Report No. PID9965 Project Name MOZAMBIQUE-Energy Reform and Access (@) Region Africa Regional Office Sector Power (78%); Renewable energy (16%); Central government administration (6%) Project ID P069183 Supplemental Project P071942 Borrower(s) GOVERNMENT OF MOZAMBIQUE Implementing Agency National Directorate of Energy (DNE) Address: 25 de Septembro Av. 1218 - 3rd Floor P. 0. Box 1381 Maputo Contact Person: Mr. Pascoal Bacela, National Director Tel: 258-1-421789, 258-1-490636 Fax: 258-1-420-245, 258-1-491048 Email: pbacela@Tropical.Co.Mz Electricidade de Mozambique (EdM) Address: 70 Agostinho Neto Av P. 0. Box 2447 Maputo Contact Person: Mr. Vicente Veloso, CEO Tel: 258-1-490636 Fax: 258-1-491048 Email: vveloso@zebra.uem.mz Fundo Nacional da Energia (FUNAE), Ministries of Health and Education Environment Category B Date PID Prepared February 25, 2003 Auth Appr/Negs Date February 6, 2003 Bank Approval Date May 29, 2003 1. Country and Sector Background The four primary issues facing the Mozambique energy sector are; (a) low access to modern energy, in particular electricity, and the poor reliability and efficency of its supply; (b) the adverse environmental, livelihood, and health impacts of traditional biofuels production and use; (c) inadequate promotion and management of low cost export-oriented energy projects; and (d) inadequate staff and under-developed institutions, such as the National Electricity Council (CNELEC) and the National Energy Fund (FUNAE). In recent years the government, with the help of the Bank and other donors, has taken some significant steps toward adopting a legislative and policy framework to reform the sector to meet these challenges. For instance, the 1997 Electricity Law allows for private participation in business units created by unbundling EdM and for awarding concessions to the private sector to develop off-grid supplies. However, little implementation has occured. Each of these issues and Government's strategy for addressing each, are discussed below. 2a. Low access to modern energy and poor reliability and efficiency of supply Only about 6t of Mozambican households (about 220,000 or a population of about 2 million) have access to electricity, and over a half of these are in the capital, Maputo, and its surrounding areas. Outside these main urban areas, electricity access is minimal, and there has been practically no increase in the last 25 years. Of the 120 or so "district capitals", over 50 are without any form of public electricity supply, or have sporadic supplies from small diesel-fueled gensets to a handful of customers via old and poorly maintained small grids. All the provincial capitals besides Maputo, and most of the other 20 or so municipalities, are served by the national grid or isolated diesel-based grids. Even in these areas, supply reliability is low, the household electricity access rate is only 15-20t, and the implicit cross-subsidies (from the Maputo area to the rest of the country) are heavy. The planned pace of access expansion along the main grid is woefully slow. For instance, only 31,000 new customers were added between 1996 and 2000, and less than 50,000 are targeted for the next four years, compared to more than 100,000 new households that will be formed over the same period. The inability of EdM, the national utility, to raise the funds required to connect more customers and the high cost of electrification, are the main reasons for the slow growth. Although the performance of EdM has shown some improvement since internal management contracting began in 1997 -- energy losses have been reduced to around 21- from over 30t in 1998, sales per employee have increased from 4.75 MWh in 1998 to 5 MWh and the rate of return has become positive -- its current performance cannot be said to be satisfactory. For instance, the ratio of payroll to operating expenses has increased from 18t to 24w, the level of receivables has deteriorated from 123 days to 147 days and its contribution to investment has reduced from over 50t to negative. Although the problems can be partly attributed to calamities such as the floods of 1999/2000, much under the control of EdM and the government could be done to improve the utility's performance, including better recurrent expenditure control, better capital expenditure planning, and more timely approval of tariff adjustments. Strategy: To expand electricity access and improve the quality of supply, the government plans to supplement the traditional approach of main grid expansion with a package of technical and institutional changes that lower the costs of service, enhance affordability, employ performance-oriented subsidies, and bring in competitive participation by the private sector, through public-private partnerships. The Electricity Law of 1997 opened the power sector in Mozambique for participation of new entrants, through concession contracts. Implementing regulations to permit private sector participation in all stages of electricity business were passed in April, 2000. Since then, the GoM: (i) has passed a decree establishing a power sector advisory body, CNELEC, with the aim of transforming it to a regulatory body within 5 years; (ii) - 2 - is in the process of separating generation, transmission and distribution/supply functions of EdM to in order to run them as separate business lines; and (iii) has established an "energy fund" (FUNAE) to collect specific levies, and to channel subsidies to specific projects to expand access to modern energy or for demonstration projects. Subsequent to the separation of EdM's functions and the creation of separate profit centers, the government plans to commercialize the utility and invite strategic private investment and management in Distribution. It should be noted that EdM-owned and operated Generation is insignificant as most of the power is either imported from South Africa or purchased from the Cahora Bassa plant, and that future generation capacity will be implemented by the private sector. Furthermore, the government intends to develop future transmission assets jointly with the private sector but to retain management of the transmission assets. The transmission company will also be the single buyer. The Government is also in the process of concessioning out the North Inhambane mini grids which were constructed under the IDA-funded Urban Household Energy Project (UHEP). This model, of decentralized energy supply through an off-grid system, could be replicated in other parts of the country which cannot be economically connected to the national power grid. 2b. Adverse environmental, livelihood, and health impacts of traditional biofuels production and use Most of Mozambique's primary energy consumption is met by traditional biofuels (wood, charcoal, and agro/animal wastes) that are produced and used inefficiently. Work done under the Urban Household Energy Project (UHEP), including the Energy Sector note, has shown that heavy urban reliance on woodfuels, while a significant source of income and employment to the supplying communities in rural areas, imposes significant environmental costs. On the supply side, the growing demand for charcoal and fuelwood in the principal cities (Maputo, Beira, Nampula and Quelimane), combined with inefficient charcoal production practices, has led to a significant depletion of the forest stocks around those cities and in some cases as far away as 200 kms. As such stocks are depleted, supplying communities lose a significant source of their cash incomes and risk a loss of land productivity. On the end-use side, traditional combustion technologies and practices cause significant indoor air pollution, with adverse health consequences, particularly for women and children. The transition to modern cooking fuels is hampered, even in urban areas, by limited access to such fuels or high initial costs. Most of the kerosene the poor purchase is used for lighting purposes due to lack of access to electricity. Strategy: To mitigate these adverse impacts, the government plans to: (a) reform the legal and regulatory framework for land use, wood extraction and charcoal production, including allowing for land ownership by the communities; (b) strengthen the resource management capabilities of rural communities and create substitute means of income generation, other than woodfuels exploitation, for them (based on a pilot implemented under the UHEP, which included brick-making, charcoal production, oil extraction, pottery and nurseries for medicine extraction); (c) expand -3 - access to modern cooking fuels (LPG and gelfuel); and (d) employ more efficient and/or cleaner technologies of woodfuels use, such as the more efficent wood/ charcoal stoves. 2c. Inadequate promotion and management of export-oriented energy projects Mozambique is rich in modern energy resources such as hydro power, natural gas, and coal, and can exploit them for exports and for domestic use. Currently the largest part of the power sector in Mozambique is the "export-oriented" market, centered around Cahora Bassa hydro power plant. In addition, GoM has recently reached agreements with foreign companies for the development of Pande and Temane gas fields, and building a gas pipeline for exports to South Africa. A number of other export-oriented, private sector-led energy projects, based on hydroelectricity, coal for energy, and other minerals such as titanium, are at various stages of planning or implementation. Prudent management of these energy and industrial projects via careful contracting and fiscal policies can yield significant revenues for macroeconomic stability and developmental expenditures, and provide an impetus for other foreign direct investments. Conversely, inappropriate management can expose the country to significant adverse risks, such as contract disputes, delays in financial closures and project investments and potential adverse environmental and social impacts of project development. Strategy: The government realizes that building internal capacity to effectively negotiate the concessions and contracts will be a long-term process and its strategy is to seek external assistance while such capacity is being built. The ongoing Gas Engineering project is providing support in this respect and in connection with the Mozambique-South Africa gas pipeline project, whereas the planned Southern Africa Power Market project will provide an interconnection of the power grid with neighboring countries. These projects will also enable Mozambique access a wider market and get better a better prices for its energy exports. 2d. Inadequate institutional and human resource capacity While in some respects Mozambique has gone far in legislative changes to liberalize the energy sector, the pace of implementation, and of showing concrete results on the ground, has been slow and will remain so because of limited institutional and human resource capacity. For instance, CNELEC was provided for in the Electricity Law of 1997, yet its board members were only appointed in November 2001 and to-date they have not begun to operate because of the lack of personnel and office facilities. Due to a shortage of adequately trained personnel in DNE, it has relied heavily on advisors provided by bilateral donors, and the transfer of knowledge has not been effective due to a shortage of graduate staff to understudy the advisors. Strategy: The government realizes that the development of local staff is a long-term process and that the energy sector will continue to rely on external assistance for a long time to come. In line with recommendations of the Institutional Diagnostic Study, it plans to develop and utilize more efficiently the limited capacity in the public sector and wherever possible, the local private sector. It plans to take advantage of this and other projects to provide hands-on and classroom training, - 4 - selectively, for existing and new staff. Furthermore, it plans to select more carefully and better coordinate, donor-funded technical assistance and investments (as is evident on this project and the Danida-funded Energy Secor Program Support project where coordination will be done jointly). Selectivity is one of the reasons the first phase of the program will be kept small, to first enable "learning-by-doing" on a small scale before scaling-up in the second phase after adequate knowledge and experience have been gained. 2. Objectives The development objectives are to: (a) accelerate, in a commercially viable manner, the use of electricity for economic growth and social services and thus improve the quality of life in un-served and under-served areas (peri-urban and rural); and (b) strengthen Mozambican capacity to increase access to modern energy. It seeks to achieve these objectives via supporting the implementation of the Government of Mozambique (GoM) National Energy Strategy of October 2000 that, inter alia, aims at reforming the country's energy sector and implementing an enabling environment for private sector participation in the sector. 3. Rationale for Bank's Involvement One of the main contributions of the Bank to this project is its ability to function as a "knowledge bank". This brings to Mozambique fresh approaches to solving its problems, taking account of Mozambique's current situation and growth potential, while incorporating the experience of and key lessons learned in other countries. Much of the sector reform work to date - preparation of 1997 electricity and petroleum laws, concessioning decrees and national energy strategy - has been financed by the Bank. Looking forward, the Bank's knowledge assistance will be geared at fostering a consensus among the various stakeholders toward new approaches to sector development and maximizing aid effectiveness, in order to achieve a broad, sustainable development impact of aid-financed investments. A second major contribution of the Bank will be in donor coordination - by providing donors with effective grant funding channels and building selective cross-sectoral partnerships in the context of the Poverty Reduction Strategy Paper. Such cross-sectoral activities are planned to be targeted at helping meet the energy needs of rural health and educational facilities and improving the quality of social services delivery. The GEF's value added goes beyond the grant support provided by it. While there have been a number of donor-supported renewable energy activities in Mozambique, their impact has been generally limited to the actual projects supported. GEF's support will make it possible to develop a more programmatic approach, within which individual projects could be developed. 4. Description Phase 1 Project activities will be clustered around the following four main components: Power Sector Reform, Grid Electrification, Renewable Energy Promotion and, Institutional Development and Capacity Building. 1. Power Sector Reform -5- 2. Grid Electrification 2.1 Main grid sub-component (29.17) Peri-urban (29.17) 2.2 Independent grids sub-component (16.39) Technical assistance (0.98) Investments (15.41) 2.3 Environmental Management (0.76) 3. Renewable Energy Promotion 3.1 Solar PV investments (6.09) 3.3 TA/capacity building (3.30) 3.4 PDF grant (0.30) 4. Institutional strengthening & capacity building 4.1 Regulatory studies & CNELEC advice (1.07) 4.3 Training (0.63) 4.4 Office equipment (1.04) 4.5 Project coordination (1.50) 4.6 Preparation of Phase 2 (0.80) 4.7 PPF (0.6) 5. Financing Total ( US$m) BORROWER $8.08 IBRD IDA $31.22 AFRICAN DEVELOPMENT FUND $8.00 DENMARK: DANISH INTL. DEV. ASSISTANCE (DANIDA) $2.00 GLOBAL ENVIRONMENT FACILITY $3.09 NORDIC DEVELOPMENT FUND $6.00 FOREIGN PRIVATE COMMERCIAL SOURCES (UNIDENTIFIED) $8.88 Total Project Cost $67.27 6. Implementation Core at the implementation of the program are the community leaders, private developers, local entrepreneurs, rural community groups and other organizations that directly interact with the rural poor the program is aiming to serve. To facilitate the involvement of these group, the following institutions have an implementing responsibility within the Project: the National Directorate of Energy (DNE), the National Energy Fund (FUNAE), Electricidade de Mozambique (EdM), Ministry of Health and Ministry of Education. PODE, even though not a formal signatory to the project, is a critical partner is providing debt financing as well as technical assistance funds for private parties. DNE will be responsible for overall coordination, through a Project Facilitation and Administration Unit (PFAU). In addition, it will have primary responsibility for implementing the off-grid and renewable components. The PFAU will complement the day-to-day duties of DNE and FUNAE, in particular with facilitation of the market development process as well as administration and other fiduciary requirements. In line with - 6 - the objective of building capacity within the enery institutions, priority will be given to utilizing existing and new regular staff for the coordination work. However, due to shortage of such staff, it will be necessary to also employ external staff to be dedicated to the project. DNE will host a Rural Energy Coordination Committee (RECC), which will consist of the core parties involved in rural development. These will include: DNE, Ministry of Rural Development, representative for the Ministries of Health, Education and Agriculture, representative from local government, FUNAE, representative from the private sector, PODE and EdM. The core task of the committee will be to initially assure coordination in the project approval process, evolving in an entity that sets the direction for rural electrification in the country; potentially into a Rural Electrification Agency. DNE (through the PFAU) will be responsible for awarding the concessions for the isolated grid projects and for providing technical assistance to FUNAE until adequate capacity is developed in FUNAE. It will also implement the technical assistance components concerning DNE, FUNAE and the other Energy institutions (excluding EdM), and Power Sector Reform. A key issue that needs to be resolved during the first phase of the APL is the level of implementation authority that will remain within DNE. Over time its mandate clearly states that it will focus on policy, strategy and coordination of energy in the country. It will facilitate the implementation and allow the financing of projects to be the full responsibility of FUNAE and commercial financiers. FUNAE will have primary responsibility for operating the MECS, and will be co-signatory for subsidy funds released by the Project (for independent grid and renewables components). Other signatories will be DNE (for all subsidy funds) and the Ministries of Health and Education (for GEF Cross-sectoral funds). FUNAE will be supported by a trust agent, that will disburse the subsidies to project sponors on achievements of the agreed outputs. Ministries of Health and Education (through existing PIUs) will be the lead agencies for the cross-sectoral component, and they will be provided technical support by DNE and the PFAU. EDM (through its PCU) will implement the Grid Intensification component and provide support to DNE on the Power Sector Reform component. PODE will provide credit for investments to the private sector (concessionaires and dealers) and also support technical assistance required by them. Funds Flow. The Government will on-lend part of the IDA Credit (about US$ 11.6 million) to EdM to implement the Peri-urban Electrification component. The Government will grant part of the Credit to the ministries of Health (US$1.5 million) and Education (US$1.5 million) for the Cross-sectoral components and to MIREME (US$6.5 million) for the Sector Reform, Institutional Development and Capacity Building components. The balance of the Credit will be administered by FUNAE and DNE (through a Trust Agent) for the MECS. -7- The GEF Grant (US$3 million) will be administered by FUNAE and DNE (through a Trust Agent) and renewable energy developers will be able to draw on the Grant on an output basis. The Grant will also be available for specific technical assistance with respect to the Renewable Energy component. 7. Sustainability The sustainability of specific investments depends on whether the geographic area in question has reasonable potential for catalyzing economic growth and expanding the market for electricity. For example, whether some "anchor customers" (such as an agro-industrial enterprise or some public service institutions) exist, and whether the rules for cost recovery and performance targets for subsidies are complied with. This is being ensured by carefully selecting areas of demonstrated ability and willingness to pay at least the operating costs of electricity provision. Further, by adopting a program approach with a small first phase comprised, mainly, of sector reform and "learning-by-doing", as well as by utilizing the experience gained from the existing three mini grids, the risk of failure is reduced. 8. Lessons learned from past operations in the country/sector Main-grid based rural electrification. In recent years, development agencies have supported few utility-executed main-grid rural electrification projects, primarily because of the generally poor past performance. In Africa, few power utilities have had any significant success in rural electrification. In general, grid-based rural electrification executed by state-owned power utilities, coupled with a uniform national tariff to cross-subsidize rural consumers, as has been common in the Bank's client countries, rarely delivers any significant development impact. It frequently leads to extension of the grid to rural areas, but without actually connecting any significant number of households or small and medium enterprises or providing reliable services. Thus, one of the key lessons is that it is best to shift to commercially-oriented rural electrification, employing cost-based, regionally differentiated distribution tariffs that provide market signals for expansion and scale-up. One implication of this approach is that subsidies should be directed at expanding access - they should finance initial capital costs rather than consumption, which tend to limit benefits to a privileged few "first-comers". The project's design thus provides for capital subsidies, which will be mainly output-based. A second key lesson is that it is possible to reduce the costs of rural electrification significantly with little, if any, loss in quality of service. The standards and procedures utilized by most power utilities are mostly too costly for rural or peri-urban conditions, and often reflect past practice in developed countries. It is possible to introduce lower-cost technical standards and operational procedures that have already been tested and found acceptable in other places in the world, including some countries in Africa, such as Ghana and South Africa. However, state-owned utilities are frequently unenthusiastic about such changes. Greater reliance on the private sector or some incentives to the utility, is therefore required. Studies on low cost electrification have been conducted during preparation, with the full engagement of EdM, and it has been established that a reduction in capital cost of at least 20- is possible. Experts on specific low-cost technologies have also made - 8 - presentations to EdM staff. EdM has agreed to adopt the recommendation of the studies in the detailed project design, for which implemetation will be through supply and installation contracts instead of force account. Independent grids. This is still an emerging option for rural electrification, with only limited experience available, which has so far been favorable. In any case, it is clear that in a number of circumstances, independent mini-grids are not only lower cost than grid extension, but also that governments find it easier to permit cost-based tariffs for these mini-grids. Here also it is important to introduce lower cost designs, technical standards and operational procedures, so that the cost-based tariffs are affordable for a larger segment of the population. Consultations with Mozambican and foreign private companies has suggested that with the sector reforms and regulatory approaches contemplated under the proposed project, they would be interested in equity and debt participation if the "rules of the game" provide sufficient incentives and protection against risks. Experience in other parts of the world has shown that even in the absence of a regulatory and financing framework, small-scale entrepreneurs often do engage in electric service business to serve small loads, provided the supply and financing chains for equipment and fuel exist and there is little risk of confiscation by the government. Solar PV systems. It is clear that solar PV systems are technically suitable for, and workable, in the rural areas of developing countries, where grid supply is not available. However, prices in Africa remain far higher than in Asian countries, where systems that meet international standards (such as those specified in Bank-supported projects) are available at prices that are up to 50- lower. Thus, better linkages between Asian and African markets would reduce prices in Africa. Another key lesson is that significant resources are required initially to lower the barriers that impede greater use of solar PV systems. These include, for instance, resource assessments, strategy papers, demonstration schemes, training, and building broader awareness of PV distribution as a viable retail business. At the same time, such nominally "upstream" activities, if carried out in isolation and without links to a program of actual procurement and use of, do not lead to market development. To the contrary, a viable investment financing program helps "learning by doing" and improve the quality and impact of such "upstream" activities. Two different institutional models have been used in disseminating solar PV systems: the vendor model in which the end-user (e.g., household) owns the system and may have service contract with the vendor, and the concessionaire model, in which an energy service company owns the system, and the end-user simply pays a periodic (e.g., monthly) fee for the energy provided. The vendor model has been used in Bank-supported projects in Asia, and the concessionaire model has been used in a Bank-supported project in Argentina. In sub-Saharan Africa, the vendor model has emerged spontaneously in countries such as Kenya, which has a vigorous solar PV market, and Zimbabwe, while the Government of South Africa has opted for a concessionaire model. The project design allows for either model to be used as appropriate. The -9- concessionaire model may be adopted where concessions are awarded for independent grid supply, but in parts of the concession area where extension of the grid is not feasible and there is therefore demand for solar PV. This will, however, not preclude customer ownership, if they so wish. 9. Environment Aspects (including any public consultation) Issues An environmental and social impact analysis (ESIA) for Phase I of the proposed APL has been prepared with a view to identify potential environmental and social impacts of future sub-projects (distribution networks and sub-stations; diesel and gas powered generators; solar PV systems; and micro-hydropower systems) and to propose measures to mitigate such impacts (loss of vegetation, habitat disturbances, soil erosion, soil and noise pollution, land acquisition). The ESIA report concluded that (i) negative impacts on natural habitats would be unlikely given that the proposed project will be implemented in small rural towns or centers and in peri-urban areas where few, if any, critical habitats are remaining; and (ii) the construction of distribution lines, sub-stations, generation plant and other project-related infrastructure is unlikely to involve land acquisition; the permanent loss of infrastructure and other assets is likely to be minor. Wherever possible, future sub-stations will be located on public land or unused "waste" lands. Nonetheless, sub-project proposals will be screened for potential safeguards issues and appropriate measures will be taken as required to ensure compliance with safeguard policies. For example, if a sub-project would result in the significant conversion of a natural habitat, this sub-project would not be funded under the proposed project. Since the sites for future sub-projects have yet to be finalized and no design details (i.e. distribution network plans) are available, a generic rather than a site-specific approach to preparing the ESIA report had to be adopted. Towards this end, the ESIA report outlines processes for (i) environmental and social screening of sub-projects; (ii) the environmental management of sub-projects; (iii) the implementation of sub-projects; and (iv) monitoring; it also (iv) identifies needs and cost estimates for capacity building and training; and (v) includes a Resettlement Policy Framework to address potential social impacts due to land acquisition. The above processes would be applied to Phase II of the APL if it were decided to finance the second tranche. In the event that Phase II includes the rehabilitation and expansion of transmission lines or other activities not included in Phase I, separate EAs would be carried out to address their environmental and social impacts. 10. Contact Point: Task Manager Reynold Duncan The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: 458-4609 Fax: 473-5123 - 10 - 11. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. - 11 -