Document of The World Bank FOR OFFICIAL USE ONLY Report No: 66932-ET PROJECT APPRAISAL DOCUMENT ON A PROPOSED CREDIT IN THE AMOUNT OF SDR 129.2 MILLION (US$200 MILLION EQUIVALENT) TO THE FEDERAL DEMOCRATIC REPUBLIC OF ETHIOPIA FOR THE ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) May 2, 2012 Energy Unit Sustainable Development Department Africa Region 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. CURRENCY EQUIVALENTS Exchange Rate Effective Date: March 31, 2012 Currency Unit = Ethiopian Birr (ETB) 17. 45 ETB = US$1 US$ 1.549 = SDR 1 FISCAL YEAR EEPCO July 8 – July 7 DBE July 1 – June 30 ABBREVIATIONS AND ACRONYMS AETPDD Alternative Energy Technology Promotion and Dissemination Directorate AfDB African Development Bank ADF African Development Fund AFD Agence Francaise de Développement APL Adaptable Program Loan BPR Business Process Re-engineering CAS Country Assistance Strategy CEO Chief Executive Officer CFL Compact Fluorescent Lamp Ci-Dev Carbon Initiative for Development CPS Country Partnership Strategy CSA Central Statistical Agency of Ethiopia CRGE Climate-Resilient Green Economy DBE Development Bank of Ethiopia EEA Ethiopian Electricity Agency EEPCO Ethiopian Electric Power Corporation EIB European Investment Bank EIRR Economic Internal Rate of Return EMP Environmental Management Plan EPC Engineering, Procurement, and Construction Contract ESIA Environment and Social Impact Assessment ESMF Environment and Social Management Framework ESMP Environmental and Social Management Plan FIRR Financial Internal Rate of Return FIT Feed In Tariff FPPA Federal Public Procurement Act GDP Gross Domestic Product GNI Gross National Income GOE Government of Ethiopia GPOBA Global Partnership on Output-Based Aid HVAC High Voltage Alternate Current HVDC High Voltage Direct Current ICB International Competitive Bidding ICS Interconnected System ICT Information and Communications Technology IDA International Development Association IFRs Interim Financial Reports INT Integrity Vice Presidency MDG Millennium Development Goals M&E Monitoring and Evaluation MFI Micro Finance Institution MOWE Ministry of Water and Energy MOFED Ministry of Finance and Economic Development NBI Nile Basin Initiative NPV Net Present Value O&M Operations and Management OFID OPEC Fund for International Development PAP Project Affected Persons PC Project Coordinator PDO Project Development Objective PIU Project Implementation Unit PPA Property Administration Agency PPP Public and Private Partnership PSE Private Sector Enterprise PV Photo Voltaic RAP Resettlement Action Plan RPF Resettlement Policy Framework RUFIP Rural Financial Intermediation Program SCS Self Contained System SIL Specific Investment Loan SHS Solar Home System SME Small and Medium Enterprise SOE Statement of Expenditures SREP Scaling-Up Renewable Energy Program in Low Income Countries TOR Terms of Reference UEAP Universal Electrification and Access Program Regional Vice President: Obiageli Katryn Ezekwesili Country Director: Guang Z. Chen Sector Director: Jamal Saghir Sector Manager: Lucio Monari Task Team Leader: Raihan Elahi Program Assistant: Raima Naomi Oyeneyin ETHIOPIA ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) TABLE OF CONTENTS Page I. STRATEGIC CONTEXT .................................................................................................9 A. Country Context ...................................................................................................................9 B. Sectoral and Institutional Context ......................................................................................10 C. Higher Level Objectives to which the Project Contributes ...............................................13 II. PROJECT DEVELOPMENT OBJECTIVES ..............................................................14 A. PDO....................................................................................................................................14 B. Project Beneficiaries ..........................................................................................................14 C. PDO Level Results Indicators ............................................................................................14 III. PROJECT DESCRIPTION ............................................................................................14 A. Project Components ...........................................................................................................14 B. Project Financing ...............................................................................................................17 C. Lending Instrument ............................................................................................................17 D. Project Cost and Financing ................................................................................................18 E. Lessons Learned and Reflected in the Project Design .......................................................18 IV. IMPLEMENTATION .....................................................................................................19 A. Institutional and Implementation Arrangements ...............................................................19 B. Results Monitoring and Evaluation ...................................................................................20 C. Sustainability......................................................................................................................20 V. KEY RISKS AND MITIGATION MEASURES ..........................................................22 A. Risk Ratings Summary Table ............................................................................................22 B. Overall Risk Rating Explanation .......................................................................................22 VI. Appraisal Summary .........................................................................................................23 Annex 1: Results Framework and Monitoring...............................................................................31 Annex 2: Detailed Project Description ..........................................................................................34 Annex 3: Implementation Arrangements .......................................................................................45 Annex 4: Operational Risk Assessment Framework (ORAF) .......................................................75 Annex 5: Implementation Support Plan.........................................................................................78 Annex 6: Economic and Financial Analysis ..................................................................................82 Annex 7: Impact Evaluation Framework .....................................................................................104 Annex 8: Financial Intermediary Assessment (OP 8.30).............................................................107 Annex 9: Operating Guidelines for Credit Line ..........................................................................126 Annex 10: Geographic Map of Ethiopia………………………………………………………..128 ETHIOPIA ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) PROJECT APPRAISAL DOCUMENT AFRICA AFTEG . Basic Information Date: May 2, 2012 Sectors: Transmission and Distribution of Electricity (75%), Other Renewable Energy (20%), General energy sector (5%) Country Director: Guang Z. Chen Themes: Rural services and infrastructure (70%), Other rural development (30%) Sector Manager/Director: Lucio Monari/Jamal Saghir EA Category: B (Partial Assessment) Project ID: P119893 Lending Instrument: Specific Investment Loan Team Leader(s): Raihan Elahi Joint IFC: No . Borrower: Federal Democratic Republic of Ethiopia Responsible Agency: Ethiopian Electric Power Corporation (EEPCO) Contact: Meheret Debebe Title: Chief Executive Officer Telephone No.: 251 111 560041 Email: miheretdw@gmail.com Responsible Agency: Development Bank of Ethiopia (DBE) Contact: Esayas Bahre Title: President Telephone No.: 251 115 51188 Email: dbe@ethionet.et Responsible Agency: Ministry of Water and Energy (MOWE) Contact: Alemayehu Tegenu Title: Minister Telephone No.: 251 1 6611111 Email: info@mowr.gov.et . Project Implementation Period: Start Date: May 29, 2012 End Date: December 31, 2017 Expected Effectiveness Date: August 30, 2012 Expected Closing Date: December 31, 2017 . Project Financing Data(US$M) [ ] Loan [ ] Grant [ ] Other [ X] Credit [ ] Guarantee For Loans/Credits/Others Total Project Cost : 250.00 Total Bank Financing : 200.00 Total Co-financing : 50.00 Financing Gap : 0.00 Financing Source Amount(US$M) BORROWER/RECIPIENT 50.00 IBRD 0.00 IDA: New 200.00 IDA: Recommitted 0.00 Others 0.00 Financing Gap 0.00 Total 250.00 . Expected Disbursements (in USD Million) Fiscal Year 2012 2013 2014 2015 2016 2017 2018 Annual 0 5 20 25 50 60 40 Cumulative 0 5 25 50 100 160 200 . Project Development Objective(s) The Development Objectives of Electricity Network Reinforcement and Expansion Project (ENREP) are to improve reliability of the electricity network and to increase access to electricity services in Ethiopia. . Components Component 1: Reinforcement and Expansion of Electricity Network US$ 100 million Component 2: Access Scale-Up US$ 50 million Component 3: Market Development for Renewable Energy and Energy Efficiency US$ 40 million Component 4: Modernization Support US$ 10 million . Compliance Policy Does the project depart from the CAS in content or in other significant respects? Yes [ ] No [ X] . Does the project require any waivers of Bank policies? Yes [ ] No [ X] Have these been approved by Bank management? Yes [ ] No [ ] Is approval for any policy waiver sought from the Board? Yes [ ] No [ X] Does the project meet the Regional criteria for readiness for implementation? Yes [ X] No [ ] . Safeguard Policies Triggered by the Project Yes No Environmental Assessment OP/BP 4.01 X Natural Habitats OP/BP 4.04 X Forests OP/BP 4.36 X Pest Management OP 4.09 X Physical Cultural Resources OP/BP 4.11 X Indigenous Peoples OP/BP 4.10 X Involuntary Resettlement OP/BP 4.12 X Safety of Dams OP/BP 4.37 X Projects on International Waterways OP/BP 7.50 X Projects in Disputed Areas OP/BP 7.60 X . Legal Covenants Name Recurrent Due Date Frequency EEPCO Financial Viability Plan No By Effectiveness NA Description of Covenant GOE to submit to the Bank a plan designed to ensure financial viability of EEPCO. Name Recurrent Due Date Frequency Subsidiary Loan Agreements No By Effectiveness NA Description of Covenant The EEPCo subsidiary agreement has been entered into between the Recipient and EEPCO. The DBE subsidiary agreement has been entered into between the Recipient and DBE. Name Recurrent Due Date Frequency Retroactive Financing No Prior to Disbursement NA Description of Covenant Retroactive financing up to USD 10,000,000 for eligible expenditures for the parts of the Project implemented by EEPCo, incurred between April 1, 2012 and the date of signing of the Financing Agreement. Name Recurrent Due Date Frequency DBE Manual No Prior to Disbursement NA Description of Covenant DBE to submit to the Bank a manual which will include eligibility criteria for selecting financial institutions and final beneficiaries (PSEs, individuals or households), and templates for sub-credit agreements. Name Recurrent Due Date Frequency EEPCO Auditor No Within 3 Months of NA Effectiveness Description of Covenant Within 3 months of effectiveness, EEPCO to assign a qualified and experienced internal auditor for the project to strengthen the monitoring of internal control systems for the project. Name Recurrent Due Date Frequency EEPCO Financial Advisor/Specialist No Within 3 Months of NA Effectiveness Description of Covenant Within 3 months of effectiveness, EEPCO to recruit a qualified and experienced Financial Advisor/Specialist who will coordinate accounting functions between EEPCO and the PIU on terms of reference acceptable to the Bank. Name Recurrent Due Date Frequency EEPCO Accounting/Billing Interface No Within 24 Months of NA Effectiveness Description of Covenant EEPCO to conduct a review to identify issues related to the Agresso accounting software and the billing interface, and resolve the issues identified within 24 months after effectiveness. Name Recurrent Due Date Frequency DBE Institutional Development Plan No Within 18 Months of NA Effectiveness Description of Covenant DBE to implement its Institutional Development Plan Name Recurrent Due Date Frequency EEPCO Financial Viability Plan Review Yes NA Annual Description of Covenant Beginning May 2013, GOE to annually review with the Bank, progress on implementation of plan to ensure financial viability of EEPCO. . Team Composition Bank Staff Name Title Specialization Unit UPI Raihan Elahi Senior Energy Specialist Task Team Leader AFTEG 171926 Babak Rezaian Senior Energy Specialist Technical Issues AFTEG 85429 Rahul Kitchlu Energy Specialist Economic/Financial Issues AFTEG 364672 Dukjoong Kim Financial Analyst Financial Analysis AFTEG 351928 Yasmin Tayyab Senior Social Develop. Specialist Social Issues AFTCS 96860 Edward Felix Dwumfour Senior Environmental Specialist Environmental Issues AFTEN 191824 Richard Olowo Senior Procurement Specialist Procurement AFTPC 237462 Tesfaye Ayele Procurement Specialist Procurement AFTPC 343168 D Mphande Sr Financial Management Specialist Financial Management AFTFM 182329 Lillian Namutebi E T Consultant Financial Management AFTFM 385388 Raima Oyeneyin Program Assistant Project Processing AFTEG 77996 Azeb Afework Program Assistant Ethiopia ACS Support AFTCE3 408482 Murat Arslaner Financial Sector Specialist Financial Intermediary Issues FFSAB 345313 Atsushi Iimi Senior Economist Impact Evaluation Issues SDNCE 282057 Kirtan Chandra Sahoo Senior Carbon Finance Specialist Carbon Finance Issues ENVCF 263566 Non Bank Staff Name Title Office Phone City Yusuf Haji Ali Consultant – Power Engineer 251-11-517-6089 Addis Ababa Chrisantha Ratnayake Consultant – Power Engineer N/A Washington . Locations Country First Location Planned Actual Comments Administrative Division Ethiopia Country Wide Country Wide The project is not limited to any specific region. . I. STRATEGIC CONTEXT A. Country Context 1. Over the past decade, the Government of Ethiopia (GOE) has been implementing a development program aimed at poverty reduction through rapid economic growth and macroeconomic stability. Ethiopia is one of the most populous (nearly 83 million1 people) countries in Sub-Saharan Africa. With US$3902 gross national income (GNI) per capita Ethiopia’s economic strength is significantly less than the Sub-Saharan Africa average of US$1,176. Although the country has abundant resources and good potential for development, poverty is pandemic and often linked to environmental and natural resource degradation. Approximately 30 percent3 of people live below the basic needs poverty line. 2. The country has recorded strong economic growth over the past six years mainly due to the government-led development policies emphasizing public investment, commercialization of agriculture and non-farm private sector development. After a significant draught-related contraction in FY2003, growth rebounded at an annual average of 11.2 percent for FY2004-2009 which was significantly above average of 6.3 percent of Sub-Saharan Africa. The economic growth rate has also exceeded the minimum growth target of 7 percent established in the Program for Accelerated and Sustainable Development (PASDEP) for FY2006-2010. 3. Ethiopia has been implementing prudent macroeconomic policies to reduce inflation and rebuild the external reserves affected by the commodity price surges in FY2008. A policy package was adopted in late 2008 that included substantial fiscal and monetary adjustments, notably the elimination of fuel subsidies and measures to protect vulnerable groups. Following these reforms, inflation declined sharply to single digits by mid-2009. However, in the last few years, inflation has been again rising sharply and stood at about 32% at the end of March 2012, aided by significant increase in international food and fuel prices. 4. Ethiopia’s new Growth and Transformation Plan (GTP) for FY2011-2015 seeks to accelerate poverty reduction and achieve macroeconomic stability through continued economic growth (at least 11 percent real growth rate), to enhance social development and reach the Millennium Development Goals (MDGs)4. Although agriculture remains the engine of growth (amounting to nearly 42% of FY2011 GDP and growing at 8% annually), service sector (growing at 14% annually) and the industrial sector are expected to play an increasing role in economic development (expected to grow at over 10% annually). Consequently, large public investments in transportation and energy infrastructure are envisaged by the GTP. 5. As strong industrial and service sector growth is an essential part of the GOE’s strategy, availability of stable energy supply is essential. Furthermore, in the GTP period, the public policy goals of the GOE related to the energy sector are to increase rural coverage and to provide access to affordable, modern, cost-effective electricity services to the population (at 1 2010 estimate, The World Bank 2 2010 estimate, Atlas Method, The World Bank 3 2005 estimate, The World Bank 4 The long-term goal of the GTP is for Ethiopia to become a mid-income country in 20-30 years 9 present, only 14% of population is connected to grid5 and the per-capita consumption of electricity is about 200 kWh per year6). The GOE also intends to produce enough electricity to generate export earnings by participating in the regional power trade through the East Africa Power Pool (EAPP). B. Sectoral and Institutional Context Energy Sector Achievements in the Last Decade 6. Since the implementation of the last five year plan, the electricity sector in Ethiopia has been growing at an extremely rapid pace. More than 41% of rural towns and villages were connected to the grid and the number of consumers connected grew from 800,000 in 2005, to more than 2 million in 2011. With the increase in access, demand for electricity also increased. Average demand growth rate of electricity was above 15% per annum during 2005-2010 (about 25%, 32% in FY2010, and FY2011 respectively). This growth of demand created saturation in the supply and also the transmission network of EEPCO (Ethiopian Electric Power Corporation). 7. To address the supply shortfall, EEPCO undertook several short term measures. A moratorium was imposed on connecting new consumers from late 2008 to 2010 to manage the rapid increase in electricity demand. Demand side management initiatives including free distribution of about 5 million CFL lamps to replace incandescent lamps were undertaken which reduced the peak demand by 80MW within a short period. Also, EEPCO rented expensive thermal generation to bridge the gap in supply and rationed supply to households and industrial consumers. 8. In 2010, EEPCO commissioned 3 large hydro power plants and presently has sufficient capacity to service the demand. EEPCO commissioned Tekeze (300 MW), Gibe II (420 MW) and Beles (460 MW) power plants that increased its power generation capacity from about 850 MW to above 2,000 MW. In FY2011, EEPCO’s peak demand was around 1,100 MW which was well within its capacity. EEPCO further embarked on an aggressive demand side management by replacing existing incandescent lamps with CFLs and the rental thermal plants have been taken off from the grid. Energy Sector Growth in the Next Five Years 9. GOE plans to become the power hub of East Africa, play a critical role in regional power trade, and increase access to electricity of its rural population. Given the renewable energy resources available in Ethiopia (about 45,000 MW Hydro potential, 10,000 MW Geothermal Potential and 5,000 MW Wind Potential) EEPCO wants to harness this resource and play a major role in regional electricity trade. GOE also plans to support the increasing electricity demand fuelled by the industrial growth in Ethiopia and work towards a middle income country over a medium term period. 5 As per GOE definition, total number of persons living in electrified villages and towns have access to electricity whether their houses are directly connected to the grid network or not. Based on this definition, population with access to electricity is about 41%. 6 Source: EEPCO Planning Department 10 10. The energy sector strategy (as outlined in the GTP) calls for ambitious expansion of the sector and large scale investments. With GOE’s target of achieving 11% GDP growth over the next five years, rapid promotion of industrial and service sectors as well as expanding the coverage of electricity, the domestic demand for electricity is expected to grow above 25% per year. Moreover, Ethiopia intends to become a regional power hub while implementing its green growth strategy (CRGE7). To keep up with the anticipated growth in demand, EEPCO has already been investing in additional generation capacity with several new large hydropower projects under various stages of construction (target of 8,000 MW of installed capacity by 2015). 11. To address the challenge of low access rates, the GOE plans to scale up grid connectivity as well as expand off-grid energy programs. As described in the GTP, the target is to expand the coverage of electricity services to 75% of towns and villages in the country and to double the number of consumers connected to the grid (to 4 million) by 2015. GOE plans on expanding grid intensification programs as well as increasing the adoption of renewable energy and energy efficiency products and services in areas where gird is not present today and also to provide modern energy services to households in grid connected areas unable to afford grid connection. 12. Strengthening of the grid network is an essential part of the expansion strategy. Upgrading the network by reinforcing existing and adding new transmission and distribution lines to provide energy access to high energy consuming industrial areas and newly connected rural areas as well as for promoting electricity exports is another major focus of sector strategy. Figure 1 summarizes the planned energy sector related targets of GTP. Figure 1: Major GTP Targets for Energy Sector Description of Target 2009/2010 2014/2015 Hydropower Capacity (MW) 2,000 8,000 Distribution Lines (Km) 126,038 258,000 Transmission Lines (Km) 10,500 18,000 No. of Consumers (Million) 2 4 Coverage (% of Population) 41 75 Source: GTP, Government of Ethiopia (Nov 2011) 13. The rapid increase in domestic demand and the associated investment in supply will mean that the energy sector in Ethiopia will continue to grow at a rapid pace in the coming years. Also, GOE is planning to ramp up electricity exports (Djibouti interconnector was commissioned in 2011, Sudan is expected to be commissioned in 2012, and Kenya in 2017) which would further increase the demand for electricity. Figure 2 shows the estimated increase in installed capacity and energy produced based on current and expected projects under construction in Ethiopia (FY2006-20). 7 Climate Resilient Green Economy 11 Figure 2: EEPCO’s Projected Demand and Supply 2006-208 Source: EEPCO Planning Department and World Bank estimates Challenges and Opportunities 14. The phenomenal growth of the sector also has brought with it many significant challenges, especially for the national utility, EEPCO, which has started to face some key capacity constraints. From a technical standpoint, the ageing electricity network (many segments of the network are over 30-40 years old) is overloaded (more than 150% loading in some cases) and is not able to efficiently service the consumers (many sections experience 35% voltage drop in transmission). The transmission and distribution lines and the sub-stations are in urgent need of repair and expansion just to keep up with the current load and essential for anticipated future demand. The upgrades are also necessary to improve the efficiency and reduce the system losses (20%) that EEPCO currently experiences. 15. Promotion of off-grid energy programs is to be an essential part of the strategy to increase access. Many countries in the region have experienced success in expanding the coverage of modern energy services, especially when it comes to efficient lighting and cooking. GOE has also implemented many such programs including improved cook-stove, biogas, solar 8 As per GTP targets, the figure assumes over 25% growth in domestic demand. However, the financial projections in the report use a more conservative 10% growth rate of domestic demand. 12 home systems, etc. However, access to finance9 remains a key constraint for scaling up of such interventions. While it takes several years for electricity grid to reach the rural masses, adoption of renewable energy and energy efficiency interventions is an important part of the GOE’s plan of increasing access to modern energy services more rapidly. 16. EEPCO itself needs to build capacity by investing in human resources and training in order to become a modern electric utility capable of handling the current and forthcoming growth in the sector. As a utility designed to handle a few hundred thousand customers, EEPCO is today handling over two million. As a result, EEPCO’s capacity to manage such a large portfolio of projects and clients is severely lacking. It faces challenges related to procurement delays, contract administration, audit and fiduciary management, etc. There is also an urgent need to modernize the sector by upgrading the skills and strengthening the organization which includes all functions carried out in planning, executing and operating the electricity network and services. 17. The high investment cost of the planned growth has created financial viability challenges for EEPCO and will create fiscal challenges for the GOE: Under the GTP, EEPCO has been leading an US$ 11B energy sector expansion program, of which US$ 3.5B has already been raised (mostly short term bonds). In the coming years, these maturing loans would amount to a large annual debt service obligation which EEPCO will not be able to meet from its current and future operating cash flows. This shortfall will place an additional burden of about US$ 2B on the GOE’s budget in FY2012-20 (cumulatively) which is equivalent to 3-4% of the GOE’s annual budget expenditure or, US$ 0.03-0.04/kWh of additional tariff for EEPCO (to boost its revenue). Therefore, the GOE needs to develop and implement a medium term program of revenue enhancement and/or debt service relief for EEPCO. C. Higher Level Objectives to which the Project Contributes 18. The Country Assistance Strategy (CAS) for Ethiopia for FY2008-12 has supported the objectives of PASDEP and GTP. The present CAS aims at (i) fostering economic growth, (ii) improving access to and quality of basic services, (iii) reducing vulnerability, and (iv) fostering improved governance. Bottom-up initiatives have been strongly encouraged as a complement to traditionally strong top-down action. The upcoming Country Partnership Strategy (CPS) for FY2013-17 will build upon the achievements of the CAS and support GOE’s broader objective for the sector to modernize the sector institutions and build their overall capacity. 19. Based on the GOE’s goals, World Bank’s strategy to support the energy sector in Ethiopia includes current investments for enhancement of rural access (Energy Access Project, Additional Financing for Energy Access Project, Electricity Access and Rural Expansion Project (EAREP I and EAREP II) and regional interconnections to Sudan. These projects were aimed at supporting the GOE’s goal of expanding coverage to many parts of rural Ethiopia and to increase access to modern energy services as well as regional integration. 20. The Bank is also planning upcoming investments in modernization of the sector (Electricity Network Reinforcement and Expansion - ENREP P119893); further enhancement in 9 Access to finance challenges includes liquidity, foreign exchange, and lender requirements such as collateral. 13 regional interconnections to Kenya (Eastern Africa Power Pool Project - EAPP P126579); as well as investment in hydropower generation (Halele Werabesa Hydropower Project – HWHPP P125734). The proposed project, ENREP, will strengthen the existing transmission network by increasing its capacity and reliability, and will increase access to electricity by grid connection intensification and off-grid electrification. II. PROJECT DEVELOPMENT OBJECTIVES A. PDO 21. The Project Development Objectives (PDO) of ENREP are to improve reliability of the electricity network and to increase access to electricity services in Ethiopia. B. Project Beneficiaries 22. Project beneficiaries will be both the rural and urban population of Ethiopia who will get (i) access to electricity through EEPCO or (ii) access to energy and/or energy efficient products through the Market Development Component implemented by DBE. As implementing agencies, EEPCO and DBE will also benefit from the project. EEPCO will reinforce its transmission and distribution network infrastructure and DBE will widen its market presence by enhancing its capacity and extending access to finance to private sector enterprises (PSEs) and micro finance institutions (MFIs). C. PDO Level Results Indicators 23. Improved reliability: a) Average interruption frequency and duration per year in EEPCO’s network (System Average Interruption Frequency and Duration Index - SAIFI and SAIDI); Increased access: b) Number of households provided with access to electricity and energy efficient products under the project (disaggregated by grid / off-grid); c) Direct project beneficiaries (number), of which female (percentage). III. PROJECT DESCRIPTION A. Project Components 24. The proposed project consists of four components: (i) Reinforcement and Expansion of the Electricity Network (Upgrade and Expansion), (ii) Access Scale-Up, (iii) Market Development for Renewable Energy and Energy Efficient Products, and (iv) Modernization Support to enable GOE to meet its electrification goals over the next 5 years. 25. Component 1: Reinforcement and Expansion of Electricity Network (estimated US$100 million): Reinforcement and expansion of the electricity network component consists of 14 two sub-components: (i) grid upgrade and (ii) grid extension in order to improve the overall service delivery of the Ethiopian electricity network. 26. The reinforcement of electricity network component will be based on a least-cost electricity sector investment plan currently under preparation by EEPCO with the assistance of consultants funded under a Bank supported project. In the past few years, Ethiopia has seen tremendous expansion in new generation and new connections (nearly 2 million customers) in EEPCO’s networks. This has created several bottlenecks in the grid which have resulted in significant depreciation of service delivery levels as well as technical losses in transmission. The network upgrade will include transmission lines, substation investments, key distribution lines and other line replacement and extensions to be implemented by EEPCO during FY2012-2017. 27. At the outset, EEPCO will carry out a study to identify critical priority segments that would provide the maximum benefits from these investments. ENREP is considering a programmatic approach for implementation as the exact line segments that will be supported under the project will be identified from an ongoing study which EEPCO has already undertaken. 28. The project will finance the replacement of technical equipment to upgrade the capacity of identified segments and to expand certain critical segments of the grid. These segments will be identified following the EEPCO analysis and in close coordination with the project team. The project will lay out specific criteria for selection of the segments. The project will also measure and report the increased capacity and reliability in EEPCO’s transmission network as a result of Component 1. 29. The project has defined an overall framework (ESMF) for addressing environmental and social safeguard issues and any potential resettlement issues that may arise following the identification of line segments. When the segments are identified, a detailed technical, economic and financial feasibility analysis, ESIA and RAP will be prepared for identified segments, as needed. The preparation of these documents will be a prerequisite for the commencement of specific activities under this component. 30. Component 2: Access Scale-Up (estimated US$50 million): Access scale-up includes intensification of connections to the households and villages in the areas already connected by the grid. The access scale-up would address the low connection intensity in the areas with grid access. The project will finance the materials and equipment required for the last-mile connectivity. This component will consist of three sub-components: (i) connection intensification in the existing segments of the grid with low connection rates and existing capacity; (ii) connection intensification in the segments of the grid which will undergo upgrade and would hence achieve increased capacity of connections; and (iii) connections in new areas where grid will be expanded. 31. Connecting the households to the grid is likely to reduce the greenhouse gas emissions associated with the consumption of energy from carbon intensive sources in the baseline. Unless the GOE has alternative arrangements to secure the carbon reduction benefits, the Bank would work with EEPCO to develop appropriate technical and methodological tools to quantify greenhouse gas reductions from its rural electrification initiatives. Since access scale up will be 15 achieved over a period of time, potential for availing the carbon benefits through a programmatic approach shall be studied and piloted. EEPCO would coordinate the carbon finance program and claim the carbon benefits. This component will also support distribution of compact florescent lamps (CFLs) and efficient street lighting. 32. Component 3: Market Development for Renewable Energy and Energy Efficient Products (estimated US$40 million): Development of stand-alone renewable energy programs such as solar home systems (SHSs), solar lanterns, improved cook-stoves, biogas plants, and similar activities will provide additional coverage for household access to energy (modern lighting, efficient cooking, etc.), especially in areas that are not yet connected to the grid. The target beneficiaries for this component will be the households and villages that are either outside the reach of the electricity grid as well as those that are in the electricity grid area but are unable to afford the connection to electricity services and the associated usage fees (through the use of renewable energy and energy efficiency products). The key constraint for implementation of such programs has been identified as access to finance; consequently, this component will establish a credit facility for private sector enterprises and households to develop the market for renewable energy products and services in Ethiopia. The credit facility takes into account the existing challenges in the market related to access to finance such as: lack of liquidity, lack of access to foreign exchange, and lender requirements such as collateral. 33. This component will be implemented by the DBE in collaboration with MFIs and MOWE. DBE will allow two lines of credit to support this component (and the MOWE will provide market development, awareness and technical support). One would be to support the working capital requirement of project developers (private sector enterprises - PSEs, small and medium enterprises - SMEs, etc.) and the other to provide on-lending support to MFIs. A PSE interested in supplying and distributing renewable energy and energy efficient products to households in villages will be able to access finance from DBE under this project. A household or small business in rural areas interested in installing renewable energy products such as biogas plants, SHSs, etc. will be able to receive funds from an MFI in partnership with DBE. In the launch phase of the project, DBE will work with a few eligible MFIs as part of the project network, followed by expansion to other MFIs, as appropriate. 34. The renewable energy component will be supported by the MOWE, which is at present implementing the Second Electricity Access and Rural Expansion Project (EAREP II). Under this project MOWE is supporting Rural Cooperatives to install SHSs. The DBE is also involved in this project as the trust agent of MOWE. Lessons learned from the EAREP II project, helped design this component under ENREP. 35. Promoting renewable energy and energy efficient solutions such as biogas plants, solar home systems, solar lanterns, improved cook stoves (ICS), etc. under Component 3, would result in potential reduction in greenhouse gas emissions. Unless the GOE has alternative arrangements to secure the carbon reduction benefits, the Bank will assist DBE in designing and implementing a carbon finance program using methodological approaches that are already proven and tested to claim carbon benefits that would result from implementation of RE and EE measures under Component 3. DBE will coordinate the carbon finance program and claim the carbon benefits. In this regard, DBE will be required to sign back to back agreements with the companies and the households to manage the carbon transactions. 16 36. Component 4: Modernization Support (estimated US$10 million): This technical assistance component includes support for key aspects of the Government’s modernization program for EEPCO including enhanced planning capabilities, operational efficiency improvements, contract management, asset management and other required commercial utility good practices. The DBE and the MOWE will also receive technical assistance to build their capacity. MFIs will receive technical assistance through their partnership with DBE. The technical assistance component will be designed to assist GOE in their entire energy portfolio as the country embarks on a massive growth program in the energy sector. Specific programs will be designed to strengthen institutions in areas such as investment planning, fiduciary management, procurement and contract management, human resource development, project management, and overall portfolio execution. B. Project Financing 37. Government of Ethiopia requested the Bank to support its Growth and Transformation Plan (GTP) of FY 2011 to 2015. As a continuation to this dialogue, GOE further requested the Bank to allocate US$ 200 million from its IDA 16 allocation of FY 2012 envelope for the ENREP project. The overall funding requirements for EEPCO’s expansion plans are substantially large and this project will address a small by significant component of such needs. The project implementation will take a programmatic approach and will address the required investments sequentially in accordance with the priority needs. In view of the substantial investment needs the World Bank discussed the issue with OPEC Fund for International Development (OFID) and secured US$ 25 million complementary financing for this project. GOE will also contribute about US$ 50 million to this project. Given that this project will support electricity access, improved cook stoves, solar home systems and biogas plants, etc. the project will bring in additional benefit through reduction in carbon emissions. It is estimated that the specific interventions mentioned above, if fully implemented, could generate about US$ 1.0 million10 of carbon revenues annually. Carbon Initiative for Development (Ci-Dev)11, a new carbon instrument that the Bank launched in Durban in December 2011, has shown interest in supporting the development of a carbon finance program through which the carbon benefits could be realized. Details of the possible funding from the Ci-Dev program are described in Annex 3 of the PAD. C. Lending Instrument 38. The Ministry of Finance and Economic Development (MOFED) will receive the US$ 200 million from World Bank on standard IDA Credit Terms. That is, 40 years of maturity with 10 years of grace period, up to 0.50% maximum commitment charge on undisbursed credit balance during project implementation and 0.75% service charge on the amount of credit disbursed from credit account. MOFED will on-lend this fund to EEPCO and DBE as per separate subsidiary 10 The quantification of carbon benefits depends upon several factors including the baseline scenario, implementation and performance of the various systems such as biogas plants, solar home systems, etc. and the prevailing carbon price. In the absence of precise information estimates have been made based on the following assumptions – number of biogas plants to be installed -15,000, number of solar lanterns/home systems to be installed – 100,000, and the number of households to be electrified - 200,000. Emission reduction potential per system has been taken from similar projects in other countries, which can vary significantly. 11 Ci-Dev was launched by the Bank in Durban in December 2012 and is presently at resource mobilization stage. 17 financing agreements entered with these implementing agencies. DBE and MFIs will also enter into agreement to determine the appropriate interest rate as per market conditions. D. Project Cost and Financing 39. The total project cost and different financing sources of the ENREP project is explained in the following table. GOE will receive about US$ 200 million credit from IDA, about US$ 25 million complementary loan from OFID. GOE, EEPCO, DBE and other project beneficiaries will provide about US$ 50 million towards the project costs. Figure 3: ENREP Estimated Project Costs Project Components Total Estimated Project Cost % of IDA Project Financed by Financing cost IDA Recipient 1. Reinforcement and Expansion of Electricity Network 120 100 20 83 2. Access Scale-Up 70 50 20 71 3. Market Development for Renewable Energy and 50 40 10* 80 Energy Efficient Products 4. Modernization Support 10 10 100 Total Financing Required 250 200 50 80 * Recipient includes DBE and equity contribution of final beneficiaries E. Lessons Learned and Reflected in the Project Design 40. Over the years, the Bank financed projects in Ethiopia to increase its generation capacity, transmission network, distribution network rehabilitation and rural access expansion. The following lessons learned from the implementation experience of these projects and ensuing country dialogue were used to design the proposed project. Figure 4: Lessons Learned Component/Lesson Reflection in Project Design Project Implementation Capacity Without adequate staffing, appropriate skill mix (i) Technical Assistance will be provided to improve and sound coordination at all levels of project performance in procurement, financial management and operation; project would be at risk of delays in safeguards. execution that can diminish time-sensitive (ii) Consultant support will be provided for power sector expected benefits. master plan and network design. (iii) Implementation of the RAP will be supported by consulting firms. Implementation of Credit Facility (i) DBE - established financial intermediary - selected as Market development of renewable energy and project implementing agency. energy efficiency products with private sector (ii) Project implementation responsibility assigned as per participation would be highly effective. institutional strength. Establishing a credit facility to promote private (iii) Joint coordination structure between MOWE and DBE. enterprise has been challenging with existing (iv) The credit facility program based on market demand. implementation processes and access to finance (v) Support provided to overcome access to finance barriers remains a key constraint. in the supply chain and to support demand growth. Safeguards Identification of specific transmission lines is (i) A framework approach has been applied. not possible prior to the completion of network (ii) EEPCO will implement RAP and carry out the ESIA study by EEPCO. supported by retained consultants. 18 Component/Lesson Reflection in Project Design Procurement Gap in procurement legal framework, efficient (i) EEPCO has extended the contract of the Procurement structural arrangement, functional inadequacy, Consultant, and appointed 3 Procurement Officers to and procurement capacity of EEPCO identified support all World Bank funded projects. as key bottlenecks for project implementation. (ii) Training on procurement will be institutionalized. IV. IMPLEMENTATION A. Institutional and Implementation Arrangements 41. The project will be implemented by EEPCO (Components 1, 2, and parts of 4), DBE (Component 3 and parts of 4) and MOWE (parts of component 4). EEPCO will implement this project through its institutional systems. There will be three different Project Coordinators (PCs) responsible for the three components carried out by EEPCO. The PC responsible for Reinforcement and Expansion of Electricity Network (Component 1) will report to the Transmission Project Executive Officer. This project unit will be supported by a Procurement Officer who will be trained by EEPCO’s Procurement Advisor. On safeguard related issues, the PC will be supported by EEPCO Environment and Management Unit (EMU) which will be strengthened by the Modernization Support (Component 4) of the project. 42. The PC responsible for Electricity Access (Component 2) will report to the UEAP Executive Officer. The PC will receive procurement, safeguards and other administrative support as the other component explained above. The PC responsible for the Modernization Support (Component 4) will report to the EEPCO Strategic Corporate Planning Office. The PC will be responsible to select qualified consultants are per EEPCO requirement to provide capacity building and implementation support on Procurement, Financial Management, Safeguards Issues, Contract Management, etc. Major investment works will be carried out by experienced contracted secured through international competitive bidding. In addition, experienced project design and supervision consultants (to work with the EEPCO team on project planning and design, social, environmental, procurement, contract management and other aspects) will be retained to assist EEPCO with project implementation. DBE, MFIs and MOWE will identify Project Coordinators who will ensure the capacity building activities are carried out as needed. 43. The Development Bank of Ethiopia will play the role of a financial intermediary (Component 3) in collaboration with MFIs and MOWE who will provide market development and technical assistance support. In the launch phase of the project, only a few MFIs will be part of the project network as household level retailer of the credit line. In the long term, the project can be expanded to other MFIs, as appropriate. As per Bank’s policy for financial intermediary lending (OP8.30), an assessment of DBE and MFIs has been carried out. Based on the assessment, it can be concluded that the core financial indicators of DBE and launch MFIs are favorable; however, there are certain capacity building, risk and internal process related challenges to overcome. The OP8.30 assessment is summarized in Annex 8. At present DBE is managing such credit lines funded by different Development Partners and supporting the implementation of EAREP II project as a Trust Agent. DBE will also receive technical assistance to enhance its capacity in certain weak areas identified in the assessment. MOWE will access some portion of the technical assistance to support building regional market capacity. 19 B. Results Monitoring and Evaluation 44. Monitoring and reporting of the project implementation progress will be the responsibility of EEPCO’s and DBE’s project management teams. In EEPCO the required data will be furnished by the PIU and EEPCO’s administrative information system (transmission unit and customer care unit). EEPCO will have the responsibility to supply current data on the set of agreed performance indicators (Annex 1) at least on an annual basis for PDO indicators and on a semi-annual basis for the intermediate outcome indicators at component level. 45. In addition, the project will draw from information provided by the Ethiopian Electricity Agency (EEA), the Ministry of Water and Energy’s (MOWE) M&E unit, and the Central Statistical Agency of Ethiopia (CSA). The MOWE, EEA and CSA’s relevant data/reports will facilitate vetting of EEPCO’s records against data that has been independently verified by these other national agencies. DBE will provide quarterly reporting on the number of loans it has approved from the project. The report will include performance of the existing loans and the number of households benefited from the project. Under the EAREP II project, EEPCO has initiative a socio economic impact evaluation. The EAREP II project will fund the baseline survey of this impact evaluation and under the ENREP project a panel survey will be conducted to assess the socioeconomic impact of rural electrification in Ethiopia. Details on this impact evaluation study are provided in Annex 7. C. Sustainability 46. Overall, the GOE (MOFED and the MOWE) have confirmed their full support for this project and EEPCO and DBE managements have demonstrated their commitment by responsive and active support for this project. Sustaining growth and increasing access: 47. EEPCO has done well in the past few years to increase generation capacity as well as to connect many more people to the grid network. The current generation capacity (about 2,000 MW) is adequate to meet the domestic demand and the existing export commitments to Djibouti and Sudan. However, domestic demand is increasing rapidly and plans are underway to connect Ethiopia’s electricity grid with Kenya through a 2,000 MW capacity High Voltage DC line. EEPCO plans to increase its generation capacity from 2,000 MW to 8,000 MW in the GTP period and will also increase the number of grid connected consumers from existing 2 million to 4 million, and will almost double the length of its transmission / distribution network from 126 thousand km to 258 thousand km by 2015. This expansion program is already under implementation, and it is expected that EEPCO will achieve most of these targets during 2015- 2018. Successful completion of these programs will ensure that the ENREP objectives of improved network reliability and increased access will be met in a sustainable manner. To ensure the sustainability of the grid based components agreements will be sought with EEPCO to ensure the efficient operation and maintenance of the networks constructed. Current arrangements for both the transmission network management from the central headquarters and the maintenance of the lower voltage lines from the regional O&M units will be reviewed and any needed improvements will be agreed with EEPCO. 20 48. In view of the increased work load in the regional levels due to load growth and increase in number of consumers added to the system over the recent past, the capacity of the regional units would be supported as part of capacity building component of the project. Overall, the risk assessment for the grid based component is low in view of ongoing practices at EEPCO which are, in general, satisfactory. Market development of renewable energy and energy efficiency products: 49. Promotion of off-grid energy programs is an important part of GOE’s target of providing modern energy services to the masses. The government has implemented some similar projects for efficient cook-stoves, biogas plants, solar home systems, etc. Further, the private sector in Ethiopia has already been importing and distributing renewable energy and energy efficient products and has successfully lobbied with the GOE to waive import and custom tax from all renewable energy based import items. In order to promote and scale up these initiatives, two major constraints have been identified: (i) access to finance and especially, liquidity, access to foreign currency for the private sector to import the renewable energy products, and lender requirements related to collateral; (ii) affordability level of the households to buy these products from them with cash. ENREP will provide a credit line (Component 3) which will lead to sustainability of such initiatives. The sustainability of this component will also depend on the satisfactoriness of the arrangements that will be made to provide credit facilities to the private sector to establish commercial arrangements for the sale of related equipment and the ability of MOWE and other partners to promote market awareness of renewable energy products and services. This project supports scaling-up of renewable energy programs using a market-driven approach which has already seen some success in Ethiopia. The design of the project includes lessons learnt from Bank sponsored projects in Ethiopia and other countries. The risk assessment for this component is considered moderate. Financial viability of EEPCO: 50. An issue of key importance is the financial viability of EEPCO and the energy sector, in general. In terms of core financial performance, EEPCO’s revenues are adequate to cover its operating expenses and to make cash operating profit or about US$ 100 million in FY2012-16. However, to finance its aggressive growth plan, EEPCO has borrowed substantially in recent years and repayments of those loans have now started. The Government has not allowed EEPCO to increase its tariff since 2006, in real terms. EEPCO’s operating revenue from tariff has effectively reduced given the high inflation in Ethiopia and the rapid devaluation of the Ethiopia Birr against the US Dollar. The level of operating profit that EEPCO will earn will not be adequate to service its current and projected level of debt service obligations of US$ 300M a year in FY2012-16. GOE should implement measures to ensure EEPCO’s financial viability, but presently, the GOE is concerned about the adverse effect of doubling the tariff rate in a short- term on poor segments of the population (inflationary and socio-political repercussions). GOE is already considering debt restructuring of limited outstanding loans (concessional lending from multilateral banks). However, even if all of the concessional loans (on-lent to EEPCO) are restructured, it would amount to less than 20% reduction in the debt service obligation shortfall for EEPCO in FY2012-20. In order to maintain financial health of EEPCO and the sector, GOE needs to pursue a strategy to revise the tariff structure to reflect full cost recovery (estimated to be US$ 0.06-0.07/kWh) in the medium term, while also pursuing options for efficient debt 21 management in the near term, such as, debt restructuring. As an effectiveness condition of the project, GOE will submit to the Bank a rolling plan designed to ensure financial viability of EEPCO in the following three years. Such plan will include among other items (i) all expenditures estimated to be incurred by EEPCo during the three year period, including debt service and capital expenditures; (ii) the estimated resources available to EEPCo, including revenues from its own operations, borrowings and equity; and (iii) proposed actions to ensure the continued financial viability of EEPCO. Going forward, GOE will annually prepare and submit to the Bank a progress report on the implementation of the viability plan not later than May 15 of each year. In parallel, GoE will update annually the financial viability plan, including measures recommended to ensure the continued financial viability of EEPCo and afford the Bank a reasonable opportunity to exchange views with the Recipient and EEPCo on the progress report and the updated financial viability plan. V. KEY RISKS AND MITIGATION MEASURES A. Risk Ratings Summary Table Figure 5: ENREP Risk Rating Risk Rating Stakeholder Risk Low Implementing Agency Risk - Capacity Substantial - Governance Moderate Project Risk - Design Low - Social and Environmental Moderate - Program and Donor Low - Delivery Monitoring and Sustainability Low Overall Implementation Risk Substantial B. Overall Risk Rating Explanation 51. The overall risk of the proposed project is Substantial. Detailed assessment of the risk of the project is provided in Annex 4. Some key issues are discussed below: Implementation Capacity: 52. An important project risk to consider is EEPCO’s implementation capacity which is stretched due to the sheer load of projects under their management. To mitigate this risk, an extensive program of capacity building will be financed as part of ENREP (Component 4). Along with that, experienced project design and supervision consultants (to work with the team on investment planning and design, social, environmental, procurement, contract management and other issues) will be retained to assist EEPCO with project implementation. EEPCO has 22 extended the contract of the international procurement advisor, appointed 3 procurement officers to aid project implementation, and trained 15 staff members in Bank procurement procedures. Financial Audits: 53. Timely submission of the audit reports has been a challenge for EEPCO in the past two years. With relentless efforts from EEPCO and the Audit Service Corporation, EEPCO was able to submit its FY2011 audit report (for the period July 7, 2010 to July 6, 2011) on February 2, 2012, when the submission deadline was January 7, 2012. However, the audit report is qualified on several accounts and EEPCO is now in process to ensure that all the audit observations are addressed adequately. EEPCO plans to use the capacity building component of ENREP to improve its financial management system to ensure that audit reports can be finalized on time and without qualification. The Bank is also working with EEPCO to carry out a just-in-time study to review the financial management arrangements of EEPCO and the findings of the report will be implemented through the capacity building component of ENREP. EEPCO has agreed to appoint an international financial advisor (consultant) to assist with improvements in its overall financial management practices. Financing Needs: 54. While several development partners are supporting the investment program of EEPCO, its financing gap (US$ 3.5 B raised out of the US$ 11 B required under the GTP) is quite large and EEPCO is using short term bonds to finance the investment plan. This has increased EEPCO’s financing cost and has created a repayment imbalance (short term loans for long term infrastructure projects). EEPCO will still require tariff increase to cost recovery levels (estimated to be US$ 0.06-0.07/kWh) in the medium term, while also pursuing options for efficient debt management in the near term, such as, debt restructuring. Project Implementation Risks: 55. Major portions of Ethiopia’s existing high voltage transmission backbone infrastructure consist of high voltage level lines and EEPCO is well experienced in maintaining and operating these lines. Technical aspects of this project are not complex, and are similar to EEPCO’s existing operations. The key risks, their potential impact, and the key mitigation measures to address these risks are listed in figure below. VI. APPRAISAL SUMMARY A. EEPCO Operational and Financial Performance 56. As part of the GTP, EEPCO is responsible for implementing the government’s two major public policy goals related to the energy sector: to provide universal access to electricity and to generate export revenues. In the past few years, EEPCO has been aggressive in terms of connecting many new towns and villages as well as connecting new customers to the grid. In fact, due to the success of the expansion program, the demand for electricity surpassed the supply capacity in FY2008-09. As a result, in FY2008 to FY2010 there was a partial moratorium placed on new connections. 23 57. During the period of moratorium, the acceleration in the number of new connections and villages connected slowed down; as a consequence, the energy sales were stagnant. However, with new hydropower plants being commissioned in FY2010, by FY2011, the energy sales were over 4,000 GWh with over 2 million customers being connected. Despite the impressive increase in the customer base and energy sales, EEPCO’s operating revenue did not improve much – operating revenue in FY2011 was US$ 130 million which was far below the FY2006 operating revenue of US$ 166 million. The reasons for the flat revenue growth were low tariff rates, and devaluation of the Birr against US$. 58. With the expected demand growth both for domestic and export markets, EEPCO sales is expected to increase from about 4,000 GWh in FY 2011 to about 8,000 GWh by FY 2015 and to about 17,000 GWh by 202012. A large part of the future growth will also come from energy exports to neighboring countries. The Djibouti interconnector has already started power trading (as of 2011) and the Sudan interconnector is expected to start power trade in 2012. Kenya interconnector is expected to begin trading in 2017. On average, EEPCO’s operating revenues are expected to be US$ 200 million in FY2012-16 and US$ 600 million in FY2017-20. In the long term, the financial returns for EEPCO look positive. A detailed analysis of EEPCO’s financial position is included in Annex 6. 59. In terms of expenses, after a period of high generation cost due to rental thermal power, EEPCO’s operational costs in FY2011 and going forward should be moderate. This is predominantly due to the heavy reliance on hydropower. It is estimated that EEPCO’s operating expenses would grow at around 2% to US$ 100 million a year (on average) in FY2012-16 growing to US$ 150 million in FY2017-20. Overall, EEPCO will be able to make operational profit and will benefit from strong domestic demand growth and the revenues will increase at around 8-10% per year in the coming decade. The prospects of bilateral trade are even more lucrative with potential for huge financial returns in the latter half of the decade. EEPCO should be in a position to operate and manage its assets adequately. 60. Major risks to financial viability of EEPCO in the near to medium term due to the massive investment program undertaken as part of the GTP. The risk stems from two factors: (a) Debt service obligations: The debt service obligation for EEPCO’s investment program would be in the order of US$ 300 million a year in FY2012-16 increasing to US$ 700 million in FY2017-20. With limited operational cash flow, this amounts to a US$ 200 million shortfall for servicing debt obligations in FY2012-16 which increases to US$ 250 million in FY2017-20. (b) Outdated tariff structure: current average tariff of US$ 0.03/kWh means that the full potential of revenue growth cannot be realized. Positive operational cash flow 12 It is to be noted, that GOE’s plan for electricity access expansion envisage a moderate growth rate of 24%, a target rate of 26%, and a high growth rate of 32%. Assuming the moderate growth rate (24%), the domestic peak load demand will reach about 5,000 MW by 2020 with overall, domestic energy consumption of over 20,000 GWh. Assuming the target growth rate (26%), the domestic peak load demand will reach nearly 6,000 MW by 2020 with overall, domestic energy consumption of over 22,000 GWh. Assuming the high growth rate (32%), the domestic peak load demand will reach nearly 7,500 MW by 2020 with overall, domestic energy consumption of over 29,000 GWh. The total exports (Djibouti, Sudan, and Kenya) increase to nearly 1,300 MW with 7,500 GWh of energy sale. 24 would be maintained due to low generation costs. In order to maintain financial health of EEPCO, full cost recovery tariff is estimated to be US$ 0.06-0.07/kWh. Figure 6: EEPCO’s Summarized Financial Projections (US$ million) Coming Five Years Latter Part of Decade FY2012-2016 FY2017-2020 Business As Usual (Current Situation) Average Annual Debt Service Obligation 314 713 Average Annual Operating Revenue 216 616 Average Annual Operating Expenses 112 167 Average Annual Operating Cash Flow 104 449 Debt Service Shortfall (based on operating cash flow) 210 264 Average Domestic Sales (GWh) 5,487 8,177 Average Debt Service Burden (US cents/kWh) 3.83 3.23 61. In order to ensure financial stability, the GOE must embark on a process of debt restructuring and modernization of the tariff structure. In this regard, the Bank and GOE will annually review the financing plan of EEPCO for upcoming fiscal years including actions to ensure continued financial viability of EEPCO. B. DBE Operational and Financial Performance 62. DBE will be implementing the credit line (Component 3) of the ENREP project. At present, major financial indicators of DBE are favorable. DBE has been producing a net positive income (US$ 12M in FY2011) in the past few years with adequate CAR (Capital Adequacy Ratio) of nearly 17%, and NPL Ratio (Non-Performing Loan Ratio) of 11.7% - which is better in terms of industry average in Ethiopia. However, some of the major risks related to the financial viability of DBE are: (a) Audit and risk management: Delays in audited financial reports along with accounting practices that are not standard within the industry introduce financial and operational risk. Further, updates to the risk management and loaning process are required to minimize credit exposure. (b) System and capacity constraints: The core banking system (IT) is not adequate for investment bank operations and the staff at the bank need training to be more effective financial decision makers. The project implementation unit will require technical assistance and capacity building to implement the credit line. 63. DBE will implement an institutional capacity development plan to mitigate the above identified risks. The specific areas of support have been identified in the financial intermediary assessment of DBE carried out by the Bank (details in Annex 8). DBE will also be working with a network of MFIs to expand the coverage of credit facility to the household level. In the launch phase a few MFIs will be part of the program. All these MFIs have also undergone OP 8.30 assessment. 25 C. Economic Analysis 64. The economic viability of the project is high. A cost-benefit analysis reveals a net present value (NPV) of US$ 211.1 million at 10% discount rate and an economic internal rate of return (EIRR) of 18.7%. The NPV stands at US$ 147.9 million at 12% discount rate. D. Financial Analysis 65. ENREP Project is financially viable with a NPV of US$ 79.7 million at 5% discount rate and US$ 47.8 million at 6% discount rate and an FIRR of 8.1%. It should also be highlighted that, in general, investment in large scale infrastructure projects such as ENREP, have a higher economic return than net financial return. The lower level of financial return of the project is also due to the low average tariff of EEPCO that has remained constant in Ethiopian Birr since 2006. EEPCO is continuing a dialogue with the GOE to revise its tariff, which will have a positive impact on the ENREP’s expected financial return. E. Technical 66. There is an urgent need to reinforce the existing power transmission system, due to very high load growth rates experienced, particularly over the last five years in all parts of the country. Many sections of the transmission network experience overloading which restricts further load growth and efficient and reliable supply of electricity. Currently, EEPCO is carrying out extensive studies to identify and prioritize the specific requirements that will be needed to optimize the performance of the transmission system and a portion of this program will be selected for inclusion under the project. As much of the required load flow studies have been carried out by EEPCO it is expected that the transmission development plan will be finalized by end August 2012 and the project specific contract will also be finalized by this date. In general, the components to be included under the project will consist of network, the upgrading of some lower voltage lines, and the augmentation of some grid substations. In addition, some conversion of existing single circuit lines to double circuit may also be included. Significant improvements to network performance such as loss reduction, reliability improvement and the ability to include new consumers in networks which are presently restricted will form the criteria for project selection. EEPCO has considerable scope to increase the number of service connections at relatively low specific costs by utilizing the networks already constructed to provide supply to other towns. Such investments consist of secondary developments from already constructed lines. These would mainly be short spur lines (both at medium voltage and low voltage) and the electrification of smaller townships already under or close to existing networks. To feed some of the smaller townships situated close to existing lines single phase transformers will also be used. 67. In general, the cost per connection established under this component is expected to be substantially lower than that achieved from the original development. This component will start implementation right after the credit effectiveness. The project components dealing with network development and extensions will use modern network design guidelines to ensure that investments are suitably optimized. The project component supporting renewable energy and energy efficient products will focus in selecting equipment from the recent market developments 26 on the smaller solar systems and solar lanterns. This component will also support installation of biogas plants, improved cooked stoves, etc. F. Financial Management 68. The Bank conducted a financial management assessment of the two implementing entities of the project, that is, EEPCO and the DBE. The conclusion of the assessment was that the financial management residual risk for DBE is moderate while for EEPCO is substantial. Although the financial management arrangements satisfy the Bank’s minimum requirements under OP/BP10.02, there remain improvements to be effected for the system to be adequate to provide, with reasonable assurance, accurate and timely information on the status of the project as required by the IDA. EEPCO has shared with the Bank: (i) a comprehensive action plan and implementation undertaken addressing all the issues raised in the audit report and management letter for the year ended July 7, 2011. Key undertakings to be fulfilled by EEPCO include: (i) Prior to effectiveness, GOE to submit to the Bank a plan designed to ensure financial viability of EEPCO. Following that, (i) within 3 months of effectiveness, EEPCO to assign a qualified and experienced internal auditor for the project to strengthen the monitoring of internal control systems for the project; (ii) within 3 months of effectiveness, EEPCO to recruit a qualified and experienced Financial Advisor/Specialist who will coordinate accounting functions between EEPCO and the PIU on terms of reference acceptable to the Bank; (iii) EEPCO to assign a team to work jointly with the Just in Time (JIT) Study Consultants to conduct a review to identify issues related to the Agresso accounting software and the billing interface and resolve the issues identified within 24 months; EEPCO will report progress made on this plan; and (iv) Beginning in May 2013, GOE to annually review with the Bank the progress report and updated financial viability plan of EEPCO. Other actions that need to be done to especially reduce the financial management residual risk of EEPCO and DBE are documented under the financial management section under Annex 3. 69. In terms of the other implementing agency, following effectiveness but prior to disbursement of credit proceeds for activities under component 3, DBE will submit to the Bank a manual which will include eligibility criteria for selecting financial institutions and final beneficiaries (PSEs, individuals or households), and templates for sub-credit agreements. Also, DBE will implement its Institutional Development Plan (more in Annex 8) and finish the audit of its financial statements for FY 2010 and 2011. 70. The implementing agencies shall follow the ―Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants‖, dated October 15, 2006 and revised in January 2011. G. Procurement 71. Though EEPCO has long term experience in implementing Bank financed projects procurement, there is high inherent risk as well as procurement governance and capacity risk: 72. Inherent risk: There is a gap of procurement oversight in the procurement legal framework for EEPCO. The oversight arrangements may not address bidder complaints which risks discouraging bidders from participating in EEPCO contracts thereby reducing competition. 27 A possible mitigation measure could be to alter procurement law to cover public enterprises in Ethiopia. This is a long term action that would involve GOE actors other than EEPCO. The lead agency for implementing this measure is most likely MOFED. 73. Procurement governance and capacity risk: There is a gap in the procurement structure and with staff needing proper skills to implement project procurement efficiently. Further, there is a risk that technical staffs undertaking procurement tasks in addition to their normal duties are not able to diligently conduct the procurement tasks. As a mitigation measure, EEPCO has retained 3 procurement officers and procurement manuals are currently under review by a consultant. Procurement under this project will be carried out in accordance with "The Procurement and Consultant Guidelines" revised in January 2011. 74. The measures to mitigate these risks are: (i) complete the ongoing update of EEPCo procurement procedures (in addition to others, these procedures have to address procurement decision matrix and business performance standards); (ii) create a central Procurement Unit with adequate oversight, staff and resources, a career path and adequate incentives to attract and retain a procurement cadre;; and (iii) In absence of highly qualified procurement officers, retaining the technical support of the international procurement advisor for this project, currently working with EEPCO, at least for the first one year of the project implementation recommended. EEPCO has extended the contract of the international procurement advisor, appointed 3 procurement officers to aid project implementation, and have trained 15 staff members in Bank procurement procedures. H. Social Safeguard 75. ENREP will underpin Ethiopia’s Sustainable Development and Poverty Reduction Program and Agricultural Led Industrialization (ADLI) strategy. The program will play a crucial role in helping to achieve the Millennium Development Goals. The project components are not expected to have significant negative social impacts. While some of the project activities related to reinforcing the high voltage transmission networks and extending the grid network to connect new consumers, may require acquisition of land to expand or clear Right-of-Way (ROW) and construction of the additional transmission lines, which in turn may temporarily or permanently displace people, impact livelihood and assets. Electric power transmission lines are linear facilities and the impacts of transmission line will be mostly localized within the ROW. The impact can be minimized through careful route selection. The locations and routes for the construction of the electricity distribution lines in specific rural and urban towns are not yet known and will be identified after the project approval. The project enhancements of the ROW may cause permanent relocation and/or temporary displacement of people, demolition of homes, removal of trees and other assets triggering Operational Policy 4.12. However, some others could require less intrusive intervention in order to upgrade them, such as lines in rural areas and those with sufficient right of way already established. EEPCO has developed an Environmental and Social Management Framework (ESMF) including a Resettlement Policy Framework (RPF) to identify potential adverse social and environmental impacts and to adequately mitigate them. EEPCO will carry out the RAP and ESIA for the transmission lines as and when they are identified with the help qualified consultants. The Project will renovate existing transmission lines which are now overloaded and operating above optimum capacity. These transmission lines extends from the national grid to the distribution networks, draw electricity from a variety 28 of lines, and are not directly connected to any specific generation plants. The new transmission lines that will be constructed under the project will transfer electricity from the existing grid network to new unelectrified villages to extend electricity network and increase access to electricity. I. Environment Safeguards 76. Environmental safeguard policies triggered: The Safeguard Category assigned to this project is Category ―B (Partial)‖. The Bank’s Operational Policy on Environmental Assessment (OP4.01) is triggered, predicated on the assumption that there could be potential environmental risks emanating from construction/upgrade, stringing, operation and maintenance of power lines and substations. It is expected that implementation of these activities under the project would largely result in positive socio-economic and environmental gains, and no potential adverse significant environmental risks and social impacts are anticipated. The project may affect physical resources triggering Bank’s OP 4.11. The ESMF includes ―chance finds‖ procedures. 77. Potential environmental impacts: To a larger extent, potential environmental, safety and health risks (loss of vegetation and biodiversity; soil erosion and sedimentation of nearby aquatic/drainage systems; air pollution; soil and water contamination from both liquid and solid waste; hazardous chemical poisoning of biotic life from use of weedicides and herbicides; etc) are foreseen during the construction phase as vegetation will be cleared to pave way for erecting substations and towers for power lines, constructing camp sites, material storage facilities, and access roads. The substations and power lines would avoid going through forests and natural habitats including protected areas, swamps/wetlands and any fragile and sensitive aquatic habitats. It is likely that transmission and distribution lines may traverse culturally sensitive sites such as graveyards, archaeological sites, etc. 78. Mitigation measures: The project would take preventive mitigation measures to remediate any potential threats during the construction and O&M phases. A key undertaking prior to starting the project would be to ensure the incorporation and implementation of the environmental and social clauses annexed to the main ESMF into the works contract; and that an effective multi-stakeholder institutional and implementation framework/arrangement is put in place for the management (including safeguard management) of all aspects of the project. This should include actions for capacity building, training and skills upgrade. Mitigation actions including the establishment of effective mechanisms for monitoring, capacity building, governance (collaboration and consultations, accountabilities and transparency), etc are essential to cost-effectively and timely counteract any potential threats that are likely to occur during the construction and O&M phases of the project. 79. Borrower’s capacity: The Borrower capacity to ensure environmental due diligence of the project is satisfactory. The Ethiopian Electric Power Corporation (EEPCO) will be responsible for implementing the project. The Environmental and Social Management Unit (ESMU) under EEPCO will implement and monitor the ESMFs. ESMU has implemented series of ESMFs and other safeguard instruments for the EEPCO in a number of donor financed projects in the energy sector including hydropower generation, transmission and distribution. 29 80. Stakeholder consultations & disclosure of safeguard documents: In accordance with the World Bank’s operational policies, stakeholder consultations in the field with public and private sector institutions, research and academia, civil society organizations, traditional authorities, communities groups have formed part of the ESMF formulation. Stakeholder workshops have been carried out to discuss all aspects of the project prior to finalization of the ESMF. These workshops have had the purpose of listening to all key beneficiary and stakeholder groups, particularly project affected persons/communities (PAPs); seeking feedback and consensus from stakeholders; and incorporating comments, suggestions and remediation proposals into the ESMF and other safeguard instruments. The final ESMF and the RPF have been publicly disclosed at the Bank’s InfoShop on January 20, 2012. These have also been disclosed in-country. J. Financial Intermediaries 81. The Bank’s Operational Policy on Financial Intermediary Lending (OP8.30) assessment was carried out for all financial intermediaries (DBE and MFIs) as part of the due diligence process during project preparation. The core financial indicators at all three institutions were found to be favorable. A detailed analysis is available in Annex 8 of this report including recommendations for project implementation, capacity enhancements, and operating guidelines of the credit line. 82. Safeguard Policies triggered under the Project: Yes No Environmental Assessment OP/BP 4.01 X Natural Habitats OP/BP 4.04 X Forests OP/BP 4.36 X Pest Management OP 4.09 X Physical Cultural Resources OP/BP 4.11 X Indigenous Peoples OP/BP 4.10 X Involuntary Resettlement OP/BP 4.12 X Safety of Dams OP/BP 4.37 X Projects on International Waterways OP/BP 7.50 X Projects in Disputed Areas OP/BP 7.60 X 30 ANNEX 1: RESULTS FRAMEWORK AND MONITORING ETHIOPIA: ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) Project Development Objective (PDO): Cumulative Target Values** Responsibility Description Core Unit of Data Source/ PDO Level Results Indicators* Baseline Frequency for Data (indicator Measure YR 1 YR 2 YR3 YR 4 YR5 Methodology Collection definition etc.) Indicator One: Number 1.42 1.42 1.42 1.42 1.42 1.27 semiannual EEPCO Grid EEPCO Average Reliability: System Average Monitoring Interruption Per Interruption Frequency Index, and Data Year within 100 SAIFI Collection km transmission line distance Indicator Two: Hours per 76 76 76 76 76 57 semiannual EEPCO Grid EEPCO Average Reliability: System Average customer Monitoring Duration of Interruption Duration Index, and Data Interruption- SAIDI Collection unplanned Indicator Three (A): Number 0 0 0 10,000 20,000 30,000 semiannual EEPCO Data EEPCO New Access: Number of HHs of HHs Collection Connections connected to the grid Indicator Three (B): Number 0 0 10,000 20,000 30,000 40,000 semiannual DBE and MFI DBE / MFIs New Products Access: Number of HHs with of HHs Data and Services access to modern energy services Collection (off-grid) Indicator Four (A): Number 0 0 55,000 165,000 275,000 385,000 semiannual EEPCO and EEPCO / DBE Beneficiaries Direct Project Beneficiaries DBE Data Collection Indicator Four (B): Number 0 0 27,500 82,500 137,500 192,500 semiannual EEPCO and EEPCO / DBE Beneficiaries Female Beneficiaries DBE Data Collection INTERMEDIATE RESULTS Intermediate Result (Component 1: Reinforcement and Expansion of the Network) Number of substations EEPCO Data constructed or upgraded under the Number 0 0 0 0 5 10 semiannual EEPCO Technical Collection project Segments of Transmission lines EEPCO Data Number constructed, upgraded or 0 0 0 0 350 750 semiannual Collection EEPCO Technical (km) rehabilitated (km) 31 Distribution System Loss EEPCO Data % 10.8 8.5 8.5 8.5 8.5 5.6 semiannual EEPCO Technical (percentage) Collection Transmission System Loss EEPCO Data % 4.5 4.5 4.5 4.5 4.5 4.0 semiannual EEPCO Technical (percentage) Collection Intermediate Result (Component 2: Access Scale-up) Number of institutions (schools, S=Schools Number 0-S 0-S 0-S 0-S 70-S 150-S health centers,) connected to the semiannual EEPCO EEPCO HC= Health 0-HC 0-HC 0-HC 0-HC 70-HC 150-HC grid under the project Centers Total energy sales (GWh) GWh 4,795 5,000 6,000 7,000 9,000 12,000 semiannual EEPCO EEPCO Technical Total energy sales (Million Birr) Mill Birr 1,000 1,500 2,000 2,500 35,000 6,000 semiannual EEPCO EEPCO Technical Intermediate Result (Component 3: Market Development for Renewable Energy and Energy efficiency) Number of partner MFIs Number 0 2 4 5 6 8 semiannual DBE DBE Technical Woredas covered by credit line Number 0 2 4 6 8 9 semiannual DBE/MFIs DBE/MFIs Technical Number of loans given to PSEs Number 0 1 2 3 4 5 semiannual DBE DBE Technical Total amount of loans given to Mill Birr 0 4 8 12 15 17 semiannual DBE DBE Loans PSEs (Mill Birr) NPL Ratio of the PSE loan % 0 10 10 10 10 10 semiannual DBE DBE Technical portfolio Number of solar home systems Number 0 0 0 1,000 3,000 5,000 semiannual DBE DBE Technical imported Number of solar lanterns Number 0 0 0 5,000 10,000 15,000 semiannual DBE DBE Technical imported Number of loans given to HHs Number 0 0 10,000 20,000 30,000 40,000 semiannual DBE/MFIs DBE/MFIs Technical Total amount of loans given to Mill Birr 0 4 8 12 15 17 semiannual DBE/MFIs DBE/MFIs Loans HHs (Mill Birr) NPL Ratio of the HH loan % 0 10 10 10 10 10 semiannual DBE DBE Technical portfolio Number of solar home systems Number 0 0 0 1,000 3,000 5,000 semiannual DBE/MFIs DBE/MFIs Technical sold Number of solar lanterns sold Number 0 0 0 5,000 10,000 15,000 semiannual DBE/MFIs DBE/MFIs Technical Number of biogas plants installed Number 0 0 0 1,000 3,000 5,000 semiannual DBE/MFIs DBE/MFIs Technical Number of efficient cook stoves Number 0 0 0 5,000 10,000 15,000 semiannual DBE/MFIs DBE/MFIs Technical installed 32 Intermediate Result (Component 4: Modernization Support and Capacity Building) Number of awareness events held Number 0 2 4 5 7 9 semiannual DBE/MOWE DBE/MOWE Events Number of beneficiaries trained Number 0 20 40 50 70 90 semiannual DBE/MOWE DBE/MOWE People Number of EEPCO staff trained Number 0 15 20 25 35 45 semiannual EEPCO EEPCO People Number of EEPCO retained Number 4 4 4 4 4 4 semiannual EEPCO EEPCO People procurement staff Number of EEPCO retained Number 1 1 1 1 1 1 semiannual EEPCO EEPCO People procurement advisors Number of EPCO retained Number 0 1 1 1 1 1 semiannual EEPCO EEPCO People financial advisors Time to complete audit report Months 7 6 6 6 6 6 semiannual EEPCO EEPCO Financial EPPCO (Months) ESIA and RAP completed – kms Kms 0 0 0 0 350 750 semiannual EEPCO EEPCO Technical of lines ESIA and RAP completed – Number 0 0 0 0 5 10 semiannual EEPCO EEPCO Technical number of substations 33 ANNEX 2: DETAILED PROJECT DESCRIPTION ETHIOPIA: ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) 1. EEPCO commenced its Universal Electrification and Access Program (UEAP) from 2005 and since then has aggressively connecting consumers in its grid network. Over these past several years EEPCO has connected many new towns and villages as well as connecting new customers to the grid. In fact, due to the success of the expansion program, the demand for electricity surpassed the supply capacity. As a result, in FY2008 to FY2010 there was a partial moratorium placed on new connections. During the period of moratorium, the acceleration in the number of new connections and villages connected slowed down. At the end of FY2011 total number of consumer served by EEPCO was about 2 million. Figure 1: Increase in Electricity Access in Ethiopia 2006 2007 2008 2009 2010 2011 Number of Consumers 1,064,268 1,377,557 1,611,735 1,740,964 1,808,008 2,030,000 Growth Rate (Year to Year) 26% 20% 8% 4% 29% Number of Electrified Villages 899 1,757 3,363 3,763 5,163 6,000 Growth Rate (Year to Year) 95% 91% 12% 37% 16% Number of Consumers Number of Electrified Villages 2,500,000 7000 6000 2,000,000 5000 1,500,000 4000 1,000,000 3000 2000 500,000 1000 0 0 2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010 2011 Number of Consumers Number of Electrified Villages 2. This rapid growth in the distribution network under the UEAP for the last several years resulted in an organic growth of the gird network. This limited EEPCO’s capacity to continue connecting new consumers from these extended rural networks constructed under UEAP program. As the GOE plans to continue increasing access to electricity during the FY 2011 - 2015 period, and Growth and Transformation Plan of the Government targets to increase the total number of consumers to 4 million and increase the total generation capacity to 8,000 MW by the end FY2015, it is critical for EEPCO to reinforce its electricity network to increase reliability and capacity to serve the domestic demand as well as cater the export demand of its electricity. 34 3. A large part of the future growth will come from energy exports to neighboring countries. The Djibouti interconnector has already started power trading (as of 2011) and the Sudan interconnector is expected to start power trade in 2012. Kenya interconnector is expected to begin trading in 2017. The combined electricity export is expected to be about 7,000 GWh by end of this decade – bulk of which would come from the Kenya interconnector (see table below). The international sale of power is expected to be at competitive prices (approx. US$ 0.06-0.07 /kWh) which will bring significant foreign exchange revenue. Overall, it is anticipated that EEPCO’s operating revenue will grow at about 8-10% a year. Figure 2: Energy Sales Forecast 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Domestic Growth at Moderate Rate (GWh) 4,035 4,466 4,927 5,441 5,999 6,600 7,214 7,840 8,491 9,163 Export to Dibouti Forecast (GWh) 33 131 150 318 788 788 788 788 788 788 Export to Sudan Forecast (GWh) 197 788 1,577 1,577 1,577 1,577 1,577 1,577 1,577 Export to Kenya Forecast (GWh) 2,978 3,723 4,468 5,585 Total Energy Sold (GWh) 4,068 4,795 5,866 7,336 8,364 8,965 12,558 13,928 15,323 17,112 4. In the above scenario, demand for electricity is assumed to grow at a rate no lower than 10-11%. However, GOE plans of connecting 75 percent of Ethiopia’s rural towns and villages to the electricity grid by FY2015. The planned demand growth can therefore be potentially much higher. 5. In particular, the Government’s plans for electricity access expansion envisage a moderate growth rate of 24%, a target rate of 26%, and a high growth rate of 32%. Assuming the moderate growth rate (24%), the domestic peak load demand will reach about 5,000 MW by 2020 with overall, domestic energy consumption of over 20,000 GWh. Assuming the target growth rate (26%), the domestic peak load demand will reach nearly 6,000 MW by 2020 with overall, domestic energy consumption of over 22,000 GWh. Assuming the high growth rate (32%), the domestic peak load demand will reach nearly 7,500 MW by 2020 with overall, domestic energy consumption of over 29,000 GWh. 6. The exports to Djibouti, Sudan, and Kenya will increase to nearly 1,300 MW with nearly 7,500 GWh of energy exports. 7. In terms of supply, based on the planned capacity additions, Ethiopia could possibly reach (based on current plans and under construction projects) installed capacity of nearly 13,500 MW by 2020, leading to an overall electricity production capacity of nearly 47,000 GWh. 8. Project Components: The ENREP project consists of four components and these are (a) Reinforcement and Expansion of Electricity Network, (b) Access Scale-Up, (c) Market Development for Renewable Energy and Energy Efficient Products, and (d) Modernization Support. 35 9. Reinforcement and Expansion of Electricity Network (estimated US$100 million): Reinforcement and expansion of the electricity network component consists of two sub- components: (i) upgrade of transmission network and (ii) extension of transmission network, in order to improve the overall service delivery of the Ethiopian electricity system. 10. There is urgent need to reinforce and improve the power transmission system of Ethiopia, due to very high load growth experienced, particularly over the last five years in all parts of the country. Many sections of the transmission network experienced overloading which restricts further load growth and efficient and reliable supply of electricity. 11. The useful life of EEPCO’s transmission system equipment is categorized into: (i) 30-40 years of age, (ii) 15-30 years, and (iii) less than 15 years of age. Equipments in the first two categories are subject to frequent failure and saturation which resulted in poor quality of electric supply to customers. 12. The increased demand has overloaded the sub-stations and transmission lines. Existing power transformers need to be replacement with higher capacity equipment. The existing high voltage transmission line can not sufficiently evacuate the required demand and need to be reinforced with line at different voltage levels to be added. 13. The distribution voltage network faces frequent power interruption, technical problems: such as over-sagging of conductors, cumbersome network, lose connections and inappropriate clearances. In the low voltage network, the voltage drop could be up to 35% due to long distances from the transformer, lower cross section of conductors, and phase imbalance. To reduce the frequent interruption, high voltage drop and power loss rehabilitating and upgrading of existing distribution network is needed. 14. Currently, EEPCO is carrying out extensive studies to identify and prioritize the specific requirements that will be needed to optimize the performance of the transmission system and a portion of this program will be selected for inclusion under the project. 15. The goals of the before-mentioned network study are to: to ensure the availability and reliability of the electric supply of transmission system; to strengthen network weaknesses in order to meet energy demand requirement with in operating limits; to provide EEPCO a comprehensive report and database for the development of its power systems; and to serve EEPCO as a tool to update its planning annually. 16. These studies are being done by simulations of load flow carried out on standard software (PSS-E) which models the performance of the existing network and the various proposed alterations and additions over a number of future years. Initial outcomes from the study suggest that the scale of the system level upgrade needed (see table below) will be large indeed. 36 Figure 3: EEPCO’s Overall Estimated Electricity Network Reinforcement Needs Estimated Need No. Description Unit Total 2012 2012 2013 2014 2015 Upgrade - Medium 1 km 1,771 2,352 2,520 2,640 2,400 11,683 voltage Upgrade - Low 2 km 1,448 4,680 4,800 4,920 4,560 20,408 voltage Upgrade - 3 Transformer each 322 990 979 1,012 1,078 4,381 upgrading Upgrade - 4 Transformer each 193 682 671 715 693 2,954 erection Expansion - 5 km 3,100 10,800 12,960 17,640 17,820 62,320 Medium voltage Expansion - Low 6 km 2,500 15,210 19,890 25,740 30,160 93,500 voltage Expansion - 7 each 3,500 4,320 5,760 7,380 10,080 31,040 Transformer 17. While some improvements needed to the system have been identified, the transmission network development plan is awaiting finalization pending the review of EEPCO’s studies by an international consultant who will prepare a comprehensive Master Plan for all proposed developments. Once this plan is finalized specific network addition/improvements will be identified for inclusion under the project. 18. EEPCO has recently evaluated the proposals received from consultants to prepare the Master Plan and the selected consultant is expected to commence the assignment in about one month’s time. As much of the required load flow studies have been carried out by EEPCO it is expected that the transmission development plan will be finalized by end August 2012 and the specific contract to be financed under the project will be selected by this date. In general the activities that will be supported under this component will consist of network additions, the upgrading of some lower voltage lines and the augmentation of some grid substations. In addition, some conversion of existing single circuit lines to double circuit may also be included. 19. EEPCO, in its Master Plan study will lay out specific criteria for selection of the segments to ensure significant improvements of the network performance after the network is renovated. Some of these criteria would be system loss reduction, reliability improvement and the ability to include new consumers in networks which are presently restricted. These will form the basis of selecting line segments under the project. 20. Access Scale-Up (estimated US$50 million): Access scale-up includes intensification of connections to the households and villages in the areas already connected by the grid. This component will consist of three sub-components: (i) connection intensification in the existing segments of the grid with low connection rates and existing capacity; (ii) connection intensification in the segments of the grid which will undergo upgrade and would hence achieve increased capacity of connections; and (iii) connections in new areas where grid will be 37 expanded. The access scale-up would address the low connection intensity in some areas with grid access. This is particularly the case in newly electrified areas where the grid network has enough capacity to handle extra connections. The project will finance the materials and equipment required for the last-mile connectivity based on least cost options for the given load densities. 21. Under the UEAP program it is expected that through a combination of distribution expansion and connectivity strategies, the GOE, at a moderate growth rate, targets adding over 200,000 new customers to the grid every year in the years to come. Figure 4: EEPCO’s Access Enhancement Projections (per year) 2012 2013 2014 2015 2016 2017 2018 Number of new customers connected 203,000 225,330 250,116 277,629 308,168 342,067 379,694 Source: World Bank estimates and EEPCO Planning Department 22. Furthermore, there is considerable scope to increase the number of service connections at relatively low specific costs by utilizing the networks already constructed to provide supply to other towns. Such investments consist of secondary developments from already constructed lines. These would mainly be short spur lines (both at medium voltage and low voltage) and the electrification of smaller townships already under or close to existing networks. To feed some of the smaller townships situated close to existing lines single phase transformers will also be used. In general, the cost per connection established under this component is expected to be substantially lower than that achieved from the original development. Under the UEAP, EEPCO has identified substations with access capacity and can support addition of new consumers. Villages surrounding these substations have been identified and EEPCO has started to prepare the procurement plan and bidding documents to procure materials from ENREP to electrify new consumers. This part of the project will start implementation right after the credit is declared effective. 23. Substations which are at present are overloaded or are operating at maximum capacity will first undergo upgrade supported by Component 1 of the project. After capacity enhancement of these substations, EEPCO will increase access around those substations. This set of villages will benefit from reliable power along with new consumer connecting to the system. The third set of villages that will benefit from the Access Scale Up (Component 2) are the ones where grid network will be expanded. These set of villages will increase the number of electrified towns and will ensure that government is moving towards it GTP target of expanding electricity network to 75% of the villages. 24. Market Development for Renewable Energy and Energy Efficient Products (estimated US$40 million): Development of stand-alone renewable energy programs such as SHSs, solar lanterns, improved cook-stoves, biogas plants, and similar activities will provide additional coverage for household access to energy; especially in areas that are not yet connected to the grid. The target beneficiaries for this component will be the households and villages that are either outside the reach of the grid as well as those that are in the grid area but are unable to afford the connection and usage fees. 38 25. The GOE established the Climate-Resilient Green Economy (CRGE) strategy. The strategy aims to protect the country against the adverse effects of climate change ('climate resilience') and build a sustainable economy ('green economy') that will help realize its ambition of reaching middle-income status before 2025. At present Bank is supporting off-grid electrification through the MOWE of Ethiopia under the EAREP II project. Through this project, GOE plans to provide access to electricity to about 25,000 households using off-grid electrification technology. In the coming years, GOE aims to establish 150,000 household solar PV systems, 3,000 institutional solar PV systems, 3,000,000 small solar lighting systems (lanterns), etc. With Bank’s support, nearly 4.5 million improved cook stoves have been disseminated with estimated reduction in opportunity costs for fuel wood of US$ 270 million. In the coming years, the government plans to train three thousand individuals in the rural area on the production and marketing of improved stoves with a goal of disseminating 9 million domestic and over 10,000 institutional/commercial stoves, 10,000 bio-ethanol stoves and 10,000 bio-oil presses. In terms of biogas sector development, GOE, in collaboration with SNV, has already established a network of strategic partners in 4 regions and has trained 110 Woreda level experts, 727 masons, and has installed nearly 2,000 biogas plants. This has led to establishment of 12 active biogas construction enterprises and a biogas consumer credit scheme in cooperation with some MFIs (Oromiya, SNNPRS) and a GOE revolving fund (Amhara, Tigray) of about US$ 2 million. The future plan calls for scale-up the project and to install over 5,000 units across the country. Lessons Learned During Past Interventions 26. Within the energy sector, DBE has been operating as a trust agent (off-balance sheet) for the REF, which is administered by the MOWE, to manage an IDA credit line which was established as part of the off-grid rural electrification component within the EAREP II project. As part of EAREP II, MOWE procures renewable energy products such as SHSs and lends them to rural co-operatives (in-kind loans) while the DBE manages and collects the repayments on a commission basis. However, it was observed that access to finance at both the PSE level to promote projects targeting renewable energy products and services (especially, access to foreign currency for importers) and at the household level (affordability of these products and services) was a key constraint for scaling up of these interventions. Moreover, it was also established that for greater efficiency within the delivery mechanisms, specialized agencies must play their respective roles in the value chain (DBE and MFIs for financing, PSEs for delivering products and services and MOWE for helping create market awareness and other capacity building tasks). This would be a different approach to EAREP II project where MOWE was procuring, financing, distributing, and was also responsible for creating an enabling environment for such products. 27. Some of the other intervention-specific lessons learned are described briefly below: (a) Solar Lighting Products (Such as Lighting Africa): Based on the Bank’s recommendations, the GOE removed the import customs and duties for Lighting Africa approved products. However, the market for these products has not flourished as the importers are not able to secure working capital loans and are also not able to secure foreign currency (National Bank of Ethiopia regulations) needed to place orders of these products overseas. 39 (b) Solar Home Systems: Similar to the case above, the SHS market has struggled due to lack of access to financing and foreign currency. MOWE have made attempts to procure/import these products, however, time delays in government procurement regulations have hampered the market. (c) Efficient Cook Stoves: Under the leadership of MOWE, GOE has been able to successfully demonstrate a viable business model for promotion of efficient cook stoves. In order to further scale up the market further financing support is needed. (d) Biogas Units: The biogas program in Ethiopia has been successful based on subsidy (up to fifty percent, 6,000 Birr of the cost of about 12,000 Birr) provided by the GOE and other donors such as SNV. The remaining amount is typically lent by MFIs to the HHs interested in installing a unit. However, without additional financial resources, the program will not be able to scale up successfully in the future. (e) Waste to Energy Plants: There are several entrepreneurs interested in establishing waste to energy projects in the Addis region and other urban areas of the country. However, these entrepreneurs, who have approached ministries of energy and finance in the past, have not been able to secure financing for such projects. (f) Industrial Energy Efficiency Projects: There is also some interest in industrial energy efficiency projects including retrofitting, insulation, etc. These projects also lack ability to raise capital for prototyping and scaling up. 28. A key requirement for financing from Ethiopian financial institutions has been collateral to secure the loans which can be as high as 125% of the loan amount. This was especially true for projects that include movable assets (for other project financing type loans, the project itself could be used as collateral). In the past, this has been a major constraint for PSEs interested in raising project financing or working capital type of loans. DBE has adopted a standard policy to valuate collateral at fair market levels basis, which has been approved by the Banker’s Association. Collateralized property used for loans for this credit line will be appraised at fair market rates. 29. This Component under ENREP has been designed based on the lessons learned and the experience gained from the EAREP II project and other interventions in the sector in the past. The credit line has been designed to address the three main issues to enhance the market for renewable energy: access to finance, access to foreign currency, fair-market collateral values. 30. The overall goal of Component 3 is to promote private sector led development of the renewable energy and energy efficiency products. DBE will be the implementing agency for this component and will work with a network of MFIs and the MOWE to enable successful promotion of renewable energy products and services in Ethiopia by addressing the main bottlenecks. A credit line using IDA financing would be established within DBE and would be used to invest in projects related to promotion of renewable energy and energy efficiency products. DBE will allow two lines of credit to support this component. One would be to support the working capital requirement of project developers (PSEs, SMEs, etc.) and the other to provide on-lending support of MFI to lend to HHs (see Figure 5 below). 40 31. There will be no limits placed on either the PSE or the HH lending, or the technologies/products being supported. This will be left to market forces on a first-come first- serve basis. (a) PSE Lending: given DBE’s extensive experience in administering PSE loans, DBE will act as a retail agent for PSE lending (loan amount of over US$ 2,500) under ENREP Component 3. These loans would promote investment by PSEs in products such as solar lighting systems (Lighting Africa products, etc.), SHS, waste to energy, other energy efficiency projects, etc. As some of these projects would tend to be import oriented, a key issue identified during the discussions was the inability of the entrepreneurs to raise foreign exchange loans. DBE, using IDA credit which is issued in US Dollars, would be able to provide the PSEs with much needed access to finance in foreign currencies. DBE will be responsible for development and marketing of the program, appraisal of the project proposals, carrying out due diligence as needed, disbursement, management and collection of the loans. DBE will work to develop the financial arrangement of the program including commission and fee, on-lending terms, fiduciary management, reporting and other requirements as needed. DBE will work with MFIs to provide access to finance at the household level and will work with MOWE to develop an enabling ecosystem for the products and services at the grassroots (more on this in the Annex 3 Implementation Arrangements). (b) Household Lending: Access to finance at the household and village level is critical for the promotion of renewable energy and energy efficiency products at the grass-roots. Typical products for such loans could be the SHS, biogas installations, improved cook stove projects, etc. (loan amount of over US$ 2,500). However, given the dispersed nature of the demand of household lending, the best way to implement such lending would be to partner with a network of MFIs that have a much deeper presence in rural areas of Ethiopia. At present there are 32 MFIs in the country. Based on their level interest and fit to the program – following implementation arrangements are planned: DBE (would act as wholesale financier for the MFIs who would then on- lend to the beneficiaries at the rural household level) will initially launch the program with a few MFIs as partners to offer the household credit facility. DBE will continue its role as a direct retailer to the private sector. Based on the progress of the program, DBE can expand the MFI network to other partners (to be determined at a later stage) according to the program guidelines, the level of interest of the MFIs, and after a due diligence (financial intermediary assessment) has been carried out to a satisfactory level according to the World Bank policies of the proposed additional MFIs. DBE and MFIs would be jointly responsible for implementing the program using the defined operating guidelines including fiduciary management, reporting and other requirements as needed. 41 Figure 5 A: ENREP Component 3 Flow of Funds Figure 5 B: ENREP Component 3 Transaction Flow Note: Typical lending rates are shown, subject to change based on GOE discussions. 32. Based on the market assessments carried out by entrepreneurs and discussions held with other industry partners and DBE’s own estimates, a possible mix of products and services for the first cycling of the credit line could be including a possible total number of households supported (approx. 40,000). In the subsequent years, as the credit line loan is collected back, the money will be channeled back into more renewable energy products and services as a revolving fund. Figure 6: DBE - Possible Financing Portfolio from Credit Line Product/Service Typical Unit Total Units Financing Cost ($) (number) Solar Lighting 40 15,000 Solar Home Systems 700 5,000 Efficient Cook Stoves 10 15,000 Biogas Units 300 5,000 Other Projects TBD TBD 42 33. Modernization Support (estimated US$10 million): ENREP will include comprehensive technical assistance, capacity strengthening, and implementation support for key aspects of the Government’s modernization program for EEPCO, including operational efficiency improvements, and capacity strengthening for contract management, asset control and other required commercial utility good practices. GOE is undertaking a transformation plan for EEPCO to modernize the utility. The plan is aimed at reorganizing and restructuring EEPCO in order to meet the demands of the growing sector. The technical assistance component will be designed to assist GOE in their entire energy portfolio as the country embarks on a massive growth program in the energy sector. In an initial assessment, ten key areas have been identified as the key areas where EEPCO will need capacity building support (detailed below). Figure 7: EEPCO’s Capacity Building Needs No Items (Technical Assisstance + Training) I.0 Operation Management 1.1 Distribution planning & Design 1.2 Transmission Operation 1.3 Generation Operation 2.0 Transmission & Substation Engineering Design 2.1 TL Design 2.2 SS Design 3.0 Transmission & Substation Construction 3.1 TL Construction 3.2 SS Construction 4.0 Financial Management 4.1 Financial Management 4.2 Financial Accounting 5.0 Human Resources Development 5.1 Operation Training Need Assessment 5.2 Operation Course Development 5.3 Operation Courses Delivery 5.4 Organization Development 5.5 Performance Management 6.0 Service Delivery 6.1 Customer Service Delivery & Compliant Handling Customer Billing 7.0 Contract Management 7.1 Generation Construction 7.2 UEAP 7.3 Transmission Construction 8.0 Planning 8.1 Master Plan 8.2 Strategic management 9.0 IT Support 9.1 System Management 10.0 Procurement and Contract Management Source: EEPCO Human Resources Department 43 34. While, the overall transformation plan is still being developed, in the interim, specific programs will be designed to strengthen institutions in areas such as procurement and contract management, financial management, safeguards, and other technical aspects. The institutional capacity development would bring skill development at international standards to enable EEPCO to provide standard, reliable and efficient services; the redesigning of modern organization that fit to the new business process; and the creation of the new generation of work force which will make it a modern and efficient organization. In the long term, a twinning arrangement with a modern utility is also being considered. EEPCO has already appointed 3 Procurement Officers to support implementation of Bank financed projects. 35. It has also appointed an International Procurement Advisor to train its Project Officers and to ensure quality standard of its procurement process. This initiative will continue to be supported under ENREP. EEPCO is also planning on hiring an International Financial Advisor to train its finance and accounting department to ensure quality standard of its financial management process. This initiative will continue to be supported under ENREP. EEPCO is also preparing terms of reference to select consultants to strengthen the capacity of its Environment and Social Monitoring Unit (ESMU). The consultant will support ESMU staff in preparing the Environmental and Social Management Plans (ESMP) and the Resettlement Action Plan (RAP) after a line segment is identified to receive support from ENREP. This will ensure that project implementation is not delayed due to safeguards related issues. 36. DBE, MFIs, and the MOWE will also receive capacity building support to function efficiently as a financial intermediary and to carry out market development activities. Specific training and technical assistance activities will be carried out at each of the participating institutions of the Component 3 in order to equip them to successfully promote the market for renewable energy and energy efficiency products. This especially includes technical specialists to ensure proper appraisal of technologies, products and services as well as to set and adhere to quality standards of the sector. Some areas of support already identified include: Figure 8: DBE and MOWE Capacity Building Needed No Description 1 Capacity Building 1.1 Training 1.1.1 DBE, MFIs, and MOWE Staff 1.1.2 Other Stakeholders 1.1.3 Project Promoters 2 Expert Consultants 2.1 For DBE and MOWE 3 Experience Sharing 44 ANNEX 3: IMPLEMENTATION ARRANGEMENTS ETHIOPIA: ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) Project Institutional and Implementation Arrangements 1. The project will have three implementing agencies: (i) EEPCO, (ii) DBE, and (iii) MOWE. MOFED will sign to Subsidiary Financing Agreements with EEPCO, DBE and MOWE to lend IDA credit to these entities to implement the ENREP project. The Components for which each of the implementing agencies will be responsible is stated in the following Table. Figure 1: Project Component by Implementing Agency Implementing Agency Project Component EEPCO 1. Reinforcement and Expansion of Electricity Network EEPCO 2. Access Scale-Up DBE 3. Market Development for Renewable Energy and Energy Efficient Products EEPCO/DBE/MOWE 4. Modernization Support and Capacity Building Project Administration Mechanisms: 2. EEPCO will implement this project through its institutional systems. There will be three different PCs responsible for the three components. A recent Business Process Reengineering (BPR) created 10 different core processes in EEPCO, which divided EEPCO functions based on these core processes (see Figure 2). Figure 2: Project Component Implementation within EECPO CEO Planning Generation Transmission Distribution UEAP Finance Projects Projects Projects Sales Generation Transmission Distribution Operations Operations Operations Human Resources Project Coordinator Project Coordinator Project Coordinator ENREP Component 1 ENREP Component 2 ENREP Component 4 3. The Reinforcement and Expansion of Electricity Network will focus on the HV lines and substations. As this function falls under the Transmission Projects Core Process, there will be 45 one PC responsible for Reinforcement and Expansion of Electricity Network (Component 1) who will report to the Transmission Project Executive Officer. This project unit will be supported by a Procurement Officer - trained by EEPCO’s Retainer Procurement Advisor. On safeguard related issues, the PC will be supported by EEPCO Environment and Management Unit (EMU) which will be strengthened by the Modernization Support Component of the project. 4. The Access Scale-Up component will focus on the rural electrification aspect, which falls within the scope of Universal Electricity Access Program Core Process. The PC responsible for Electricity Access (Component 2) will report to the UEAP Executive Officer. The PC will receive procurement, safeguards and other administrative support as the other component explained above. 5. The Modernization Support component of the project will focus on strengthening EEPCO Capacity in Contract Management, Financial Management, Human Resource Capacity, Safeguards issues, System Planning, etc. This component will also support EEPCO improving its billing and revenue collection systems. 6. EEPCO can also use this component to implement required training programs for its staff. EEPCO’s Human Resource Department in association with its Strategic Planning Unit is preparing a scope of work to be funded under this component. The PC responsible for the Modernization Support (Component 4) will therefore have to work closely with the Human Resource Executive office and will report to the EEPCO Strategic Corporate Planning Officer. 7. The Development Bank of Ethiopia will play the role of a financial intermediary and will be responsible to implement Component 3 of the ENREP project on Market Development for Renewable Energy and Energy Efficient Products. 8. The credit line that DBE will implement has two main elements – retail lending to private sector enterprises (PSEs) and wholesale lending to MFIs. Further, market development activities will be carried out by MOWE. DBE will implement the retail lending portion of the project through its typical institutional arrangements and will implement the wholesale portion using a specific project implementation unit. There will be one PC appointed for the overall project focusing on specific issues of retail and the MFI lending operations. 9. This type of arrangement has been established at the DBE in previous projects. DBE has worked with many international donors including multilateral partners in providing access to finance to promote entrepreneurship and project promotion in various ear-marked sectors. Specifically, DBE has worked with EIB to provide PSE loans ranging from Euro 50 thousand to Euro 2 million. These loans were generally available at 8.5% interest rate for a term of 6 years with a 1 year grace period and promoted investment in service and manufacturing sectors. DBE has also lent (as a wholesaler) to a network of MFIs to deliver household level access to finance under projects such as the Rural Financial Intermediation Program (RUFIP), a program of AfDB and IFAD. Figure 3 below illustrates how such arrangements will be made at DBE. 10. Currently, DBE has four executive functions and over 15 other core functional units such as: Internal Audit, Risk Management Process, Credit Process, Loan Approval, Legal, Project Appraisal, Project & Loan Recovery, Human Resource, Finance & Accounts, IT, Rural Financial 46 Intermediation Program Bureau, etc. The PC will report to the Export Credit Guarantee and Special Fund Administration Bureau. MOWE will provide technical support to the program through their usual institutional arrangements. Figure 3: Project Component Implementation within DBE CEO Credit Services Project App. Branch Corporate Support Sub-Process Operations Services Services Credit Process Export Credit Project Coordinator Guarantee and SFAB Special Fund Adm. Bureau Credit 11. As per Bank requirement (OP8.30), a financial intermediary capacity assessment Guarantee and for DBE has been Special out. carried Fund The OP8.30 assessment is summarized in Annex 8. Based on the Adm. Bureau assessment, it can be concluded that the core financial indicators of DBE are favorable; however, there are certain capacity building, risk and internal process related challenges to overcome. 12. DBE, MFIs, and MOWE will receive technical assistance to enhance its capacity in certain areas of weakness identified will also implement this as part of the Modernization Support Component to enhance its capacity in implement the ENREP project. The areas of capacity building focus at DBE include: Internal Audit and Risk Management, IT and MIS related capacity building and Credit Policy and Procedures. DBE will also assist in providing technical assistance to partner MFIs and MOWE to enhance their project implementation capacity and to ensure timely implementation of the ENREP project. This capacity building measures will be implemented as part of the overall credit line operation by each of the PCs (retail and wholesale). 13. Specific roles of participating institutions of ENREP Component 3 are listed in Figure 4: Figure 4: ENREP Component 3 - Roles of Participating Institutions 47 14. The roles and responsibilities of each of the participating agencies will be outlined in detail in the DBE Project Operating Manual (POM) and will be enforced using Memoranda of Understanding (MOUs) and other lending agreements as necessary. Financial Management, Disbursements and Procurement Financial Management: 15. The Bank conducted a financial management assessment of the two implementing entities of the project, that is, EEPCO and DBE. The conclusion of the assessment is that the financial management residual risk for DBE is moderate while for EEPCO is substantial. Although the financial management arrangements satisfy the Bank’s minimum requirements under OP/BP10.02, there remain improvements to be effected for the system to be adequate to provide, with reasonable assurance, accurate and timely information on the status of the project as required by the IDA. 16. The Bank conducted a financial management assessment of the two implementing entities of the project, that is, EEPCO and the DBE. The conclusion of the assessment was that the financial management residual risk for DBE is moderate while for EEPCO is substantial. Although the financial management arrangements satisfy the Bank’s minimum requirements under OP/BP10.02, there remain improvements to be effected for the system to be adequate to provide, with reasonable assurance, accurate and timely information on the status of the project as required by the IDA. 17. EEPCO has shared with the Bank: (i) a comprehensive action plan and implementation undertaken addressing all the issues raised in the audit report and management letter for the year ended July 7, 2011. Key undertakings to be fulfilled by EEPCO include: (i) Prior to effectiveness, GOE to submit to the Bank detailed program of actions to ensure financial viability of EEPCO, including the financing plan for EEPCO for FY 2013. 18. Following that, (i) within 3 months of effectiveness, EEPCO to assign a qualified and experienced internal auditor for the project to strengthen the monitoring of internal control systems for the project; (ii) within 3 months of effectiveness, EEPCO to recruit a qualified and experienced Financial Advisor/Specialist who will coordinate accounting functions between EEPCO and the PIU on terms of reference acceptable to the Bank; (iii) EEPCO to assign a team to work jointly with the Just in Time (JIT) Study Consultants to conduct a review to identify issues related to the Agresso accounting software and the billing interface, submit an implementation plan by October 31, 2012, and resolve the issues identified within 24 months; EEPCO will report progress made on this plan; and (iv) Beginning with May 2013, GOE to annually review with the Bank, the financing plan of EEPCO for the upcoming fiscal year to ensure financial viability of EEPCO. Other actions that need to be done to especially reduce the financial management residual risk of EEPCO and DBE are documented under the financial management section under Annex 3. In terms of the other implementing agency, following effectiveness but prior to disbursement, DBE will submit to the Bank a manual which will include eligibility criteria for selecting micro finance institutions and final beneficiaries (PSEs, individuals or households), and templates for sub-credit agreements. Also, DBE will implement 48 its Institutional Development Plan (including bringing finishing the audit of its financial statements for FY 2010 and 2011. Figure 5: ENREP Risk and Mitigation Residual Risk Rating Effectiveness (Y/N)? Risk Rating before Incorporated into Risk Mitigating Project Design Conditions for mitigation Measures Risk Inherent Risk Country Level The risk is being addressed by the ongoing Civil Risk arises from weak capacity and staffing Service Reform Program through the S N issues especially in audit and accounting since H Expenditure Management and Control Program the country does not have an accounting (EMCP) which is the strategy for PFM reform. profession. Further, there is high staff turnover Bank operations like PSCAP and PBS II are and shortage of qualified accountants and major instruments for addressing the risk in auditors. question.GOE has just drafted new Financial Reporting law and a separate law to establish an Institute of Certified accountants.GOE is working on a PFM strategy to professionalize accounting in government. Entity Level EEPCO to submit a comprehensive action plan EEPCO has experience in implementing Bank S and implementation undertaken addressing all S N Financed projects, However, the entity has in the issues raised in the audit report and the past and current bank financed projects management letter for the year ended July 7, suffered a number of accounting shortcomings 2011. EEPCO will assign a team to work jointly where the accounting system is not up to-date with the Just in Time (JIT) Study Consultants to due to difficulties in software interface and conduct a review to identify issues related to the mapping, weak staff capacity to produce Agresso accounting software and the billing quality financial reports, late submission of interface, and submit an implementation plan by audit and interim financial reports, weak October 31, 2012, to resolve the issues internal Audit. identified. The JIT consultants are expected to be available from May – June 2012. EEPCO will inform, in the Quarterly IFR Narrative Summary, progress made in implementing (i) the identified Agresso accounting software and billing interface issues implementation plan and (ii) the audit report and management letter issues action plan. Within 3 months of effectiveness, EEPCO to assign a qualified and experienced internal auditor for the project to strengthen the monitoring of internal control systems for the project and will also recruit a qualified and experienced Financial Advisor/Specialist who will coordinate accounting functions between EEPCO and the PIU. DBE on the other hand has robust systems but S DBE will train the relevant staff to the project in M N weak capacity of staff to correctly implement World Bank policies and guidelines, these systems disbursement guidelines, etc. 49 Residual Risk Rating Effectiveness (Y/N)? Risk Rating before Incorporated into Risk Mitigating Project Design Conditions for mitigation Measures Risk Project Level Clear and proper sub-loan appraisal, approval Because DBE will be disbursing some of the S and follow up guidelines for MFIs and house S N project funds to MFIs in a whole seller fashion hold lending will be developed and defined at there is a risk of disbursing the bulk of the the start of the project (Operating Manual) and funds to weak MFIs since there are few strong adherence monitored by internal audit of DBE. ones. In most cases, such institutions have Only MFIs with good performance track record weak capacity to produce the necessary reports. (OP 8.30 compliant) will be selected to Failure by households or MFIs to pay back the participate in the project. loans is likely and therefore a risk. The coordination between the different projects S EEPCo to improve coordination and supervision M N implemented by EEPCO further needs to be of different projects implemented through a strengthened and improved. coordinator. Inherent risk S S Control Risk Budgeting EEPCO &DBE have clear and well laid out L The project will follow the EEPCO & DBE L N budgeting procedures-although the risk arises budgeting procedures and where necessary from a failure to monitor and use the budget as follow the budget as laid out in the PAD. a management tool. Categories of expenditure should be kept simple. Accounting EEPCO &DBE use the accrual basis of Through the accounting systems review, the S N accounting when it is less meaningfully S recommendations will include training on understood accrual accounting so that it is well understood. Both entities have computerized accounting According to the finance department a consultant M N softwares, Agresso for EEPCO and Globus for S has been hired to sort out the accounting DBE. EEPCO has had continuous problems of software problems. The consultant should be software interface and mapping with other maintained on a retainer to support the system. modules for the last couple of years. This has resulted in a backlog of un-updated information. Possibility of future/ continuous breakdowns/ problem is persistent. DBE’s Globus also has shortcomings but mainly arising from the weak capacity of staff to operate the system correctly. The Finance Department of EEPCO has a new S Continuous training and capacity building of M N acting Finance & Supply Chain Executive staff. Induction of the new finance head in Officer but has no training in World bank World Bank policies and guidelines shall be policies and procedures. conducted before the project becomes effective The adequacy and capacity of some staff to Training and continuous capacity building will S N execute the accounting functions is weak, S be undertaken hence the poor quality outputs such as financial reports is to be expected. 50 Residual Risk Rating Effectiveness (Y/N)? Risk Rating before Incorporated into Risk Mitigating Project Design Conditions for mitigation Measures Risk Internal Control EEPCO to submit a comprehensive action plan EEPCO has well defined financial management S and implementation undertaken addressing all S N manual and the internal controls as designed the issues raised in the audit report and are clearly spelled out. Execution of these management letter for the year ended July 7, internal controls is very weak. 2011 DBE has a strong internal control system as S Training of staff for DBE in the correct M N documented in the accounting manual but, the application of the internal controls is mandatory internal audit department has raised significant for this project as well as the application of risk compliance issues. to internal audit approach. Internal Audit: EEPCo has an internal audit department but S Within 3 months of effectiveness, EEPCO to S N past supervisions have revealed that most assign a qualified and experienced internal projects implemented by EEPCo have hardly auditor for the project to strengthen the been audited by the internal audit other than monitoring of internal control systems for the case based audits. On overall internal audits are project. done postmortem rather than in real time. Funds flow Simple fund flow arrangement. No major risk L No mitigation measure is proposed L N is expected Financial Reporting EEPCo submits its quarterly IFRs and audit S Within 3 months of effectiveness, EEPCO will M N belatedly. The quality of the reports has been recruit a qualified and experienced Financial wanting. Advisor/Specialist who will coordinate accounting functions between EEPCO and the PIU. Auditing DBE’s entity audit reports are not completed on S Auditors will be recruited early to avoid delays. S N time. DBE’s recent audited accounts for FY Senior Accountant to facilitate timely closure of 2009 were qualified, and there is a backlog of accounts and submission of draft financial unaudited accounts. statements to the auditors after sorting out the billing and accounting interface. Terms of reference to be agreed before the start of the project. Monitoring and follow up by the project team to support the project to resolve the backlog. Control Risk S S Total Project FM Risk S S 51 Strengths and weaknesses of the financial management system 19. The project financial management is strengthened by the following features:  Both entities have a set of Financial Management manuals/accounting guidelines, which describe the financial management systems and related internal control systems and other set procedures.  Both implementing entities have experience in executing Bank financed projects.  Strong budget preparation processes for both entities exist. 20. The project financial management is challenged by the following features:  Failure of the Accounting system to interface with the billing module for EEPCO which make accounting system outputs unreliable.  Delays in closing of accounts and late submission of the entity audit reports by EEPCO.  EEPCO’s entity audit report for the years 2009, 2010, and 2011 have all been qualified on similar grounds, which makes the entity’s financial management environment weak and unsatisfactory.  DBE’s internal control system has significant weaknesses as identified by the internal audit  DBE’s financial statements are not up to date in terms of audit, and the most recent audited accounts were qualified.  DBE’s staff capacity is weak  Shortage of qualified accountants and auditors in Ethiopia Budgeting Arrangements: 21. EEPCO: the budgeting process for EEPCO is adequate for the project. The entity has budgeting guidelines and the budget is approved by their Board of Directors. Staff capacity is adequate for budgeting. EEPCO budget is submitted to the Ministry of Finance and Economic Development (MOFED) to be consolidated under the government budget. Funds released to the project by the ministries are based on the approved budget. 22. DBE: the budgeting process for DBE is adequate for the project. The entity has a planning department responsible for the budgeting process. All units are involved in the process of budgeting, they prepare individual unit budgets, submit to the planning department who compile and consolidate the master budget for discussion with management. The budget is subsequently forwarded to the Board of Management for approval. After approval, it is sent to the Public Financial Enterprises Supervising Agency (PFESA) a directorate under the Prime Minister’s Office which regulates all public enterprises and state owned banks. The bank prepares 3 types of budgets (Capital budget, Recurrent Budget, and the Loan performance budget). Performance is monitored on a quarterly basis and variances must be justified. These quarterly reports are presented to the board to evaluate performance. The Loan performance 52 budget is used to budget credit activities at the beginning of every fiscal year to determine how many loans to approve, disburse and monitor performance of these loans. Accounting Arrangements: 23. FM manuals: EEPCO is using the Finance Procedures and Accounting Manual which is adequate for the project. DBE has an accounting manual that describes the principles and procedures used by the bank. 24. Accounting staff: EEPCO will need to recruit a qualified and experienced senior accountant to prepare the project accounts and this will be an effectiveness condition. The staff who will be handling this project will have to be specially trained in World Bank Financial Management and Disbursement guidelines and this training will be done by the Bank FMS. 25. DBE has a total of 73 staff in the finance and accounts management process. This department is divided into 4 teams that is; (i) the domestic banking team responsible for delivering baking services and the capturing of transactions into the financial system, (ii) account management and reconciliation team, responsible for checking transactions processed under the domestic and fund management teams. They check the reliability and accuracy of the transactions and do the reconciliations for the inter branch accounts, (iii) management information system team responsible for producing reports, analyze financial information, update the credit reference bureau and forward reports to the strategic planning and development effective process, (iv) fund management team responsible for mobilizing funds in form of Ethiopian Government Savings Bonds, Corporate Bonds from corporate investors, priority sector loans and are responsible for managing the resources at optimal level. The staffing is deemed adequate. For this project DBE will appoint two staff to be focal points for all issues pertaining to the project. The staff will have to be trained in Bank Financial Management and Disbursement guidelines and this training will be done by the Bank FMS. 26. Accounting software: EEPCO will use its Agresso accounting software to prepare the project accounts. However, Agresso has had continuous problems of software interface and mapping with other modules for the last couple of years. This has resulted in a backlog of un- updated information, wrong data, etc. The risk/possibility of future, continuous breakdowns and problem may persist, and EEPCO is determined to resolve this issue. In addition, EEPCO with support from the Bank agreed to review the entity’s financial management using a holistic approach with the help of an international consultant to identify areas of weakness and propose solutions, focusing on auditing, internal controls, internal audit, accounting and corporate governance. The same intervention will look at providing solutions to address the interface and mapping issues between Agresso and the billing software. Internal Control and Internal Audit Arrangements: 27. Internal audit: EEPCO has an internal audit department. Past experience in dealing with the unit indicates that the internal audit department is weak, and mainly concentrates on case based audits and not its annual plan. For purposes of this project and to further strengthen the financial management of the PIU, EEPCO will assign an internal auditor specific to the project with the prospect of being integrated into EEPCO’s internal audit mainstream to oversee 53 the proper functioning of the PIU’s internal control and will be the focal point to develop an annual risk-based audit plan to help management identify, inter alia, key risks and weaknesses in the operations and internal control systems. Internal audits shall be conducted in compliance with the annual risk-based audit plan. The assignment Project internal auditor will be a condition for effectiveness. Quarterly internal audit reports for the project will be prepared and submitted to the General Manager of EEPCO for action. The internal auditor will have to be trained in World Bank Financial Management guidelines and this will be done by the respective FMS. In addition, the internal audit unit will include the project’s internal audit requirements in their annual audit plan. 28. DBE has an independent internal audit department reporting to the Board of Management. It has a total number of 19 staff including 1 Internal Audit Manager (Bsc in Agriculture Economics), 2 Principle Auditors (Bsc in Agriculture Economics), 7 auditors financial (BA Accounting), 7 auditors operational (Bsc in Economics and Management). They are divided into two teams; one team is responsible for the operational audits (Process audit, procurement, risk analysis, property management, IT Audit, legal and audit) the second team is responsible for financial related audit and international banking. The teams are guided by the internal audit charter formulated specifically for the bank. It provides the framework for operations and the enhancement of the independence of the internal audit functions within the bank. They prepare an annual plan which is followed throughout the year. Quarterly reports are prepared and submitted to the President of the bank. The reports examined reveal internal control weaknesses within the bank. DBE will prepare annually a risk-based audit plan specific to the project, which will be used to audit the project transactions on an annual basis. 29. The internal control system for DBE is strong and robust. There are clear lines of communication, segregation of duties, procedural and policy manuals, clear authorization, transactions reconciled on a daily basis, and bank reconciliations are regularly done. However, there is a general capacity issue as far as staff are concerned and a number of weaknesses are identified within the processes such as receiving incomplete loan applications, poor document screening, incomplete project appraisal reports, missing conditions of appraisal, approving loans on the basis of the incomplete appraisal reports, in some cases failing to prepare loan contracts as per decision of the loan approval team, failing to maintain the required debt-equity, long delays in to block equity, releasing loans before preconditions are fulfilled, disbursing loans without verifying the utilization of equity or previous disbursements, failure to conduct proper follow up, long outstanding receivables and payables, long outstanding uncleared effects, lack of source documents, absence of subsidiary accounts for some assets, high differences between the GL and SL ledgers, missing documentation etc. During the course of implementation follow up on these issues will be made to monitor rectification. 30. DBE has a risk management team that assesses the risk and prepares a risk profile which is updated annually. 31. EEPCO internal control system: EEPCO has relatively good internal control system as described in the Finance procedure and Accounting manual, to help the management of the project in achieving the project objectives in an orderly and efficient manner. The entity’s financial policies and procedures manual specify the detailed internal control procedures to be applied in managing funds. The main focus of the internal control is placed on segregation of 54 duties, project assets safeguard, authorization and approval, Clear lines of communication, arithmetic and accounting accuracy, integrity and performance of staff at all levels and supervision. However, the management letters for the entity audit for the fiscal years ended July 7, 2010 and 2011, note significant weaknesses in the system that include the following:  Weak internal controls in transaction processing leading to missing supporting documents, delays in deposit of cash collections to the bank, delays in meter reading and non-issuance of goods received notes and non- sequencing of these notes all of which make the entity susceptible to fraud and irregularities.  Long outstanding advances to contractors and new connections.  Incomplete fixed assets registers whereby the property and equipment register does not include physical location of the assets which makes verification of existence difficult. There are also differences in fixed asset register and ledger records with respect to accumulated depreciation. 32. EEPCO has submitted a follow up progress report regarding the issues raised in the audit report and management letter for the year ended July 7, 2010 and provided a comprehensive action plan stating how the issues raised in the audit report and the management letter for the year ended July 7, 2011 will be addressed. Disbursements: 33. Disbursements arrangements: The disbursement methods that would be used under this project will be based on The World Bank Disbursement Guidelines dated May 1, 2006. Disbursement methods that are commonly used could be direct payments to a third party for works, goods and services upon the Borrower’s request; special commitments, letters of credit; reimbursements for expenditures incurred under the project, etc. Further details about disbursements to the project will be included in the disbursement letter. As implementing agencies of the project, EEPCO and DBE will maintain Designated Accounts. If ineligible expenditures are found to have been made from the Designated Accounts, the Borrower will be obligated to refund the same. If the Designated Accounts remain inactive for more than six months, the Borrower may be requested to refund to IDA amounts advanced to DA. IDA will have the right, as reflected in the Financing Agreement, to suspend disbursement of the Funds if reporting requirements are not complied with. 34. Banking arrangements for EEPCO: EEPCO will open a new Designated Account denominated in United States Dollars (USD) at the National Bank of Ethiopia. Local Account in Birr will also be opened to receive transfers from the USD account. 35. Banking arrangements for the Development Bank of Ethiopia: The Development Bank of Ethiopia will open a Designated Account denominated in United States Dollars (USD) at the National Bank of Ethiopia. A local account in birr will also be opened to receive transfers from the USD account. 55 36. Both the Designated Accounts and Project Accounts need to be opened and the details including the account signatories communicated to the Bank within one month after effectiveness. 37. Flow of funds arrangements: Funds flow arrangements for the project (through the designated and project bank accounts above) are as follows:  IDA will make an initial advance disbursement into the Designated Accounts for the project being implemented by EEPCO and DBE in US Dollars upon receiving a withdrawal application from the respective institutions.  Replenishment of funds from IDA to the two Designated Accounts will be made upon evidence of satisfactory utilization of the advance, reflected in SOEs and/or on full documentation for payments above SOE thresholds. Replenishment applications would be required to be submitted regularly on a monthly basis. Sub-credits made by DBE would be divided into two categories. One would be to MFIs and the other would be to the PSEs. (i) Sub-credit to MFIs: Due to the large number of sub-credits and the relatively small amounts involved (up to USD 5,000), it has been agreed that the Statements of Expenditure would evidence payments made by MFIs to eligible households/sub-credit recipients on the basis of signed credit agreements and payments made to eligible recipients. The expenditure would be recognized at that time and the verification that payments made to eligible recipients were used for the purposes intended would then rely on DBE's control mechanism and monitoring and evaluation. (ii) Sub-credit to PSEs: Due to the larger amounts involved, eligible expenditures reported on the Statements of Expenditure would be the actual costs - invoices, receipts, depending on the SOEs' thresholds - incurred with the acquisition of Goods, Works and Services by the PSEs.  Funds will be transferred from the Designated Accounts to the project accounts and payments in relation to project eligible expenditure can be made from both accounts.  Counterpart funds from the Federal Government of Ethiopia will be deposited in the Project Account to pay for all local currency project transactions. 56 Figure 6: ENREP Funds Flow  World Bank IDA Figure 4: ENREP - Proposed Flow of Funds GOE/MOFED EEPCO Development Bank of Ethiopia (Implementing Agency) (Implementing Agency) Contractors Private Sector MFI 1 MFI 2 Consultants Lending Suppliers Household Household Lending Lending Financial Reporting Arrangements: 38. DBE and EEPCO will prepare quarterly un-audited Interim Financial Reports (IFRs) for the project in form and content satisfactory to the Bank, which will be submitted to the Bank within 45 days after the end of the quarter to which they relate. The format and content of the IFR has been agreed between the Bank, EEPCO and DBE. 39. The contents of the IFR will include:  Statement of Sources and Uses of Funds; and  Statement of Uses of Funds by Project Activity/Component. 40. The project will also prepare the projects annual accounts/financial statements within three months after the end of the accounting year in accordance with accounting standards acceptable to the bank. The audited financial statements should be submitted to the bank within six months after the end of the accounting year. EEPCO and DBE will prepare their accounts in accordance with International Financial Reporting Standards (IFRS). 57 41. DBE has a two year entity financial audit backlog. Whilst it has been agreed that the annual financial statements of DBE will include project sources and expenditures and notes to its entity accounts, such backlog needs to be resolved before the project becomes effective. Failure to do will warrant separate production of quarterly interim unaudited financial reports (IFRs) which will be submitted to the Bank forty five days after the end of each quarter. 42. Auditing arrangements: The project audit will be done using an acceptable auditor to the Bank that has to be cleared by the Financial Management Unit. The audit will be done using International Standards on Auditing (ISA) and the audit report together with the management letter has to be submitted to the Bank within 6 months after the end of the financial year. The audit report will be disclosed in accordance with the Bank’s Access to Information Policy. EEPCO will submit audited accounts for the project and the entity, while DBE will submit entity audited accounts with sufficient disclosures of the project’s sources and uses of funds in the notes to the audited accounts. The project shall be audited annually at the end of each financial year. DBE and EEPCO have shared the audit TOR of the project with the Bank. 43. A review of DBE’s most recent audited accounts for the period ended June 30, 2009 showed that DBE had a qualified opinion stating that due to the limitation in scope the auditor could not sufficiently form an opinion on a number of issues that are material in nature. DBE needs to resolve the issues stated in this report and provide sufficient documentation to the Bank showing that the issues have been resolved as an indicator of having a good financial management system. In addition, DBE accounts are not up to date and financial statements for two years (2010 & 11) are not audited. As DBE informed that the reason for the back log has been resolved, it should work on expediting the outstanding audits. Important to note is that this qualification does not relate to Bank funding. 44. A review of EEPCO’s audit status reveals that audit reports are received with delays. The entity audit report for EEPCO for the financial year ended July 2011 has been submitted belatedly with a qualified opinion and the management letter has a number of significant weaknesses raised. The issues of qualification are exactly the same as in the previous years. 45. The audit reports that will be required to be submitted by DBE & EEPCO together with due dates for submission are: Figure 7: Audit Reports Audit Report Due Date 1) Entity Financial Statements and management Submitted within six months after the end of letter to be submitted by DBE. each financial year. 2) Project Specific Financial Statements and Submitted within six months after the end of management letter to be submitted by EEPCO. each financial year. 3) Entity audit report and management letter to be submitted by EEPCO 58 Financial Management Action Plan: 46. The table below shows the financial management action plan for the project. Figure 8: Financial Management Action Plan Action Date Due By Responsible 1. Within 3 months of effectiveness, EEPCO to assign a 3 months EEPCO qualified and experienced internal auditor for the project to after strengthen the monitoring of internal control systems for the Effectiveness project. 2. Within 3 months of effectiveness, EEPCO to recruit a 3 months EEPCO qualified and experienced Financial Advisor/Specialist who after will coordinate accounting functions between EEPCO and Effectiveness the PIU on terms of reference acceptable to the Bank. 3. EEPCO to assign a team to work jointly with the Just in Ongoing EEPCO Time (JIT) Study Consultants to conduct a review to identify issues related to the Agresso accounting software and the billing interface, submit an implementation plan by October 31, 2012, and resolve the issues identified within 24 months after effectiveness; EEPCO will report progress made on this plan. Conclusion of the Assessment 47. A description of the project’s financial management arrangements above indicates that although they satisfy the bank’s minimum requirements under OP/BP10.02, there remain improvements to be effected for the system to be adequate and provide, with reasonable assurance, accurate and timely information on the status of the project as required by the Bank. The recommended improvements are detailed in the financial management action plan. 48. The overall financial management residual risk rating for DBE is moderate (medium- low) while for EEPCO is substantial (medium-impact) which means the planned supervision for DBE will be performed once a year while done twice a year for EEPCO. Procurement A. General 49. Procurement for the proposed project would be carried out in accordance with the World Bank’s Guidelines: Procurement under IBRD Loans and IDA Credits, January 2011; Guidelines: Selection and Employment of Consultants by World Bank Borrowers, dated January 2011; and the provisions stipulated in the Legal Agreement. The general description of various items under different expenditure categories will be presented in the financing Agreement and will be elaborated in the Procurement Plan. For each contract to be financed by the credit, the different procurement methods or consultant selection methods, the need for prequalification, estimated costs, prior review requirements, and time frame are agreed between the Recipient and the Bank’s project team in the Procurement Plan. The Procurement Plan will be updated at least 59 annually, or as required, to reflect the actual project implementation needs and improvements in institutional capacity. B. Procurement Environment 50. Public procurement in Ethiopia follows the federal structure of the government. Procurement at the federal level is governed by the procurement code issued by the federal government on January 12, 2005 and revised in July 2009. At the regional level the procurement code is enacted by the regional government, and the procurement directive is adapted to each region based on the model prepared by the federal government. According to the Ethiopia CPAR 2010, the SBD and SRFP are not yet revised based on the newly amended procurement Law. 51. The Country Procurement Assessment Report (CPAR) conducted in 2010 identified weakness in the country procurement system. Both the legal as well as the practice have got some limitations as compared to internationally accepted good practices. The National Competitive Bidding Procedure requires some amendments to be acceptable by the Bank. The government has plans to address the identified weaknesses in its continued public procurement reform activities. 52. National Competitive Bidding Procedures:  Amended NCB Side Letter: The competitive bidding procedures of the Federal Government have been reviewed by the Bank. Based on this review, contracts that will not be procured under International Competitive Bidding (ICB) may follow the Recipient’s FPPA’s procurement procedures, subject to the following additional procedures: (i) the Recipient’s standard bidding documents for procurement of goods and works shall be used; (ii) if pre-qualification is used, the World Bank’s standard prequalification document shall be used; (iii) margin of preference shall not be applicable; (iv) bidders shall be given a minimum of 30 days to submit bids from the date of availability of the bidding documents; (v) use of merit points for evaluation of bids shall not be allowed; (vi) foreign bidders shall not be excluded from participation; (vii) the results of evaluation and award of contract shall be made public and (viii) in accordance with para.1.16 (e) of the Procurement Guidelines, each bidding document and contract financed out of the proceeds of the Financing shall provide that : (1) the bidders , suppliers, contractors and subcontractors shall permit the Association, at its request, to inspect their accounts and records relating to the bid submission and performance of the contract, and to have said accounts and records audited by auditors appointed by the association; and (2) the deliberate and material violation by the bidder, supplier, contractor or subcontractor of such provision may amount to an obstructive practice as defined in paragraph 1.16(a)(v) of the Procurement Guidelines. 53. Procurement of Works: The Procurement of Works will be in accordance with Bank’s guidelines for Procurement of Goods, Works, and Non-Consultancy Services under IBRD Loans and IDA Credits & Grants by World Bank Borrowers, January 2011. The procurement process will be conducted based on the details in the procurement plan to be agreed and using the Bank’s 60 Standard Bidding Documents (SBD) for all ICB and National SBD as modified and found to be satisfactory by the Bank. (The details of procurement methods and thresholds are as below). 54. Procurement of Goods: Goods procured under this project will be in accordance with Bank’s guidelines for Procurement of Goods, Works, and Non-Consultancy Services under IBRD Loans and IDA Credits & Grants by World Bank Borrowers, January 2011. The procurement process will be conducted based on the details to be agreed in the procurement plan and Bank’s Standard Bidding Documents (SBD) for all ICB and National SBD as found satisfactory to the Bank. (The details of procurement methods and thresholds are as below) 55. Selection of Consultants: Selection of consultants will be in accordance with the Bank’s consultant selection guideline (January 2011) and shall be carried out using Bank’s standard Request for Proposals (RFP). Consulting firms for services estimated to cost more than US$100,000 equivalent would be selected through Quality and Cost Based Selection (QCBS) method. Consulting firms services estimated to cost less than US$100,000 equivalent may be selected using the Consultants’ Qualification (SBCQ) method. Individual consultants will be selected on the basis of their qualifications in accordance with Section V of the Bank’s Consultants Guidelines. Consulting services for audits and other services of a standard nature or routine nature may be procured using the Least Cost Selection method (LCS). Single source selection may be used where it can be justified. Short lists of consultants for services estimated to cost less than US$200,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultants Guidelines. When there is need for capacity reasons, NGOs, universities, research institutions, public training institutions, or any special organizations could be employed to assist where they have an advantage over commercial firms. Venues for workshops and training and purchase of materials will be done on the basis of at least three quotations, but annual training plans and budget shall be prepared and approved by the Bank in advance of the training. (The details of selection methods and thresholds are below). C. Implementing Agency (EEPCO) Procurement Capacity assessment I. Legal Aspects and Procurement Practices 56. Adequacy of procurement procedures of the recipient: Ethiopia has a satisfactory public procurement law that was revised in July 2009, and enabling Directives. The regional states have been provided with prototypes of the procurement law and directives based on which to enact similar procurement legislation. The procurement law establishes the Public Procurement and Property Administration Agency (PPA), the regulator, with the mandate to set national public procurement standards and build procurement capacity nationally. According to the Ethiopia 2010 CPAR, the Federal PPA SBD is not yet updated in line with revised Procurement law and is not issued by the FPPA. The old SBD which was based on the 2005 procurement proclamation is still in use. The incompatibility of the procurement Law and the SBD and/SRFP may pose some risk in the use of these documents for NCB contracts procurement. Therefore the team will base its assessment on the currently available (old) SBD for NCB and this SBD has already been found having some shortcomings that need to be qualified to be acceptable for use in Bank financed NCB contracts procurement. The exceptions in the NCB SBD are discussed above in NCB procedures. FPPA has published a public 61 procurement manual. However, PPA has no jurisdiction over enterprises like EEPCO that are established under the Public Enterprises proclamation. 57. EEPCO is a Government Owned Enterprise and is an entity whose procurement is not necessarily regulated under Ethiopia’s Federal Government Public Procurement Proclamation of 2009. However, EEPCO has volunteered to follow the FPPA law, and has prepared its own procurement guidelines and manual (this is currently under revision by an international procurement consultant hired by EEPCO from Energy additional financing project). Procurement oversight for EEPCO is provided by its Board of Directors and the Electricity sector regulator. Therefore, there is a gap of procurement oversight in the procurement legal framework for EEPCO. 58. Procurement cycle management: EEPCO’s procurement function falls under the Finance and Supply Chain Process – according to the product of the recent Business Process Re- engineering (BPR). However, this unit (process owner) doesn’t conduct actual operational procurement activities of projects, but only provide limited administrative support to the units conducting their own procurement. But the units who conduct their own procurement have neither dedicated procurement units nor skilled procurement officers. As the result, EEPCO has inadequate professional Procurement Officers on its staff and project procurement activity is conducted by technical specialists as a side task or by consultants. Contrary to the national standard (Para. # 8 of the Federal Government of Ethiopia Procurement and Property Administration Proclamation), EEPCO recognizes procurement as a profession less and the procurement function is considered as a general service that can be rendered by any technical specialist as and when required. Experience from ongoing projects show that major procurement bottleneck is the quality of procurement submissions and the lengthy time it sometimes takes to make procurement decisions. 59. Such delays affect timely implementation of development programs/projects and this seems to stem from either lack of procurement skills or over-regulation of the procurement process or both. But since recent, it seems EEPCO’s management is developing better understanding of the critical role of procurement in project implementation and there are some initiatives towards institutionalizing the need for professional procurement unit and career path for procurement staffs. But this is yet to be seen in future. 60. With the current situation, incompetence in terms of efficient procurement cycle management is a real challenge. The following weakness have been observed in this regards and need mitigation measures to reduce the risks with procurement Cycle management: EEPCO's contract management capacity is also another area of concern. a) Procurement planning (PP) has been a challenge with EEPCO and there is lack of use of PP as project implementation monitoring tool. Lack of regular updating of PPs and record of actual information in the PPs as well as keeping contract registers/information has been noticed as weakness in procurement management of EEPCO. And this will continue to be causes of project procurement risks; b) Preparation of bidding documents and pre qualification documents and subsequent evaluation of the bids and applications for prequalification has been a 62 challenge with EEPCO. EEPCO sometimes outsources the preparation of bidding documents to consultants and this is good practice but needs ultimate quality assurance of the consultants’ products by the client. The final responsibility and ownership of the documents will be of EEPCO and therefore EEPCO has to make sure the documents produced by the consultants are acceptable. It has been observed that a lot of time is lost with back and forth to get quality BDs and evaluation reports from EEPCO. This will remain as procurement risks of the new project. c) EEPCO’s experience also reveals that Preparation and signing of contracts is another challenging area in the procurement cycle management. d) Contract management during implementation, including dispute resolution methods has also been a challenge. These are some of the risks experienced within the existing projects contract management and may remain as risk for the new project unless appropriate mitigation measures are implemented. 61. Organization and functions: Review of EEPCO’s procurement organizational structure of the procurement unit, in terms of how responsibilities are allocated, its reporting relationships, its decision-making authority and its business performance standard reveals that there is lack of effective procurement functional unit and this is the major organizational and functional inadequacy to handle Bank financed projects procurement in EEPCO. 62. Organization of procurement unit and allocation of functions and internal procedural manuals and instructions and historical compliance are not satisfactory. Therefore risk related with procurement organization and Function seems high.. The attached Procurement Process Flowchart for Ethiopian Electric Power Corporation (EEPCO) depicts the weakness in this regards. 63. Support and control systems: The EEPCO’s internal Services and control mechanisms that provide checks and balances in the system and the independence and credibility of procurement audits and the quality of internal controls are yet to be improved. 64. According to the Country’s public procurement Law, the Public Procurement oversight and auditing function is supposed to be done by FPPA, but EEPCO is not governed under the Federal procurement Law and therefore FPPA has no jurisdiction over EEPCO. But EEPCO’s own internal technical and administrative controls system in the areas of performance audit, quality control and the oversight role of its Board of Directors on high value contracts may reduce the risk expected in this regards. However, this will remain as high risk area. 65. Record-keeping: EEPCO needs to further improve its procurement records availability, quality, security and completeness of procurement records and files. Overall data quality on numbers, types, values and dates of contracts awarded and names of awardees, records of plan and actual times taken to complete key steps in the procurement process are aspects that need further strengthening. This is one of the aspects with moderate risk. 66. Staffing: EEPCO doesn’t have sufficient staff to carry out the project procurement tasks. There has been an effort by EEPCO to recruit procurement officers to work on Bank financed 63 projects. But possibly due to non-attractiveness of the salaries and lack of career path and adequate incentives to attract and retain a procurement cadre, the recently recruited procurement officers were not interested to accept the assignment. At the moment, there is an international procurement advisor supporting all Bank financed projects. 67. This individual consultant was supposed to provide on job training to the EEPCO staffs so that EEPCO’s staff will be capacitated and take over the full task of the consultant. But as the recruits are not there, the plan in this regards seems less successful. The lack of a Procurement structure and staff with the procurement skills needed to implement project procurement efficiently is a high risk area and needs practical mitigation measures. II. General Procurement Capacity 68. Procurement Governance and Capacity Risk seems high. The actual weakness of performance of the procurement unit as evidenced by: (i) lack of timely procurement decisions taking; (ii) lack of existence of business standard for each actor; (iii) lack of existence of process quality assurance and accountability system in place and functionality of the system; and (v) absence of procurement capacity building and clear career development path with low salary structure of procurement staff increase the general procurement environment risk. III. Private Sector Viewpoint: 69. The assessment has included the views of few private firms dealing with the EEPCO on how the written regulations and procedures are applied in practice. The view of most of the private firms contacted is mixed and positive to the general predictability of the system regarding Bank financed contracts. They are also positive to the transparency of the procurement process, but have some reservations on the efficiency and quality of procurement and contract management process. IV. Risk Assessment: 70. Based on the assessment on the EEPCO’s procurement risk seems high. 71. The Risk to Procurement under the project and Risk Mitigation Measures may be summarized as here below. 72. Inherent risk: There is a risk that the lack of procurement legal framework will not allow compliance monitoring and procurement audits that are needed to enforce the creation and maintenance of the structures required to implement transparent, fair, efficient, accountable and value for money procurement. Further, the oversight arrangements wouldn't satisfactorily address bidder complaints which risks discouraging bidders from participating in EEPCO contracts thereby reducing competition. The mitigation measure for this risk is to develop and enact a procurement law that covers public enterprises in Ethiopia. This is a long term action that would involve GOE actors other than EEPCO. The lead agency for implementing this measure is MOFED. 64 73. Procurement Governance and Capacity Risk: The lack of a Procurement structure and staff with the procurement skills needed to implement project procurement efficiently is a risk. Further, there is a risk that technical staffs undertaking procurement tasks in addition to their normal duties are not committed/ capable to diligently conduct the procurement tasks. EEPCo’s procurement manuals are currently under review by a consultant. Procurement Operations and actual procurement processing practices in terms of (i) Adequacy of procurement competence among EEPCo officials/staffs in executing procurement routines in terms of Procurement Planning, Adverting, Bidding documents, pre-qualification preparations, short listing, Evaluation and Award of contracts, (ii) Norms for the safekeeping of records and documents related to transactions and efficiency of contract management, and (iii) Staffing and availability of quality training for continuous skill development in procurement and contract management...etc has been found not adequate. The track record from the ongoing projects reveals that there is inefficiency in Procurement Operations and actual procurement processing practices of EEPCo and this will make the procurement risk rating high. 74. Procurement Risk Mitigation Measures: The measures to mitigate these risks are: (i) complete the ongoing update of EEPCo procurement procedures (in addition to others, these procedures have to address procurement decision matrix and business performance standards) ; (ii) create a central Procurement Unit with adequate oversight, staff and recourses, and a career path and adequate incentives to attract and retain a procurement cadre; and (iii) In absence of highly qualified procurement officers, retain the technical support of the international procurement advisor for this project, at least for the first year of the project implementation. EEPCO has extended the contract of the international procurement advisor, appointed 3 procurement officers to aid project implementation, and have trained 15 staff members in Bank procurement procedures. V. Action Plan to Build Agency's Capacity 75. The following preliminary risk mitigation action plan is recommended Figure 9: Capacity Building Issue/finding Recommended Action Time and Responsibility Inefficient Procurement Cycle Complete the ongoing update of EEPCo procurement EEPCo. Management procedures (in addition to others, these procedures have to address: (i)the Project procurement institutional arrangement; (ii) system of accountability with clearly defined responsibilities and delegation of authority on who has control of procurement decisions; (iii) provide comprehensive and clear instructions for all steps of the procurement process (planning, tendering methods, evaluation, award, , review thresholds, record keeping etc; (iv)Procurement decision matrix, business delivery standards and procurement complaint handling procedures, etc. and provide training on the use of the manual. Inadequate Procurement As a medium term plan, EEPCo to create a central EEPCO (medium Organization and Functions Procurement functional Unit with adequate oversight, a 65 Issue/finding Recommended Action Time and Responsibility (Governance & capacity) career path and incentives to attract and retain a term & short term) procurement cadre. (medium term) and/or As short term plan, EEPCo to have projects procurement desk/team who will work closely with the International advisor and at the same time accountable for their respective projects procurement activities; (to be completed by the time of project effectiveness); (short term) Inadequate Procurement Develop and enact a procurement law that covers public GoE/MoFED/EEP Legal framework enterprises in Ethiopia. This is a long term action that Co, (medium would involve GOE actors other than EEPCo. The lead term) agency for implementing this measure is MOFED. Inadequate Procurement Retain the technical support of the international EEPCo Staffing and lack of procurement advisor for this project, at least for the first international procurement year of the project implementation experience. Limitation of the SBD for Include exceptions or qualifications for modification of WB and Project NCB the Federal SBD for use in NCB procedure. This has to team be clearly explained in the procurement manual. General procurement and Provision of Procurement and contract management Before June, 2012 Contract administration Training/clinics to EEPCo staffs on Bank financed WB & EEPCO Capacity limitations contracts. As a minimum, all Procurement staffs to attend the Basic procurement training organized by EMI in collaboration with the World Bank, in Addis Ababa. high staff (talent) turnover Government to consider appropriate incentives, EEPCO including professionalizing the procurement activities, career development structure and salary scale revisions. VI. Setting of Prior Review Thresholds, preparation of the initial PP and Supervision Plan: 76. With High Risk rating, the following thresholds for prior-review are suggested. Not exceeding $0.5 million for goods, $5 million for works, $ 0.2 million for consulting services with firms and $100,000 with individual consultants, but all ToRs need to be cleared by the Task team. The initial procurement plan will be prepared by the Borrower and has been reviewed and agreed. Procurement supervision and post-reviews and audits will be conducted Semi Annually. 66 VII. Simplified Procurement Plan Template 77. This is only an initial sample with the minimum content that is required for disclosure on the Bank’s website in accordance with the guidelines. The Client has prepared a detail Procurement Plan, using the comprehensive procurement Plan template, and that will be reviewed and cleared by the Bank before it is put in use. The initial procurement plan will cover the first 18 months of the project and then updated annually or earlier as necessary. I. INITIAL PROCUREMENT PLAN: a) Project information: Country: Ethiopia, Borrower: GOE, Project Name: P119893: Electricity Network Reinforcement and Expansion Project (ENREP), Loan/Credit No. ___, Project Implementing Agency: Ethiopian Electric Power Corporation (EEPCO). b) Bank’s approval date of the procurement plan (Original:__ Revision 1:__) c) Date of general procurement notice: __ d) Period covered by this procurement plan: __ II. Goods and Works and non-consulting services a) Prior Review Threshold: Procurement Decisions subject to Prior Review by the Bank as stated in Appendix 1 to the Guidelines for Procurement: Figure 10: Prior Review Threshold Procurement Method Prior Review Threshold Comment ICB and LIB (Goods) =>$0.5 million NCB (Goods) The first one contract ICB (Works) =>$5 million NCB (Works) The first one contract ICB (Non-Consultant Services) =>$0.5 million Shopping =>$100, 000.00 Direct Contracting All contracts b) Pre-Qualification: Bidders for works contract and Plant Design, supply and installation estimated to cost equivalent or above $10 million shall be prequalified in accordance with the provisions of paragraphs 2.9 and 2.10 of the Guidelines, unless specifically agreed otherwise. c) Reference to (if any) Project Operational/Procurement Manual. d) Any Other Special Procurement Arrangements: (including advance procurement and retroactive financing, if applicable). e) Procurement Packages with Methods and Time Schedule (List the Packages which require Bank’s prior review first and then the other packages). 67 Figure 11: Procurement Packages 1 2 3 4 5 6 7 8 9 Ref. Contract Estimated Procurement Prequalification Domestic Review Expected Comments No. (Description) Cost Method (yes/no) Preference by Bank Bid- (yes/no) (Prior / Opening Post) Date III. Selection of Consultants a) Prior Review Threshold: Selection decisions subject to Prior Review by Bank as stated in Appendix 1 to the Guidelines Selection and Employment of Consultants: Figure 12: Prior Review Threshold Selection Method Prior Review Threshold Comments Competitive Methods (Firms) =>$0.2million Single Source (Firms & ICs) All contracts Individual consultants(Competitive Method) =>$0.1million b) Short list comprising entirely of national consultants: Short list of consultants for services, estimated to cost less than $0.2million equivalent per contract, may comprise entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. c) Consultancy Assignments with Selection Methods and Time Schedule Figure 13: Consulting Assignments Selection Ref. No. Description of Estimated Cost Selection Review by Expected Comments Assignment Method Bank Proposals (Prior / Post) Submission Date IV. Implementing Agency Capacity Building Activities with Time Schedule a) In this section the agreed Capacity Building Activities (some items could be from CPAR recommendation) are listed with time schedule Figure 14: Capacity Building Expected Outcome And Estimated Cost Estimated Duration Start Date Comments Activity Description 68 Figure 15: Procurement Flow Chart Procurement Process Flowchart for Ethiopian Electric Power Corporation (EEPCo) Checked by PM & No-Objection -WB Assignment of Evaluation Committee by N Executive Officer – In advance N Y Preparation of Bidding BER Review & Specification / TOR Preparation Document /PQD– Project IFB/EOI/IPQ Made Opening- done by Recommendation by under the Project Office Bid Evaluation and Office / Consultant through PR & Corporate Corporate EO Purchasing BER by Technical Procurement Procurement Committee committee Y Forwarded to Executive Management Team (EMT) by EO No-Objection - WB N Recommendation made by MET following the Presentation of BER by Technical C. Final Delivery and Contract Administration Negotiation and Contract Acceptance Signature N N Y Publication for Contact Award & letter Approval by EEPCo Board No-Objection - which consists of Ten (10) Y WB Y Ministers Records Management 69 Environmental and Social Environment Safeguards: 78. Environmental safeguard policies triggered: The Safeguard Category assigned to this project is Category ―B (Partial)‖. The Bank’s Operational Policy on Environmental Assessment (OP4.01) is triggered, predicated on the assumption that there could be potential environmental risks (see below for possible threats) emanating from construction/upgrade, stringing, operation and maintenance of power lines and substations. Main activities will include (i) construction/erection of new steel towers; (ii) erection/rehabilitation of new substations; (iii) erection of concrete poles; (iv) mounting of transformers; and (v) stringing of overhead distribution lines. It is expected that implementation of these activities under the project would largely result in positive socio-economic and environmental gains, and no potential adverse significant environmental risks and social impacts are anticipated. Extending access to the selected areas should relieve pressure on biomass use and therefore contribute to protecting vegetation cover and reducing biodiversity loss. Any potential environmental threats are believed to be likely insignificant, reversible and manageable. 79. Further, socio-economic benefits are likely to be more prominent since domestic demand in the project areas for electricity, telecommunication and telephony would likely be met with supplies from the expansion. Given that the specific site location and scope of the interventions are not yet known, an Environmental and Social Management Framework (ESMF) has been developed by the Client for the initial screening. Once sites have been selected and the nature and scope is known during implementation, appropriate safeguard screening instruments may be applied prior to commencement of any interventions likely to cause adverse significant risks or threats. 80. Potential environmental impacts: To a larger extent, potential environmental, safety and health risks (loss of vegetation and biodiversity; soil erosion and sedimentation of nearby aquatic/drainage systems; air pollution; soil and water contamination from both liquid and solid waste; hazardous chemical poisoning of biotic life from use of weedicides and herbicides; etc) are foreseen during the construction phase as vegetation will be cleared to pave way for erecting substations and towers for power lines, constructing camp sites, material storage facilities, and access roads. The substations and power lines would avoid going through forests and natural habitats including protected areas, swamps/wetlands and any fragile and sensitive aquatic habitats. It is likely that transmission and distribution lines may traverse culturally sensitive sites such as graveyards, archaeological sites, etc 81. Mitigation measures: The project would take preventive mitigation measures to remediate any potential threats during the construction and O&M phases. A key undertaking prior to starting the project would be to ensure the incorporation and implementation of the environmental and social clauses annexed to the main ESMF into the works contract; and that an effective multi-stakeholder institutional and implementation framework/arrangement is put in place for the management (including safeguard management) of all aspects of the project. This should include actions for capacity building, training and skills upgrade. 70 82. Mitigation actions including the establishment of effective mechanisms for monitoring, capacity building, governance (collaboration and consultations, accountabilities and transparency), etc are essential to cost-effectively and timely counteract any potential threats that are likely to occur during the construction and O&M phases of the project. 83. Borrower’s capacity: The Borrower capacity to ensure environmental due diligence of the project is satisfactory. The Ethiopian Electric Power Corporation (EEPCO) will be responsible for implementing the project. The Environmental and Social Management Unit (ESMU) under EEPCO will implement and monitor the ESMFs. ESMU has implemented series of ESMFs and other safeguard instruments for the EEPCO in a number of donor financed projects in the energy sector including hydropower generation, transmission and distribution. ESMU’s capacity therefore has been enhanced through the active involvements in these projects and also on the number of in-house and external training and skills upgrade received. Nevertheless, the Bank’s team recommends that a strategic training plan is developed by the project to enhance ESMU’s capacity to implement and monitor the execution of safeguard instruments. At the woreda and community levels public administrative structures and civil society organizations should be capacitated to assist. Woreda administrations would need training and skills upgrade to be effective. The project has allocated over US$1.85m for implementation of the mitigation measures including capacity building of all these key entities. 84. Stakeholder consultations & Disclosure of safeguard documents: In accordance with the World Bank’s operational policies, stakeholder consultations in the field with public and private sector institutions, research and academia, civil society organizations, traditional authorities, communities groups have formed part of the ESMF formulation. Stakeholder workshops have been carried out to discuss all aspects of the project prior to finalization of the ESMF. These workshops have had the purpose of listening to all key beneficiary and stakeholder groups, particularly project affected persons/communities (PSPs); seeking feedback and consensus from stakeholders; and incorporating comments, suggestions and remediation proposals into the ESMF and other safeguard instruments before full public disclosure in-country and at the Bank’s InfoShop was done Social Safeguards: 85. Access and reliable supply of electricity will contribute and make a real difference in improving the lives of poor people and enhance socio-economic development. Lack of access to electricity hampers development and affects the progress of the country. The ENREP will upgrade the power transmission system and enhance the power transmission capacity to extend electrification of towns and villages. 86. ENREP will underpin Ethiopia’s Sustainable Development and Poverty Reduction Program and Agricultural Led Industrialization (ADLI) strategy. The program will play a crucial role in helping to achieve the Millennium Development Goals. The project components are not expected to have significant negative social impacts. While some of the project activities related to reinforcing the high voltage transmission networks and extending the grid network to connect new consumers, may require acquisition of land to expand or clear Right of Way and construction of the additional transmission lines, which in turn may temporarily or permanently displace people, impact livelihood and assets. 71 87. Electric power transmission lines are linear facilities in nature and since the work is mostly upgrading of the existing power transmission facilities through low and medium voltage distribution lines adverse social impacts will be limited. As a linear facility, the impacts of transmission line will be mostly localized within the Right-of-Way (ROW). The impact can be minimized through careful route selection. This type of distribution lines normally follows the road network except for bends and curves where it is more economical to make shortcut if that is technically feasible. 88. The project area covers all nine Ethiopian’s Regional States, namely Tigray, Afar, Amhara, Oromiya, Somali, Benshangul Gumuz, Southern Nations, Nationalities and Peoples (S.N.N.P), Gambela, and Harari Regional States. The specific locations and routes for the construction of the electricity distribution lines in specific rural and urban towns are not yet known and will be identified after the project approval. 89. While the long term impacts of the project will most certainly have a positive impact on the lives of the poor people generally and a sustainable economic development of the country. In the short term, during the construction phase, the implementation of the project components under the ENREP might create adverse social impacts on the lives of the population living in the project areas. Consequently, to minimize the adverse social impacts, such as loss of property and assets, income loss, involuntary resettlement and relocation, EEPCO has developed an Environmental and Social Management Framework (ESMF) including a Resettlement Policy Framework (RPF) to identify potential adverse social and environmental impacts and to adequately mitigate them. 90. The ESMF and RPF define a framework and list of criteria that will be used for preparation of each of the upgraded and new segment of lines and access components of the project at the preparation stage. Once the segments have been identified, there will be increased voltage levels, potential increase of width of Rights of Way which would be adequately studied. Based on the potential increase in the RoW, a detailed ESIA and RAP will be prepared for each segment of the line that would be reinforced, and will become a key condition for funds disbursement for that category. 91. An important project risk to consider is EEPCO’s capacity which is very limited due to the sheer load of projects under their management. To mitigate this risk, an extensive program of capacity building will be financed as part of Modernization Support under the ENREP. Under this component, EEPCO will contract experienced consultants to support EEPCO staff on social and environmental impact management throughout the construction and the implementation of the project. Monitoring & Evaluation: 92. Monitoring and reporting of the project implementation progress will be the responsibility of EEPCO’s, DBE’s and MOWE’s project management teams. In EEPCOo the required data will be furnished by the PIU and EEPCO’s administrative information system (transmission unit and customer care unit). EEPCO will have the responsibility to supply current data on the set of agreed performance indicators (Annex 1) at least on an annual basis for PDO 72 indicators and on a semi-annual basis for the intermediate outcome indicators at component level. 93. In addition, the project will draw from information provided by the Ethiopian Electricity Agency (EEA), the Ministry of Energy’s M&E unit, and the Central Statistical Agency of Ethiopia (CSA). The MoE, EEA and CSA’s relevant data/reports will facilitate vetting of EEPCO’s records against data that has been independently verified by these other national agencies. 94. DBE and MOWE will provide quarterly reporting on the number of loans it has approved from the project. The report will include performance of the existing loans and the number of households benefited from the project. Role of Partners: Carbon Finance 95. The Access Scale up component and the Renewable Energy and Energy Efficiency components of the project will result in carbon reductions as most of the households will switch from Kerosene based lighting and cooking to either grid/off-grid based lighting and improved stove cooking or biogas cooking. Emission reductions to be generated from implementation of these components would provide additional financial resources through the sale of carbon credits that could improve the financial viability of the components. It is envisaged that Ci-Dev, would provide necessary technical assistance to develop the carbon asset for this component following UNFCCC regulations and then would purchase the credits generated through commercial carbon purchase contracts. 96. The project will bring in additional revenues through the carbon finance programs to be developed for the access intensification, renewable energy and energy efficiency measures planned under component 2 and 3. These carbon revenues can only be realized after successful implementation of the measures, and it would ultimately benefit the households in terms of lowering the cost of implementing RE and EE solutions. Carbon revenues could also be used to remove the market barriers and incentivize the up-take of electricity connections, and RE and EE solutions by households. In the two carbon finance programs mentioned above, Bank will assist both EEPCO and DBE in finding credible market players who could advance part of the carbon revenues upfront, to be used for removing the market barriers. 97. The Carbon Initiative for Development (Ci-Dev), a new carbon fund that the Bank launched in Durban in December, 2011 is being seen as a potential avenue to transact the carbon credits to be generated from the two carbon finance programs mentioned above for component 2 and component 3 respectively. Ci-Dev is meant for Least Developed Countries (LDC) like Ethiopia and is being designed with three complementary facilities – (i) a ―Readiness Fund‖ to finance development of carbon finance programs, (ii) a ―Carbon Fund‖ to purchase emission reductions, and (iii) a ―Financing Fund’ to advance part of the future carbon revenues upfront to finance the programs. It is estimated that the specific interventions mentioned above, if fully implemented, could generate about US$ 2.0 Million of carbon revenues annually. 73 98. Given the fact that the program implementation would attain the full scale only over a period of time, it is expected that about US$ 10.0 Million of carbon revenues may be generated over the first 10 years period. The program may thus benefit from an advance payment in the range of US$ 2.0 – 3.0 Million from Ci-Dev, which could be used for various market promotion activities. About US$2.0 million could also be secured from the Ci-Dev ―Readiness Fund‖ as technical assistance for developing the two carbon finance programs. However, these are all contingent upon Ci-Dev being made operational with all its 3 funds. Implementation Arrangements for Carbon Finance Operation 99. The carbon finance program for electricity access (Component 2) will be implemented by EEPCO, as Coordinating and Managing Entity (CME), which has multiple subsidiaries across the project regions to carry out the on-the-ground subprojects. DBE will play the role of Coordinating and Managing Entity (CME) of the carbon finance program for component 3 with the various private sector enterprises (PSEs) involved in actual implementation of the various RE and EE measures in a coordinated manner contingent upon Ci-Dev being made operational, the Bank would sign separate Emission Reduction Purchase Agreements with the two CMEs mentioned above to manage the commercial transaction. Both the carbon finance programs would require very strong monitoring and reporting systems that could gather and feed data/information from the ground level (Household level) all the way to the level of the CME. Both the CMEs mentioned above (EEPCO and DBE) would be required to set up separate unit/cells equipped with appropriate manpower to administer the carbon finance programs. The Bank would work closely with these two agencies to build their capacity and provide necessary technical support to enable the agencies manage these programs. 100. The primary performance indicator for carbon finance operation is the timely delivery of the CERs, for which payments will be made by the World Bank according to Emission Reductions Purchase Agreements of the programs. Complementary Financing from OFID 101. OFID is in discussion with the GOE to provide US$ 25 million in ENREP to finance Access Scale Up activities. While procurement of materials under this fund will be carried out separately from Bank funded procurement packages, OFID informed that they will support following the Bank Procurement Guidelines while EEPCO procures materials using OFID funds. 74 ANNEX 4: OPERATIONAL RISK ASSESSMENT FRAMEWORK (ORAF) ETHIOPIA: ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) 1. Project Stakeholder Risks Rating Low Description : Risk Management: The project will directly benefit rural communities as it will EEPCO will ensure that it follows closely the instruction of the Environment and Social Management expand access to electricity in rural Ethiopia. It will further help Plan while implementing the project. This will ensure that stakeholder expectation on the project will be in increasing reliability of supply by the grid, so all existing managed. consumer will benefit from the project. However, there will be temporary disruption during the construction phase, and Resp: EEPCO Stage: Due Date : Status: stakeholder expectation of that time has to be managed. 2. Implementing Agency Risks (including FM and PR) 2.1 Capacity Rating: Substantial Description : Risk Management : Procurement Risk Description: "EEPCO’s procurement processes are associated with some Procurement Risk Management Measures: generic risks. Firstly, as EEPCO is established under the Public Enterprises proclamation, it is not governed by the public The mitigation measure, which is outside the scope of the project, is to develop and enact a procurement procurement law and there is a risk that the lack of procurement law that covers all public enterprises in Ethiopia. This is a long-term action that would involve GOE legal framework will not allow compliance monitoring and actors other than EEPCO. The lead agency for implementing this measure is MOFED. procurement audits that are needed to enforce the creation and maintenance of the structures required implementing transparent, We suggest the International Procurement Advisor to support this new project and EEPCO to complete fair, efficient, accountable and value-for-money procurement. the ongoing update of EEPCo procurement procedures. Secondly, the lack of a Procurement structure or procurement function and staff with procurement skills needed to implement EEPCO needs to create a central Procurement Unit with adequate oversight, a career path and adequate project procurement efficiently is a risk. Thirdly, the lack of incentives to attract and retain a procurement cadre. We suggest the project needs to recruit two effective procurement process management and oversight Procurement Officers with sufficient qualifications and each of the Procurement Officers should arrangements do not satisfactorily address timely procurement undertake basic procurement training conducted in ESAMI or GIMPA in the next 12 months. decision makings, which results decreased bidders’ confidence in EEPCO procurement system and therefore risks adequate bidders’ participation in EEPCO contracts thereby reducing Technical Risk Management : competition". And the rating is ―Substantial‖ ENREP will plan on an extensive program of financing for training the EEPCO staff. The capacity Technical Risk description building measures will be multi-disciplinary and will be designed to benefit the EEPCO as a whole. The EEPCO has fairly good experience in managing technical aspects areas of focus could include procurement, contracting, budgeting, FM, HR, project management, etc. and the sector is managed professionally. However, the utility Furthermore, some functions related to operations and maintenance of the line will be contracted out to has been facing growth challenges, mainly due to the doubling of experienced contractors. Along with that, experienced consultants will be retained to assist EEPCO with its generation portfolio within a very short period and of its additional capacity. distribution network over the last several years. This has created 75 severe capacity constraints and delays in operational delivery, Renewable Energy Component timely financial management issues, etc. There are several large DBE and MOWE will be provided with capacity building support to carry out program activities as generation, transmission and access projects in preparation. described in the project component. EEPCO needs to enhance its management capacity to manage its growing operation and maintenance challenges. Resp: EEPCO Stage: Due Date : Status: Renewable Energy Component DBE and MOWE have limited capacity and experience in implementing large scale renewable energy programs. 2.2 Governance Rating: Moderate Description : Risk Management : Due to the growth experienced in the past several years, the As part of its capacity building activities, the project will include FM component which will be designed billing and accounting systems have come under a lot of stress. to streamline and implement best practices in the EEPCO operations. The Bank is also working with As a result, there has been a delay (of nearly 12 months in the EEPCO to carry out a just-in-time study to review the financial management arrangements of EEPCO and past two financial years) in producing reconciled financial the findings of the report will be implemented through the capacity building component of ENREP. accounts as well as audited financial statements. Meanwhile, based on Bank’s initial recommendation, EEPCO has already agreed to appoint a Financial Advisor (consultant) to assist with improvements in its overall financial management practices. Resp: EEPCO Stage: Due Date : Status: 3 Project Risks 3.1 Design Rating: Low Description : Risk Management : EEPCO: Improper selection of lines for upgrade and renovation. EEPCO: A detailed power sector master plan study is being carried out which will become the basis of DBE and MOWE: lack of coordination between the two selection of the bottlenecks and line segments for upgrade. implementing agencies. DBE and MOWE: An MOU will be signed by the two implementing agencies detailing roles and responsibilities, and a detailed Project Operations Manual will be agreed upon. Resp: EEPCO Stage: Due Date : Status: 3.2 Social & Environmental Rating: Moderate Description : Risk Management: The ENREP program and its components are likely to be The project considers a framework approach - a detailed feasibility study, ESIA and RAP will be carried considered category ―B‖ projects. The project triggers: out for each of the segments by outsourcing to qualified retained consultants. The project will finance (a) Bank’s Environmental Assessment (OP 4.01) extensive training to the staff of the implementing agencies and closely monitor implementation of EMPs (b) Physical Cultural Resources (OP 4.11) and RAPs. (c) Involuntary Resettlement (OP 4.12) Resp: EEPCO Stage: Due Date : Status: 3.3 Program & Donor Rating: Low Description : Risk Management: Partner contributions are in the form of parallel financing and independent of IDA Partners identified: Ci-Dev and OFID project implementation. Resp: Stage: Due Date : Status: 3.4 Delivery Monitoring & Sustainability Rating: Low 76 Description : Risk Management : Due to the coordination and capacity issues, there is some risk of Additional external consultants will he hired to augment project staff as needed in order to ensure delivery delays in the implementation of the projects. efficiency. Project staff and other stakeholders will receive capacity building in various areas of project management including procurement, contracts, bids, fiduciary management, etc. Resp: EEPCO Stage: Due Date : Status: 4. Overall Risk 4.1 Implementation Risk Rating: Substantial Comments: EEPCO’s implementation capacity and financial viability remain major concerns. The project provides capacity building support; however, the risk remains substantial pending their outcome. 77 ANNEX 5: IMPLEMENTATION SUPPORT PLAN ETHIOPIA: ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) 1. Strategy and approach for implementation support: The strategy for implementation support (IS) was developed based on the nature of the project and its risk profile. Its aim is to make IS to the client more flexible, efficient, and focused on the risk mitigation measures defined in the ORAF. 2. Implementation capacity: The project will be implemented by two different institutions: EEPCO will be responsible for Components 1, 2, and 4; and the Development Bank of Ethiopia will be implementing Component 3 and 4. Implementation capacity issues are discussed below for each implementing agency. (a) EEPCO: The team has conducted extensive discussions with EEPCO’s management to ensure that the PIU staff are selected from the pool of EEPCO staff with proven track record in the necessary technical and project management areas required for this project. EEPCO’s management has been very responsive in this regard, and has agreed to form an effective project implementation team supported by EEPCO’s various technical and administrative units. Project risks such as ensuring training programs for PIU and EEPCO staff would be best addressed jointly with the PIU and EEPCO’s management. The direct involvement of EEPCO’s management will facilitate identification of staff and training areas in line with EEPCO’s performance improvement plan and objectives of this project. (b) Development Bank of Ethiopia: The Development Bank of Ethiopia had its exposure to Bank projects through its role as a Trust Agent of Rural Electrification Fund under the EAREP II project. DBE and MOWE have already identified the unit within the institutions that will be responsible to implement the project. They have also started consultation with the interested Private sector and the MFIs to assess their interest to become partner organizations in the project. Bank will support DBE and MOWE through the Modernization Support component in terms of financing training requirements, creating public awareness and supporting the development of the renewable energy market in Ethiopia. 3. Procurement: IS for procurement will include: (a) providing training to PIU staff; (b) reviewing procurement documents and providing timely feedback to the Client; (c) providing detailed guidance on the Bank’s Procurement Guidelines to EEPCO procurement specialists who are responsible for preparing the procurement documents; and (d) monitoring procurement progress against the Procurement Plan, which will be updated as required to reflect project implementation needs and improvements in institutional capacity. 4. Financial management: The team will review the project’s financial management system including, but not limited to, accounting, reporting and internal controls. It was 78 determined that the controls risk is moderate. The Bank team will also work with the PC to assist the PIU in improving financial management and reporting. 5. Environmental and social safeguards: Compliance with environmental and social safeguards will be the primary responsibility of the PIU at EEPCO. The Environment and Social Affairs Unit of EEPCO has adequate experience and capacity related to World Bank social and environmental safeguards based on implementation of previous World Bank projects. The Bank team will provide guidance to the PIU at EEPCO to address any issues as they may arise. The PIU is also responsible for oversight of the existing transmission line right-of-way (ROW) in project target areas and will ensure that all relevant participatory processes embedded within various national legal regulations and the EIA, ESMP, RPF, RAP and other relevant project documents are followed. 6. Other issues: The Bank team members have been selected from across the Bank operational and sector units and will be available to provide timely, efficient and effective implementation support to the PIU and EEPCO. Implementation Support Plan: 7. Bank team members will be based both at headquarters and in the Ethiopia Country Office to ensure timely, efficient and effective implementation support to the client. Formal IS missions and field visits will be carried out twice a year. 8. Technical inputs: Technical knowledge of state of the art high voltage power transmission lines and substations, engineering works and site supervision are required for proper assessment of technical specifications and other aspects of bids and contracts. During project implementation, technical supervision is required to ensure contractual obligations are met. EEPCO’s supervision capacity will be augmented by hiring of consultants as needed. The Bank’s project team and PIU staff will conduct site visits to project sites on a regular basis throughout the duration of the project. 9. Fiduciary requirements and inputs: The Bank project team will help EEPCO identify its capacity building needs to strengthen its project financial management capacity and improve procurement management efficiency. The Bank’s regular FM and procurement supervisions will provide timely advice on budget planning and related matters. The PIU will be responsible for the timely compilation of annual project financial statements for the independent external audit. Project financial statements will be audited by an independent auditor acceptable to the Bank. 10. Audit: EEPCO has adequate internal controls for the project, including regular reconciliation of bank accounts, adequate segregation of duties, proper accounting policies and procedures, and monthly reconciliation of World Bank disbursement summaries with accounting records. However, EEPCO has been slow in proving the annual audit reports in a timely manner. Therefore, the team will continue its diligent attention to the timing of audit report preparations to ensure that the audit reports are prepared and submitted on schedule. 79 11. External auditors are expected to identify any internal control deficiencies and accounting issues. The audit reports, audited financial statements and management letter will be delivered to the Bank within six months of the end of each fiscal year. 12. Monitoring and evaluation: EEPCO has developed some M&E capabilities from working on other World Bank projects, and will further strengthen its capacity for project performance and results monitoring as needed. M&E will be based on administrative data sources. The baseline indicators developed by EEPCO draw from existing EEPCO data and project preparation studies. The results of the M&E activities will be fed back into the implementation process to inform decisions for improved implementation. Figure 1: Implementation Support Plan Time Focus Skills Needed Resource Partner Role Estimate First Hiring of the $150,000 Close coordination of twelve engineering Technical and implementation activities months consultants and procurement is required for parallel completion of expertise financing. the transmission system upgrade design and preparation of corresponding Procurement Safeguards documents. Implementation of environmental and social FM/Procurement safeguards FM/Procurement system 12-36 Technical Power Engr. $300,000 Close coordination of months supervision implementation activities Safeguards is required for parallel Safeguards financing. supervision M&E M&E Procurement/FM supervision Procurement & FM supervision 80 Figure 2: Skills Mix Required Skills Needed Number of Staff Weeks Number of Trips Comments Power Engineer Local staff Social Local staff To be adjusted Environmental 7-10 weeks per year Local staff annually depending Econ. / Fin Analyst across the team 2 per year on available Monitoring 1 per year supervision budget Procurement Local staff Financial Mngmnt. Local staff Energy Specialist 2 per year TTL 2 per year Figure 3: Partners Name Institution/Country Role Ci-Dev Donor Complimentary financing OFID Donor Complimentary financing 81 ANNEX 6: ECONOMIC AND FINANCIAL ANALYSIS ETHIOPIA: ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) A. Economic Analysis 1. The analysis of economic justification was carried out in three main stages: (i) existence of a market for the output of the project; (ii) ability of the project components to demonstrate least-cost means of serving the market; and (iii) estimation of the economic rates of return. I. The existence of a market: 2. The Ethiopian energy sector is expanding at a very rapid pace. Through the PASDEP and GTP period investments, the government has been able to bring 41% of the rural towns and villages under the electricity grid. This has resulted in rapid growth in the number of customers connected to the grid from 800,000 in 2005 to over 2 million in 2010 representing a 137% growth rate during the period. This growth has been achieved despite a moratorium on new connections in 2008-2009 due to shortage of electric supply (caused by delayed implementation of certain hydropower projects). The table below demonstrates the growth rates from 2005-2010. Figure 1: Number of Customers and Electrified Towns & Villages 2005 2006 2007 2008 2009 2010 2011 Number of electrified villages 648 899 1,757 3,363 3,763 5,163 6,000 (growth rate) 39% 95% 91% 12% 37% 16% Number of customers connected 856,228 1,064,268 1,337,557 1,611,735 1,740,964 1,808,008 2,030,000 (growth rate) 24% 26% 20% 8% 4% 12% 3. Going forward, The GOE has ambitions of connecting most of the rural towns and villages of the country to the electricity grid, doubling the consumers to 4 million, while continually investing in new generation capacity and in modernization and upgrade of the grid network. With more and more areas being connected by the electric grid the domestic demand for electricity is expected to grow at a high rate in the coming years. The table below lists the anticipated growth in energy sales (from all sources) from FY2011-2030 based on various growth scenarios provided by EEPCO. Figure 2: Anticipated Growth in Energy Sales13 2011 2020 2030 Moderate Forecast (GWh) 4,035 9,163 18,880 Target Forecast (GWh) 4,035 11,012 30,537 4. We thus find a thriving electricity market in Ethiopia. Moreover, investments in grid network upgrade also helps with Ethiopia’s goal of becoming a major supplier of electricity to the regional markets. Ethiopia has already established interconnections with Djibouti and Sudan and is in talks with Kenya on erecting a new transmission line. 13 Estimated growth rate of 10% assumed 82 5. Commensurate with the growing demand, capacity additions are planned to meet the demand in the least-cost and in the environmentally and socially sustainable manner. However, in the short-medium term horizon, the immediate priority is to improve efficiency and reliability of the distribution system and to expand access to new markets in the rural areas. The proposed project is in line with this strategy. II. Least-cost justification: 6. The expenditures to improve efficiency and reliability were compared with the alterative of increasing generation to make up for incremental losses. Due attention was paid to the power loss savings, un-served energy savings as well as the operational and maintenance savings that an improved system would achieve. EEPCO is also conducting a study of load flows to arrive at the cost-effective investment requirements to reduce line and transformer outages. The grid extension was compared with the alternative of isolated generation at prevailing costs (mostly based on hydropower sources - at incremental production costs of US$ 0.05/kWh). 7. Overall, given the development and technical complexity that EEPCO faces in managing a growing customer base, a modern network for improved reliability has become an absolute necessity. Depending on the functional applications to be performed, the upgrade of the system will be designed in a cost-effective manner to achieve the objective. III. Cost-benefit analysis: 8. Analysis of the rate of return of the project are based on the following broader assumptions: a. Capital costs of the components are based on estimates to include IDA portion, OFID contribution and government co-financing (total US$ 265 million). b. The capital costs are assumed to be invested over 5 years with the following rate: Year 1: 5%, Year 2: 15%, Year 3: 30%, Year 4: 30%, Year 5: 20%. c. The capital costs are assumed to be invested at constant USD rate (of 2012). d. The costs exclude taxes, but might include government subsidies. e. Benefits vary by project Components, however, a project-level analysis is provided for ease of comparison. f. Component 4 (modernization/capacity building) is not included in analysis. g. The useful life of the grid investments is assumed at 25 years (conservative estimate) and for the renewable energy products it is assumed to be 5 years. Assumptions related to costs: 9. Beyond the capital costs of the Components, majority of the costs are associated with operations and maintenance (OM) of the Components as described below: a. Network upgrade: OM costs are assumed to be 2% of the capital costs. b. Access expansion: OM costs are assumed to be 2% of the capital costs. c. Renewable energy/efficiency: 3% management fee of the credit line is assumed. 83 d. Cost of grid supply: The project is assumed to add 225,000 new customers to the grid and at current average cost of generation per customer of US$ 10 per year; this would mean an additional cost of US$ 2.25 million per year. Assumptions related to benefits: 10. In terms of the benefits, the following assumptions are made: a. Network upgrade: i. Power loss savings: It is assumed at EEPCO would reduce its transmission losses by 5% (from the current rate of 20%) in the project affected area, which would result in US$ 2 million a year in savings. ii. New generation savings: It is assumed that 225,000 new customers would consume 420 GWh of energy. At US$ 0.05/kWh as cost of production (mostly hydropower) this would result in US$ 21 million of saving a year. iii. Un-served energy savings: It is assumed that outages would be reduced as a consequence of improved reliability. In a study conducted by EEPCO, the cost of un-served energy to the economy was estimated at US$ 0.52/kWh resulting in an estimated loss of US$ 450 million (1.5% of GDP) to the economy. A 1% improvement of reliability as a result of this project would result in additional savings of about US$ 4 million a year. iv. Operational and maintenance: It is estimated that the 5% cost savings in OM cost due to improved network reliability would result in savings of US$ 0.5 million14 a year. b. Access expansion: i. Incremental sales: As a result of adding 225,000 new customers EEPCO can expect US$ 16.5 million15 in additional revenue (with organic increase in consumption and tariff rates). c. Renewable energy/efficiency: i. Lighting: the net avoided costs of lighting using products such as SHSs, solar lanterns (Lighting Africa) include saving in fuel sources such as kerosene, candles, etc. and exclude the additional investment in batteries and maintenance of the systems. The net yearly savings are estimated at around US$ 50 per household. ii. Cooking: the net avoided costs of cooking using efficient products such as improved cook stoves, biogas, etc. include saving in fuel sources such as firewood, charcoal, etc. and exclude any additional maintenance of the systems. The net yearly savings are estimated at around US$ 20 per household. 14 At present EEPCO’s OM costs are around US$ 10 million 15 EEPCO’s current per customer revenue per year is US$ 75 84 Results: 11. The economic viability of the project is high. A cost-benefit analysis using the framework described above reveals a net present value (NPV) of US$ 211.1 million (at 10% discount rate) and an economic internal rate of return (EIRR) of 18.7%. The NPV stands at US$ 147.9 million at 12% discount rate. Table below summarizes the results of the economic analysis. Figure 3: Results of Economic Analysis Discount Rate 10% Discount Rate 12% NPV (US$ million) 211.1 147.9 EIRR (%) 18.7 18.7 Sensitivity Analysis: 12. Sensitivity analysis was conducted to test the robustness of the profitability of the project to changes in key parameters of project costs and benefits. The rates of return were examined under the following cases: a. Total project costs: Increase of 5% and 10% in the overall project cost was considered which could be introduced as a result of delays or other unexpected variables. b. Decrease in benefits: Decrease in benefit of the project of 5% and 10% was considered which could be introduced as a result of slower connection rates (fewer new customers) or sluggish market uptake of renewable energy and energy efficiency products (limited dissemination at household level). c. Combined effect: The combined effect of 10% increase in project cost and 10% in benefit was also considered as a worst case scenario for the project. 13. The results of the sensitivity analysis are included in the table below: Figure 4: Results of Sensitivity Analysis Scenarios (at Discount Rate 10%) NPV (US$ million) EIRR (%) Base Case 211.1 18.7 Costs Increase 5% 186.5 17.8 Costs Increase 10% 171.2 16.9 Benefits Decrease 5% 189.3 18.2 Benefits Decrease 10% 176.6 17.8 Costs Increase and Benefits Decrease 10% 145.9 16.1 14. In summary, the number of new customers added to the grid and the cost of the project are the two key variables that have the strongest impact on the economic viability of the project. 85 Figure 5: Cost Benefit Analysis* BASE CASE (US$ Thousands) 2013 2014 2015 2016 2017 2018 2019 2020 COSTS Capital Costs Network Upgrade ($135m) 15,458 44,167 44,167 28,708 Access Expansion ($90m) 9,938 18,771 24,292 19,875 15,458 Renewable Energy / Efficiency ($40m) 3,313 5,521 11,042 15,458 8,833 Total Capital Costs (US$ 265m) 13,250 39,750 79,500 79,500 53,000 Operating & Maintenance Costs Network Upgrade (2% of capital) 309 1,192 2,076 2,650 2,650 2,650 Access Expansion (2% of capital) 199 574 1,060 1,457 1,767 1,767 1,767 Renewable Energy / Efficiency (3% management fee) 99 265 596 1,060 1,325 1,325 1,325 Cost of Grid Supply (225k customers, $10 cost per year) 113 450 1,125 1,800 2,250 2,250 2,250 Total Operating & Maintenance Cost 411 1,598 3,974 6,393 7,992 7,992 7,992 TOTAL COSTS 13,250 40,161 81,098 83,474 59,393 7,992 7,992 7,992 Discounted Cash Outflows 13,250 40,497 82,142 85,471 61,733 4,962 4,511 4,101 Grand Total Costs (Undiscounted) 417,334 Present Value of Costs (Discounted) 325,289 BENEFITS Network Upgrade Power Loss Savings (5% reduction) 400 1,000 1,600 2,000 2,000 2,000 New Generation Savings (420 gWh at 5c/kWh) 4,725 11,813 18,900 23,625 23,625 23,625 Un Served Energy Savings (Outages cost 30c/kWh) 800 2,000 3,200 4,000 4,000 4,000 O and M Savings (Reduced maintenance overhead) 100 250 400 500 500 500 Access Expansion Incremental Sales (225k customers, $75 rev per year) 844 3,375 8,438 13,500 16,875 16,875 16,875 Renewable Energy / Efficiency (Net Avoided Costs) Lighting (SHS/Lighting Africa) (1m HHs at $50 per year ) 2,500 10,000 25,000 40,000 50,000 47,500 40,000 Cooking (Cookstoves/Biogas) (1m HHs at $20 per year) 1,000 4,000 10,000 16,000 20,000 19,000 16,000 TOTAL BENEFITS 0 4,344 23,400 58,500 93,600 117,000 113,500 103,000 Discounted Cash Inflows 0 3,949 19,339 43,952 63,930 72,648 64,068 52,855 Grand Total Benefits (Undiscounted) 1,361,345 Present Value of Benefits (Discounted) 536,473 NET BENEFITS -13,250 -35,817 -57,698 -24,974 34,207 109,008 105,508 95,008 Discounted Net Cash Flow -13,250 -36,548 -62,803 -41,519 2,197 67,686 59,557 48,754 Grand Total Net Benefits (Undiscounted) 944,011 NPV of Project 211,184 Discount Rate 10% Economic Internal Rate of Return 19% * Only first seven years of analysis are included as a sample – full analysis extends to 25 years. 86 B. Financial Analysis 15. The financial analysis includes: (i) an overview of sector finances, (ii) a detailed review of the financial performance of EEPCO, and (iii) an analysis of project level finances. I. Sector Background: 16. The key institution in the Ethiopian power sector is the Ethiopian Electric Power Corporation, EEPCO. EEPCO is a vertically integrated, government-owned utility with the responsibility for electricity generation, transmission and distribution. EEPCO reports to the Ministry of Water and Energy, which has the overall responsibility for the energy sector. 17. Grid-based expansion programs are implemented by EEPCO within the Universal Electricity Access Program (UEAP), while some off-grid electrification programs are the responsibility of the Ministry of Water and Energy (MOWE) – under the Alternative Energy Technology Promotion and Dissemination Directorate (AETPDD). As the major sector institution, EEPCO will be the focus of our analysis. 18. As part of the GTP, EEPCO is responsible for implementing the government’s two major public policy goals related to the energy sector: a. Provide universal access to electricity: a major focus of the GOE is to increase the coverage of population under the electricity grid (UEAP). In 2005, there were 800,000 customers connected to the grid covering about 20% of towns and villages in Ethiopia. Thorough strategic investments in the PASDEP period in generation, transmission and distribution and access enhancement projects, EEPCO has been able to increase the number of customers connected to the grid to over 2 million (14% of population), connecting 41% of towns and villages. In the GTP period, the goal is to increase the number of customers to 4 million and cover 75% of towns and villages. b. Generate export revenues: another major goal for the GOE is to become a regional power hub and generate export revenues by means of exploiting its vast natural (mainly hydropower) resources. In order to achieve this, EEPCO invested in ambitious generation programs and is also participating in the East Africa Power Pool project by erected transmission lines to Djibouti (commissioned in 2011), Sudan (to be commissioned in 2012) and Kenya (planned commissioning in 2017). 19. Along with these major goals, GOE also has many short to mid-term goals, such as: to modernize the energy sector by investing in operational efficiency of its systems and organizations, increase reliability and become a modern energy producing and consuming nation. To fulfill these goals, EEPCO has been investing heavily in the sector which has resulted in the ongoing hyper growth phase of the energy sector in Ethiopia and has had financial consequences on EEPCO and other sector institutions. 87 II. EEPCO Financial Analysis: 20. The section below provides an analysis of the operational financial performance (revenue and expenses) as well as the investment program performance (borrowing). A discussion of future projections is also included along with highlights of some of the major challenges affecting financial performance of the sector. Operational Performance – Sales and Revenue: 21. In the past few years, EEPCO has done very well in terms of connecting many new towns and villages as well as connecting new customers to the grid. In fact, due to the success of the expansion program, the demand for electricity surpassed the supply capacity. As a result, in FY2008 to FY2010 there was a partial moratorium placed on new connections. During the period of moratorium, the acceleration in the number of new connections and villages connected slowed down; as a consequence, the energy sales were stagnant. The energy sales improved once the moratorium was lifted and in FY2011 were over 4,000 GWh with over 2 million customers. 22. However, despite the impressive increase in the customer base and energy sales, EEPCO’s operating revenue has not improved much. In fact, operating revenue in FY2011 was US$ 130 million which was far below the FY2006 operating revenue of US$ 166 million. Moreover, the average operating revenue per customer fell from US$ 156 per year in FY2006 to US$ 73 per year in FY2011 (table below). There were a few reasons for this: a. The tariff rates (average of US$ 0.03/kWh) in Ethiopia have not changed since 2006 and this has affected revenue growth (more discussion on the tariff structure in the sections below). b. The UEAP has added many new customers in the rural parts of the country. The average energy consumption of these new customers is lower than those already connected which has slowed the revenue growth rate. c. The devaluation in Ethiopia Birr as compared to US Dollar from 8.3 Birr/US$ in FY2006 to 17.1 Birr/US$ in FY2011 has contributed to lower operating revenues. Figure 6: Historical Operating Revenue, Energy Sales and New Connections 2006 2007 2008 2009 2010 2011 Operating Revenue (US$ million) 166 208 202 164 132 130 Growth Rate (Year to Year) 25% -3% -19% -20% 12% Energy Sales (GWh) 2,408 2,799 2,966 3,132 3,264 4,218 Growth Rate (Year to Year) 16% 6% 6% 4% 29% Customers 1,064,268 1,337,557 1,611,735 1,740,964 1,808,008 2,030,000 Growth Rate (Year to Year) 26% 20% 8% 4% 12% Villages Connected 899 1,757 3,363 3,763 5,163 6,000 Growth Rate (Year to Year) 95% 91% 12% 37% 16% Revenue per Customer (US$) 156.0 155.5 125.3 94.2 73.0 72.9 88 2006 2007 2008 2009 2010 2011 Energy Consumed per Customer (kWh) 2262.6 2092.6 1840.3 1799.0 1805.3 2077.8 US$ to Birr Conversion 8.3 8.7 9.3 9.9 13.5 17.1 Figure 7: Historical Operating Revenue, Energy Sales and New Connections Future Growth in Demand: 23. As EEPCO continues to expand its access program and connect more customers from newer parts of the country, the domestic demand for electricity is expected to remain strong. The domestic demand is expected to reach nearly 17,000 GWh by end of this decade using EEPCO’s moderate growth forecast. 24. Moreover, a large part of the future growth will also come from energy exports to neighboring countries. The Djibouti interconnector has already started power trading (as of 2011) and the Sudan interconnector is expected to start power trade in 2012. Kenya interconnector is expected to being trading in 2017. The combined electricity export is expected to be over 7,000 GWh by end of this decade – bulk of which would come from the Kenya interconnector (see table below). The international sale of power is expected to be at competitive prices (approx. US$ 0.06-0.07 /kWh) which will bring significant foreign exchange revenue. Overall, it is anticipated that EEPCO’s operating revenue will grow around 8-10% to US$ 200 million a year (on average) from FY2012-2016, growing to US$ 600 million FY2017-20. 89 Figure 8: Energy Sales Forecast 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Domestic Moderate Growth (GWh) 4,035 4,466 4,927 5,441 5,999 6,600 7,214 7,840 8,491 9,163 Export to Dibouti Forecast (GWh) 33 131 150 318 788 788 788 788 788 788 Export to Sudan Forecast (GWh) 197 788 1,577 1,577 1,577 1,577 1,577 1,577 1,577 Export to Kenya Forecast (GWh) 2,978 3,723 4,468 5,585 Total Energy Sold (GWh) 4,068 4,795 5,866 7,336 8,364 8,965 12,558 13,928 15,323 17,112 Demand and Supply Scenarios: 25. In the above scenario, demand for electricity is assumed to grow at a rate no lower than 10-11%. However, GOE plans of connecting 75 percent of Ethiopia’s rural towns and villages to the electricity grid by FY2015. The planned demand growth can therefore be potentially much higher. 26. In particular, the Government’s plans for electricity access expansion envisage a moderate growth rate of 24%, a target rate of 26%, and a high growth rate of 32%. Assuming the moderate growth rate (24%), the domestic peak load demand will reach about 5,000 MW by 2020 with overall, domestic energy consumption of over 20,000 GWh. Assuming the target growth rate (26%), the domestic peak load demand will reach nearly 6,000 MW by 2020 with overall, domestic energy consumption of over 22,000 GWh. Assuming the high growth rate (32%), the domestic peak load demand will reach nearly 7,500 MW by 2020 with overall, domestic energy consumption of over 29,000 GWh. 27. The exports to Djibouti, Sudan, and Kenya will increase to nearly 1,300 MW with nearly 7,500 GWh of energy exports. 28. In terms of supply, based on the planned capacity additions, Ethiopia could possibly reach (based on current plans and under construction projects) installed capacity of nearly 13,500 MW by 2020, leading to an overall electricity production capacity of nearly 47,000 GWh. Tariff Structure: 29. In a large part, EEPCO’s future revenue potential would be influenced by the domestic tariff regime. As mentioned before, due to GOE’s policy of universal subsidy to the electricity sector, the tariff rates in Ethiopia have been highly suppressed. The tariff structure has not been updated since 2006. When it was last updated, the average tariff was set at Birr equivalent of US$ 0.06/kWh, however, due to currency depreciation over time, as of 2011 the effective average electricity tariff rate in Ethiopia stands at US$ 0.03/kWh which makes it largely out of sync with the global competitive tariff rates (see table below). 90 Figure 9: Ethiopia Electricity Tariff Structure Tariff Category Consumption Rate (US$) Domestic Equivalent Flat Rate 0.023 First Block 50 kWh 0.016 Second Block 50 kWh 0.017 Third Block 100 kWh 0.024 Fourth Block 100 kWh 0.027 Fifth Block 100 kWh 0.027 Sixth Block 100 kWh 0.028 Seventh Block > 500 kWh 0.033 General Equivalent Flat Rate 0.032 First Block 50 kWh 0.029 Second Block > 50 kWh 0.033 Industrial Equivalent Flat Rate 0.028 Industrial - 15 kV Equivalent Flat Rate 0.020 Industrial - 132 kV Equivalent Flat Rate 0.018 Street Lighting Equivalent Flat Rate 0.023 30. When compared to global trends of electricity tariffs of net energy importing and exporting nations (both low and high income), Ethiopia has fallen far below international trends (figure below). In fact, even when compared to the regional countries, Ethiopia’s tariff rates are some of the lowest (table below). Figure 10: Electricity Tariff Comparison by Country Group 91 Figure 11: Average Electricity Tariffs in Selected African Countries Country Residential Tariff Industrial Tariff Commercial Tariff US cents/kWh US cents/kWh US cents/kWh Ethiopia 3 3 4 Botswana 5.9 6.7 3.1 Cameroon 8.6~12 9.9~11.3 8.5~8.7 Kenya 4.9~44 21.4 14~16.4 Senegal 23.8~26.2 14.4~20.8 13~18.7 Tanzania 4.1~13 5.3 4.9 Uganda 3.4~23.3 21.8 16.7 Zambia 1.6~3.7 3.7 1.2~2.2 31. EEPCO’s operating expenses (mostly based on hydropower) are low and it can even sustain an operating profit in most years of normal rainfall (more details in sections below). However, for long term financial feasibility, especially in the wake of huge existing and even larger future debt obligations, EEPCO must revisit its tariff structure in order to bring it to competitive levels. The combined effect of tariff under-pricing and the system losses (discussed below) mean significant loss of revenue for EEPCO and the GOE. Operational Performance – Expenses: 32. The increase in EEPCO’s operating expenses has been much higher than the increase in revenues during the past five years, mainly due to high generation costs. The generation cost increased by 73 percents in FY2008, by 72 percents in FY2009 and by 48 percents in FY2010. 33. The main drivers for the increased operating expenses have been: a. Delayed commissioning of major hydropower plants: EEPCO’s access expansion program was successful in creating the target demand, however, the planned capacity increase via three new hydropower plans (Tekeze 300MW, Gilgel Gibe II 420 MW, Beles 460MW) suffered from many months of construction delays. The plants were eventually commissioned in 2011. b. There was also a two year period of low rainfall conditions which limited hydropower production from existing plants. c. EEPCO had to rent expensive thermal power generation to meet the demand shortfalls which increase their production costs significantly. d. Also, the increase in international fuel prices, combined with the fact that EEPCO’s expenses were denominated in foreign currency while the Birr was devaluating against the US Dollar. 34. As a result of these predominately generation related issues, EEPCO’s operating expenses during this period were much higher than anticipated and EEPCO suffered operating losses during this period. However, as of FY2011, the per unit generation costs, due to heavy hydropower usage, were very moderate and stood at below US$ 0.02/kWh. Table below summarizes the generation related costs over 2006-2011. 92 Figure 12: Historical Generation Costs 2006 2007 2008 2009 2010 2011 Total Cost of Sales (US$ million) 38 39 63 91 109 29 Generation Cost (US$ million) 5 7 21 59 86 21 Growth Rate (Year to Year) 5% 75% 75% 48% -76% Per Unit Generation Cost (US$ / kWh) 0.002 0.002 0.007 0.019 0.026 0.019 Hydropower Hydro Generation Cost (US$ million) 4 5 9 12 12 18 Growth Rate (Year to Year) 28% 83% 40% -4% 51% Generation Amount(GWh) 2,371 2,765 2,830 2,769 2,890 4,168 Thermal (Diesel) Diesel Generation Cost (US$ million) 1 2 12 46 74 2 Growth Rate (Year to Year) 57% 457% 267% 62% -97% Generation Amount(GWh) 37 34 136 351 355 30 Geothermal Geothermal Generation Cost (US$ million) 0 0 0 1 1 0 Growth Rate (Year to Year) 6% 1% Generation Amount(GWh) 0 0 0 12 19 20 Figure 13: Historical Generation Costs 35. In terms of the operational and maintenance expenses, mostly related to the day to day management of the transmission and distribution network and related expenses, EEPCO has suffered from lack of efficiency due to its high growth rate. 36. As a utility company designed to handle a few hundred thousand customers and few hundred MW of installed capacity, EEPCO is today managing over two million customers, over 200 MW of installed capacity with over 10,000 kms of transmission lines and 125,000 kms of distribution lines. There are massive technical bottlenecks in the existing infrastructure as well as other day to day operational issues such as lack of proper staffing and capacity at various levels. As a result, EEPCO lacks overall efficiency and suffers from higher than industry average system losses of nearly 20%. However, when compared to the overall operating expenses, the lack of efficiency has a relatively small effect to EEPCO’s bottom line. Based on FY2011 estimates, a 5% reduction in losses (from 20% to 15%, which is closer to the industry average) would result in a US$ 1-2 million saving. Furthermore, transmission and distribution expenses have reduced over the last several years with a shift towards greater use of hydropower generation and in FY2011 per unit costs related to operations and maintenance stood at less than US$ 0.01 /kWh. 93 Figure 14: Historical Transmission and Distribution Costs 2006 2007 2008 2009 2010 2011 Transmission Expenses (US$ million) 14 19 14 2 3 3 Distribution Expenses (US$ million) 15 6 11 3 4 4 Other O and M Expenses (US$ million) 35 39 47 67 67 18 Total Per Unit O and M Expenses (US$ /kWh) 0.022 0.019 0.020 0.019 0.019 0.005 Energy Produced (GWh) 2,890 3,331 3,531 3,727 3,980 5,062 Energy Sold (GWh) 2,408 2,799 2,966 3,131 3,264 4,218 Transmission and Distribution Loss (%) 20% 19% 19% 19% 22% 20% 37. Overall, it is estimated that EEPCO’s operating expenses would grow at around 2% to US$ 100 million a year (on average) in FY2012-16 growing to US$ 150 million in FY2017-20. Investment Program and Financing Expenses: 38. As EEPCO ramps up its investment in generation, transmission and distribution, access expansion, sector modernization and other related projects, there is an associated large investment program which can have significant current and future financial implications. 39. Overall, GOE’s GTP related sector investments call for US$ 11 billion worth of new projects. The financing plan for these public sector projects includes a mix of funding sources, part of it coming from GOE’s self-financing and customer contributions, but most of it coming from new loans. Borrowing is sought from multilateral and bilateral partners, international donor agencies, commercial banks as well as domestic and Diaspora bonds issued directly by EEPCO. It is important to note that as of yet, there is no private financing included in the investments. 40. Of the total investment program, nearly US$ 3.5 billion has already been raised and the expectation is that an additional US$ 4 billion will be raised and invested in the remainder of the GTP period (through FY2015) with the remainder to the program investments coming before the end of the decade (FY2020). 41. The current loan portfolio (US$ 3.5 billion) which sits on EEPCO’s balance sheets can be summarized in the following categories (table below): a. Government to EEPCO on-lending: GOE (MOFED), signs loans with international finance institutions (such as: IDA, AfDB, EIB, etc.) on concessional financing terms and on-lends them to EEPCO. Typically, these loans have a 20 year maturity with a 5 year grace period and charge interest rates of 3-6% to EEPCO. The current estimated portfolio of such loans is US$ 800 million. b. Commercial bank loans: EEPCO has also been able to raise significant amount of money from commercial sources (mostly Chinese and Indian banks) for financing of large projects, especially hydropower. Typically, these loans have a 10 year maturity with a 3 year grace period and charge interest rates around 6% to EEPCO. The current estimated portfolio of such loans is US$ 500 million. 94 c. Bonds issues by EEPCO: EEPCO has been highly successful in raising financing from domestic and Diaspora bonds. Many Ethiopians (nationally and internationally) have spent a month’s worth of their salaries to purchase these bonds as part of the government’s campaign to promote sector investments. Typically, these bonds have a 7 year maturity with a 5% interest rate. The current estimated portfolio of these bonds is over US$ 2 billion. d. Supplier’s credits: EEPCO also has long term agreements with many suppliers for providing credit. Typically, these loans tend to be for 2-4 years with 1 year grace period and carry interest rates of 4-6%. The current estimated portfolio of these suppliers credit is around US$ 210 million. Figure 15: EEPCO’s Current Estimated Loan Portfolio Loan Repayment Grace Interest Borrowing Source Amount Period Period Rate US$ million years years % IFIs / Government On-Lending 800 20 5 5.00% Commercial Banks 500 10 3 6.00% EEPCO Bonds 2,000 7 0 5.00% Supplier's Credits 210 4 1 5.00% Total Current Estimate 3,510 [averages of categories used] Debt Servicing: 42. As many of these loans were taken on in the recent past, the repayments have not significantly affected EEPCO’s financial performance. However, many of the loans are now starting to become due and the repayment will significantly ramp up in FY2011 and beyond. EEPCO has already been feeling the burden of the repayments as some of the past loans (mostly on-lending by the government) were not fully serviced in the past financial years, including 67% of debt service shortfall in FY2010. Table below summarizes debt servicing by EEPCO: Figure 16: EEPCO’s Historical Debt Servicing US$ million 2007 2008 2009 2010 Total Debt Service Amount: Payable 25.4 29.6 38.9 88.0 Long-term Loans: Payable 0.0 3.0 1.8 14.0 Bonds: Payable 0.0 0.2 10.3 44.5 Suppliers’ Credits: Payable 0.8 0.0 0.3 0.1 Total Debt Service Amount: Paid Repayment (Principal) : Paid 4.4 5.0 2.4 2.7 Interest : Paid 20.3 21.4 24.1 26.8 Loan Amount Transferred to Current Asset: Not Paid 0.8 3.2 12.4 58.6 Ratio of Payable/Paid 3% 11% 32% 67% 43. In the coming years, it is estimated that the maturing loans would amount to a yearly debt service obligation of US$ 300 million (on average, FY2012-16) for EEPCO including around US$ 240 million of principal and US$ 60 million of interest payments, growing to US$ 700 million a year in the latter half of the decade (FY2017-20). 95 Figure 17: EEPCO’s Future Debt Servicing US$ million 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Estimated Debt Service Amount Repayment (Principal) 45 58 222 268 309 300 514 492 464 364 Interest 42 47 71 81 86 68 289 255 224 196 Total Debt Service 87 105 293 349 395 368 804 747 688 559 Financial Projections: 44. Based on the details provided in the preceding sections, the overall assessment is that EEPCO will have positive operating cash flows and will deliver solid operating performance. EEPCO will benefit from strong domestic demand growth and the revenues will increase at around 8-10% per year in the coming decade. The prospects of bilateral trade are even more lucrative with potential for huge financial returns in the latter half of the decade. On average the operating revenues are expected to be around US$ 200 million in FY2012-16 and around US$ 600 million in FY2017-20. 45. In terms of expenses, barring unforeseen circumstances, such as massive reduction in rainfall levels, the need for rental thermal generation, etc., EEPCO’s expenses should nominally grow at around 2% per year in the coming decade. It is estimated to around US$ 100 million in FY2012-16 and around US$ 150 million in FY2017-20. It is important to point out that the consumer price inflation rate in Ethiopia is rather high (approx. 40% in November 2011), however, most of EEPCO’s expenses are not related to these fluctuations, such as wages, administration and sales expenses, etc. Major risks to financial viability of EEPCO stem from two factors: a. Debt service obligations: as described before, the debt service obligation for EEPCO’s investment program would be in the order of US$ 300 million a year in the coming years. With operational cash flow of US$ 100 million, this amounts to a US$ 200 million shortfall for servicing debt obligations in FY2012-16. b. Outdated tariff structure: current average tariff of US$ 0.03 /kWh means that the full potential of revenue growth cannot be realized. Positive operational cash flow would be maintained due to low generation costs however, tariff regime should be updated to keep pace with investment program priorities. 46. The summarized projections based on the discussion and assumptions are provided in the table below which highlights the major risk to the financial health of the sector. It is to be noted that the major jump in the operating revenues comes from the regional trade in the second half of the decade, which is why the analysis has been split in two halves. However, despite the upswing in revenues from regional trade, and without any other changes such as tariff structure revision or debt restructuring, the shortfall for servicing debt obligations would remain. 96 Figure 18: EEPCO’s Summarized Financial Risk Projections (US$ million) FY2012-2016 FY2017-2020 Business As Usual (Current Situation) Average Annual Debt Service Obligation 314 713 Average Annual Operating Revenue 216 616 Average Annual Operating Expenses 112 167 Average Annual Operating Cash Flow 104 449 Debt Service Shortfall (based on operating cash flow) 210 264 Average Domestic Sales (GWh) 5,487 8,177 Average Debt Service Burden (UScents/kWh) 3.83 3.23 47. Based on the overall analysis, the trend-line charts of the financial projections of EEPCO for the future are provided below: Figure 19: EEPCO’s Financial Projections 2011-2020 Operating Revenue and Expenses (US$ M), FY2011-20 700 600 500 400 Operating Revenue 300 Operating Expenses 200 Operating Cash Flow 100 0 -100 Operating Cash Flow and Debt Service (US$ M), FY2011-20 600 Operating Cash Flow 400 Debt Service - Interest 200 Expenses 0 Debt Service - Principal -200 Operating Cash Flow -400 Surplus/Shortfall for Debt Service -600 97 Sensitivity Analysis: 48. Sensitivity analyses of the financial viability risks identified were evaluated based on two main criteria. It was assumed that the investment program will proceed as planned and would not be included as a variable for analysis. The main variables chosen for sensitivity analyses were: a. Efficiency (reducing transmission losses) – analysis determined the effects of reducing the transmission losses by 5% on the financial projections. b. Tariff Scenarios – analysis determined the effects of increasing the average tariff rates from the current US$ 0.03/kWh in one cent increments on the projections. Case 1: Lower Transmission Losses: 49. If the transmission losses are reduced by 5% (from 20% to 15%) starting in FY2012, the anticipated change would be a US$ 2 million reduction in operating expenses. However, overall, the financial projection would not show any major change than current scenario (figure below). Figure 20: EEPCO’s Financial Projections 2011-2020 (Lower Transmission Losses) Operating Revenue and Expenses (US$ M), FY2011-20 700 600 500 400 Operating Revenue 300 Operating Expenses 200 Operating Cash Flow 100 0 -100 Operating Cash Flow and Debt Service (US$ M), FY2011-20 600 Operating Cash Flow 400 Debt Service - Interest 200 Expenses 0 Debt Service - Principal -200 Operating Cash Flow -400 Surplus/Shortfall for Debt Service -600 98 Case 2: Tariff Scenarios: 50. The analysis conducted included increasing tariff rates from the current US$ 0.03/kWh in one cent increments. The scenario was split in two parts – averages of FY2012-16 and averages of FY2017-20 (when the Ethio-Kenya interconnector is commissioned). The various scenarios presented demonstrate the average debt service shortfall or surplus (using operating cash flow as the basis). It should be noted that based on operating cash flow and debt service obligation, the shortfall is maintained even if the domestic tariff rate is doubled to US$ 0.06/kWh (surplus at US$ 0.07/kWh). Moreover, it should also be noted that as the current debt level increases, the obligation would increase further, making it harder for EEPCO to meet all its obligations. Figure 21: Tariff Scenarios Average of FY2012-16 0.03 0.04 0.05 0.06 0.07 US$/kWh US$/kWh US$/kWh US$/kWh US$/kWh (current rate) Domestic Sales (GWh) 5,487 5,487 5,487 5,487 5,487 Foreign Sales (GWh) 1,578 1,578 1,578 1,578 1,578 Total Sales (GWh) 7,065 7,065 7,065 7,065 7,065 Operating Revenue - Domestic (US$ M) 137 219 274 329 384 Operating Revenue - Foreign (US$ M) 79 79 79 79 79 Operating Revenue - Total (US$ M) 216 298 353 408 463 Operating Expenses - Total (US$ M) 112 112 112 112 112 Operating Cash Flow (US$ M) 104 186 241 296 351 Debt Service - Interest (US$ M) 69 69 69 69 69 Debt Service - Principal (US$ M) 245 245 245 245 245 Debt Service - Total (US$ M) 314 314 314 314 314 Debt Service (Shortfall) / Surplus (US$ M) (210) (128) (73) (18) 37 Average of FY2017-20 0.03 0.04 0.05 0.06 0.07 US$/kWh US$/kWh US$/kWh US$/kWh US$/kWh (current rate) Domestic Sales (GWh) 8,177 8,177 8,177 8,177 8,177 Foreign Sales (GWh) 6,553 6,553 6,553 6,553 6,553 Total Sales (GWh) 14,730 14,730 14,730 14,730 14,730 Operating Revenue - Domestic (US$ M) 255 327 409 491 572 Operating Revenue - Foreign (US$ M) 360 360 360 360 360 Operating Revenue - Total (US$ M) 616 687 769 851 933 Operating Expenses - Total (US$ M) 167 167 167 167 167 Operating Cash Flow (US$ M) 449 520 602 684 766 Debt Service - Interest (US$ M) 246 246 246 246 246 Debt Service - Principal (US$ M) 467 467 467 467 467 Debt Service - Total (US$ M) 713 713 713 713 713 Debt Service (Shortfall) / Surplus (US$ M) (264) (193) (111) (29) 53 99 51. Hence, we can conclude that for long term health of the sector, it would be necessary to increase the tariff rates well over US$ 0.06/kWh to sustain the operating costs as well as the current investment program costs. Reducing the transmission losses, however important, would not create financial stability in the sector related to the high investment program costs. There are also other ways to possibly increase the financial health of the sector, some of which are discussed in the section below. The above assessment bodes well with the fact that in 2006 when EEPCO tariff was equivalent to US$ 0.06/kWh. As the tariff had been kept fixed in birr and was never adjusted for inflation and foreign currency devaluation, EEPCO’s tariff in real terms has actually reduced over the period. If EEPCO’s tariff is corrected for devaluation and inflation and retained at 2006 level, then EEPCO will be able to operate in a sustainable manner. This will further increase EEPCO’s ability to implement the Government Energy Sector Strategy as defined in the GTP. Fiscal Impact Analysis: 52. Since there are no significant subsidies to EEPCO or to the private sector investors included as part of the project, it would appear that there are no direct fiscal impacts to the government. However, deeper financial analysis presented here suggests there could be significant fiscal challenges to the government ahead in terms of sector wide issues (which are not essentially project related). To a lesser significant level, there may be loss of revenue to the government if EEPCO appropriates all proceeds from customers added as part of the project and is not required to pay taxes or dividends to the government based on the benefits from the project. On the other hand the government budget could benefit from the differential between the concessional terms upon which the IDA credit will be extended to the government and the near-commercial terms on which part of the credit will be on-lent to EEPCO. However, the key issues to be dealt with are the issue of ballooning debt that EEPCO is taking on due to the capital investment required for government’s public policy related projects. Policy makers in the government would have to enact a sector wide approach in order to tackle the issue of US$ 200 million a year in immediate debt service obligation shortfall that EEPCO faces in the immediate future. The discussion below offers some suggestions on how these changes could be incorporated to meet the financial challenges of the sector: Tariff Structure Revision: 53. Increasing the average tariff rate to be able to recover costs would be the most financially prudent way to balance the investment program needs with the operational reality of the sector. This would ensure that there is adequate coverage for servicing the debt obligations. However, it is recognized that there are several socio-political challenges associated with tariff structure revisions, especially for a country where significant portion of the population lives below the poverty line. The solution could lie in achieving the desired average tariff level using a tiered tariff structure that represents the economic reality of the various segments of the population. For instance, the residential tariff rates could still be subsidized to a certain level where lower income households pay a reduced rate and higher income households pay a higher rate. Also, the commercial/industrial tariffs could be raised enough to increase EEPCO’s revenues and make the tariff structure reflective of the true costs of production. Studies have shown that the economic loss to the country due to cost of un-served energy is nearly US$ 450 million. This leads to captive power generation which pushes up production costs for the industrial and commercial 100 sectors. It is estimated that the willingness to pay for electricity in these sectors is over US$ 0.5/kWh. Examples of tiered tariff rates from the countries in the region are included below: Figure 23: Examples of Tariff Structure from Regional Countries Residential Tariff Industrial Tariff Commercial Tariff Country (US cents/kWh) (US cents/kWh) (US cents/kWh) Uganda 3.4~23.3 21.8 16.7 Kenya 4.9~44 21.4 14~16.4 Other Options: 54. At present, EEPCO is directly responsible for implementation of government’s public policy goals for the sector. The financial health of the sector would be better served with assistance from the government in term of bearing the burden of some of the capital costs of the investment program. This could be achieved by restructuring of EEPCO’s current debt portfolio by the line ministries. A large portion of EEPCO’s debt is on-lent by the government on near commercial terms to EEPCO. Further, EEPCO is also taking on a lot of direct loans from other means including commercial banks and bond issuances. Government could assist the sector by restructuring the debt by means of a debt for equity swap, or changing of the lending terms that EEPCO is charged for these loans. Such restructuring programs can be then financed by government’s budget using the broader tax-payer revenue stream in order to subsidize large scale infrastructure investments of the energy sector. These types of arrangements have been used in many countries including Ethiopia’s neighboring country Kenya, where the government has established a separate entity for equity based investments in the energy infrastructure and a separate entity for overseeing the operational and management portion of the utility functions. If the government were to fund the US$ 200 million a year in debt service shortfall from the tax- payers (FY2012-16), it would mean a per capita increase of US$ 3 per tax-payer per year or an increase of 3% of government budget expenditure16. From a fiscal standpoint, this should be affordable as Ethiopia has a low tax to GDP ratio of 10% when compared to the Sub-Saharan African average of 18%. Combination of Tariff Revision and Other Options: 55. Another possible alternative could be to enact a policy which includes a combination of tariff revision and partial debt restructuring. This can be a viable way to reduce the government’s (and tax-payer’s) burden for energy infrastructure investments and can share the burden with the consumers of the utility. A possible scenario could be increasing the tariff rate from US$ 0.03 /kWh to a level which is economically and socially feasible (not as high at US$ 0.06/kWh) and restructuring the remaining debt. Conclusion: 56. In conclusion, it should be reiterated that EEPCO is an operationally sound entity based on the financial analysis. It is able to control and meet its expenses and will experience significant growth in the coming years. The financial challenges related to the sector are more structural in nature than project oriented. Some fundamental reforms need to be carried out by 16 GOE budget expenditure for FY2011 of US$ 7B assumed 101 the policy makers in order to ensure financial health of the sector. The proposed project, ENREP, does not significantly add incremental financial burden to EEPCO. In fact, it would assist in making EEPCO a more effective and efficient utility with some desperately needed funding for modernization and upgrade of its systems and operations. ENREP brings significant economic value (EIRR of around 18%) to the sector and the economy while providing enhanced capacity to EEPCO to generate additional revenue from an increased customer base. In general, investment in large scale infrastructure projects such as transmission and distribution upgrade, have a higher economic return than net financial return. Further, with energy consumption levels in their infancy in Ethiopia, the investment returns might not be as lucrative as in many other countries. However, investment in such projects is necessary for long term development of the sector, and as such the project also provides a financial return for the investment (FIRR of around 8% - described below). In terms of the structural changes needed in the sector related to sharing of the capital investment costs by the government and the utility as well as for reforming the tariff structure, dialogue is already undergoing between various stakeholders in the government to enact policy level changes. These arrangements will serve the sector as a whole. Figure 24: EEPCO’s Financial Projections 2011-2020 (Key Accounts)* 2011 2012 2013 2014 2015 2016 Income Items Revenue (US$ million) 130 151 191 251 289 301 Cost of Sales (US$ million) 32 62 71 83 90 92 Gross Margin ( percent of Sales) 75% 59% 63% 67% 69% 69% Other Operating Expenses (US$ million) 78 66 79 113 171 230 Operating Income (US$ million) 20 22 40 53 28 -22 Net Income/Loss before Income Tax (US$ million) 0.5 -27 -96 -115 -167 -224 Avg. Tariff (US$ /kWh) 0.032 0.032 0.033 0.034 0.034 0.034 Balance Sheet Items Total Assets (US$ million) 4,864 5,600 6,895 8,197 9,036 9,429 Total Liabilities (US$ million) 2,937 3,595 4,819 6,061 6,948 7,497 Total Equity (US$ million) 1,926 2,004 2,075 2,135 2,088 1,931 Cost of Service Study Sales (GWh) 4,035 4,795 5,866 7,336 8,364 8,965 Generation Required (GWh) 5,044 5,919 7,153 8,838 9,957 10,622 System Loss 20% 19% 18% 17% 16% 16% Generation (US$ million) 21 50 60 72 79 82 Hydro (US$ million) 16 22 26 30 33 34 Portion of Hydro Power (GWh) 4,176 5,618 6,684 8,120 9,108 9,749 Per Unit Hydro Generation Cost (US$ /kWh) 0.0039 0.0040 0.0039 0.0038 0.0036 0.0035 Diesel (US$ million) 4 22 23 25 26 28 Portion of Diesel Power (GWh) 26 110 120 131 143 156 Per Unit Diesel Generation Cost (US$ /kWh) 0.1670 0.1999 0.1941 0.1884 0.1829 0.1776 Geothermal (US$ million) 1 6 11 17 20 20 Portion of Geothermal Power (GWh) 15 191 349 588 706 717 Per Unit Geothermal Generation Cost (US$ /kWh) 0.0422 0.0312 0.0303 0.0294 0.0286 0.0277 Transmission (US$ million) 3 7 7 6 6 6 Distribution (US$ million) 8 5 5 5 5 4 Per Unit Generation Cost (US$ /kWh) 0.0053 0.011 0.010 0.0099 0.0095 0.0092 Per Unit Sales Cost (US$ /kWh) 0.0081 0.013 0.012 0.011 0.011 0.010 Per Unit Total Cost (US$ /kWh) 0.037 0.038 0.050 0.051 0.055 0.059 * Only first five years of analysis are included as a sample – full analysis extends to FY2020. 102 III. Project-Level Financial Analysis: 57. The discussion of project level finances involves a financial internal rate of return (FIRR) analysis of the project. For the purposed of the financial analysis, the credit line has not been used and the estimates are based on the core capital expenditures only and include IDA, GOE and OFID contributions total US$ 225 million. 58. To evaluate if the project is financially viable on its own, a virtual project entity is assumed, which would invest in, operate and maintain the investments. The basic assumptions related to the analysis were similar to the ones described in the economic analysis section. Expenses related to operations, maintenance, etc. are similar to the ones described in the previous section (OM costs assumed to be 2% of the capital costs, cost of grid supply: US$ 10 per year per customer). In addition taxes (15%) are also considered. Revenues are primarily obtained from incremental sales due to acquisition of 225,000 new customers (with organic increase in consumption and tariff rates). 59. Overall, from an operational standpoint, the project is financial viable with a NPV of US$ 79.7 million (at 5% discount rate) and US$ 47.8 million (at 6% discount rate) and the FIRR of 8.1% (see table below). The discount rates have been selected based on EEPCO’s current cost of capital which ranges between 5-6%. Figure 26: Results of Financial Analysis Discount Rate 5% Discount Rate 6% NPV (US$ million) 79.7 47.8 FIRR (%) 8.1 8.1 60. Sensitivity analysis was also conducted to test the robustness of the financial profitability of the project to changes in key parameters of project revenue and expenses (see results below). The rates of return were examined under similar conditions as described in the previous section - total project costs: increase of 5% and 10% in the overall project cost, decrease in revenue: decrease in revenue of 5% and 10% was considered. Figure 27: Results of Financial Analysis - Sensitivity Analysis Scenarios (at Discount Rate 5%) NPV (US$ million) FIRR (%) Base Case 79.7 8.1 Expenses Increase 5% 67.3 7.5 Expenses Increase 10% 21.9 5.8 Revenues Decrease 5% 63.3 7.4 Revenues Decrease 10% 46.8 6.8 Expenses Increase and Revenues Decrease 10% 21.9 5.8 61. In summary, from a financial analysis, the capital cost and the number of customers added are the key variable that will have the strongest impact on the financial viability of the project. 103 ANNEX 7: IMPACT EVALUATION FRAMEWORK ETHIOPIA: ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) A. Research Questions for the Impact Evaluation 1. The proposed impact evaluation (IE) aims at examining whether and how rural electrification could improve people’s benefits from basic social services and economic opportunities. In Ethiopia, the vast majority (about 80 percent) of the population lives in rural areas. Most of them fall below the poverty line and still use traditional biomass for energy. This has long been a challenge for the country to improve the quality of life in both economic and social terms in rural and remote areas. The existing literature, though limited, indicates that electricity could improve the quality of services at school and hospitals. Lighting and TV could have significant implications to people’s social and educational life. There may be some potential of displacing firewood or kerosene stoves in households. 2. The evaluation will primarily focus on the socio-economic impacts of increasing access to electricity in rural and remote villages under the Universal Electrification Access Program (UEAP), which is supported by the ENREP in collaboration with other donors. The proposed can also cover the impacts of non-UEAP interventions for rural electrification. 3. The evaluation will take into account both private and public good effects: (i) household electricity consumption and use of home appliances, (ii) alternative energy consumption (e.g., biomass), (iii) education benefits (at school and home), (iv) health and fertility benefits (at hospital and home), (v) productive use (agriculture and SMEs), (vi) employment, household income and consumption, and (vii) public good benefits (e.g., street lighting, security and global emissions). Detailed outcome and impact indicators will be developed during the course of establishing the M&E framework. B. Identification Strategy and Analytical Methodologies 4. The proposed evaluation will use the pipeline comparison technique. As discussed, about half the population has not yet been electrified. To achieve the country’s new Growth and Transformation Plan (GTP), the Government aims at doubling the number of grid connections from 2 million in 2012 to 4 million by 2015. Despite such increasing efforts, it is estimated that one-fourth of the population would still be left unelectrified. Using this time lag of implementation of rural electrification interventions across villages, those who would be electrified within next 1-2 years are defined as the treatment group. Those who would remain unelectrified within next 2 years are treated as the control group. 5. In the proposed IE, at least two surveys will be carried out: before the project (baseline), and 2 year after the intervention (follow-up). Given the baseline and follow-up data, the evaluation will use a difference-in-difference (DID) technique, which compares the treatment and control groups between two periods (before and after the intervention). This will help to 104 eliminate potential bias caused by time-invariant unobservable heterogeneity between the two groups, as long as time-variant factors related to selected indicators are ignorable. 6. In order to complement the DID estimator, the regression discontinuity (RD) method may also be used, because there remains a significant gap in rural electricity access in Ethiopia and the UEAP implementation is prioritized to ensure regions equity. Given the ranking on the priority list of villages, the RD method assumes that villages above and below a cutoff point between the treatment (first two years) and control (after two years) groups would have similar characteristics and therefore be comparable. The RD estimator, by construction, has to be considered to be ―local‖ but will be useful to examine robustness of the DID estimator. C. Implementation and Sampling 7. The discussion about a basic framework of IE has already been started with the Government. EEPCO will finance the baseline survey from the Bank funded EAREP II project, which is now under implementation. Further detailed design will be developed based on the terms of reference for the socioeconomic monitoring and IE under preparation. As discussed, at least two questionnaire-based surveys will be carried out for data collection. The baseline survey will take place at the beginning of the first year of the project. The follow-up data collection will take place 24 months after the project implementation in the treatment group (approximately in 2014). 8. The sample will be selected randomly, for instance, 100 villages that will be electrified within the first two years and another 100 villages that will not be electrified within two years. The village selection is designed to be representative nationally in terms of location and development level. In each village, about same number of households, for instance, 15-20 households, will be surveyed. The household sample size will be approximately the same between the treatment and control groups. 9. The surveys will collect both village- and household-level data. At the aggregate level, village characteristics, such as access to electricity and other infrastructure services (e.g., transport, water, telecommunications and irrigation) and availability of social services (e.g., school and health facility), will be collected from all the villages in the sample. At the household level, social and welfare impact indicators, such as energy use, home appliance ownership and expenditure, will be collected. To control observable heterogeneity across households, the surveys will also cover general household information, such as housing, education, health, economic activities, employment, land and non-land assets, credit, savings, and access to other basic infrastructure services, such as electricity and water supply and sanitation. D. Potential Risks 10. One potential risk of the proposed IE is that it may fail to observe some long-term and indirect impacts of the intervention given the above timeframe. For instance, it is well known that rural electrification would not be likely to replace household use of traditional energy in the short run. Economic impacts on productive use in agriculture or cottage industry, employment, income and consumption may also be difficult to observe in the short run. To measure these longer-term impacts of the intervention, another round of follow-up survey may be carried out 105 two years after the project completion (approximately in 2016). Some of the villages in the control group will be provided with access to electricity, whereas others will not. 11. The same analytical framework can be applied: The long-term, dynamic impacts will be captured by comparison the treatment group and the villages that would not still be electrified at that time. In addition, a quantitative assessment will also be possible to examine the relationship between the intervention and the impacts with the duration of new access exposure taken into account. 12. Another potential risk may be the contamination problem. Many unintended events could happen during the project implementation. This may be difficult to avoid given the above setting, if they are time-variant. However, to ensure robustness of the estimated impacts, an additional cross-sectional analysis can be implemented with the baseline data. This will require the sampling from another set of villages where electricity has already been provided. The results can be used to not only check the estimation robustness but also fine-tune the design of IE before the project implementation. 106 ANNEX 8: FINANCIAL INTERMEDIARY ASSESSMENT (OP 8.30) ETHIOPIA: ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT (ENREP) Compliance with Bank Policy on Financial Intermediary Lending (OP 8.30) 1. The project design is fully compliant with Bank operations policy on financial intermediary lending, as contained in OP 8.30. Macroeconomic policies and sectoral conditions. 2. The Government of Ethiopia (GoE) reported that GDP grew at 11.4 percent in FY2010- 11 (vis-à-vis the Fund’s estimate of 7.5 percent). Estimates of sectoral growth indicate that agriculture grew by 9 percent, while the industrial and service sectors expanded by 15 percent and 12.5 percent, respectively. The Fund’s estimate of GDP growth rate (Table 1) appears to be reasonable, especially if seen through the lens of tight credit ceilings on private sector through April 2011, mounting domestic inflation, and irregular power supply arising from distribution difficulties that could account for a lower growth rate than the Government’s own estimate. Table 1. Comparison GDP estimates, GoE and IMF 2008/09 2009/10 2010/11 2007/08 GOE Fund GOE Fund GOE Fund Real GDP growth 11.2 10.1 10.0 10.5 8.0 11.4 7.5 Nominal GDP Billion Birr 248.0 335.4 335.3 382.9 383.4 511.2 486.3 GDP deflator, growth 30.3 24.1 24.2 1.4 3.8 20.1 17.9 3. Figure 1 shows that inflation continues to decline after its acceleration in the first half of 2011. The Central Statistical Agency statistics indicate that the year-on-year inflation decreased from 39.2% in November to 35.9% in December and further down to 32.0% in January. The food inflation rate is the main driver – it decreased from 50.3% in November to 46.5% in December to 41.4% in January. Non-food inflation also decreased, from 24% in November to 21.8% in December to 19.2% in January. Despite the decreasing trend, the inflation levels are still a painful reminder of the inflation spikes of 2008-2009. Figure 1. Inflation in Ethiopia. CPI from CSA, year on year 107 4. Inflation is forecasted to continue its decline in 2012 owing to improved domestic food production, lower global commodity prices and lower rates of money supply. Prices increased in 2011 on the back of rising global food and fuel prices, rapid expansion of the broad money supply and large currency devaluations. Global food and fuel prices are expected to moderate as a result of weaker global demand, and the lower oil price will also reduce the cost of imported goods. Domestic food production is expected to pick up in line with better weather, following a poor harvest in 2011 caused by substandard rainfall. Forecasts indicate that inflation will be halved - from an estimated 33% in 2011 to 16% in 2012. However, it is expected to remain in double digits because of persistent fiscal deficits, weak monetary policy, a depreciating exchange rate and a pick-up in global oil prices from 2013 onwards.17 5. The banking sector: Currently, the banking system consists of 17 banks, 3 of which are owned by the State. Before the financial sector reform in 1994 only state-owned banks were operational in Ethiopia. The reform opened the sector to private ownership even if the state owned banks still make up of half of the system, with the domination of the Commercial Bank of Ethiopia (CBE), far and away. The banking system remains closed to foreign ownership. However, Ethiopia’s 14 private banks showed generally positive results for the year ending in June 2011. For the private banking industry as a whole, deposits rose by 30 percent while loans were up 21 percent, with the latter’s slower growth due to credit caps in place till April 2011. Foreign assets held by banks fell during the year, despite a strong balance of payments surplus, but this partly reflected a deliberate sell-off of foreign exchange holdings to build up local currency liquidity following a new NBE Bills Purchase Directive that came into force towards the end of the fiscal year. Profits were up 45 percent for the year (same growth as the year before) and returns on equity averaged 30 percent for the industry as a whole. Because of a volatile macro-economic environment, deposits have a short term maturity. Currently, DBE and the Construction and Business Bank (CBB) are the only banks which provide medium and long term loans. The banking sector is also very small to any criteria, both in absolute size and in relative figures. The level of loans to private sector was around 10% of GDP as of June 2010. The NPL ratio is 5% in average in the system, with a range up to 20% in some banks. Currently, interest rates in the banking system are well below the inflation rate of 37%. Interest rates on savings deposits, set as minimum by NBE, and lending rates are around 5% and 12% on average, respectively. 6. The microfinance sector: The Ethiopian microfinance sector is relatively young (started in 1997) and consists of 31 regulated MFIs that reach over 2.5 million clients (June 2011) with an outstanding loan balance of Birr 6.5 bill. (384 mill. USD) and a balance of saving of Birr 3.4 bill (199 mill. USD). The MFIs have a rural orientation and largely work with the group-lending methodology. The industry is very concentrated, with more than 80% of the clients (and more than 90% of outstanding loans) being served by the 5 largest MFIs. Moreover, as these large MFIs are bound to their own ―territory‖ – being one of the regions – competition in the industry is very limited. These 5 largest MFIs are likely to be influenced in different ways by their respective regional governments, which practically own the MFI and provide below market-rate 17 Inflation may be higher if instability in South Sudan cuts off Ethiopia’s main oil supply and forces it to import oil at a higher cost from elsewhere. Conversely, it may be lower if the government agrees to a program with the IMF and reduces public spending and tightens monetary policy as a result. 108 funds. MFIs are supervised by the National Bank of Ethiopia and operate within a clear regulatory framework18. Financial Institutions Selection and eligibility criteria. 7. This section will separately focus on the selection of the Development Bank of Ethiopia (DBE) as a retailer and wholesaler and on the selection of the participating MFIs as retailers. 8. The Development Bank of Ethiopia has been initially selected as the wholesaling institution based on its track record of managing lines of credit and on its management commitment to the project. In order to ensure compliance with the eligibility criteria set out under OP 8.30 a due diligence assessment of DBE has been conducted during project preparation.19 9. DBE`s eligibility as a PFI has been confirmed subject to its agreement to implement an Institutional Development Plan, including a set of time-bound monitorable performance indicators and regular review of progress, to address weaknesses in the following areas: - Risk management and internal audit, - Human capital and performance assessment, - Loaning process, - MIS and IT. DBE Institutional Development Plan Areas need improvement (with key factors, unless otherwise Deadline agreed with IBRD) i) Internal Audit and Risk Management June 2013 Hire advisers for the Risk Management and Internal Audit Committees in consultation with the Committee members on a need basis (subject to BOM approval) Provide training to the directors of Board of Management and the Committees on loaning, financial and operational risks, asset- liability management, internal audit, and MIS Ensure the Risk Management Process is free from day-to-day operations Conduct an assessment of operational risk by Risk Management Process and develop policies and establish procedures to mitigate operational risk involved in loaning operations Perform annual IT audit and audit of financial reporting and MIS functions carried out by Finance and Accounts Mgmt Process Fill the vacant positions of Internal Audit Process with senior level financial and operational auditors, and IT auditor 18 See NBE proclamation no. 40/1996 and no. 626/2009 together with NBE directive no. 18/2006. 19 A due diligence assessment of DBE has been conducted by Mr. Murat Arslaner (World Bank) in January 2012. The information related to DBE contained in this Annex is therefore based on the financial analysis report prepared by Mr. Arslaner. 109 Areas need improvement (with key factors, unless otherwise Deadline agreed with IBRD) ii) Human Resource and Performance Assessment June 2013 Cascade the Balanced Scorecard system to launch a performance assessment system for staff with the integration of findings and recommendations of Internal Audit, Risk Management, and Internal Control findings to the performance assessment system Allocate enough budget for filling skills gap at the bank according to a plan developed by the HR process iii) Loaning Process June 2014 Review and update the maximum loan-size for the Regions based on their NPL ratio and NPL recovery rate Review and update the credit ratings of customers every year Establish appropriate reward and penalty system for loaning staff to comply with the Credit Policy and Procedures iv) IT and MIS December 2013 Expand the core banking system to cover Branch and Regions operations and integrate performance assessment and MIS process into the core banking system Develop layers of controls in the core banking system to enforce the responsible staff check the compliance with the policies and procedures during the loaning process in the HQ and Regional Offices Minimize the manual entry of Finance and Accounts Mgmt Process in generating financial reports 10. The legal document ensures that DBE will follow the Institutional Development Plan, which identifies the most critical areas which need to be improved in order to allow DBE's continued participation in the project. The World Bank will provide a technical assistance to DBE to address the identified gaps and implement the Institutional Development Plan on a need basis and will monitor progress to this end. The TA program needs to be developed jointly by ENREP and WEDP (Women’s Entrepreneurship Development Program, P122764). 11. DBE will also ascertain that: - Annual financial reports will be prepared according to the Generally Accepted Accounting Standards without major breaches, unless otherwise NBE requires different; - The reports will be audited within a year after the closure of the accounts and the original audited reports would be sent to the World Bank; and - The Bank will comply with NBE`s regulations in general and loan classification and provisioning in particular, without major compliances. 110 12. DBE will be required to provide an on-going proof of compliance with the above listed compliance criteria – every quarter by its management, and annually by auditor’s certification. 13. DBE's continued participation in the project will be subject to satisfactory implementation of agreed Institutional Development Plan. Key information collected through the due diligence assessment of DBE covered the following areas: Financial Institutions Selection and eligibility criteria. This section will separately focus on the selection of the Development Bank of Ethiopia (DBE) as both wholesaler and retailer and on the selection of the participating MFIs as retailers. Development Bank of Ethiopia (DBE) 14. Managerial Autonomy and Governance: DBE is owned by the government and has a Board of Management (BOM) appointed by and answerable to Public Financial Enterprises Agency (PFEA). PFEA, a directorate which reports directly to the Prime Minister`s Office, is in charge of overseeing the operations of all state-owned financial institutions. BOM is comprised of seven directors with one of them acting as the Chairman. The Chairman is the Minister of Revenue; and the other directors are mostly senior officials at various ministries. BOM approves the bank`s five-year strategic plan and its annual implementations prepared by Executive Management Committee. The bank involves the views of relevant government institutions in the preparation of strategies and implementation plans. The bank reports its results of activities on a quarterly and annual basis to PFEA. Per regulation, the members of BOM, like the President, are subject to fit and proper test by the NBE. However, the regulation does not require the directors of BOM hold experience in banking business. BOM has the authority to appoint a president and management team, Executive Management Committee (EMC), who are responsible to the BOM for the day-to-day management of the business of the bank. The President of the bank attends the meeting of BOM as a non-voting member. The current President of the bank was appointed in 2008 to undertake an institutional capacity improvement program, called the Business Process Reengineering (BPR). Prior to DBE, he had served at the Commercial Bank of Ethiopia around 23 years in various capacities. 15. Supervision: DBE is supervised by the National Bank of Ethiopia (NBE). All banks in Ethiopia need to renew their license with NBE every year. NBE`s on-site examination team visited the bank in May-June 2011, but the examination report has not been yet completed. Prior to that, BNE had performed an on-site examination of the bank in 2007. In addition to an on-site examination on a yearly basis for risky banks, NBE performs an off-site examination of all banks on a quarterly basis. In its draft off-site report, DBE has been rated at ―3‖ fair by NBE. NBE pointed out the inadequate board and management oversight and weak asset quality as a supervisory concern in its letter. Although DBE is subject to prudential regulations of the NBE, there are a few areas where the rules are in favor of DBE over other banks. For example, DBE is not subject to the single borrower limit, which is 25% of paid-up capital for other banks. Since its paid-up capital was not large enough for the bank to comply with thus rule in lending operations, especially related to large infrastructure projects, NBE eased the single borrower 111 limit for the bank, while at the same time requesting a capital injection from the MOF. The classification of medium and long term loans for DBE is also different from the practice followed by other banks. BNE differentiated the rule for DBE since 90-95% of DBE`s loans were medium and long term while this ratio for other banks was around 5-10%. According to NBE, DBE has a capital adequacy ratio of 16.68% as of September 2011, lower than the previous quarter. NBE believes the bank`s capital should be increased, as a reflection of DBE`s fast growth in lending since 2009. The bank`s NPL ratio, 11.51% as of September, is also above NBE`s unofficial target of minimum 5 % for all banks, but still below 15% prescribed by the African Development Bank for development banks. 16. External Audit: DBE`s annual financial have been audited by a private audit company, Taddesse Woldegabriel & Co., since 2009. The company performs audit according to the generally accepted accounting principles. The audit company has been approved by the PFEA and NBE upon BOM`s selection in a competitive bid for a three year period, from 2009 to 2011. The audit of the financial reports of 2010 has not yet been completed despite a regulatory rule that an audit would be completed within one year. The delay in the audit has been explained by the bank as a result of the audit company`s dispute with the bank over price. The head of Internal Audit Process has estimated that within a few months the audit of 2010 accounts would be completed and then the audit of 2011 accounts would begin. The audit company gave a qualified opinion under 15 items on the financial reports of 2009 because of non-compliances with the accounting standards. The major breaches in the standards are: not measuring bonds at amortized cost, including suspended interest receivables in the accrued interest on balance sheet, not reversing the accrued but uncollected interests related to NPLs, not maintaining provision for short term receivables past due more than a year, not provisioning against deterioration of assets waiting in resale, capitalizing the interest accruals related to a rescheduled loan, not provisioning against NPLs and related interest accruals according to NBE`s directives, and not measuring completely the gains and losses from FX fluctuations. The auditors were also not able to ascertain the completeness and accuracy of the interest incomes on loans and were not provided by the bank with Board minutes and correspondence files with the regulatory bodies. The bank has two different versions of the audit report of 2009, for internal and external purposes. The version on the website and printed hard-copies are missing the qualification pages about the breaches in accounting standards. 17. Internal Audit Process: With its improved structure, the Internal Audit Process (IAP) conducts, financial, operational, and special investigative audits based on its annual audit plan or request of Executive Management or BOM. In 2011, IAP performed audit in loaning, property management, procurement, finance and accountants (in cash management and international banking) functions minimum once a year. HR, IT, and the core functions-financial reporting and MIS-of Finance and Accounts departments have not been audited because of the lack of required skills. According to IAP, main deficiencies with loaning functions are incomplete due-diligence, lack of background check with tax authorities and other banks, and missing audited financial reports. The audit findings are not linked to the performance assessment of the core functions conducted by Strategic Planning Department. The Internal Audit Committee, consisting of three members of BOM and head of IAP, is in charge of internal audit. The committee was established at the end of 2011 in accordance with NBE`s request to do so. The head of IAP, appointed 2.5 years ago, has extensive expertise in banking operations. Although, the Head reports to the Audit Committee, the President is in charge of his/her appointment and performance assessment. IAP 112 has 24 positions in audit profession, 5 of which are vacant currently. Although the core banking system has been upgraded recently and there may be serious continuity problem in bank operations, IAP does not have capacity to perform an IT audit. IAP needs to be strengthened by hiring several senior financial auditors and an IT auditor. 18. Risk Management Process: Risk Management Process (RMP) was established in 2008. The bank has recently established a Risk Management Committee which consists of two directors of BOM. The head of the RMP is the secretary of the Committee. Like the head of Internal Audit Process, the head of the RMP is under the President in terms of appointment, performance evaluation, and benefits. The department has 17 staff. The RMP generates reports on portfolio concentration, loan quality, and provisioning on quarterly basis. The RMP reviews about 80% of the loan portfolio every year. It is also in charge of reviewing loan procedures and updating internal risk rating criteria. The reports are sent to BOM and President. The bank`s major risks are credit, liquidity, and interest rate risks. The RMP needs to be strengthened in the areas of liquidity, interest rate, and operational risks. The Executive Management Committee should implement the recommendations of RMP especially on credit risk. Currently, the bank has established credit limits for sectors but not clients. The bank does not comply with these risk limits for sectors. Because of a mismatch between the maturities of assets and liabilities, the bank is exposed to interest rate and liquidity risk in the medium and long term. Up to a year, the bank is not exposed to liquidity risk. 19. Human Resource Process: DBE has 509 staff in the HQ and 548 staff in the branches and regions, of which significant numbers are non-professional staff. Although most of the professional staff has a university and college degree, the HR, Internal Audit, Risk Management, Strategic Planning and Change Management Processes underlined that lack of skills are major weaknesses of the bank. The skills gap is manifested by poor loan quality and the bank`s dependence on government support. The bank put in place a transformation program in 2006 to reengineer the business processes with an aim of enhancing the capacity. As part of this program, HR Process has identified skills gap in almost all areas, particularly in project management, credit process, financial management, audit, risk management, and HR, and devised a training program to improve the gap. However, the bank lags behind the target because of budget constraints. According to the HR Process` program, the bank needs Birr 6-7 million per year to enhance human capital at the bank. The budget allocated has fallen short of the required amount so far. Among the receivers of training were staff as well as the President and Vice Presidents. The directors of BOM have not been provided with training so far. Currently, the bank does not have a performance assessment system for staff. Since 2011 the bank has conducted performance assessments of the departments and branches in accordance with the Balanced Scorecard System. It was envisioned to be implemented in the performance assessment of staff by the end of 2012. 20. IT and MIS: DBE generates its financial reports in monthly, quarterly, and annual frequency within a few weeks after the closure of accounts. However, the Finance and Accounts Process (FAP) is in charge of analyzing and reconciling accounts, producing financial statements, as well as managing payment systems, operating the MIS, and managing non-lending interest earning assets and interest bearing liabilities. FAP is having difficulties to measure the bank`s results with precision according to Generally Accepted Accounting Principles and NBE`s regulations, originating from poor IT support, manual entries, and skills gap. IT Process is organized under a Head into three divisions: the system development (4 staff), system 113 administration (6 staff), and network and security teams (7 staff). The bank has just upgraded its core banking system from Globus to T-24 in the HQ, with the technical support of the provider, Temones. The system was originally designed for commercial banks. The provider does to provide customization of the system to the bank`s business model. So far, regional office and branch operations have not been integrated into the core banking system. IT Process expects the integration to be completed within a few months. The bank has not yet established a data recovery center, although the bidding process has completed. The old core banking system did not support the bank`s business process, control, reporting, management information, and performance measurement functions and the new core banking system is expected to address some of the problems. The IT Process needs to be improved in order to support the bank`s operations vigorously. 21. Profitability: According to the audited and un-audited financial statements, interest incomes on loans and provisions against NPLs have been the main drivers of the bank`s financial results. Since the bank had a loose policy in reversing the accrued interests of NPLs and provisioning against NPLs in accordance with NBE`s regulation, the bank had achieved a reasonable amount of profitability until 2010. In 2001, the bank reversed some of interest accruals related to NPLs, while reducing the provisions against the NPLs through rehabilitations. In that year, the bank compensated the decrease in interest incomes with FX gains on short-term deposits with international banks. The depreciation of Birr against foreign currencies was the main reason of such a huge FX gains. However, this kind of unusual income cannot be a sustainable source of profitability. The bank needs to increase interest incomes on the lending portfolio which is expected to cover at least losses on bad loans, operational expenses, as well as funding costs. Given the problems with measuring DBE`s operational results in accordance with the Generally Accepted Accounting Principles, the Bank has achieved relatively high ROA and ROE in 2011, in comparison with the past. However, this improvement in the bank`s profitability ratios were mainly the result of Birr`s depreciation against foreign currencies. Except that year, the bank`s profitability ratios had been below the sector averages. 22. Capital Adequacy: Currently, DBE has a paid up capital of Birr 1.8 billion Birr. Its capital adequacy ratio is 16.66% with a downtrend as of 2011, in excess of the minimum regulatory requirement of 8%. The bank`s very fast growth strategy in lending in the recent years is one of the reasons of improvement in capital adequacy. Most of the new loans are still on a grace period. As the potential problems with these loans fully emerge in the future, the bank may face deterioration in its capital adequacy. The bank has also substantial amount of legacy NPLs, originating from politically driven lending decisions during the previous regimes. Although the bank has written off some portion of these NPLs so far, further write offs to clean out the balance sheet may lead to a capital shortage in the future. Indeed, as a preemptive action, NBE has already requested the MoF to increase the bank`s capital to the registered level of Birr 3 billion. 23. Portfolio Quality: The bank has grown very fast after 2009 under the new management with the mobilization of domestic funding sources. Indeed, the bank`s total assets were up to Birr 13,841 million in June 2011 from Birr 6,408 million in June 2009. Because of the difficulty of identifying viable lending projects in such a short period, most of the new funds have been invested in liquid instruments, such as cash& banks, short-term deposits, and government securities. The bank`s NPL balance as of June 2011 amounts to 11.7% of the total loan portfolio, substantially down from its level of 30.8% in 2008. The improvement in NPL ratios is the result 114 of rehabilitative actions (write offs and loan reschedules) against NPLs and the rapid expansion of the lending portfolio since 2009. Since most of the new loans are on a grace period, it is premature to conclude that the recovery of NPL ratios would continue in the future. As of June 2011, the largest 20 loans account for Birr 8.5 billion or 72.1% of the loan portfolio. Such a high concentration is related to the loans which have surpassed the single borrower limit, established as 25% of paid-up capital for other banks. There are almost 20 loans which are larger than 5% of the bank`s paid up capital. Participating MFIs 24. 12 MFIs have been assessed against the following criteria by an international consulting firm appointed by the World Bank20: - The MFI must be duly licensed in Ethiopia and at least two years in operation. - MFI’s owners should be ―fit and proper‖. It must have qualified and experienced management, adequate organization and institutional capacity for its specific risk profile. - The MFI must be in ―good standing‖ with its supervisory authority (i.e., it should meet all prudential and other applicable laws and regulations) and remain in compliance at all times. - The MFI must have well defined policies and written procedures for management of all types of financial risks (liquidity, credit, currency, interest rate and market risk, as well as risks associated with balance sheet and income statement structures). - The MFI must maintain capital adequacy prescribed by prudential regulations (i.e. minimum capital ratio of 12% computed as ratio of total capital to total risk-weighted assets). - The MFI must have adequate liquidity (i.e. shall maintain at all times liquid assets equal to 20% of their total deposits). - The MFI must have positive profitability and acceptable risk profile. - The MFI must classify its assets and off-balance-sheet credit risk exposures (at least four times per year) and make adequate provisions. It must have adequate portfolio quality (i.e. an NPL ratio as percentage of total assets not exceeding 8%). 20 The World Bank appointed the firm Business & Finance Consulting on November 2011. The assignment started on November 28, 2011 and ended with the submission of the final report on January 20, 2011. The experts first conducted a desk study and then a site visit to Ethiopia from December 12—23, during which time they held meetings with the management of all 12 MFIs as well as with the head of MFI supervision of the National Bank of Ethiopia (NBE), with the National Association of MFIs (AEMFI), and with the World Bank Ethiopia country office. The 12 MFIs evaluated as part of the assignment were Addis CSI, Africa Village Financial Services, Amhara CSI, Dedebit CSI, Dire-dawa MFI, Harbu MFI, Meklit MFI, Metemamen MFI, Omo MFI, Oromia CSSCO, Specialized Financial and Promotional Institution, and Wasasa MFI. 115 - The MFI must have adequate internal audits and controls for its specific risk profile. - The MFI must have adequate management information systems. - The MFI must agree to engage in individual lending to female-led micro and small enterprises. - The MFI must agree to undergo an intensive mandatory technical assistance which may require substantial changes to their business model. 25. Table 2 below summarizes the consultant’s conclusions regarding the compliance of the MFIs with each of the OP 8.30 requirements listed above.21 Table 2: MFIs’ compliance table Adequate portfolio quality Commitment to lending to Fit and proper owners and Licensed and operating 2 Positive profitability and Adequate internal audits Interest in the program acceptable risk profile In good standing with management policies Adequacy of capital Adequate liquidity Well-defined risk Adequate MIS and provisions management and controls women years NBE Addis CSI AVFS X Amhara CSI Dedebit CSI Dire MFI * X X Harbu MFI Meklit MFI X X Metemamen MFI X Omo MFI Oromia CSSCO SFPI Wasasa MFI * Dire-dawa’s license was just renewed in late December 2011. 26. Four MFIs did not meet one or more of the requirements, thus excluding them from participation in ENREP. These MFIs are AVFS, Dire-dawa MFI, Meklit MFI, and Metemamen MFI. 21 Compliance is indicated by the color green. Non-compliance is indicated by the color red and an ―X‖ mark. 116 27. Amhara, Dedebit, and Oromia were notably stronger than the other MFIs with regard to the evaluation criteria and thus are identified separately in the ―top tier‖ of the list below. Table 3: MFIs’ ranking Top tier 1. Amhara CSI 2. Dedebit CSI 3. Oromia CSI Middle tier 4. SFPI 5. Addis CSI 6. Wasasa 7. Harbu 8. Omo MFI Bottom tier 9. AVFS (non-compliant) 10. Metemamen MFI 11. Meklit MFI 12. Dire MFI 28. In the launch phase of the project, in order not to avoid overload on the MFIs because of the Bank`s two lending operations, ENREP and WEDP, ENREP is suggested to include OCSSCO (Oromia Credit and Saving Share Company) and Wasasa at the initial stage, followed by expansion to other MFIs later, as appropriate. Both MFIS have been engaged in lending to biogas projects and accumulated extensive knowledge and expertise which would eventually benefit the implementation of ENREP greatly. These selected MFIs will be retailing the credit facility to the household level via wholesale agreements with DBE. Each of the twelve MFIs studied requires extensive technical assistance in a variety of areas in order to be in line with international best practices. The TOR for technical assistance elects to focus on five key areas, as reflected in the following five objectives: - Strengthen lending operations by improving the credit policies, processes and staff capabilities of participating MFIs, with a special emphasis on individual lending to women in urban areas - Assist MFIs to mobilize more savings from customers - Improve the frequency, accuracy, and scope of financial and operational reporting - Strengthen the risk management function of participating MFIs - Improve corporate governance through the introduction of best practices in recruitment and governance policies 29. TA will be provided to the eligible MFIs accessing the ENREP credit line in collaboration with WEDP. 30. The table below summarizes key general information (as of Sept 2011) for the 8 eligible MFIs identified by the due diligence. The last row shows the % of Government ownership. Ethiopia represents a very special context, where the presence of the Government in the economy is pervasive at all levels. The story of microfinance in Ethiopia is intimately linked to the country’s historical background. The Ethiopian government has assumed a dominant role in providing microfinance at various levels. It owns the largest MFIs and has been directly involved 117 in other ways such as targeted lending programs. Against this background, the ENREP line of credit will necessarily work with MFIs whose share of Government ownership vary from 25% to 96% as specified in the table below, as these are the largest and most financially viable MFIs operating in Ethiopia. Managers of the government-owned MFIs stated during interviews that the government did not control or influence their strategy or operations. The presence of government employees on the boards of directors of many MFIs, however, ensures that some level of government influence is present.22 Even in MFIs which are not government-owned, the influence of the government is apparent in the relatively low interest rates (compared to other countries), small average loan sizes, and the prevalence of group lending techniques, all of which are encouraged by the government, whether local or federal. The ENREP will try to limit the Government’s influence through the TA program in collaboration with WEDP, where the design of tailored financial products and the structuring of operational procedures will take into account the necessity to limit such sphere of influence. At the same time, by supporting also MFIs which are not Government-owned, the ENREP line of credit will provide an important support to the creation of a level playing field in the microfinance sector. Table 4: General information on compliant MFIs ADCSI ACSI DECSI OCSSCO SFPI Wasasa Harbu OMO Q1 2011-12 Q1 2011-12 Q1 2011-12 Q1 2011-12 Q1 2011-12 Q1 2011-12 Q1 2011-13 Q1 2011-14 GENERAL INFORMATION Number of branches 134 238 157 249 10 24 13 168 Number of employees 690 3,000 2,041 2,407 168 225 88 1,263 Number of active borrowers 160,971 689,951 392,639 515,280 55,866 19,359 509,888 Number of outstanding loans 159,783 689,951 392,639 515,280 33,421 55,866 19,359 382,405 Number of active savers 1,705,683 484,626 672,000 33,335 58,036 22,232 51,227 Percent of women borrowers 64% 68% 51% 37% 56.3% 43.8% 47.2% 30.3% Average loan amount (USD) 205 165 281 149 101 127 89 108 Avg. deposit balance (USD) 50 118 64 39 35 25 367 Government ownership (%) 96% 25% 25% 83% 0% 0% 0% 80% 22 This is particularly true for MFIs like Omo, at which 9 of 10 directors are from the government. 118 31. Key financial data for the same subset of MFIs are reported in the table below. Table 5: Financial information on compliant MFIs ADCSI ACSI DECSI OCSSCO SFPI Wasasa Harbu OMO Q1 2011-12 Q1 2011-12 Q1 2011-12 Q1 2011-12 Q1 2011-12 Q1 2011-12 Q1 2011-13 Q1 2011-14 BALANCE SHEET SUMMARY (USD) Total assets 45,102,650 195,231,508 155,945,657 95,300,010 4,988,949 8,138,070 2,224,018 50,249,227 Net loans 32,240,577 111,370,377 107,504,628 75,265,986 3,294,712 6,960,469 1,685,636 36,457,709 Total deposits 10,169,317 84,499,941 57,285,914 46,255,892 1,303,928 2,041,725 629,556 18,776,723 Equity 22,845,936 56,162,898 39,625,307 25,684,725 1,993,288 2,865,126 959,121 11,454,809 CAPITAL ADEQUACY Regulatory capital adequacy ratio 61.9% 36.0% 36.0% 30.4% 44.7% 37.0% 46.8% Total equity to total assets 50.7% 28.8% 25.4% 27.0% 40.0% 35.2% 43.1% 22.8% Paid-up capital (ETB) 231,017,000 2,000,000 4,775,000 65,050,000 406,000 201,000 200,000 1,896,250 PROFITABILITY Return on assets 5.6% 6.4% 2.5% 3.7% 3.7% 8.3% 1.8% 0.7% ROA less donation & non-oper. income 5.6% 4.1% 2.5% 3.7% 8.3% 1.8% 0.6% Return on average equity 11.3% 22.4% 10.4% 14.2% 8.5% 23.7% 3.7% 2.7% LIQUIDITY Regulatory liqudity ratio 90.4% 54.1% 38.0% 23.0% 50.7% 20.1% 36.9% 42.0% Gross loans to deposits 322.6% 135.0% 192.9% 165.8% 258.4% 348.1% 274.3% 219.2% Liquid assets to total assets 20.4% 23.4% 14.1% 11.1% 13.2% 5.1% 10.4% 15.6% CREDIT RISK PAR ratios: 31-90 days 0.1% 0.3% 2.6% 0.00% 0.1% 91-180 days 0.9% 0.1% 0.3% 0.0% 0.5% 0.00% 0.2% 2.7% 181-360 days 0.9% 0.3% 1.3% 0.0% 0.3% 0.00% 0.1% 2.0% 361+ days 1.1% 1.1% 2.0% 2.9% 4.2% 2.49% 3.2% 14.0% Total classified loans (91+) 3.0% 1.5% 3.5% 2.9% 5.0% 2.49% 3.5% 18.8% PAR 31+ to total loans 1.5% 3.8% 5.5% 2.49% 3.6% 18.8% Loan loss reserve to PAR 91+ 58.0% 162.7% 75.9% 65.4% 43.9% 83.1% 68.5% 60.8% Exchange rate 16.98 16.98 16.98 16.98 16.98 16.98 16.98 16.98 32. Some MFIs are more active than others in issuing individual loans, as shown in the following table, where the % of individual lending declared by each of the 8 compliant MFIs is reported.23 Some MFIs is already engaged in lending to renewable energy projects. This indicates that these MFIs may not necessarily need to wait for the completion of the TA before being able to disburse individual loans. Table 6: Individual lending by compliant MFIs MFI % Addis CSI N/A Amhara CSI 19% Dedebit CSI 22% Harbu MFI 15% Omo MFI 1% Oromia CSSCO N/A SFPI 3% Wasasa MFI 1% 23 MFIs are not required to report the number or volume of individual loans to NBE, so the availability of data was limited. 119 Lending Operations and Dedicated Units 33. The lending operations in the HQ are organized under Credit Process, Project Appraisal Sub-Process, and Corporate Loan Approval Team. Credit Process is under a Vice President, while Project Appraisal Sub-Process and Corporate Loan Approval Team report directly to the President. The Bank has also separate units to manage Rural Financing Project (RUFIP) and Export Credit Guarantee and Special Fund, which are under the same Vice Presidency as Credit Process. 34. DBE will act both as a retailer and wholesaler as part of the project. The retail loans will be carried out by current loaning departments according to the bank`s lending policies and procedures. To carry out the project, DBE needs to improve the capacity of RUFIP or establish a new unit under (PIU) the Vice Presidency in charge of Loan Process, which will be responsible for monitoring retail lending operations as well. The Project Coordinator will report to the Credit Officers in the Credit Process and Branch Operations for retail loans and the Deputy PC for the wholesale lending portion will (likely) report to the RUFIP Bureau (or another department under the Credit Process with similar arrangements) Project Officer. Both these functions will be part of the Credit Services Executive Function. 35. DBE has gained extensive expertise in the wholesale lending through Rural Financial Intermediation Program (RUFIP), amounting to US$88.73 million, implemented between 2003 and 2010. The program was financed jointly by IFAD, the African Development Bank (AfDB), the Ethiopian Government, DBE, other participating commercial banks, and MFIs. The objective of the program was to enhance the access of poor rural people to regular and reliable financial services with a view to improving food security and family incomes, as well as to expand outreach to about 1.5 million rural households, develop a community banking framework, and promote linkages between rural financial institutions and the banking sector. Its main focus was to provide incremental resources for on-lending through microfinance institutions (MFIs) together with targeted institutional support. It also provided support to the credit- cooperative sector, which was still in its infancy. After the compilation of the first phase of the program, the lenders have been preparing for the second phase of the program which is expected to amount to US$248 with an IFAD contribution of 40%. 36. DBE has also gained substantial knowledge on the renewable energy through its engagement in lending to renewable energy projects. As a trust agency, the bank has conducted financial assessment of the clients (SMEs, cooperatives, and households) as part of the Ministry of Energy`s (MOE) lending under the Rural Electrification Fund. The bank has been in charge of the loan disbursements and collections on behalf of the MOE. 37. The PIU will report to the Project Steering Committee once a year. The PIU will be staffed with qualified personnel capable of satisfactorily implementing all aspects of the project. Its responsibilities include: - on-lending to PFIs for final lending to sub-borrowers; - effective functioning of the on-lending facility to final borrowers through PFIs; - on-going monitoring of the PFIs and retail loans to ensure compliance with project criteria; 120 - adherence to all fiduciary and safeguard requirements of the World Bank for final borrowers; - monitoring and evaluation based on key project development indicators. Interest rates and on-lending terms On-lending terms from DBE to PSEs: 38. PSEs. The eligible PSEs need to generate enough cash during the pay-back period of the sub-loan to maintain an IRR above the lending rate. They must maintain a maximum debt to equity ratio of 70:30 (after receipt and throughout the payback period of the sub-loan) with capital fully paid-in. No loans will be granted for refinancing purposes. 39. Interest rate. DBE will be free to set its PSE on-lending rates on the basis of market conditions. The sub-loan pricing will be determined by DBE for each particular sub-borrower and sub-project being financed based on their risk ratings in the due diligence reports, with the provision that the interest rate at a minimum be equal to the costs of IBRD loan funds, operating costs of DBE, and an appropriate credit risk margin. DBE will bear the full risk of the loans to PSEs. Currently, DBE charges fixed interest rates at 8.5% in priority sectors and 9.5% in others. As part of the ENREP, DBE`s lending rates will not be fixed. The bank will set the rates in line with market rates. PSEs are expected to pay a commitment charge of 0.5% per annum on committed but not on disbursed funds. 40. Loan amount. DBE will act as a retail agent for PSE lending (loan amount of over US$ 2,500). Inflexible collateral requirements may result in loan amounts being reduced due to inadequate collateral. Loans will be provided on a first come first serve basis, until the PFI achieves its credit cap. 41. Maturity. Loans from DBE to PFIs will have medium-term maturities of 10 years with a grace period of 2 years. On-lending terms from DBE to PFIs: 42. Interest rate. Based on the due diligence conducted on the MFIs, the interest rates from DBE to MFIs should be market based. 43. Maturity. Loans from DBE to PFIs will have medium-term maturities of 10 years. RUFIP is lending at very long maturities of ten years with a five-year grace period. ENREP may reserve the option to include a grace period of no more than 2 years for its loans to MFIs. 44. Allocation of the loan amount to PFIs: The loan amount will initially be credit capped for the PFIs based on their financial strength and perceived absorptive capacity. But loans will be provided on a first come first serve basis, until the PFI achieves its credit cap. 45. On-lending arrangements. DBE would make arrangements for on-lending the funds to the selected PFIs on a monthly or quarterly basis against the prior month’s loan book. PFIs may be eligible for advance payments from DBE against a loan demand schedule to be prepared by 121 the PFI in advance. The procedure for advance payments will be determined in the Operations Manual. Once the allocated amount was drawn down the PFI would be free to recycle the loan as long as it utilizes the funds, in conformity with the ENREP guidelines. 46. Arrangements for Closing of the Line. Interest payments on the line and principal payments after year ten (or year five, depending on the original maturity) by the PFIs would be channeled to the PIU in DBE. The PIU will have the responsibility, subject to approval by MoFED, to channel the reflows back to selected MFIs to extend more sub-loans to the target sector. The PIU could choose at that point to select additional MFIs or to award the amount to the best performing of the initially chosen MFIs. On-lending terms from PFIs to final beneficiaries: 47. Interest rate. PFIs will be free to set their own MSE on-lending rates on the basis of market conditions and without interest rate caps. The PFIs will bear the full risk of the loans to the borrowers. 48. Loan amount. The maximum loan size will be less than US$ 2,500. Inflexible collateral requirements may result in loan amounts being reduced due to inadequate collateral. The lending limits should be set on an individual basis by each MFI, considering market conditions and the MFI’s institutional and operational capacity. 49. Maturity. Loans from PFIs to final beneficiaries will have medium-term maturities of 5 years with no grace period. Monitoring arrangements Monitoring of DBE 50. The PIU will be expected to inform the Project Steering Committee once a year and to report to the Bank on the program’s progress on a quarterly basis. During project implementation regular reviews, which include inter alia, (i) assessing capital adequacy, profitability; and asset quality, (ii) compliance with prudential and regulatory requirements of the National Bank of Ethiopia (NBE); (iii) ownership structure; and (iv) corporate governance and risk management; will be carried out. Specifically the following indicators will be regularly monitored: Table 7: Compliance with the National Bank of Ethiopia (NBE) Prudential Provisions.24 Indicator Requirement Capital adequacy ratio At least 8% Liquidity ratio-general At least 20% Total open foreign currency exposure toward capital At least 15% Maximum exposure to single borrower relative to capital (*) At most 25% Maximum exposure to group of related borrowers relative to capital (*) At most 35% NPL Ratio At most 15% (*) These criteria will apply to loans granted as part of the lending operation. 24 These are based on current NBE prudential requirements and are subject to change. 122 51. DBE will also ascertain that: - Annual financial reports will be prepared according to the Generally Accepted Accounting Standards without major breaches, unless otherwise NBE requires different; - The reports will be audited within a year after the closure of the accounts and the original audited reports would be sent to the World Bank; - The Bank will comply with NBE`s regulations in general and loan classification and provisioning in particular, without major compliances; and 52. DBE will be required to provide an on-going proof of compliance with the above listed compliance criteria – every quarter by its management, and annually by auditor’s certification. Monitoring of PFIs 53. The performance of the PFIs will be evaluated based on the following: (i) number of loans provided through the ENREP line of credit; (ii) average loan size; (iii) total amount disbursed; (iv) collection rate through a report on portfolio aging; (v) portfolio at risk greater than 30 days. 54. Loan agreements with PFIs will contain covenants designed to encourage MFIs to maintain acceptable financial performance (see table below). Table 8: Financial covenants for PFIs Indicator Requirement Regulatory liquidity ratio (as defined by NBE) At least 20% Liquid assets (as defined by NBE) to total assets At least 10% Capital adequacy ratio (as defined by NBE) At least 12% Single credit exposure limit At most 1% of capital Aggregate credit exposure to related parties At most 15% of capital PAR 90 At most 5%25 of gross loans Equity investments26 At most 20% of capital Net fixed assets At most 50% of capital Net income Positive net income in at least one of the previous 3 quarters 55. Non-compliant PFIs will have their access to the LOC suspended, and ultimately terminated. If satisfactory corrective action is not taken, PFIs will be subject to a substantial penalty27. Additionally, the independent external auditors of the PFIs will be required as part of each PFI’s annual statutory audit to provide a report to DBE regarding the accuracy of the loan balance information supplied by the PFI to the DBE when determining the amount of its lending 25 For the purposes of this calculation the MFI can exclude loans which have been delinquent more than 3 years, as some MFIs do not write off old bad loans. 26 Excluding investments in subsidiaries which would be consolidated under IFRS 27 Details on the amount of the penalty and related procedures will be outlined in the Subsidiary Loan Agreement. 123 eligible for ENREP financing. Reporting and compliance checks should be performed quarterly based on the full set of reports required by NBE. 56. The PIU under DBE will have the responsibility of supervising and monitoring the credit line implementation progress. The PIU will monitor the PFIs by the receipt of monthly loan portfolio schedules and supplemental information on loan performance. After the draw down period reports will be quarterly. The PIU will also receive audited financial statements from the PFIs annually with a certification by the auditor of the PFI’s activity financed through ENREP. In addition, PIU staff will be expected to visit the PFIs and interview their management on a periodic basis. Should an MFI prove unable to on-lend its allocation within two years from the first loan draw down, the PIU would be free to allocate the remaining amount to the other MFIs. The PIU and the World Bank, during loan supervision, would have access to the books of the MFI, upon reasonable notice, to do ex-post review of the portfolio under the loan. Use of Bank’s funds 57. Based on their level interest and fit to the program – following implementation arrangements are planned: DBE (would act as wholesale financier for the MFIs who would then on-lend to the beneficiaries at the rural household level) will initially launch the program with OCSSCO and Wasasa MFIs as partners to offer the household credit facility. DBE will continue its role as a direct retailer to the private sector (loan amount of over $2,500). The loans target off- grid renewable energy programs such as, stand-alone solar home systems, solar lanterns, improved cook-stoves, biogas, compact fluorescent lamps, etc. Based on the progress of the program, DBE can expand the MFI network to other partners (to be determined at a later stage) according to the program guidelines, the level of interest of the MFIs, and after a due diligence (financial intermediary assessment) has been carried out to a satisfactory level according to the World Bank policies of the proposed additional MFIs. DBE and MFIs would be jointly responsible for implementing the program using the defined operating guidelines including fiduciary management, reporting and other requirements as needed. 124 Figure 2: ENREP Component 3 Flow of Funds Consultation with IFC 58. The World Bank has received IFC support since the preparation phase of the project, when discussions were held between IFC and the Bank on how to better coordinate and exploit synergies. IFC has been invited to consider its involvement in the provision of credit guarantees to MFIs even if no concrete decision on this has been taken by IFC by the time of project’s appraisal. While IFC is increasing its presence within the Ethiopian private and financial sector, it is recognized that it is not positioned to lend to a policy bank as a wholesaler, as envisioned under this project. 125 ANNEX 9: OPERATING GUIDELINES FOR CREDIT LINE ELECTRICITY NETWORK REINFORCEMENT AND EXPANSION PROJECT Measure Arrangement/Entity 1 Project Life Five (5) years [2012 - 2017] 2 Loan Amount and Financing Total: US$ 50 million (IDA: US$ 40 million, Project Sources Developer’s Equity: US$ 10 million) 3 Borrower Federal Democratic Republic of Ethiopia 4 Implementing Agency Development Bank of Ethiopia 5 Estimated Commitment Period Five years after Credit Effectiveness 6 Eligibility Criteria (Retail PSEs - Investment proposals for renewable energy Lending) and energy efficiency projects. Funds cannot be used for financing or acquisition of existing assets (including land) or refinancing of existing debts 7 Eligibility Criteria (Wholesale MFIs - Investment proposals for renewable energy Lending) and energy efficiency projects to be on-lent to Households. Funds cannot be used for financing or acquisition of existing assets (including land) or refinancing of existing debts 8 Service Charge: IDA to GOE/DBE Standard IDA service charge, 0.75 percent p.a. 9 Interest Rate: GOE/DBE to Market Based PSE/MFIs 10 Interest Rate: MFIs to Household Market Based 11 Maturity: IDA to GOE Standard IDA terms with 40 years maturity including 10 years grace 12 Maturity: GOE/DBE to Based on lending agreements reached PSEs/MFIs 13 Maturity: MFIs to Households Based on lending agreements reached 14 Repayment: GOE/DBE to IDA Semi-Annual 126 15 Repayment: PSEs/MFIs to Monthly (or as agreed) GOE/DBE 16 Repayment: Household to MFIs Monthly (or as agreed) 17 Portion of Loans Market based (or as agreed) -including standard equity requirements for PSEs. 18 Responsibility of GOE/DBE • Processing requests for disbursement of loans; • Maintaining the credit facility related statistical records, incorporating, among other things approval of loans and disbursement made in respect thereof; • Preparing/submitting quarterly statistical reports; • Incorporating, among other things approval of loan and disbursement made in respect thereof; • Informing IDA from time to time, provide regular reports, and assist IDA supervision and/or evaluation mission regarding the progress of the Project; • Monitoring timely preparation and submission of loan completion reports. 19 Environmental/Social In accordance with national standards and Requirements procedures 20 Procurement Procedures Commercial practice 21 Audit Requirements Annual external audit required of Project Account and Special Account, and separate opinion on Statement of Expenditures (SOEs) and the reports should be submitted to the Bank within 6 months after the end of the financial year. 22 Exchange Risk GOE would bear all foreign exchange risk 23 Compliance with Prudential DBE will monitor that participating organizations Regulations are under appropriate laws and conform to regulations. 24 Consumer Education and MOWE in partnership with DBE will educate Protection consumers and promote the renewable energy credit facility * These are general guidelines – formal project guidelines will be outlined in the DBE manual. 127 32°E 36°E 40°E 42°E 44°E SUDAN ERITREA To Keren R REP. ETHIOPIA e OF SELECTED CITIES AND TOWNS d ETHIOPIA To Humera Adigrat YEMEN REGION CAPITALS S Gedaref ek eze Axum T 14°N 14°N NATIONAL CAPITAL D D e T I G R AY en RIVERS a Mekele ak Ras Dashen Terara (4620 m) MAIN ROADS ki Atb il ara RAILROADS Gonder De De REGION BOUNDARIES AMHARA A FA R Lake INTERNATIONAL BOUNDARIES se Dinder Tana 12°N Debra 12°N Tabor Weldiya DJIB DJIBOUTI r rt Bahir Dar Asayita ue 46°E 48°E Bl Nile n Dese o f A d e G u l f Abay b BENSHANGUL Debre Awa w sh er Markos ng Asosa Ethiopian Ha 10°N 10°N Plateau DIRE DAWA Dire Dawa Didesa To Harer Hargeysa Gimbi Nekemte ADDIS ABABA ADDIS HARARI Jijiga ABABA Awash SOMALIA Nazret R Baro Aware am a Welkite Degeh Bur Gore O R O M I YA is Gambela 8°N Domo 8°N GAMBELA y Asela e Ak SOUTH abe Shebele l l o Jima Hosaina O g a d e n W bo a Bonga SUDAN SOMALI V Shashemene Goba Warder Sodo Awasa Dodola Kebri Dehar f t SOUTHERN NATIONS, Wendo W Imi R i NATIONALITES ab e Ge t 6°N AND PEOPLES e sr Wa 6°N ro be Shebe t le e a 0 50 100 150 200 Kilometers Genale G r Negele 0 50 100 150 Miles Ferfer To Yavello Dawa Mogadishu Dolo Odo This map was produced by the Map Design Unit of The World Bank. IBRD 33405 R2 4°N Lake Mega The boundaries, colors, denominations and any other information 4°N shown on this map do not imply, on the part of The World Bank Turkana Group, any judgment on the legal status of any territory, or any INDIAN endorsement or acceptance of such boundaries. KENYA Moyale JULY 2011 OCEAN 32°E UGANDA 34°E 36°E 38°E To 40°E To Wajir 42°E To Mogadishu 44°E 46°E 48°E Marsabit