PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE Report No.: 64701 Natural Gas Efficiency Project Project Name Public Disclosure Authorized Region South Asia Country Pakistan Sector Oil and gas (100%) Lending Instrument Specific Investment Loan Project ID P120589 Borrower(s) Government of Pakistan Ministry of Petroleum and Natural Resources Pak Secretariat, Block A Pakistan Tel: (92-51) 921-1220 Fax: (92-51) 920-1770 [email protected] Implementing Agency Sui Southern Gas Company Limited (SSGC) Public Disclosure Authorized Sir Shah Suleman Road Gulshan-e-Iqbal Block 14 Karachi 75300 Pakistan Tel: (92-21) 9231602 Fax: (92-21) 9231620 [email protected] Environmental Screening Category [ ] A [X] B [ ] C [ ] FI [ ] TBD (to be determined) Date PID Prepared September 9, 2011 Date of Appraisal Completion February 14, 2011 Estimated Date of Board Approval December 15, 2011 Decision Project authorized to proceed to negotiations upon Public Disclosure Authorized agreement of pending conditions and/or assessments I. Country Context 1. Pakistan has important strategic endowments and development potential. The country is located at the crossroads of South Asia, Central Asia, China and the Middle East. This places Pakistan at the fulcrum of a regional market with a vast population, large and diverse resources, and an untapped potential for trade. But Pakistan faces long-term challenges to realizing its growth potential. It requires a strong and stable tax base, and more efficient public spending to expand fiscal space. Other measures required include creating adequate employment opportunities; improving income distribution; and harnessing economic competitiveness through trade, investment, improved business environment, and competition. Today, Pakistan’s key economic challenges are the large fiscal deficit and energy shortages. Public Disclosure Authorized 2. Electricity and gas shortages plague households and industry alike. The energy sector is experiencing deficits of energy as well as finances. Key contributors to the energy deficit are: declining gas supply from domestic fields, slow expansion of low-cost power generation capacity, inefficiency in power generation, high losses in electricity and gas distribution networks, etc. And key contributors to the financial deficit are: high cost of imported furnace oil (which is now a leading fuel for power generation), inadequate power tariff increases, inadequate subsidy payments by the government, low collections from government entities, sub-optimal commodity-based subsidies, etc. All these factors contribute to the circular debt problem across the sector. II. Sectoral and Institutional Context 3. Natural gas is a vital energy source for Pakistan. In FY2010, Pakistan consumed about 1.3 trillion cubic feet (tcf) of gas, all domestically produced and representing about half of primary energy consumption. Proven remaining reserves of conventional natural gas were estimated at 27.6 tcf in FY10. Pakistan has a mature gas industry that has been operating since the 1950s. Domestic gas exploration and production is undertaken by state-owned and private firms (Pakistani as well as international). By international standards, and compared to oil products, natural gas is inexpensive in Pakistan which leads to inefficient use. 4. Natural gas is transmitted and distributed by two companies: Sui Southern Gas Company Ltd. (SSGC, the sub-borrower in this Project) supplying Sindh and Balochistan; and Sui Northern Gas Pipelines Ltd. (SNGPL) supplying Punjab and Khyber-Pakhtunkhwa. Both are listed on the domestic stock exchanges but have significant government stakes. 5. Pakistan’s main challenges in the gas sector are related to: scarcity of gas, sub- optimal gas allocation, high levels of Unaccounted-For-Gas (UFG), and inefficient end-use. 6. Scarcity of gas. The sector supply gap is forecasted to reach about 0.5 tcf in 2015 that is set to increase to almost 2 tcf by 2025. Many large gas fields are in decline and low wellhead prices have led to little upstream investment. But new customers have consistently been added. The Government is planning to introduce LNG as well as pipeline import of gas. Pakistan also has unconventional gas resources in ‘tight’ reservoirs and shale—both more costly to extract. The Government is introducing financial incentives to exploration and production companies to invest in both conventional and unconventional gas. 7. Sub-optimal allocation of gas. Pakistan’s “Natural Gas Allocation and Management Policy” of 2005 gives low priority to government-owned (PEPCO) power plants without firm gas purchase agreements. For many years, major PEPCO plants have operated without binding gas purchase agreements and have received less gas for power generation while electricity demand has increased sharply. The plants have substituted gas with furnace oil. 8. High levels of unaccounted-for gas (UFG). UFG is the difference between the total volume of metered gas purchased by a gas utility and the volume of gas sold. In OECD countries, UFG is typically 1-2 percent. In Pakistan, UFG was recorded at about 9% in FY10. UFG is therefore a major contributor to the gas supply crisis. Most of the UFG is due to dilapidated/deteriorating pipelines. Other sources are leaking joints in service connections; gas theft (tampered meters, illegal connections), malfunctioning metering equipment, and gas leakage due to higher than required pressure. 9. The dollar equivalent of Pakistan’s UFG in FY10 was US$ 362 million in terms of gas purchased. If the volume of lost gas could be channeled to power generation, the furnace oil substitution value would be three times higher. The Oil and Gas Regulatory Agency (OGRA) has punished both gas companies for excessive UFG by reducing their returns dramatically (in FY09, SNGPL: US$ 58 million, SSGC: US$ 35 million). 10. Inefficient end use of gas. The household gas appliance industry in Pakistan generally produces low-efficiency appliances that do not meet Pakistan’s thermal efficiency standards. Furthermore, residential gas consumers have limited incentive to shift to more efficient appliances because of relatively low gas prices. Improvements are necessary in appliance certification, energy efficiency labeling, and enforcement of standards. 11. Against this backdrop, the Government has requested World Bank support to address the UFG problem. The Government believes Bank support is suitable because: (a) the gas companies have over the last decade been unable to solve the problem on their own; (b) significant financial resources are necessary; (c) the UFG problem is increasingly intolerable in view of the growing gas and power shortages; (d) a UFG reduction project would give significant results over the medium term (3-5 years). The Project is also seen as a catalyst for organizational improvement in capacities and accountability. III. Project Development Objective & Project Benefits 12. The development objective of the Project is to enhance the supply of natural gas in Pakistan by reducing the physical and commercial losses of gas in the pipeline system. 13. Project beneficiaries will be mainly consumers of natural gas in Sindh and Balochistan, who would have more gas available; see less UFG cost in their tariff; and adequate gas pressure. The benefits to Pakistan would be more gas potentially available for power generation and lower greenhouse gas emissions (natural gas is nearly all methane, CH 4). The key benefit to SSGC would be an improved bottom line. IV. Project Description 14. The Project has three components (estimated World Bank financing in parentheses): 15. Component 1: UFG Reduction (US$ 190 million). Four sub-components: 16. Segmentation and pressure management ( US$ 18 million ) are at the core of the Project. This entails ring-fencing segments of the network by installing bulk meters at inlet points. Input-output gas measurements (the difference is UFG) will be complemented by pressure testing and leakage surveys to rank segments for rehabilitation work and theft control. About 400 bulk meters will be procured. In conjunction, automatic pressure management and monitoring systems will be procured to match pressure levels to demand. 17. Pipeline rehabilitation (US$ 117 million) will involve replacement of 5,750 km of irreparable leaking pipes and rectification of 18,700 km of less damaged ones. The Project will finance pipelines of varying types and diameters, mostly polyethylene (PE) pipes, but in special cases steel pipes. Operational equipment will also be procured. 18. Cathodic protection (CP) (US$ 20 million). CP reduces the rate of corrosion from underground steel pipes, thus arresting the increase in leakages. This subcomponent will finance the installation of recoating material for 450 km of pipes, installation of power sources, battery back-up systems, magnesium anodes, and remote CP monitoring systems. 19. Advanced metering systems (US$ 35 million) will replace inaccurate, tamper-prone meters and install surveillance equipment to monitor gas theft. About 270 turbine meters for large industrial customers, 12,500 ultrasonic meters for commercial customers, data acquisition/monitoring systems, and provers (for testing meter accuracy) will be procured. 20. Component 2: Appliance Efficiency Pilot Project (US$ 5 million). This sub- component will finance the deployment of high-efficiency gas appliances and/or the retrofitting of components in consumers’ existing appliances to enhance thermal efficiency. 21. Component 3: Technical Assistance (US$