municipal Infra. Reh 0.00 18.00 0.00 1.02 2.65 0.00 S S 8417 GE-PE- 1996 Gov't of Georgia Transport 0.00 12.00 0.00 .09 .88 0.00 HS S 39892 GE-PE- 1996 Gov'tofGeorgia Health 0.00 14.00 0.00 9.46 8.19 0.00 U U 8414 GE-PE- 1997 Gov't of Georgia Oil Institution Bldg 0.00 1.40 0.00 .56 .23 0.00 S S 44830 GE-PE- 1997 Gov't of Georgia Agriculture Develop. 0.00 15.00 0.00 6.73 -3.52 0.00 S S 8415 GE-PE- 1997 Gov'tofGeorgia PowerRehab. 0.00 52.30 0.00 2.70 -3.17 0.00 U S 35784 GE-PE- 1998 Gov't of Georgia Cultural Heritage 0.00 4.49 0.00 4.23 1.22 0.00 S S 55573 GE-PE- 1998 Gov't of Georgia SATAC II 0.00 5.00 0.00 1.50 1.38 0.00 S S 51034 GE-PE- 1998 Gov't of Georgia Social Invest. Fund 0.00 20.00 0.00 17.30 5.39 0.00 S S 39929 GE-PE- 1998 Gov'tof Georgia MunicipalDev. 0.00 20.90 0.00 18.61 7.74 0.00 S S 50910 GE-PE- 1999 Gov't of Georgia Tmspt Min Restruct. 0.00 2.30 0.00 2.44 1.54 0.00 S S 56514 GE-PE- 1999 Gov't of Georgia Integ. Coastal Mgt 0.00 4.40 0.00 4.34 .12 0.00 S S 50911 GE-PE- 1999 Gov't of Georgia Enterprise Rehab. 0.00 15.00 0.00 14.90 0.00 0.00 8416
Total 0.00 184.7 0.00 83.88 22.65 0.00 9
Active Projects Closed Projects Total Total Disbursed (IBRD and IDA): 97.44 213.56 311.00 of which has been repaid: 0.00 0.00 0.00 Total now held by IBRD and IDA: 184.79 209.90 394.69 Amount sold 0.00 0.00 0.00 Of which repaid 0.00 0.00 0.00 Total Undisbursed 83.88 .01 83.89
a. Intended disbursements to date minus actual disbursements to date as projected at appraisal. b. Following the FY94 Annual Review of Portfolio performance (ARPP), a letter based system was introduced (HS highly Satisfactory, S = satisfactory, U = unsatisfactory, HU = highly unsatisfactory): see proposed Improvements in Project and Portfolio Performance Rating Methodology (SecM94-901), August 23, 1994. Annex 6 Page 1 of 1
ANNEX 6 Georgia STATEMENT OF IFC's Committed and Disbursed Portfolio As of April 1999 (In US Dollar Millions)
Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1997 Georgia G&MW Co. 0.00 2.80 0.00 0.00 0.00 2.80 0.00 0.00 1998 TBC Bank 3.00 0.00 0.00 0.00 .38 0.00 0.00 0.00 1999 Ninotsminda 0.00 0.00 6.00 0.00 0.00 0.00 0.00 0.00
Total Portfolio: 3.00 2.80 6.00 0.00 .38 2.80 0.00 0.00
Approvals Pending Comnmnitment Loan Equit Quasi Partic 1999 GEORGIA M-F BANK 0.00 Y74 0.00 0.00 1998 TBC Bank 0.00 1.00 0.00 0.00 1999 ThilComBank 3.00 0.00 0.00 0.00 1998 THE KSANI 6.32 2.50 0.00 0.00
Total Pending Commitmnent: 9.32 4.24 0.00 0.00 Annex 7 Page 1 of 2
Georgia at a glance 10/1/98
Europe& Lower- POVERTYand SOCIAL Central middle- - Georgia Asia income Developrnentdiamond' 1997 Population, mid-year(millions) 5.4 476 2,285 Life expectancy GNP per capita (Atlas method, US$) 840 2,320 1,230 GNP (Atlas method, US$ billions) 4.5 1,106 2.818 Average annual growth, 1991-97 Population(V.) -0,2 0.2 1.2 GNP Gross Labor force t%) -0.1 0.5 1.3 perpimr ppeGmary Most recent estimate (latest year available, 1991-97) capita enrollment Poverty (A of population below nationalpoverty line) 30 .. Urban population(% of total population) 58 67 42 Life expectanCyat birth (years) 73 69 69 Infant mortaiity(per 1,00 tive births) 18 25 36 Child malnutrition(% of children under 5) ...... Access to safe water Access to safe water (%ofpopulation) . .. 84 Illiteracy (% of population age 15+) 1 ., 19 Gros primary enrollment ( ofschol-age population) 86 92 111 -Georgia Male .- . 118 Lower-middle-incomegroup Female .1 ,. t13 1
KEY ECONOMICRATIOS and LONG-TERMTRENDS 1976 1986 1996 1997 Economicratios' GDP (US$ bilions) - 4,6 52 Gross domesticinvestment/GOP .. 29.9 6,0 6.7 Trade Exports of goods and services/GDP . .. 11.2 11.9 Gross domesticsavings/GDP .. 29.8 -1,8 -4.2 Gross national savings/GDP .. .. 2.3 1.9
Cunrentaccount baiancelGDP .. .. -9.1 -10.2 Domestic / n Interest payments/GOP . .. 1.4 0.8 Savings Investment Totaldebt/GDP .. .. 30.1 29.6 Total debt service/exports ,. .. 15.3 13.9 Presentvalue Of debt/GDP .. .. 23.9 19.1 Presentvalue of debt/exports .. .. 213.4 208.9 Indebtedness 1976-86 1907-97 1996 19S7 199842 (average annualgrowth) GDP .. .. 10.5 10.9 7.6 Georgia GNP per capita * 12.7 12.8 8.1 Lower-middle-incomegroup Exports of goodsand services .. .. 17.8 18.4 12.2 e
STRUCTUREof the ECONOMY 1976 1986 1996 1997 Growthrates of output and investment (%6) (% of GDP) iso Agriculture * 26.8 33.4 31.6 75- industry .. 37.0 25.1 23.4 + Manufacturing .. 27.8 18.8 17.5 o Services .. 36.2 41.5 45.0 74 9S 9S 97
Private consumption .. 57.4 92.7 95.2 -1SO General govemment consumption .. 12.8 9.1 9.0 GDI 6 GDP Imports of goods and services .. .. 18.9 22.7
197646 1987-97 1996 1997 Growthrates of exportsand Imports(%) (average annualgrowth) 45 Agriculture .. .. 3.0 3.5 5 T Industry .. .. 2.0 2.0 30- Manufacturing .. .. 2.0 2.0 iS Services .. .. 16.8 17.2 /"e
Private consumption .. .. 2.2 15.4 -1S 92 93 94 5S 97 General govemment consumpton .. .- 40.0 10.9 Gross domestic investment .. .. 57.0 90.9 -30 Imports of goods and services .. .. 9.7 39.2 -E xports Imports Gross national product 4.4 -16.5 12.7 11.2
Note: 1997 data are preliminaryestimates. The diamondsshow four key indicators in the country (in bold) comparedwith its income-groupaverage. If data are missing, the diamond will be incomplete. Annex 7 Page 2 of 2
Georgia
PRICES and GOVERNMENTFINANCE 1976 1986 1996 1997 Infation (%h) Domestic prices 20OC0 (% change) . Consumer prices .. .. 39.4 7.1 15.000 /I\Q Implicit GDP deflator 0.5 6.1 40.2 7.1 10,00 -0
Government finance 5,00. (% of GDP, includes current grants) o Current revenue .. .. 8.1 9.9 92 93 94 90 96 97 Current budget balance .. .. -4.6 -3.5 GDPdenator O CP Overall surplus/deficit .. .. -5.8 4.6 -G-P-d-|at-r-0-OP
TRADE (US$ miifons) 1976 1958 1996 1997 Exportand import levels (US; millions)
Total exports (fob) ,- - 463 559 1,00 Black metal .. .. 80 101 Tea .. .. 19 24 750 Manufactures .. .. 231 236 Total imports (cif) *. * 768 947 sr Food 213 154 9r Fuel and energy . .. 184 196
Capital goods . .. 129 330 o 91 92 93 94 90 9 97 Export price index (1995100) .. Import price index (1995=100) ...... Exports Imports Terms of trade (1995=100) .. .. _.._..
BALANCE of PAYMENTS
(US$ millions) 1976 1986 1996 1997 Current account balance to GEIP ratio (h)
Exports of goods and services . .. 511 623 0 Imports of goods and services . .. 867 1,192 91 92 93 94 97 Resource balance .. .. -356 -569 | .
Net income . .. -62 34 Net current transfers .. 141 188 -20
Current account balance .. .. -418 -535 .30
Financing items (net) .. .. 339 474 Changes in net reserves ,. .. 79 61 |40 Memo: Reserves including gold (US$ millions) .. .. 159 175 Conversion rate (DEC, localUUS$) .. .. 1,263.0
EXTERNAL DEBT and RESOURCE FLOWS 1976 1986 1996 1997 (USS millions) Composition of total debt. 19ie (USS millions) Total debt outstanding and disbursed .. .. 1,378 1,550 IBRD .. 0 0 lF:1 IDA .. .. 157 212 B:157
Total debt service .. .. 49 53 / lORD . .. 0 0 C:196 IDA. 1 1
Composition of net resource flows Official grants - 141 84 D:13 Official creditors .. .. 186 192 Private creditors .. .. 0 0 Foreign direct investment .. .. 54 189 E: 995 Portfolio equity .. . 0 0
World Bank program Commitments .. .. 91 155 AA- IBD E- Bilateral Disbursements .. .. 76 64 8 - IDA D- Othermulfilateral F - Prvate Principalrepayments .. a0 C-IMF G - Short-term Net flows .. .. 76 64 1 s Interest payments .. .. 1 1 Net transfers .. .. 76 63
Development Economics 10/1/98 MAP SECTION no GAS LINESWITH FLOW IN I C SELECTEDCITIES MILLIONSOF CUBIC FEET(MCF) 0 AUTONOMOUS OBLAST(AO) CENTER R U S S I A N F E D E R A T I O N COMPRESSORSTATIONS ° AUTONOMOUS REFUBLIC(ASSRI CENTERS 425o FILLINGSTATIONS WITH CAPACITYIN MCF O ATONAL CAPUBL E % ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~*NATIONALCAPITAL EFThEE BUILT-UPURBAN AREA GLACIERAREAS
RIVERS
-MAIN ROADS ) gK V/ < A_<4g - SECONDARYROADS
_/ 7 y - RAILROADS Sukhut ...... INTERNATIONAL_S=_ =/>,< i BOUNDARIES <,;==,,,,&7>,, 43 -*-
7'0 z Xvgrdlb ,-" " = 0 15 30 45 60 7s K7LOMETERS
V'NN1A T U RniekI,iE Y - T,oAToLeninrogi ToTaTir,Aloverdi Wt=wA O.
Ae*ro I i~~'I USA 0 ~~~~~~~~~~~~~~~~~FEDERATION
2 DusI,e~ Ames,\/ Z~~~~~~~~~~~~~~~ eecl
- Tear / coal~~~~~~~~~~~~~4'
/ ojm 'tlhe / N 4 ooeA
cZAKHSTAN 'LIkIk 27Tol-Tar
7> ~~~~~~~~TU R K E Y~ ~'rTR oAl4~!,
"C' 7 T reaLaaT T.T~~~~~~~~~~~~K 4 E HYDROPOWER PLANT 0 AUTONOMOUS OBLAST(AO) CENTER ! SUBSTATION ® AUTONOMOUS REPUBLIC(ASSR) CENTERS POWER LINES: ®k NATIONALCAPITALS
- 220--- kv GLACIERAREAS _I,,% _ _ . . < - - 330 kV RIVERS
( Ruv-- 500oOt .skV - .: M AINROADS J\ At ~.. - 1 - BUILT-.. UP URBAN AREA -- SECONDARYROADS KNU d \ 's . t _.' ...... 1RAILROADS XA/ Sukh ~D ( N b( -- INTERNATIONAL,S CJA BOUNDARIES
se-Ps0p 1 F ~ --TKVAR(-HEL-' 0 15 30 45 60 75 KROMETEP5
7• li Ti,~~~~~~~~~~~~~~~~~~~~~~~GbiT N4I(-9Kthesehi \'E ;;O ekE, Gebi TAO,e 0 N.~ 5 *la'ir k ½'liav
0~~~~ER- r Toef t~ A2JANURI 'Yev . r •). ,,,-AU( 9 Keee 0 \,
INRI~~~~~~~~~~~~~~~~~~~~~ FDRTO
ot~~~~~~~~~~~~~~~~~~~~~~~~-N.Loeel uht { Tpcif
TS¶USL --- 'K I~ U ~~~~~~~~~'TIo \;~~~~~~~~~~~~~~~~~~~~~/4611,i,j 'Y< Euekhev --- HAOR-Tse'j -5kh 1 :Rier.D' i''' Raiser, /.ii~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ IIE- D ATI ANSHN t'''-- y' '' '\s ' 2 "- .~~Kseis t'' _, .
v~~~~~~h m <- -\ . SNA l ( S.hhr - - .. RUSSIAN
C, ~~~ ~ ~ ~ ~ ~ ~ ~ EhoIkoM~~~~~~~~~~~~~~~~~~~/ 2~~~~~I
'-V~~~~~~~~~~~~~~~~~~~~~~~A
TURKEY~~ ~~~~~~~~~~~~~~T 1ik 4r''-e GDo OIL FIELDS AREAS R U S S I A N F E D E R A T I O N L=OLNGSERNRGOS2'';3GLACIER OILREFINERIES RIVERS ROADS ~~~~~~s _< _ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~OIL PIPELINE MAIN ROADS C;17-sR< Rt ' ' ' OILTERMINALS ~~~~~~~~~~~~~~~~~~~~~~SECONDARY
4 ! 0 .. ~~~~~~~5~~ ' , ; g < o17 SELECTEDCITIESRALOD (;/> < /f3 <_==g' -;w>t g O~~~~~~~~~~~~~~~~~AUTONOMOUSOBLAST (AO) CENTER (ASSR)CENTERS 4 t >_ t /z~~~~~i
X \ "@>>9r teeo.lzv@ .'.,r32gE.i.C} ~ \ # <~- -- .-- -. r
=v4~~~~~~~~~~~~~~~~~~~~~7 > 41'T U R K E Y /- rE;.r,=i"_,,, , ,._,,,,,,9.ii~.2JS3.7