Report No. PID11480 Project Name CROATIA-CROATIA - ENERGY EFFICIENCY PROJECT (@) Region Europe and Central Asia Region Sector District heating and energy efficiency services (50%); Power (50%) Supplemental Project P071461 Borrower(s) HRVATSKA ELEKTROPRIVREDA LTD. (HEP) Implementing Agency Address HRVATSKA ELEKTROPRIVREDA LTD. (HEP) HRVATSKA ELECTROPRIVREDA Ltd. (HEP) Address: Ulica Grada Vukovara 31 10000 Zagreb, Croatia Contact Person: Mr. Gordana Lucic, ESCO Team Leader, Development Department Tel: (385) 1 632-2302 Fax: 617-0478 Email: Gordana.Lucic@Hep.Hr Environment Category F Date PID Prepared March 20, 2003 Auth Appr/Negs Date March 18, 2003 Bank Approval Date June 24, 2003 1. Country and Sector Background Croatia is undergoing postwar recovery and aspires to energy security and competitive energy markets. The Government's draft energy strategy calls for in-depth reform of the Croatian energy sector. That strategy's objectives are "to assure an efficient energy supply in an environmentally sustainable manner at realistic but socially acceptable prices and to achieve financial sustainability and efficient operations of public enterprises." The sector needs transparent regulation, more competition and private sector participation, increased use of market mechanisms, and tariffs based on production costs. There also need to be concrete programs for increasing energy efficiency and developing renewable energy resources. New energy legislation is under preparation and addresses these key issues facing the sector. 2. Objectives The proposed project will make Croatia's economy less energy intensive by creating an economically and environmentally sustainable market for energy efficiency goods and services. The project will establish a utility-based energy service company (ESCO) to guide the development of the market. ESCO will rely on domestic partners--including service providers, banks, and equipment manufacturers--to exploit project opportunities. By creating such a energy efficiency market, the project will also reduce greenhouse gas emissions in Croatia. The project will focus on reducing two barriers to commercial energy efficiency projects and services: a lack of funding, due to perceived risks among lenders and investors, and a lack of know-how among key stakeholders. The project will address these barriers through a World Bank (IBRD) Loan and a blend of grant and non-grant financing from the Global Environment Facility (GEF). 3. Rationale for Bank's Involvement Local banks, private and public utility customers, and potential investors are reluctant to move forward in the absence of demonstrable success in developing energy efficiency projects. The Bank's involvement is essential to add credibility to local authorities' efforts to increase energy efficiency and reduce dependence on energy imports. The Bank's involvement will enable a sustainable market for energy efficiency goods and services to flourish. GEF's leading role in the project is critical to overcoming barriers to efficient use of energy resources through commercially viable activities. 4. Description The project has four main components: (i) an IBRD loan to the national power utility, HEP, will purchase goods and services that support ESCO activities; (ii) a GEF contingent grant will cover preparation costs for and early investment in the first pipeline of projects; (iii) a GEF partial risk guarantee will leverage commercial bank lending to the ESCO and its projects; and (iv) a GEF technical assistance grant will support training, monitoring and evaluation, and information and dissemination related to overall market development. 5. Financing Total ( US$m) BORROWER $1.00 IBRD $5.00 IDA FOREIGN PRIVATE COMMERCIAL SOURCES (UNIDENTIFIED) $17.40 GLOBAL ENVIRONMENT FACILITY $7.00 Total Project Cost $30.40 6. Implementation HEP will be the borrower of the IBRD loan. HEP and its ESCO will be the recipients of the GEF contingent grant and part of the GEF technical assistance. HEP will coordinate project activities and assume all fiduciary responsibilities for the use of IBRD and GEF funds. ESCO will be responsible for implementing energy efficiency capital investments, assisted by external consultants and a strategic partner that can help build its capacity. A domestic financial intermediary, not yet selected, will act as trustee of the GEF contingent grant and guarantee facilities and will implement related activities. 7. Sustainability The project will contribute to the sustainability of energy efficiency services in Croatia by creating new and better services, removing barriers, increasing the number and size of commercially viable projects, and reducing the risks associated with energy efficiency activities. The proposed project is also sustainable because it requires participation by independent actors--financial institutions, energy service and equipment providers, project sponsors, and users--who are pursuing commercially viable development of the energy efficiency market, with each actor retaining and adjudicating the specific project risk within its core business competency. Project activity in Croatia will be replicated on a commercial basis after the GEF program ends. Lending to users should -2 - continue to grow as financial intermediaries gain experience with the performing loans in their portfolios. 8. Lessons learned from past operations in the country/sector Project design and implementation will draw on utility ESCO models in Canada, Poland, and the United States, and on the Energy Sector Management Assistance Program (ESMAP) on energy efficiency funds. Utility-based demand-side management programs like the Croatia project are appropriate in countries where risks are currently too high for private sector initiative and where public policies can create demand for private services. The project design will also benefit from experience with GEF contingent grant and partial risk guarantee that was gathered from IBRD, IFC and GEF in countries in the region. 9. Environment Aspects (including any public consultation) Issues 10. Contact Point: Task Manager Rachid Benmessaoud The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 473-2696 Fax: (202) 614-1582 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. This PID was processed by the InfoShop during the week ending March 28, 2002. - 3 -