Document o f The Wor ld Bank

FOR OFFICIAL USE ONLY

Report No. 24202-MD

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT

IN THE AMOUNT OF

SDR 25.7 MILLION (US$35.0 MILLION EQUIVALENT)

TO THE REPUBLIC OF MOLDOVA

FOR AN

ENERGY I1 PROJECT

October 30,2003

Infrastructure and Energy Department Ukraine, Belarus and Moldova Country Unit Europe and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not be otherwise disclosed without World Bank authorization.

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ANRE CAS CHP CP DH EA EBRD

EIRR EMP E M S ERR FIRR FRR F S U GDP GOM I A S I C R IDA

IFC IMF I S A

kWh

MIGA

CURRENCY EQUIVALENTS

(Exchange Rate Effective September 2003)

CurrencyUnit = L e i L e i 13.5 = US$1 US$.07 = L e i 1

FISCAL YEAR January 1 -- December 31

ABBREVIATIONS AND ACRONYMS

National Energy Regulatory Agency Country Assistance Strategy Combined Heat and Power Communist Party District Heating Environmental Assessment European Bank for Reconstruction and Development Economic Internal Rate o f Return Environmental Mitigation Plan Energy Management System Economic Rate o f Return Financial Internal Rate o f Return Financial Rate o f Return Former Soviet Union Gross Domestic Product Government o f Moldova International Accounting Standards Implementation Completion Report International Development Association International Finance Corporation International Monetary Fund International Standards o f Auditing

ME MTE MWh N D C NPV O & M PCB

PIP P I U PLC PMR PPF QCBS SA SAC SCADA SEK SIDA SIL

SOE tcm UCTE

Moldelectrica Moldtranselectro Megawatt hour National Dispatch Center Net Present Value Operation and Maintenance Polychlorinated Biphenyls

Project Implementation Plan Project Implementation Unit Power line carrier Project Monitoring Report Project Preparation Facility Quality and Cost Based Selection Special Account Structural Adjustment Credit System Control and Data Acquisition Swedish Kronor Swedish International Development Agency Specific Investment Loan

Statement o f Expenditure thousand cubic meters Union for the Coordination o f Transmission o f Electricity

Development Kilowatt hour U S A I D United States Agency for International

Multilateral Investment Guarantee Agency

Vice President: Shigeo Katsu Country Director: Luca Barbone

Sector Director: Hossein Razavi Task Team Leader: Vladislav Vucetic

A. Project Development Objective

1. Project development objective 2. K e y performance indicators

CONTENTS

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2. M a i n sector issues and Government strategy 3. Sector issues to be addressed by the project and strategic choices

C. Project Description Summary

1. Project components 2. K e y policy and institutional reforms supported by the project 3. Benefits and target population 4. Institutional and implementation arrangements

D. Project Rationale

1. Project altematives considered and reasons for rejection 2. Major related projects financed by the Bank and/or other development agencies 3. Lessons leamed and reflected in the project design 4. Indications o f borrower commitment and ownership 5. Value added of Bank support in this project

E. Summary Project Analysis

1. Economic 2. Financial 3. Technical 4. Institutional 5. Environmental 6. Social 7. Safeguard Policies

Page

2 2

2 3 7

8 11 11 11

13 14 16 17 17

18 18 25 26 29 32 35

F. Sustainability and Risks

1. Sustainability 35

This document has a restricted distr ibution and may be used by recipients only in the performance o f their official duties. I t s contents may not be otherwise disclosed without W o r l d Bank authorization.

2. Critical risks 3. Possible controversial aspects

G. M a i n Loan Conditions

1. Effectiveness Condition 2. Other

H. Readiness for Implementation

I. Compliance with Bank Policies

Annexes

Annex 1: Project Design Summary Annex 2: Detailed Project Description Annex 3: Estimated Project Costs Annex 4: Cost Benefit Analysis Summary, or Cost-Effectiveness Analysis Summary Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary Annex 6: Procurement and Disbursement Arrangements Annex 7: Project Processing Schedule Annex 8: Documents in the Project File Annex 9: Statement o f Loans and Credits Annex 10: Country at a Glance Annex 1 1: Social Assessment: Energy-related Social Issues Annex 12: Criteria for the Selection o f Buildings for the Heating Improvement Component

36 37

37 37

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40 44 50 51 54 63 80 82 83 84 86 89

MOLDOVA Energy I1 Project

Project Appraisal Document Europe and Central Asia Region

Infrastructure and Energy Department Ukraine, Belarus and Moldova Country Unit

Date: October 30,2003 Sector Managermirector: Hossein Razavi Country Managermirector: Luca Barbone Project ID: PO40558 Lending Instrument: Specific Investment Loan (SIL)

Team Leader: Vladislav Vucetic Sector(s): Power (80%), Central government administration (20%) Theme(s): State enterprisehank restructuring and privatization (P), Infrastructure services for private sector development (P)

[ ]Loan [XI Credit [ ]Grant [ ]Guarantee [ ]Other:

For LoanslCreditslOthers: Amount (US$m): 35.0 equivalent

Proposed Terms (IDA): Standard Credit Grace period (years): 10 Commitment fee: 0.5%

Years to maturity: 40 Service charge: 0.75%

IDA SWEDEN: SWEDISH INTL. DEV. COOPERATION AGENCY

Borrower: REPUBLIC OF MOLDOVA Responsible agency: MOLDELECTRICA, SELECTED MUNICIPALITIES AND MINISTRIES Moldova Energy Projects Implementation Unit (MEPIU) Address: str. 31 August, # 82, Office # 2 Contact Person: Ms. Ludmila Burlui, Executive Director Tel: (373-2) 23-47-56 Fax: (373-2) 23-34-41 Email: mepiu@ch.moldpac.md - Estimated Disbursements ( Bank FY/US$m):

Project implementation period: 4 years Expected effectiveness date: 0212512004 Expected closing date: 04/30/2008

C I PAD ‘03 Ita? u m m

A. Project Development Objective

1. Project development objective: (see Annex 1)

The objectives o f the project are to:

(i) improve the security and reliability of the electricity transmission system and wholesale electricity supply and, therefore, facilitate unimpeded commercial operation o f the power system, both domestically and intemationally; and (ii) improve the availability, quality, and efficiency o f heating in selected priority public buildings (schools, hospitals, and residential buildings for disabled and other vulnerable groups).

2. K e y performance indicators: (see Annex 1)

For the first objective, the key performance indicators by the end o f the project and in comparison to parameters in the year 2002, are:

(a) Reduced outage rates o f the high-voltage transmission l ines and substations (see Annex 1) by 35%.

(b) Reduced unserved energy by 200 MWh per year.

(c) Reduced technical losses by 5% from upgraded dispatch.

(d) Reduced nontechnical losses (through the upgraded metering) by 75%.

For the second objective, the key performance indicators by the end o f the project and in regards to the consumers identified in para. Al(ii), are:

(a) service, from 30 days to 120 days per year during the heating season.

Increased availability of heating service to those public buildings which have access to the heating

(b) Number o f buildings included in the project: 80.

(c) in the design conditions.

30% increased heating-system efficiency, exemplified by a lower specific heat consumption (W/m2)

B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: IDA/R2002-0089

The 1999 joint IBRDIIDMFC CAS has three objectives: macroeconomic sustainability, private sector development, and public sector reform, designed to improve economic growth in support o f reducing poverty and social hardship. The joint I D N I F C CAS Progress Report, which was discussed by the Board on June 20, 2002, reflected the same objectives. The proposed project i s consistent with all three objectives. It would promote macroeconomic sustainability by: (i) helping stem the accumulation o f new public debt related to electricity sector enterprises by fostering better financial performance and supporting the further privatization o f these companies, (ii) promoting economic growth by improving the reliability o f electricity supply to the economy, and (iii) helping restructure the outstanding debt in the energy sector. The project would support private sector development through better supply o f electricity to private

Date of latest CAS discussion: June 20,2002

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industry and by supporting privatization o f major electricity companies. It would also support public sector reform by helping improve energy efficiency in selected public buildings, reinforcing the autonomy of the national energy regulatory agency (ANRE), and encouraging the Govemment to maintain well-targeted and fiscally affordable subsidies for energy consumption and control consumption o f budget entities.

2. M a i n sector issues and Government strategy:

Background. Moldova i s poorly endowed with commercially exploitable energy resources and the country has to rely almost entirely on importing o i l products, gas, electricity, and coal to cover i t s energy needs. Energy consumption plummeted during the last decade, reflecting the even steeper economic decline. Moldova now consumes about 0.8-1.2 bi l l ion cubic meters o f gas annually, excluding Transnistria (the breakaway region o n the le f t bank o f the Nistru river), al l imported from Russia at a net price o f US$60 per thousand cubic meters (the gross price i s US$80 per tcm, but Moldova collects transit fees for the Russian gas transported over Moldova to third countries, which reduces the net price o f gas consumed in Moldova). Annual consumption o f o i l products i s about 350,000-400,000 tons (all imported), and o f electricity about 3-3.5 bi l l ion kwh, o f which only 20-25% i s generated by the plants on the right bank o f the Nistru river, the rest being imported from Ukraine (mostly) and Romania and generated in Transnistria. Retail gas tar i f fs in Moldova are about US$2.1 per bi l l ion Joules. Electricity tar i f fs are among the highest in the Former Soviet Union: 4.5-5 US cents per kwh (depending on the exchange rate) for the northem parts o f the country, supplied by the state-owned companies, and 5-5.5 U S cents kwh for the remaining temtory, supplied by the privatized companies.

Transnistria covers about 12% of Moldova's territory, with a similar share o f population. The Transnistrian authorities declared independence in 1994, but it has not been recognized intemationally nor by Moldovan government. The region is, however, o f high economic importance, as it straddles major land routes to Ukraine (and on to Russia), as well as significant energy transport infrastructure -- electricity transmission l ines and gas transport pipelines. Some o f the largest industrial facilities in Moldova, including the largest power plant (Moldovskaya thermal power plant) are also located in Transnistria.

Moldova's strategic choices regarding the mix o f energy imports, technological options for electricity generation, heating and energy usage, physical infrastructure for energy delivery, and industrial structure o f the energy sector were developed during the Soviet era and driven by the Soviet political considerations and economic development objectives and conditions, in which inexpensive energy and central planning were major elements. This had led to some sub-optimal choices both in the country's energy infrastructure -- such as poor electricity connections with non-FSU countries, development o f uneconomic centralized district heating systems, energy intensive technologies and construction standards, inadequate energy metering, etc. -- and energy sector governance and organization. These problems were exacerbated by the c iv i l conflict in the early 1990s and the subsequent self-separation o f Transnistria, which controls significant elements of Moldova's energy infrastructure (gas transit pipelines, electricity import lines, and electricity generation capacities).

Moldova responded slowly to the rapidly increasing prices o f energy imports in the post-independence period. The Government, acting simultaneously as policy maker, regulator, owner, and utility manager, was slow in passing the increase to energy consumers and was not able to pay the difference between the supply costs and consumer tariffs. This resulted in a large energy-related quasi-fiscal deficit (estimated to be at about 5% o f GDP in 1998 and 1999), financed in large part through asset consumption and accumulation of debt (mainly in the form o f payment arrears). As result, the country accumulated large external debts, while postponing maintenance o f and investments in energy infrastructure. In parallel, financial discipline

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in the sector weakened, quality of management deteriorated, and corruption became widespread. The companies had increasing difficulty in maintaining supply and shortages in electricity and gas supply developed. The sector, forced to subsidize consumers and suffering from theft and mismanagement, was rapidly deteriorating, accelerating economic decline.

Energy Sector Reforms 1997-2002. To avert the escalating energy crisis in the mid 1990s, Moldova embarked on an ambitious set o f reforms in the energy sector, whose main objective was full commercialization o f energy supply, accompanied by appropriate social policies implemented through fiscal instruments to protect the most vulnerable groups. The reform has been supported by international finance organizations, with the World Bank playing the leading role. The main elements o f the reforms were:

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development of a new, market-oriented legal framework a new set o f energy laws, codifying separation o f regulatory, policy and ownership functions, allowing private ownership in the energy sector, unbundling and corporatization o f the industry, and liberalization o f energy trading was adopted in 1998;

establishment of an independent energy regulatory agency (ANRE), in 1997;

restructuring and corporatization: the country's vertically integrated electricity monopoly was unbundled into 5 distribution companies, 4 generation companies (3 combined heat-and-power plants, and a small hydropower plant), and Moldelectrica, a transmission and dispatch company. All companies were converted into joint stock corporations, except Moldelectrica, which i s a state enterprise. The country's district heating networks were transferred from the central state to the municipal governments;

changing electricity trading rules: in 1999, electricity trading rules were changed so that distribution companies were made solely responsible for contracting directly with importers and domestic generators sufficient amounts o f electricity to supply their customers. This model displaced the single buyer model, where the single buyer (Moldtranselectro) imported electricity or bought it from domestic generators and sold it to distribution companies. In conjunction with privatization o f a substantial share o f electricity distribution (about 70%), this bilateral contracts-based market allowed significant reduction o f state's direct or indirect involvement in electricity trading, unlike in the case o f single-buyer trading arrangements through which the state usually continues to exercise i t s influence and/or accumulate direct and contingent liabilities. In early 2003, the regulatory commission began allowing gradual opening o f the end user market, starting with consumers connected directly to the transmission network;

debt restructuring: historic debts o f the electricity sector -- accumulated by distribution companies before their privatization and by Moldtranselectro (before the change o f electricity trading ru les and the creation o f Moldelectrica) -- were transferred and consolidated on the books o f Moldtranselectro, which became a debt-holding company, without any involvement in the sector's operations;

adjusting the level and the structure of tarus: in the pre-reform period (before 1997) nonresidential tariffs for all types o f energy were significantly higher than residential, and al l tar i f fs were generally below costs. For example, residential electricity tar i f fs in 1996 were between 1.2-1.6 U S cen tskwh (average tar i f fs were below 3 U S centskwh). This implied significant cross-subsidies to residential consumers for energy consumption In 1997, tari f fs were increased and equalized for al l consumers to about 5.1 U S centskwh, the level which has been more or less maintained since then;

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0 reducing and re-targeting subsidies for energy consumption: subsidies for electricity, heating, and gas have been substantially reduced in 2000 and brought in l ine with budget means by eliminating a number o f groups whose eligibility was unrelated to their income;

privatization of electricity distribution companies: three o f the five electricity distribution companies, covering about 70% o f the market, were sold in February 2000 to Union Fenosa, an international investor and electricity operator from Spain, through an open intemational tender, and

divestiture of gas industry: The majority o f shares in Moldovagas - the country’s monopoly gas supplier - were sold to Russia’s Gazprom, in exchange for a portion o f the debt.

These achievements have put the energy sector in Moldova at the forefront o f economic reforms in the country and at the forefront o f energy sector reforms among the FSU countries. The reform achievements have started to show important benefits, and have improved the sectoral environment for the proposed project:

0 payment collections increased, especially for electricity: both privatized and state-owned electricity distribution companies improved their collections. While some problems with collecting from state-owned entities remain, such as district heating and water companies, state-owned distribution companies have been collecting between 90% and 100% (and even recovering some debts for past deliveries), almost entirely in cash (in mid 199Os, cash collections were about 30-40%). The privatized distribution companies also report collections close to 100%;

reliability of energy supply improved: reliability o f energy supply improved dramatically, especially in the areas outside the capital Chisinau (it improved in Chisinau as well, but the supply in the city had been better than in the rest o f the country even before the reform);

electricity import prices to the privatized companies have dropped substantially (by 25-30%), as the creditworthiness and credibility o f the companies improved, and

quasi-fiscal deficit reduced The Government stopped accumulating extemal debt for gas and electricity imports, except for the electricity supply in non-privatized areas.

The Bank Group has been supporting the energy sector reform in Moldova through investment, adjustment, technical assistance, and guarantee operations. The first Energy project, approved in M a y 1996 and closed at the end o f 2001, helped install consumer gas meters and provided some high priority repairs at the country’s largest CHP plant. An Energy Sector Reform Institutional Development Fund grant, disbursed over the 1995-1997 period, helped advance institutional reforms in the sector. Two structural adjustment loans and credits, one approved in 1997 and the other in 1999, supported the sector’s institutional restructuring, commercialization, and privatization. The Third Structural Adjustment Credit (SAC 111), approved in FY 2002, closed at the end o f September 2003, with only one tranche out o f three disbursed. SAC I11 also included support to privatization o f electricity distribution, debt audit, and maintaining proper regulatory framework, pricing, and subsidy policies. In FY200 1, MIGA provided a guarantee o f US$6 1.1 mi l l ion to Union Fenosa to support privatization o f three o f the five electricity distribution companies. In FY2001, IFC also provided a US$25.0 mi l l ion investment loan to Union Fenosa, to improve the operations of the three electricity distribution companies it had purchased.

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Current Sector Issues. The main sector issues at this stage include:

0 electricity transmission, dispatch, and metering: The obsolescence and physical deterioration o f electricity transmission and dispatch equipment represents a risk for domestic consumers and puts the country at a disadvantage in relation to i t s energy security and i t s potential role in international energy trade. Moldova already plays a significant role in regional gas transit (about 18-20 bi l l ion

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cubic meters o f gas annually transit f rom Russia to South-Eastern Europe and Turkey), but i s set to play a role in electricity transit as well. I t has two high-voltage transmission l ines connecting the Russian and Ukrainian electricity networks with the networks o f Romania and Bulgaria and further o n to other South-Eastern European countries and Turkey. The surplus in generation capacity in Russia and Ukraine (and in Transnistria) represents a potential for significant trade o f electricity through the Moldovan network. Insufficient metering in the high voltage transmission network creates difficulties both in the domestic electricity market and in the international electricity trade;

high commercial (billing) losses in electricity distribution: Total losses in the electricity distribution network in 2002 were between 25% and 35% percent. While perhaps about 12-15% are technical, the remaining losses are mainly the result o f theft through meter tampering and illegal connections bypassing meters. Union Fenosa i s investing in metering and takmg other measures to reduce commercial losses in i t s networks. However, the two state-owned distribution companies have little free cash o f their own to invest and no access to significant investment capital otherwise;

deterioration of heating services: Municipal district heating companies are either defbnct or bankrupt, and even if functioning, provide poor quality and reliability o f heat supply. District heating systems are inefficient, and therefore expensive and unaffordable at the level o f income in Moldova, which - inter alia -- also threatens the economic viability o f the CHP plants. In addition, many schools, hospitals and public buildings have little or no heat during the winter season.

historic debts of the energy sector: Although most o f the historic debt o f the sector has been transferred out o f the accounts o f the operating companies and consolidated on the books o f Moldtranselectro, the debts will continue to burden the sector with the risk o f possible supply interruption or request for assets, as the main creditors (Russian, Ukrainian, and Romanian state enterprises, and the Moldovskaya power plant located in Transnistria) continue to be Moldova's main energy suppliers and may use that leverage to collect the old debts, and

resistance of vested interests: Sector reforms changed the responsibilities and increased transparency in contractual relationships and accounting. This, however, has hurt vested interests, triggering fierce resistance from these groups (Union Fenosa has been subject to particularly intense pressure from these groups).

Government Strategy. Government's strategy in resolving the main current issues in the energy sector i s the following:

upgrade electricity transmission, dispatch, and metering: The Government i s keen to take advantage o f the opportunity to participate in international electricity transit and help Moldelectrica borrow from international finance institutions to upgrade i t s equipment and organize itself to perform the duties o f a transmission-and-dispatch system operator. This would largely complete rehabilitation of Moldova's electricity sector and create conditions for i t s competent performance both domestically and internationally;

reduce commercial (billing) losses in electricity distribution: The Government hopes to privatize the state-owned distribution companies to attract investment needed to improve their technical and commercial efficiency. An effort i s under way to privatize RED N o r d and RED Nord Vest to strategic investors (RED stands for "Retele Electrice de Distributie" which in Romanian means "Electricity Distribution Network");

improve heating services: The Government wants to facilitate development o f commercial decentralized heating systems. The Government i s using grant funds from U S A I D to prepare legal, regulatory and institutional framework for such systems, while using, in the meantime, public

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funds to upgrade heating systems in priority budgetary organizations (schools and hospitals). The Government considers that it should hrther develop the gas distribution network to address heating problem;

restructure historic debts of the energy sector: The Government has undertaken an audit o f the debts, in order to establish their legitimacy. The Government intends to service, from i ts budget, those debts that are found valid; and

vested interests, corruption, and sector reforms: Some measures -- improved payment discipline in the state-owned electricity companies, bankruptcy o f Termocom (the Chisinau district heating company) -- have clearly narrowed the room for corruption, although there i s s t i l l a long way to go in these efforts. Sti l l high commercial losses, even in privatized areas, i s the most visible indicator that electricity theft remains a problem. The Government i s pursuing privatization o f two state-owned electricity distribution companies, with assistance from USAID. The Government's position o n sector regulation i s ambivalent, though, as many o f i t s supporters -- especially in Parliament, dominated by the Communist Party (CP) -- are finding it difficult to overcome the ideological impulse to control tariffs directly, rather than delegating th is responsibility to the independent regulatory agency. U S A I D continues to provide technical assistance for strengthening ANRE. ANRE increased electricity tar i f fs a number o f times during the last three years, most recently in the summer o f 2003 -- after a long tariff review -- but the Government i s l ikely to remain wary o f additional tariff increases, especially given that the electricity tar i f fs in Moldova are now among the highest in the FSU countries. The Borrower declared its commitment to maintaining a legal, remlatow, policv and institutional framework in the enerm sector conducive to efficient commercial operation, attracting private investments and ensuring reliable and affordable enerm services. Such a framework i s necessary to sustain and enhance the gains from the energy reform, as wel l as to ensure that the objectives o f the Energy I1 project are achieved and sustained.

The Government's strategy i s expected to be incorporated in the Poverty Reduction Strategy Paper (PRSP), which i s now under preparation. The current working draft o f the PRSP recognizes the importance o f maintaining an efficient energy infrastructure, operated on commercial principles and with participation o f the private sector, with adequate social protection, aiming at supporting economic and social development and enhancing energy security, but reducing energy intensity o f the economy. The strategy calls for strengthening o f the electricity market, improved technical and financial performance o f the network-delivered energy (electricity, gas, district heating) modernization o f heating systems, and protection o f the environment. The coming drafts are expected to propose specific measures to be implemented during the next several years, complementing those included in the Energy I1 project.

3. Sector issues to be addressed by the project and strategic choices:

The sector issues which the project will address directly include:

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the obsolescence and disrepair in electricity transmission and dispatch networks;

improvements in heating o f public buildings, and

technical assistance for debt restructuring, development o f decentralized commercial heating, and strengthening and continuation o f electricity sector reforms.

The Government considers that the electricity transmission network -- as a strategic asset - should stay under Government's ownership and control. Regional electricity trade could eventually inspire interest o f the private sector in Moldova's electricity transmission, but such trade - although potentially significant --

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i s yet to be established, as it i s driven by developments in Russia and Ukraine. The networks o f these two countries have been separated for most o f the past 10 years and only recently have they started to institutionalize their parallel (i.e., joint) operation. The transmission and dispatch company, Moldelectrica, has few options for raising financing needed for capital investments. Local banks are not able to lend such amounts, and commercial borrowing from foreign banks would be rather expensive and would require Government’s guarantees. Thus, raising the financing through official borrowing from international institutions i s the only viable option at this stage.

Moldelectrica has no responsibilities for procuring electricity, which reduces the r i sk that the Government or vested interests would exercise pressure on the electricity market or introduce inefficiencies associated with non-transparent andor preferential contracting and trading. Moldova’s power system, dispatched by Moldelectrica, has few power plants and there are no structural transmission bottlenecks, which simplifies dispatch. There have been no reported problems with dispatch being subject to political pressure or other improprieties. On the other hand, technical inefficiencies associated with disrepair and inadequate dispatch and metering equipment would be a serious obstacle to the ability o f the power system to deliver electricity to end users, and to Moldova’s chances o f being included in the regional electricity trade business. Rehabilitation o f the transmission system i s an important part o f ensuring proper functioning o f the domestic electricity market, complementing the efforts undertaken in electricity distribution.

The worsening o f heating services based on physically deteriorating district heating systems, caused by increasing and unaffordable costs, calls for a wholesale transition toward decentralized heating, where end-consumers would be able to control the level o f service and adjust to the available budget. This i s an important but complex task, which requires confluence o f a number o f factors, especially for residential heating: a proper institutional organization in the housing sector, identification o f affordable heating options acceptable to home owners, financial intermediary institutions to fund and facilitate financing, regulatory framework to regulate prices, etc. This transition i s easier to implement for buildings in the public sector, where institutional requirements and financial intermediation are much simpler. Addressing the problem from this end, in addition to providing direct benefits f rom improving heating in the priority public buildings (schools and hospitals), would also be useful for testing some technological options for the residential sector, which would be an important input in preparing a heating transition strategy on a broader scale.

By helping restructure historic debts and further advance energy reforms, the project will hr ther consolidate and strengthen commercialization o f the sector and i t s sustainability.

C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown):

The Project comprises four components:

(A) Electricity system upgrade;

(B) Heating supply and efficiency improvement;

(C) Technical assistance for project implementation and energy sector reforms, and

(D) Project management and administration (incremental operating costs).

The total project cost i s estimated at about US$39.9 million, o f which US$27.8 mi l l ion i s the cost o f the electricity component, U S 9 . 1 mi l l ion i s the cost o f the heating component, US$1.6 mi l l ion i s the cost o f technical assistance, and US$1.4 mi l l ion i s the incremental operating cost for project management.

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Component A: Electricity system upgrade. This component includes the following subcomponents:

1.

ii.

iii.

iv.

Improvement of metering in the electricity transmission network. This component includes installation o f energy meters at all interconnecting points o f the 1 10-400-kV transmission network, which would enable metering and recording o f active and reactive electricity flows in the wholesale electricity market. The meters would record at 15-minute intervals, be able to transmit information to the National Dispatch Center, and have remote and on-site data downloading and reading capabilities. The metering system should be able to support a variety o f market arrangements, f rom bilateral contracts to short-term spot markets based on competitive bidding.

Rehabilitation and upgrade of power system dispatch. This component includes installation o f the necessary hardware and software to enable real time acquisition o f operational information from the main facilities (power stations and transmission system substations), analysis and monitoring o f the system status at the National Dispatch Center, and control and dispatch o f the power plants, load centers, and the transmission system, to maintain a reliable, secure and economic operation, and facilitate financial settlements in the wholesale electricity market. The main elements o f the system include Remote Terminal Units (RTU) and the corresponding local data acquisition equipment at the power plants and transmission substations, the System Control and Data Acquisition (SCADA) system, and the Energy Management System (EMS).

Rehabilitation and upgrade of system telecommunications. This component includes installation o f the necessary communications equipment (fiber optics, power line carrier systems-PLC, and radio systems), which would serve the communication needs o f metering and dispatch.

Priority rehabilitation of the transmission network, including environmental upgrades. This component covers replacement and repair o f high voltage transmission line pylons and the most urgently needed rehabilitation measures in selected high-voltage substations (station batteries for 11 substations, 330-kV equipment for the Chisinau, Straseni and Bal t i substations and a number o f 1 1 0-kV circuit breakers for various substations). Depending on the outcome o f the PCB follow-up study (see below under Component C), this component could include physical mitigation measures for appropriate protection o f PCB-containing condenser batteries, and for their disposal to be implemented when replacement o f the batteries i s required.

Component B: Heating Supply and Efficiency Improvement. This component includes improvements in supply and distribution o f heat and demand side measures for heat and hot water consumption in selected public buildings (schools, hospitals, and residential buildings for disabled and other vulnerable groups). About 20 subprojects, comprising the f irst investment batch, have been identified and technically appraised. An indicative l is t o f additional buildings has been prepared, and includes about 95 objects in 8 municipalities (initially including Cantemir, Chisinau, Falesti, Floresti, Ialoveni, Soroca, Straseni and Ungeni) and under the central Ministries o f Health and Education. The l i s t includes approximately 50 schools and kindergartens with more than 15,000 pupils and 25 hospitals and clinics with more than 4,000 beds. A detailed analysis during project implementation may result in some o f the objects being changed owing to technical or financial constraints. An-eement was reached during nenotiations that by March 31, 2005, the Borrower wi l l identif? the specific investments under the heatina component. in accordance with the eligibilitv criteria defined in Annex 12.

The Ministry o f Energy expressed strong interest in including in the project some residential apartment buildings which are located close to the chosen public buildings, assuming that this represents a technically and economically viable way of meeting the heating needs o f the apartments. At this stage (the start o f the

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project), there i s no sufficiently developed legal, institutional, and regulatory framework in place to include individual private apartments and other commercial users into the investment project. The Enerav 11 Project could include some pilot schemes with residential and other buildinas. in apeement with IDA and once the leaal. r e p l a t o w and institutional framework, whose develoument may take place outside the pro ject, is sufficientlv advanced.

Component

The heating component will be implemented in three phases: the first phase would include the already identified and appraised 20 buildings (including the pilot project in Ungeni); the second phase will be prepared (identified and appraised) with the assistance o f the Swedish and local consultants within 6-8 months from the start of the project; and the third phase will be identified and appraised within 18-24 months from the start of the project. For each phase, a technical and financial feasibility analysis o f the proposed investments will be completed (including associated environmental measures). The investments should be least cost - i.e., the proposed technical solution should satisfy the required heating standards at minimum costs (investment plus operating costs).

Indicative Bank- % of costs % of financing Bank-

(US$M) Total (US$M) financing

Component C: Technical Assistance for Project Implementation and Energy Sector Reforms. The project would include technical assistance for the following activities:

Heating supply and eficiency improvement

Technical assistance for project implementation and energy sector reform

1.

ii.

iii.

9.16 22.9 8.09 23.1

1.60 4.0 1 .oo 2.9

Project implementation: consultant services for procurement and project management for the electricity and heating components, and audit o f the project and Moldelectrica's financial statements;

PCB follow-up study (electricity system) : the environmental assessment carried out in the context o f project preparation indicated that no appreciable adverse environmental impacts would result f rom the implementation o f the proposed electricity system upgrades. However, in order to strengthen i t s capacity to deal with the potential problem o f condenser batteries containing PCBs located at substations throughout the country, the Government has requested the inclusion in the technical assistance component o f funds to carry out a follow-up study on this issue, including the development o f recommendations for appropriate protection o f the sites and disposal o f o ld PCB-containing condenser batteries, to be implemented when replacement o f the batteries i s required. Actual removal o f the capacitors or renewal o f o ld ones i s not foreseen under the project.

Assistance for sector reforms: Provision o f selected technical assistance for improving institutional and regulatory framework in the energy sector, energy trading, privatization, and debt restructuring.

Project Management and Administration

Component D: Project Management and Administration. This component includes the incremental costs associated with the establishment and operation o f a Project Implementation Unit, created by the project beneficiaries specifically for implementation o f this project.

1.38 I 3.5 I 1.20 I 3.4

Electricity System Upgrade

- 10-

Total Project Costs 39.93 100.0 35.00 Total Financing Reauired 39.93 100.0 35.00

2. Key policy and institutional reforms supported by the project:

The project will contribute to:

0

0

improved conditions for economic growth through more reliable electricity supply;

better environment for private participation in energy infrastructure by providing accurate metering o f electricity and upgrading dispatch and transmission systems to enable dispatch o f electricity consistent with contractual arrangements;

improved technical and financial management in the electricity sector;

improved technical and financial performance o f heating in public buildings, and

improved legal, regulatory and institutional environment for heating residential buildings.

0

0

0

100.0 100.0

3. Benefits and target population:

The main benefits o f the electricity component include: reduced unserved energy; reduced transmission technical and commercial losses; improved security; and improved telecommunications. The main benefits o f the heating component include increased efficiency o f heat supply and heat consumption (better thermal efficiency, reduced losses).

The benefits in the electricity sector would be system-wide and, therefore, would accrue to al l consumers, including the poor. Benefits from the heating component would accrue to the public agencies operating the buildings included in the project and to the users o f the buildings (schools and hospitals).

4. Institutional and implementation arrangements:

Implementation period: four years.

Executing agencies: Moldelectrica will be the executing agency for the electricity component o f the project, while the selected municipalities and central govemment ministries o f health and education will execute the heating component. The Ministry o f Energy will oversee implementation o f the entire project and be directly responsible for some technical assistance components. The PIU will be responsible for procurement, accounting, record keeping and reporting.

Lending and On-Lending Arrangements. The Borrower for the IDA Credit will be Moldova, represented by the Ministry o f Finance. The amount o f the credit will be US$35 mil l ion equivalent, on standard IDA terms o f 40 years, including 10 years grace. An annual service charge o f 0.75 percent will be applied o n balances disbursed and outstanding. Commitment fees will be charged on undisbursed balances in accordance with the terms set annually by the Association, but will not exceed 0.5 percent.

The Ministry o f Finance will onlend an amount equivalent to US$26 mil l ion to Moldelectrica. Onlending terms discussed with the Ministry o f Finance call for repayment o f the sub-loan by Moldelectrica over a period not exceeding 20 years, including 5 years grace o n repayment o f the principal. Interest o n disbursed and outstanding balances would be calculated at a rate equivalent to the semi-annual IBRD Variable Rate on currency pool loans. The Association would advise the Government o f the applicable rate for each period. Commitment fees incurred by the Government on undisbursed balances would be passed o n to

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Moldelectrica. The Ministry o f Finance and Moldelectrica would s i g n a Subsidiary Loan Agreement, specifying terms and conditions o f the on-lending. A draft Subsidiary Loan Agreement was received by IDA. The Subsidiaw Loan Agreement, satisfactow to IDA, should be sianed before Credit effectiveness.

The Ministry o f Finance would onlend the relevant portions o f the IDA credit financing improvements in heating o f public buildings to the municipalities participating in the project, either through direct loans with a guarantee from the local rayons ('judets), or through a loan to the rayons ('judets) which would then be on-lent to the municipality. Because o f the limited financial capacity o f the municipalities, and the significant social impacts o f the proposed investments, the Ministry o f Finance would pass most o f the subsidies implicit in the IDA terms to the local govemments/project beneficiaries. Funds would be on-lent for a period o f not less than 15 years and not more than 40 years, including a grace period o f not less than 3 years and not more than 10 years, at an interest rate o f 1.5 percent. A draft Subsidiary Loan Agreement between the Ministry o f Finance and the local governments was received by IDA. The Subsidiarv Loan Agreement, satisfactow to IDA, between the Ministry of Finance and the local government of at least one participating municiualit-v should be signed before credit effectiveness.

Fund Flows. The total project expenditures will be US$39.93 million, o f which US$35 mi l l ion would be financed from the IDA credit, US$4.33 mi l l ion from internal cash generation and municipal contributions and US$0.6 mill ion from the Swedish International Development Agency (SIDA).

The project's funds will f low as shown in the f low chart detailed in Annex 6. Counterpart contributions will be made available by the selected municipalities through their existing Treasury current accounts and by Moldelectrica in i t s Project Account. The counterpart contribution records will be kept separate by the beneficiaries from their other activities and the PIU will be informed on a regular basis in this respect. The procedures for replenishments and withdrawals from these accounts will be established by the PIU and the other parties involved at the local level.

Disbursements: Disbursements from the IDA Credit will be transaction-based (Le. f rom direct payments from the Credit Account, and from the Special Account). To facilitate timely project implementation, Borrower wi l l establish, maintain and ouerate, under terms and conditions acceptable to IDA, a single, seuarate Suecial Account, denominated in US Dollars. The Borrower will select a commercial bank, acceptable to IDA, to hold the Special Account.

Implementing Entities. The project will be implemented by a Project Implementation Unit (PIU), an independent legal entity established under the Government Decree 1276 o f December 21, 2000. Moldelectrica, a state enterprise created by the Decree No. 1000 o f the Government o f Moldova o f October 5, 2000 i s the executing agency that will implement the Electrical System Upgrade. The participating municipalities and two ministries (Health and Education) will execute the Heating Supply and Efficiency Improvement component.

The PIU will work closely with project implementing agencies. The P I U i s supervised by a Supervisory Board, appointed by the Government. The Supervisory Board appoints the Executive Director o f the PJU, who i s selected competitively and whose qualifications and experience are satisfactory to IDA. The PIU will be assisted by a qualified international procurement and project management consultant, for whom allowance has been made in the project cost. A Project Implementation Plan (PIP) was submitted to IDA. The incremental operating costs o f the PIU will be partially financed by the IDA Credit, excluding any taxes, on a declining basis. Agreement was reached during negotiations that the Borrower wi l l maintain the PIU until completion o f the Proiect, with staff resources and Terms of Reference acceutable to IDA.

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Procurement (see Annex 6). The general strategy for project implementation i s to procure the works, equipment, goods and services in larger packages, making contractors responsible for supply and installation o f equipment, whenever practical. This would minimize coordination needs on the part o f the implementing agencies and simplify project implementation, mitigating the risk o f project delays. Details o f the procurement arrangements are given in Annex 6.

Project Preparation Facility. The Government o f Moldova has financed preparatory activities: consulting services for the PIU, incremental operating costs for project management, and pilot installation o f boilers and pipes in selected buildings in the municipality o f Ungeni through a Project Preparation Facility (PPF) advance o f US$1.5 million.

Supervision, Monitoring and Reporting. IDA'S supervision will cover (i) physical implementation o f the investment components o f the project and associated project management issues (including procurement and financial management); and (ii) performance o f the sector and associated sectoral issues. Project supervision will require intensive interaction with the beneficiary organizations, the Government, and the donors. The supervision effort will need to be especially intensive during the first two years o f project implementation, which will be procurement-intensive and are therefore critical for successful implementation.

The PIU, with the assistance o f implementing agencies (Moldelectrica, participating municipalities and the relevant Government ministries), will monitor progress against agreed performance indicators specified in Section A.2 and Annex 1. The PIU wi l l provide, on a quarterly basis, 45 days after the end of each quarter, consolidated reports on project implementation progress in the FMR format. Draft annual action programs for the upcoming year wi l l be included with the December reports for IDA'S review and comment. The GOM and IDA will conduct joint reviews annually during supervision missions.

The PIU wi l l prepare a detailed mid-term report bv December 31, 2005 to serve as the basis for a project mid-term review, to be undertaken not later than March 31, 2006. In addition to the topics covered under the quarterly reports, the mid-term review will include a review o f the economic viability o f the project, based on actual costs and benefits achieved to-date as wel l as progress in the reform process. Based on the outcome o f the mid-term review, measures will be taken to ensure efficient completion o f the project.

The PIU, with guidance from IDA, will also help prepare a Borrower's contribution to an Implementation Completion Report (ICR), so that IDA could complete the ICR within six months o f the closing date o f the IDA Credit. Included in the I C R will be an assessment o f the execution o f the project, i t s costs and benefits, the performance o f the Borrower, the implementing agencies, Moldelectrica and the selected Municipalities, the Bank and other agencies involved in the project regarding their respective obligations and accomplishments, and lessons learned.

After completion o f the project, Moldelectrica and the selected Municipalities wi l l submit to IDA a plan for operating the project.

D. Project Rationale 1. Project alternatives considered and reasons for rejection:

The main problems in the Moldovan electricity transmission network are the following:

0 metering o f the system i s inadequate to provide reliable measurements o f energy flows between generating plants and imports -- on the one side -- and distribution companies, exports, and

- 1 3 -

end-consumers directly connected to the transmission network, on the other side; therefore, commercial transactions cannot be properly accounted and supported;

the existing SCADA system has deteriorated over the years, with the result that presently only a limited number of real time data are acquired from substations, which makes it difficult to securely control the system and ensure that dispatch i s consistent with commercial contracts. Repair and upgrading of the existing outdated dispatch and SCADA equipment to meet the requirements for safe, reliable and economic operation o f the HV transmission network in the new market environment i s not possible;

the present telecommunications system cannot support the SCADA system to be installed and needs to be upgraded with channels that are adequate in number and quality, and

the electrical high voltage network includes equipment that i s more than 20 years o ld and in some substations older than 28 years, which i s considered by Moldelectrica as the maximum physical lifetime. The Project will finance upgrades o f the items in the highest priority class, as full rehabilitation o f the network would need a budget several times larger than what i s available for the Project.

Sector Issue

Ban k-financed Public sector management including

There are no technical alternatives to proper metering, dispatch and communication systems, and replacement o f aging and failing components o f the transmission network to support continued and improved electricity trading and reliable and efficient operation o f the power system. Proper functioning o f the transmission and dispatch systems i s essential for the ability to deliver electricity f rom power plants -- located either in Moldova or abroad -- to end consumers, and to facilitate commercial transactions associated with electricity trading domestically or internationally. Thus, the project would play an important role in completing the physical rehabilitation o f the energy sector and i t s institutional reforms, especially in helping financial recovery o f the sector, commercializing electricity supply, and supporting privatization o f the industry. The proposed technical solutions are based on well-established and proven standard technical concepts and technologies, which are being applied worldwide.

Project

Rehabilitation Loan (Ln. 3653)

I n the heating sector, the overriding priority i s to facilitate restoration and improvements o f services through decentralized heat delivery and improved energy efficiency. The Energy I1 project would help solve an important part o f this issue - heating o f priority public buildings (schools and hospitals) -- through installation or rehabilitation o f decentralized heating systems and improvements in energy efficiency o f the buildings. The main alternative solution -- heating based on centralized production and delivery o f heat -- was rejected by the feasibility studies conducted as part o f project preparation as economically and technically inferior.

Implementation Progress (IP)

Technical assistance provided by the project i s closely related to implementation o f the investment components and associated energy reform-related tasks. In addition, the project will provide financing for expertise needed to help audit and restructure the large historic debts accumulated by the sector.

2. M a j o r related projects financed by the Bank and/or other development agencies (completed,

Development Objective (DO)

S S

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economic reform, financing o f critical imports (energy, health, agriculture), financial discipline.

Macroeconomic stabilization, growth, enterprise privatization, reforms in agricultural, social and energy sectors.

Accelerate the government reform program in the enterprise and financial sectors; privatization o f electricity companies.

Energy sector restructuring, improved measurement o f consumed energy and efficiency o f electricity production

Pension reform, land privatization and farm restructuring, unbundling the energy enterprises and starting the process o f privatization, and enterprise privatization.

Continuing the privatization process in agriculture, energy and the enterprise sector; privatization o f electricity and gas companies; improving financial performance o f energy enterprises; restructuring o f district heating companies; strengthening o f regulation and development of electricity market rules; fiscal and social issues -- redesigning subsidies for energy consumption).

Structural reforms in agriculture, Energy, reducing bamers to new mterprise formation, and telecommunications and winery privatization; at the same time, the program engenders improvements in the jublic sector to help ensure that the penefits o f the structural reforms are xoadly received. Ither development agencies EBRD

Structural Adjustment Loan [Ln. 3815)

Private Sector Development :Ln. 3977-0, 3977-1)

h e r g y Project (Ln. 4020)

Second Structural Adjustment Loan (Ln.4229; Cr. 2988)

5tructural Adjustment Credit :Cr. 3256)

rhird Structural Adjustment Zredit (Cr. 3667)

tehabilitation o f Chisinau Iistrict Heating Network.

S

S

S

S

S

U

S

S

S

S

S

U

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U S A I D

Netherlands

Sweden

Numerous programs o f technical assistance to assist in re structuring/privat izat i on o f the gas and electricity industries.

Technical assistance for project implementation o f the First Energy Project; and support in counterpart financing under S A L 11. Technical assistance for development o f national heating strategy.

I

'/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

3. Lessons learned and reflected in the project design:

The BanMIDA has accumulated substantial experience in implementation o f projects and understanding o f the problems in the power sector in Moldova and in other countries in the region. The most important lesson i s that the priority problems include two closely inter-related issues: sector govemance and financial performance o f the electricity (energy) companies. These are, o f course, complex problems with legal, regulatory, structural, economic, financial and technical aspects. As explained in the previous sections (see B.2), Moldova embarked on reforming the energy sector about 5 years ago, with legal, institutional and structural reforms aimed to improve sector governance and transparency, and to create conditions for commercialization o f the sector and attraction o f private investments, expecting that these measures would improve the then dismally l o w cost recovery and rapid capital consumption. This process has advanced considerably, supported largely by the Bank's/IDA's adjustment operations: the power sector has been unbundled and corporatized; an autonomous energy regulatory agency i s in place; about 70 percent o f the electricity distribution business i s in private hands, which -- given the new trading rules making distribution companies responsible for contracting with generators and importers and given the fact that Moldova imports 75-80 percent o f i t s electricity -- means that private operators have substantial control over the wholesale market; and the bulk o f historic debts have been separated from the sector's current operations. The proposed project would complement these achievements with the needed investment in electricity wholesale trading infrastructure. Such sequencing o f policy and investment actions has been designed to maximize their combined effect on sector's financial position and sustainability o f sector reforms.

The dissolution o f the former Soviet Union led to a breakdown in trade between the FSU republics, including electricity trading, which particularly adversely affected Moldova. The project would contribute to restoring the regional electricity markets, which -- as amply demonstrated -- carries a multitude o f benefits: cheaper and more secure energy supply resulting from increased competition and market arbitrage; more reliable operation o f energy systems; improved quality o f power system operation; increased attractiveness o f local industry to investors; and potential for revenues from serving other markets.

The project leverages funds with other donors (SIDA), which enhances cooperation among the donors, ensures better consistency o f policy advice, and enhances the impact o f donor activities. Signature and effectiveness of the SIDA Grant is a condition of Credit effectiveness.

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The financing o f the project takes into account the fact that financial recovery o f the sector i s s t i l l going on, and the ability o f the beneficiary organizations to co-finance the project i s limited, especially in the heating sector, Thus, local financing contribution i s kept relatively low, which should reduce the risk o f implementation delays.

4. Indications of borrower commitment and ownership:

The following actions indicate the Borrower's commitment to and ownership o f the project:

implementation o f legal, regulatory and structural reforms which have taken place in the energy sector during the last several years, spanning the mandate o f several Governments, including privatization o f 70 percent o f the electricity distribution market and continuing efforts to privatize the remaining 30 percent, complemented with strengthening financial discipline in the state-owned companies;

completion o f technical and financial studies for the project;

creation o f a separate transmission and dispatch company;

separation o f historic debts from the transmission and dispatch company and other companies operating the power system, and initiation o f efforts to compile a detailed inventory o f these debts, and to audit and restructure them;

early establishment o f a Project Implementation Unit (PTCT);

using an advance from the credit (PPF advance) to finance preparation activities, including a pi lot project for decentralization o f heating in public buildings (in the Ungeni municipality), and

increasing tari f fs for Moldelectrica (the electricity transmission and dispatch company).

5. Value added of Bank support in this project:

The Bank/IDA plays an important role in assisting the Government to reform the energy sector. The reform strategy was developed and agreed with the Government during preparation o f the Second Structural Adjustment Loan in 1997, and supported continuously by the Bank since then through a series o f adjustment operations. Energy reform was also one o f the main policy areas included in the Third Structural Adjustment Credit. The Bank/IDA has been focusing particularly on reforms in the power and gas industries, and has been the main donor supporting these efforts, in coordination with U S A I D who has provided valuable technical assistance for power sector reform. This reform i s now at a decisive stage: with the substantial presence of the private sector in electricity distribution, and the Energy I1 project providing the needed investments to upgrade and modemize transmission, the sector should cross the critical point in i t s transition to a financially and physically improved, more efficient industry, structurally and institutionally fit to operate in a market economy.

The Bank'sADA's past involvement in Moldova and in the region make it a unique institution in a position to provide assistance of the type and the scope required. Through this operation, the Association would complement i t s policy advisory work effected through structural adjustment lending, with investments which could not be fbnded from other sources at this stage, and strengthen i ts credibility with the Borrower. The Association's continued involvement would help ensure consistency in the implementation o f reforms and increase the likelihood that the process remains o n track The Association's involvement i s complemented by U S A I D technical assistance for development o f commercial heating systems, energy sector regulation and operation o f the wholesale electricity market.

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The Association has been less active in the heating sector in Moldova, where other donors - notably EBRD - took the lead in the mid-1990s. EBRD financed a US$20 mi l l ion investment project for rehabilitation o f Chisinau's district heating network operated by Termocom, which it subsequently restructured and sharply scaled down. As Termocom's technical and financial problems in Chisinau - and the heating problems elsewhere in the country -- deepened in the wake o f sharply decreasing demand (as industrial demand for heat and steam dwindled and residents also started disconnecting themselves due to deteriorating services and unaffordable prices), it became clear that a thorough rethinlung o f heating strategy was needed. The Association, in cooperation with the Swedish International Development Agency (SIDA), launched a strategic heating study, which concluded that centralized large-scale district heating systems need to be abandoned (except possibly in part o f Chisinau) and replaced by decentralized ones. In parallel with this, the Government - with support from the Association under the Structural Adjustment Credit -- transferred district heating networks to municipalities in 2000, preparing institutional grounds for decentralization. Heating i s an important and difficult problem, given i t s economic and social dimensions, and the Government i s keen to continue workmg with the Association to address the problem. The proposed project would advance implementation o f the new heating strategy one step further.

E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8)

1. Economic (see Annex 4): 0 Cost benefit 0 Cost effectiveness 0 Other (specify)

NPV=US$ million; ERR = % (see Annex 4)

0

0 Power component: cost-benefit analysis resulted in an EIRR o f 39%. Heating component: least cost investment.

The economic analysis o f the proposed investments in the power sector indicates a high retum even under conservative assumptions o f the probability o f system failure in the "no project'' scenario, growth in power demand and the shadow price o f electricity produced under own-generation.

In the context o f preparing the heating component, least-cost and affordability analyses were conducted o f the short- and long-term heat supply options o f municipalities in Moldova. The analyses concluded that district heating, which in the Soviet era was common in Moldovan cities, has good prospects for long-term survival only in Chisinau. In other municipalities, which are the proposed beneficiaries o f the heating component, individual building-level boilers or mini-networks are the economically justified options.

The EIRR o f the heating component was not calculated in view o f the difficulty o f meaningfully evaluating the benefits o f improved heating for the type o f the buildings included (mostly schools and hospitals), that is, the complexity o f the methodology and data required (the lost school-days and their value; the cost o f increased incidence o f illnesses o f staff, students, and patients; the cost o f poorer educational services and hospital care; inefficiencies and the costs o f the present-mode heating, etc.). Rather, the proposed investments are the least cost for a given standard o f services necessary for the affected institutions to operate normally.

2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = % (see Annex 4) Under the Energy Law, the electricity tariffs are regulated by the Energy Regulatory Commission (ANRE). The tariff o f the beneficiary company i s fixed to allow recovery o f prudently incurred operating costs, including interest expenses and a fixed mark-up on the costs. Hence, the FIRR o f the project to the transmission company will be limited to the allowable return on investment. Residual financial benefits, such as O & M savings, reduced losses, etc., will f low to customers in the form o f lower electricity tar i f fs.

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(a) Current Financial Status and Performance of Moldelectrica:

Liab i l i t i es and E q u i t y Equi ty Long Term L iab i l i t ies Current L iab i l i t ies

Moldelectrica (ME) was established on October 5, 2000 by Decree # lo00 o f GOM, by separating the transmission and dispatch assets from the state enterprise Moldtranselectro (MTE), to provide solely electric transmission and dispatch services throughout Moldova as a State Enterprise under the Ministry o f Energy, without engaging in electricity trading. The company started operation as an independent entity in November 2000.

(196.8) 4 0 6 . 6 407.4 590.0 17.4 7.2 10.8 5.6

1,621.2 6.2 4.7 13.0

Most historical data for the two companies are merged with the historic accounts o f MTE, which, in addition to transmission and dispatch, served as the wholesale buyer and re-seller o f electricity. It would be very difficult, if not impossible, to extract from these accounts a reliable picture o f the past performance o f the transmission and dispatch functions. Hence, the analysis o f current financial performance i s based on the very short operating history o f ME.

The financial statements o f ME have been restated according to Intemational Accounting Standards (IAS) and, together with 2001 and preliminary 2002 financial data, were used as a base to project future cash flows. End-1999 Balance Sheet and the 2000 income statement data o f MTE were adjusted to reflect the performance only for transmission and dispatch functions.

The Balance Sheet positions o f ME as o f December 31, 1999, 2000, 2001 and 2002 illustrate that ME started operations without the overhang o f o ld payables and receivables, and has a relatively strong financial base.

The current ratio i s improving over time, and net working capital increased from L e i 11 to 23 mi l l ion within a year after separation. The income statement, when restated to IAS, showed an operating loss o f L e i 20 mi l l ion in 2000 due to the poor collection rate from the distribution companies. However, the situation improved in 2001, as a result o f significantly improved collections, and the company showed a modest operating profit. In addition, the transmission tar i f f was increased in the 4th quarter o f 2001 f rom 1.876 b a n i k W h to 2.8 banikWh. In September, 2002 the tariff was further increased to 3.5 b a n i k w h . Figures for 2002 show net profits from operations o f 7.9 mi l l ion le i before tax and before provision for uncollectible accounts. Nonpayments during the year were 8.1 mi l l ion o n revenues o f 97.3 mill ion. If fully uncollectible, ME would incur a small loss in 2002.

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Year Ended Gross Revenue

Net Operating Revenues Cost o f Salesw

Less nonpayments

I N e t Profit f rom Operations I (20.1) I 4.8 1 (0.3)

3 1/12/00 31/12/01 31/12/02 57.5 65.9 97.3 27.5 3.3 8.1 30.0 62.6 89.2 50.1 58.0 89.5

The positive trends in collections began in the last quarter o f 2000 and continued through 2002, as both the privatized distribution companies (the Chisinau, Central and South, holding about 70% o f the market share) and the state-owned ones (the Nor th and North-West, holding about 30% o f the market share) improved payments to ME and strengthened collections from their customers. It i s assumed that the privatized companies, which are owned by Union Fenosa, a major international investor and operator in electricity distribution from Spain, will sustain their f i l l payment to ME. The performance o f the two state-owned distribution companies i s more r i s k y and represents an ongoing financial risk for ME. The Govemment i s undertaking effort to privatize these two companies to strategic investors while, at the same time, improving their performance, as described above. hvat izat ion would provide much needed investment in the areas served by the North and North-West distribution companies, and improve their commercial and technical efficiency, with significant benefits for the sector and Moldovan economy. Regardless of the outcome of the privatization efforts, the project requires that the Government maintain a legal. remlatow. policv and institutional framework for the enerm sector conducive to efficient commercial operation. attracting private investments and ensuring reliable and affordable ene rn services. This would include maintaininz an independent reaulatow agency, mandated to establish tariffs that fullv reflect the operating costs of ME. I t has been further agreed that the accounts receivable for ME at the end of each fiscal vear wi l l not exceed 60 davs sales equivalent based on the prior vear 's sales figures.

(b) Projected Financial Performance of ME

The current tar i f f methodology used by ANRE uses historical data as a basis for future tariffs. In reality, however, past expenses are a reflection o f meeting only very basic needs, rather than true costs o f operating the transmission system. Until recently, the problem was compounded by the fact that the book value o f the fixed assets o f ME, which i s the basis for calculating depreciation component for the tariff, seriously understated their actual net value based on depreciated replacement cost.

A detailed study carried out by PricewaterhouseCoopers, together with a local firm o f technical specialists, concluded that the company's assets needed to be adjusted by a factor o f approximately two to appropriately reflect their current depreciated value. Moldelectrica i s now in the process o f carrying out these adjustments, (net f ixed assets were revalued by approximately 50 percent in 2002) and the tar i f f increase in September o f 2002 was a preliminary reflection o f the revaluation. The new tariff, if maintained in real terms, will provide Moldelectrica with sufficient cash to cover operating expenditures, planned investments, and debt service until the primary project investments are completed in 2006. From 2007 onwards, the company i s assumed to maintain i t s capital investment program, using internally generated funds. These presumed obligations, together with increased debt service obligations, would require that the transmission tariff be increased once again in real terms.

Projections o f ME'S financial requirements were carried out under two alternative scenarios: (i) a cash-flow based tariff that covers the company's cash requirements (operating costs, self-financing o f

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investments, and debt service); and (ii) a full-cost recovery tar i f f that covers al l operating costs plus depreciation. The table below provides highlights o f tariff requirements and Moldelectrica's related financial performance assuming that tariffs are set to cover the company's cash f low requirements. Detailed pro forma financial statements are included in Annex 5, Tables 5.1 - 5.3.

Under the above assumptions, the financial outlook for ME looks satisfactory. The required tar i f f drops initially, but increases to parity with current levels (adjusted for inflation) by 2006. Debt Service ratio remains within the acceptable limits. The ratio o f current assets to current liabilities i s well above 1 at al l times. Profitability and retum on assets indicators are limited by the tar i f fs that were deliberately set to cover only cash f low requirements.

The second tariff scenario assumes that ME tari f fs are immediately set at full cost recovery levels, including depreciation o n revalued assets. This results in a steady need for tar i f f increases through to 2006, (together with fairly significant uncommitted cash balances which could be used for additional capital investment projects or set aside to cover future cash f low deficits). However, by 2007, the tariffs o f the two scenarios would converge. The table below presents the financial highlights o f this altemative projection. Pro forma financial statements are included in Annex 5, Tables 5.4 - 5.6. Either o f the two tariff options would lead to a satisfactory result in terms o f the financial viability o f the company. The f irst scenario minimizes the impacts in the initial years, while the second scenario involves a steadier progression o f tariff increases in the early years, followed by a leveling o f tari f fs (and in fact a decline in real terms) during the 2007 - 20 10 period.

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The Government has committed under the project to maintain a proper regulatory environment in the sector, including the authority o f the regulatory agency (ANRE) to maintain adequate tariffs. The Association, through the supervision o f the Energy I1 project, will seek that this commitment i s maintained and tariffs indeed kept at a level which ensures that ME can recover the full cost o f i t s operations.

(e) Financial Status of the Selected Municipalities Which are Beneficiaries of the Heating Component:

The Municipalities o f Cantemir, Chisinau, Falesti, Floresti, Ialoveni, Soroca, Straseni, and Ungeni, and the Central Government Min is t r ies o f Health and Education are the expected beneficiary agencies o f the heating component. Investments in the heating systems o f the municipalities will be owned and operated by the local administrations through their heating organizations or through other municipal balance sheets such as the Education Department. Heating organizations have typically been established as Municipal Enterprises, wholly owned by the local administration, and based o n assets transferred to the municipality by the decentralization and dissolution o f the state enterprise Termocomenergo. In most instances, the municipalities were ill-equipped financially to take on these responsibilities, and service both to public and residential buildings has deteriorated - in many cases to the point o f nonexistence. Where heating i s available, ta r i f f s generally cover only short-run operating costs (fuel and energy purchases, water, salaries). Notwithstanding, the costs o f heat supply to public buildings ranges fi-om 12 percent (Soroca, Ungeni) to 40 percent (Cantemir) o f total municipal budgets. Given the perilous financial status o f some o f the heating subsidiaries, it is recommended that the new investments be segregated from the books o f the heating enterprise and that separate budgetary provision be made to cover their operating costs.

As noted earlier, the heating investments to be financed for some o f the municipalities and ministries have not yet been fully defined. Once feasibility and engineering studies have been completed, the Association will finalize appraisal o f these sub-components during project implementation. However, during the design

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stage, appropriate attention will have to be given to the local administrations' financial capacity, particularly with respect to covering the operating costs o f new investments and the associated debt service. The amount o f credit which each city can afford will depend on the level o f operating savings arising from the investments, and on the municipalities' own assessments o f their ability to increase budgetary expenditures. Each municipality should review the budget impacts o f proposed investments and determine an affordable level o f expenditure on heating projects. Subsidiary Loan Agreements with the municipalities will include a provision that the operating and debt service costs o f the new investments i s included each year as a line item in the municipal budget.

(d) Historical Sector Debts:

Electricity Sector Debt. As a result o f the reorganization o f the power sector, the former state company Moldtranselectro (MTE) was restructured so that a new transmission and dispatch company, Moldelectrica (ME), was created and al l operational assets and hnctions related to transmission and dispatch - but not historic debts -- were transferred from MTE to ME. MTE remained a 'shell' company, holding the sector's historic debts (accounts payable and accounts receivable), without any involvement in sector operations. The objective o f this restructuring was to facilitate commercialization and privatization o f the sector, especially implementation of measures to improve i t s financial performance. Such measures also included changes in electricity trading and contracting, which became the exclusive responsibility o f the distribution companies. Private investors acquiring distribution companies were, therefore, inheriting a more transparent situation, with clear prices for transmission and dispatch and somewhat lower - although not completely eliminated -- r i sk o f suppliers (exporting countries or domestic plants) disconnecting because o f debts for previous deliveries. The reorganization allowed the Government to distance itself further from the operation o f the system, as the need for i ts direct or indirect involvement in negotiating import contracts (through the state-owned transmission and dispatch company) was eliminated, and focus on restructuring the historic debts. The separation of debt f rom the companies operating the sector should also make debt restructuring and negotiations with creditors less subject to pressure from the impact on current supply o f electricity.

However, the need to deal with the debts and find a way o f servicing them remains. At the time o f establishment, MTE's balance showed a net indebtedness o f approximately 1 bi l l ion le i (approximately US$77 mi l l ion equivalent) - 0.8 bi l l ion in accounts receivable and 1.8 bi l l ion in accounts payable. Conceptually, the net debts o f MTE were to be covered in the 2001 budget, but Parliament declined to accept this expenditure. As a consequence, MTE continued to operate as a state company under the supervision o f the Ministry o f Energy. MTE has directed i t s efforts towards collection o f receivables and their application to the settlement o f debts. Because the budget has priority for repayment, a l l collections to date have been passed o n to the Ministry o f Finance.

The current situation i s highly undesirable for the following reasons:

The difference between payables and receivables, compounded by the fact that almost 500 mi l l ion le i o f receivables are either frozen or due from nonexistent enterprises means that MTE i s at best an interim solution to the settlement o f sector debts. In the interim, the company incurs operating costs, and unpaid debts continue to accumulate interest and penalties and exchange rate losses. In 2001, MTE collected 128 mi l l ion l e i o f receivables, and incurred net losses o f 144 mi l l ion lei, while in 2002 it collected 44 mi l l ion le i and incurred net losses o f 102 million.

Failure to reach satisfactory agreements o n mechanisms for settlement o f net sector debts puts the assets and operating ability o f the sector at risk, particularly when a significant portion o f the debts

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(approximately US$55 million) are owed to Ukraine and Romania, both o f whom have a potential interest in the assets of the Moldovan electricity network while continuing to be important suppliers of electricity, especially Ukraine.

The Government has engaged an international audit firm to carry out a detailed audit o f the debts o f MTE, with the assistance of financing from USAID. Completion o f this audit and development o f a detailed debt restructuring plan fo r the timely settlement o f outstanding debts was agreed under SAC 111. Assuming that MTE has a role in this plan, the Government will also amend the company's Statutes to include revised responsibilities and a defined time horizon for the operations o f MTE. The proposed Energy I1 project includes funding for technical assistance to financial and legal specialists to assist in these efforts. Government has also agreed that neither the assets nor the cash flow of ME wi l l be pledped against or merged with the debts of MTE.

(e) Financial Performance Criteria.

During negotiations the Government and ME anreed on the followina financial performance criteria:

0 Short-term Liquidity: To ensure that there i s sufficient liquidity to meet current obligations, ME will be required to maintain a ratio o f current assets to current liabilities o f not less than 1.2.

0 Debt Service Coverage: T o ensure that ME maintains creditworthiness, particularly in view o f the substantial capital expenditures which will be required to rehabilitate and replace existing assets, ME will incur additional debt only if it can demonstrate that it can maintain a debt-service-coverage ratio o f not less than 1.5 (current net revenues divided by projected annual debt-service requirements).

0 Accounts receivable: ME'S total accounts receivable for the provision o f services at the end o f each fiscal year will not exceed 60 days sales equivalent based on the prior year's sales figures.

cfl Financial Management and Auditing:

ME i s completing the conversion o f i t s accounting systems to international standards. The company has qualified accounting staff in place, al l of whom have received training in international accounting practices. At present, understanding o f management accounting i s limited. However, training in this aspect will be addressed as part o f the technical assistance to assist the company in establishing and maintaining separate project accounts.

ME will appoint qualified auditors to carry out audits o f the company's financial statements and project accounts to international standards, and submit to the Association audited financial statements not later than 6 months aRer the close o f i t s fiscal year.

Fiscal Impact:

No Government funds will be required for the electricity component o f the project, since local financing will be provided by ME. The Government will on-lend proceeds o f the IDA Credit on terms less concessionary than the terms o f the Credit to the Government, which will have a positive fiscal impact. Restructuring o f the large power sector debt may have a major fiscal impact, which will be assessed as part of the debt restructuring exercise.

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The Government budget will need to finance incremental operating costs for investments in heating o f buildings owned by State Ministries. However, given that the proposed investments will result in more efficient heat supply to these buildings, the impact on the budget i s expected to be positive in the long term.

3. Technical:

Technically satisfactory operation o f a transmission system means unimpeded, reliable, and efficient f low o f electricity f rom power plants to the consumers. To achieve this, the system must have adequate transmission lines and substations as well as means to continuously plan, control, and monitor the operation o f the complex system. In addition, the system must also be able to meter electricity flows with sufficient frequency and accuracy to settle numerous commercial transactions among trading parties, which become quite complex in a liberalized, competitive market. Given the nature o f the physical processes involved, system operation must be centrally monitored and controlled in real time. This requires continuous collection o f information from geographically dispersed facilities (power plants, substations and lines) and transmission o f this information to the central dispatch center, and vice versa -- communication o f dispatch control commands (either automated or executed by personnel manning the facilities) to locations where action must be taken. For this reason, a modem power network includes an elaborate system o f data acquisition and metering devices, data transmission and communication lines, computers and software, physically and functionally integrated to ensure secure and reliable operation o f the system.

The transmission network in Moldova, with i t s associated metering, dispatch and communications facilities, suffers f rom years of neglect, maintenance backlogs, and lack o f investment in upgrades and new equipment. O f the existing number o f substations, 9 have operated for more than 39 years, and 70 for more than 28 years. The substations have been well maintained considering the lack o f spare parts and the age o f the installations. At present, most o f the problems are the result o f insufficient maintenance (lack o f funds for spare parts) and extreme operation conditions (large number o f on- and-off switching o f circuit breakers and tap changers because o f load shedding requirements).

The existing dispatch system, with i t s present SCADA equipment, was installed over two decades ago. It i s based on old Soviet technology, which i s difficult, if not impossible, to maintain and expand, due to a number o f reasons, such as functional and technical limitations, lack o f spare parts, technological obsolescence and incompatibility with modem equipment. The SCADA covered power plants and substations in Moldova, f rom which information was collected. The existing SCADA system has deteriorated over the years with the result that presently only a limited number o f real time data are acquired from substations. Besides this, the existing dispatch system at the NDC does not provide the data processing and presentation capabilities to effectively monitor and control the transmission network in on-line mode. Repair and upgrading o f the existing, outdated dispatch and SCADA equipment to meet the requirements for safe, reliable and economic operation o f the HV transmission network in the new market environment i s not possible. The SCADA system, as designed, i s deficient in many respects: not a l l relevant information i s acquired (e.g., equipment alarms, transformer tap-changer positions, energy counter values), transmission speed i s low, and there i s no capability for remote control. Furthermore, a number o f the remote terminal units (RTUs) are not operational and dispatchers rely on telephones -- also not very reliable -- to obtain updated information on the status o f the system.

The telecommunications network i s based on power line carriers (PLCs), radio links, some communication cables, and leased telephone lines that are obsolete and incapable to perform their fimction satisfactorily.

Metering o f electricity does not cover all the interconnection points between the transmission network and the generating plants and the distribution companies. The existing system i s based o n electromechanical

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meters, with no remote reading capabilities, nor the capability to support time-of-day tari f fs required for pool-based trading arrangements. Furthermore, the metering has been designed for a vertically integrated system and for the times o f the integrated Soviet Union; it i s ill-suited for settling transactions in a restructured system with many market participants.

The Project aims to repair, rehabilitate, and upgrade the metering, dispatch, telecommunications infrastructure, and selected transmission facilities (equipment at substations) and transmission lines, which will improve system reliability and efficiency and enable better integration with the neighboring systems. The adopted technical solutions are based on standard concepts and proven technologies, accepted and applied worldwide. Transmission substations were selected for rehabilitation on the basis o f their importance for system operation and their age.

Cost estimates are based on the technical feasibility study conducted by an intemational consultant with broad experience in this type o f projects. The estimates are consistent with similar projects in the region. Physical contingencies were estimated at 5 percent. Price contingencies for locally procured goods and services were based on the I M F N o r l d Bank projections for Moldova, and for imported equipment, o n Wor ld Bank projections for the intemational manufacturers unit value indices.

The heating component includes modem l o w cost solutions for decentralized heating o f public buildings in 8 municipalities. Project technical design will be applied to local conditions tahng into account local technical and safety standards for gas boilers, heating substations and other equipment. Similar solutions have been used in other F S U countries. The heating component i s planned to be a demonstration project for efficient use o f energy in public buildings resulting to similar measures for other buildings, both public and residential.

The heating component cost estimates are based on a feasibility study prepared by Swedish consultants, financed by SIDA. The cost estimates are based on local price levels checked by quotations from local companies representing intemational products. Also the cost estimates reflect the price level o f similar products in Bank financed projects in other countries in the ECA region. For the Municipality o f Ungeni a bidding procedure for boiler, pre-insulated pipes and substations was organized according to Bank’s ICB-rules. The price level o f the bids was in l ine with the cost estimates for the project. The cost estimate includes a physical contingency of 10 percent. Price contingencies for locally procured goods and services were based on the I M F N o r l d Bank projections for Moldova, and for imported equipment, on World Bank projections for the international manufacturers unit value indices.

4. Institutional:

4.1 Executing agencies:

The executing agencies for the investment part o f the project will be: Moldelectrica for the electricity component; and the selected municipalities and relevant central government agencies (Ministries o f Health and Education) for the heating component.

Moldelectrica i s a state enterprise, created by the Decree #IO00 o f the Government o f Moldova o f October 5, 2000, by separating the transmission assets, central dispatch and a training center f rom the state company Moldtranselectro (MTE). ME performs the functions o f a system operator, maintains and operates 110-400-kV transmission network (and the 35-kV network o n the territory o f the North and North-West distribution companies), and manages intemational interconnections. ME does not engage in sales and purchases of electricity, which i s the responsibility o f distribution companies. ANREi issued two

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licenses in April 2001 to ME, one for dispatch and the other for transmission services. ME’S tariffs are regulated by ANRE. Provided that all distribution companies are able to pay fdly to ME for transmission and dispatch services, and that ME’S tariffs are sufficient to cover i t s costs, ME should be able to sustain i t s business. ME operates i t s network with a reasonable technical efficiency, with total losses o f 4-5% -- not unreasonably high given the level o f disrepair in the network and the fact that it includes a good part o f the 35-kV network.

ME has about 1,000 employees, assigned to five general locations, at the headquarters in Chisinau and four regional offices. The workforce i s well educated, with one third o f the employees having completed higher education (above high school). The current organizational structure i s a carryover f rom MTE and i t s predecessor Moldenergo. ME, with assistance from an international consultant under U S A I D financing, has developed a plan for i t s internal reorganization, more closely aligned with i t s functions in the restructured sector and clearer functional split between dispatch & settlement and transmission service provision. The program also envisages training o f ME’S employees in management o f the wholesale electricity market in a liberalized market environment. U S A I D has been also providing support for development o f market rules, grid and metering code, and least cost investment planning.

Public Agencies. Municipalities o f Cantemir, Chisinau, Falesti, Floresti, Ialoveni, Soroca, Straseni, and Ungeni, and the Central Government Ministries o f Health and Education are beneficiary agencies o f the heating component. Investments in the heating systems o f the municipalities will be owned and operated by the local administrations through their heating organizations or through other municipal balance sheets such as the Education Department. Heating organizations have typically been established as Municipal Enterprises, whol ly owned by the local administration, and based on assets transferred to the municipality by the decentralization and dissolution o f the state enterprise Termocomenergo. In most instances, the municipalities were ill-equipped financially to take on these responsibilities, and service both to public and residential buildings has deteriorated - in many cases to the point o f nonexistence. Where heating i s available, ta r i f f s generally cover only short-run operating costs (he1 and energy purchases, water, salaries). Notwithstanding, the costs o f heat supply to public buildings ranges from 12 percent (Soroca, Ungeni) to 40 percent (Cantemir) o f total municipal budgets. Given the perilous financial status o f some o f the heating subsidiaries, the mission recommends that the new investments be segregated from the books o f the heating enterprise and that separate budgetary provision be made to cover their operating costs.

The heating investments to be financed have been fully defined for four municipalities. The other participating municipalities will identify their public buildings to be included in the project during the f irst year of project implementation. During the design stage, appropriate attention will have to be given to the local administrations’ financial capacity, particularly with respect to covering the operating costs o f new investments and the associated debt service. The amount o f credit which each city can afford will depend o n the level o f operating savings arising from the investments, and on the municipalities’ own assessments o f their ability to increase budgetary expenditures. Each municipality should review the budget impacts o f proposed investments and determine an affordable level o f expenditure o n heating projects.

4.2 Project management:

Project Implementation Unit (Pnr). The Ministry o f Energy (MoE) will be the chief Government agency responsible for project implementation. I t s role will be to ensure that the project i s implemented in an efficient manner, consistent with project objectives and agreements signed with IDA. The Government, under Decree No 1276 o f December 21, 2000, established the Project Implementation Unit (PIU), as an independent legal entity, responsible for the day-to-day management o f the project, with particular emphasis on procurement, contract administration, financial management, accounting, and reporting. The Supervisory Board o f the PIU i s presided over by the Minister o f Energy, and includes representatives o f

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the Ministry o f Finance, Ministry o f Economy, Ministry o f Environment and Territorial Development, and State Chancellery.

Most o f the s ta f f o f the P I U were involved in implementation o f the Energy I project, which was financed by an IBRD loan, and closed in December 200 1. The staff acquired significant expertise and experience in implementing Wor ld Bank-financed projects. The P I U will employ foreign consultants to assist in procurement, upgrade procurement management and supervision system, and provide additional training for the PIU staff. This assistance will be especially intensive during the first two years o f project implementation, but will be available o n an as-needed basis throughout the project.

Moldelectrica will have i t s own technical project implementation team, working, on the one side, with contractors on physical implementation and, on the other side, with the P I U in administering the project. Moldelectrica’s management and technical personnel will be closely involved in all stages: procurement design, preparation o f bidding documents (especially technical specifications), evaluation o f bids and selection o f contractors, engineering design, installation, testing, commissioning, and quality control. The PrU will clear al l invoices with Moldelectrica to ensure their consistency with the project’s physical progress. The PIU will also exchange al l contractual and financial information with Moldelectrica.

The agencies executing the heating component will also have their project teams, who will be involved with on-site project activities, and will have similar working arrangements with the P I U as Moldelectrica.

4.3 Procurement issues:

Procurement o f equipment, goods and works and selection o f consultants financed by the IDA Credit will be done according to the Wor ld Bank guidelines. The PIU, with assistance from international consultants, will carry out al l procurement. The Wor ld Bank’s Standard Bidding Documents will be used for IDA-financed procurement. Procurement not financed by the IDA Credit will be carried out in accordance with Moldovan public procurement law and regulations, or according to SIDA procedures. A procurement workshop, including the PIU’s procurement team and their consultants, will be organized during the project launch. The workshop will focus on the Wor ld Bank’s procurement policy and procedures and their application to the procurement arrangements planned for the project.

The goods and equipment for the electricity component will be procured mainly through larger supply-and-install contracts, awarded through international competitive bidding (see Annex 6). For these contracts, the World Bank’s Standard Bidding Documents for the Supply and Installation o f Plant and Equipment will be used. Consulting contracts for technical assistance will be awarded competitively through the quality and cost based selection method, using Wor ld Bank’s standard bidding documents.

Large value contracts for the heating component, which require specialized contractors (boilers, heat-networks, etc.), will be implemented through goods contracts (procured through ICB). The total amount o f these contracts will be about 50% o f the heating component procurement. Building energy efficiency rehabilitation contracts (windows, doors, intemal piping, etc., about 12% o f the total) will be implemented through minor works contracts. Certain minor contracts, not financed by IDA, will be procured locally (building roo f insulation and preparation o f the existing boiler house structures to accommodate new boilers) according to Moldovan procurement regulations.

A Procurement Capacity Assessment for the project has been carried out (Annex 6). The procurement capacity review was based o n the country’s general procurement environment, the Public Procurement Law, other laws and regulations and intemal procurement practice.

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Based on the review, the following thresholds will be observed for prior review o f bidding documents and bid evaluations:

(i) (ii) (iii)

Goods equal or above U S $ 100,000; Works equal or above US$200,000; Consulting f i r m s above US$ 50,000.

All other contracts will be subject to post reviews.

Project Implementation Plan. The P I U has submitted a satisfactory Project Implementation Plan (PIP), detailing institutional, administrative and monitoring project implementation arrangements and procedures.

4.4 Financial management issues:

A review o f the financial management arrangements o f the project was carried out in June 2001 and subsequently updated in March 2002 and again in September 2003. The project’s financial management arrangements are acceptable to the Bank.

A draft Country Financial Accountability Assessment (CFAA) for Moldova has been prepared which concludes that there i s a need for substantial strengthening o f the overall public financial management framework. It further concludes that it would therefore be inappropriate for the Bank to place a blanket reliance on that framework for the purposes o f satisfying the Bank’s fiduciary financial management requirements. Reliance on any particular aspect o f the country’s financial management framework would need to be established on a case-by-case basis with reference to the specific financial management arrangements o f the institutions involved. The I-PRSP o f November 15, 2000 also confirms that improvement i s required in the management o f public expenditures, including the budget process and budget execution, as wel l as cash and debt management. Thus the P I U has developed policies and procedures that operate in addition to those o f the current public expenditure management framework to minimize project financial management r isks. The Bank conducted a Country Portfolio Financial Management Review (CPFMR) o f all projects under implementation in Moldova and identified some common financial management issues; the Bank confirmed that al l such issues have been appropriately addressed in the design of this project’s financial management arrangements.

The banking sector in Moldova i s relatively weak. However, the P I U has been operating satisfactorily i t s PPF Special Account in a commercial bank acceptable to the Bank whose financial status and statements are reviewed on an ongoing basis by the Bank. As these arrangements have been satisfactory, they will remain in place during the Second Energy project implementation.

5. Environmental: 5.1 Summarize the steps undertaken for environmental assessment and E M P preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis,

In accordance with OP/BP/GP 4.0 1 (Environmental Assessment) the project has been rated Environmental Category B. The reasons for this rating were (i) the inclusion o f the transmission network components and associated potential environmental issues (described below) and (ii) the heating component with the installation o f new local heat boilers at selected public buildings. The electricity component entails repairs and replacement o f existing equipment; there will be no expansion o f the substations or construction of new facilities. N o resettlement or property rights issues are involved as a l l work will be executed within the premises o f the existing facilities. Under bidding document clauses, contractors will be responsible for keeping work sites pollution-free, minimizing work-related nuisance, and retuming the sites to their original conditions.

Environmental Category: B (Partial Assessment)

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Generally, it i s expected that the project will have no appreciable adverse environmental impacts, but instead will have environmental benefits associated with the replacement o f old equipment with more environmentally-benign equipment, and the execution o f certain mitigation measures that otherwise would l ikely not be carried out.

I. Power component, transmission network rehabilitation: (a) PCBs. One o f the main environmental problems associated with open-air substations i s the possible presence o f polychlorinated biphenyls (PCBs) in transformer/circuit breakerheactor o i l or capacitor fluid. An environmental impact can arise from leaks from the transformers, circuit breakers and reactor with possible contamination of the soil and the groundwater. Serious environmental and health impacts can also arise if PCBs catch fire.

Oil samples taken by the consultants indicated no detectable levels o f PCBs. Only natural o i l i s used in transformers, circuit breakers and reactors in Moldova. Typically, this o i l comes from Russia and the same o i l i s used throughout the country. O n the basis o f the laboratory analyses and expert interviews, it was deduced that it i s unlikely that PCBs are contained in any o f the high voltage transformers, reactors or circuit breakers.

In contrast, the capacitors used in Moldova most likely contain PCBs (specifically, trichlorobiphenyl, PCB 28). There are some 20,000 capacitors at substations in Moldova. While Russian specifications contain no information about the amount o f "synthetic liquid" inside the tins, on the basis o f general experience it can be deduced that each of the tins contains PCBs in the amount o f 3040% o f volume, for a total o f 180,000-240,000 l i ters o f this hazardous substance in the country.

Storage i s a concem in some locations, such as Vulcanesti, where old capacitors are stored in metal containers protected only from rainfall.

Because removal of the capacitors or renewal of the old ones is not envisioned under the project, these PCBs do not represent a risk within the proposed rehabilitation measures. Nevertheless, the project will provide some funds to help Moldelectrica secure the sites with capacitors which may contain PCBs (see Section 5.2 below). Any future projects proposing to rehabilitate the capacitor batteries would also have to give serious consideration to the PCB problem.

Bidding documentation for the repair, replacement, or rehabilitation o f any existing equipment will specify that PCBs are not allowed. The project will bring environmental benefits, as the new switchgears will be o f SF6 type, replacing the o ld oil-based equipment, and the new transformers will have o i l pits and working sprinkler systems, thus ameliorating any existing problems.

(b) Asbestos. Another possible environmental impact arises f rom asbestos plates, which are in use at substation control buildings. Asbestos i s known to be harmful to people, especially if the plates and panels are worked and dust i s raised; inhaled asbestos dust can be carcinogenic. At present, there i s no possibility o f removing and disposing of the panels and plates o f asbestos f rom the substation control buildings in Moldova.

11. Heating comDonent: The proposed investments are expected to improve the efficiency o f heat supply and consumption and reduce energy consumption relative to the levels that prevailed in early to mid-1990s, when the level o f services was s t i l l adequate although inefficient. Because o f the progressive collapse o f the heating networks throughout the country starting in the mid-l990s, the project will actually result in an

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increase in energy consumption compared to the extremely low levels o f recent years, when the level o f service became inadequate. The low level o f production and consumption o f recent years has, o f course, resulted in a reduction o f the overall level o f the environmental impact o f these processes, but it i s important to stress that this i s a result o f abnormally reduced levels o f supply and consumption below the levels required for adequate heating, not the result o f long-term, sustainable ameliorative action.

(a) Air quality: The main environmental impact o f the stand-alone heat boilers will be related to emissions of nitrogen oxide (NO), and carbon dioxide (C02). NOx i s an important input into the formation o f ground-level ozone, which also has a major environmental impact. The emissions from other air quality parameters related to fossil-fuel-fired plants (such as particulates and hydrocarbons) are expected to be too l o w to have any serious environmental impact.

Total emissions were calculated for 15 o f the public buildings identified thus far for participation in the project. Mazut (heavy fuel) i s not expected to be used in the project-financed boilers, given their small size, which will mean lower emissions. Compared with the situation that prevailed in the early to mid-1990s (full service, before the collapse o f the heating system), the proposed investments will result in significant reductions in the levels o f emissions o f pollutants. Even if the larger gas-buming units might have had better year-round efficiency than local boilers, the reduction in the losses o f temperature and water due to the shorter transportation distances will result in a more efficient use o f energy and, thus, lower emissions.

(b) Pipe insulation: Asbestos insulation i s used extensively in Moldova, and there are no regulations forbidding the use of asbestos in new construction. For purposes o f this project, procurement documentation will explicitly forbid the use o f asbestos. Procurement documentation will also prohibit the use o f pipes insulated with CFC HCFC.

5.2 What are the main features o f the E M P and are they adequate?

The costs o f the mitigation, monitoring and training measures stipulated in the EMP have been included in the project costs and, hence, will be a part o f project implementation.

I. Power component, transmission network rehabilitation: In addition to the specific mitigation measures described below, institutional arrangements for environmental management have been provided for through the appointment o f an Environmental Manager at Moldelectrica who will participate in a training course on environmental management, sample-taking methodology, data interpretation and monitoring and reporting. The Environmental Manager will be responsible for ensuring the implementation o f the power component EMP.

(a) PCBs: In the course o f project implementation, an in-depth study, financed from loan proceeds, will be carried out to identify the scope o f the problem o f the future disposal o f capacitors that may contain PCBs, although these are not to be replaced under the project. This study will recommend various options for the disposal o f these capacitors.

Throughout project implementation, the presence o f PCBs in ground- and drinking water and in the soil will be monitored within and around substations containing capacitors (soil monitoring will be conducted once a year, and water monitoring will be conducted four t imes annually). It i s envisioned that samples will be taken from capacitors themselves once in the course o f project implementation, prior to recycling in order to verify whether or not they contain PCBs.

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In order to address the storage concems, as an urgent measure the E M P calls for providing lockable containers for leaking capacitor tins in Vulcanesti and other substations where leaking capacitor tins were found. The project includes fhds to address this problem.

(b) Asbestos. As there i s no possibility o f proper disposal o f the asbestos at present, the panels and plates will be painted with a special surface-sealing paint to prevent the rising o f hazardous asbestos dust.

11. Heating component: Asbestos-insulated pipes will be dismantled and replaced with pipes insulated with mineral wool and sheet metal or pre-insulated pipes that are free o f CFC and HCFC.

5.3 For Category A and B projects, timeline and status o f EA: Date o f receipt o f final draft: August 8,2001

The project EAEMP received from the Borrower together with the description o f the public disclosure and consultation process were forwarded to the InfoShop in February 2002.

5.4 How have stakeholders been consulted at the stage o f (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms of consultation that were used and which groups were consulted?

Stakeholder consultations with a wide range o f concerned ministries and municipalities that are potential participants in the heating component were an intrinsic part o f project preparation and identification o f the 20 buildings thus far identified.

The Ministry o f Energy published an announcement in the major newspapers o f Moldova, indicating the availability for review o f the project E M P by any interested party. The same public announcement included information o n a public meeting for discussion o f the project EMP. The public meeting was organized by the Ministry o f Energy with the active participation o f the Ministry o f Environment and Territorial Development (Environmental Policy Division), which routinely maintains close working t ies with the environmental NGOs represented in Moldova. The public meeting took place on M a y 15, 2001 and was attended by 45 representatives o f various NGOs, the media, municipalities and ministries. The Borrower's combined EAEMP for the project was submitted to the Bank in August 200 1, together with the report on the public consultation and disclosure process.

5.5 What mechanisms have been established to monitor and evaluate the impact o f the project on the environment? D o the indicators reflect the objectives and results of the EMP?

The costs of the mitigation, monitoring and training measures stipulated in the EMP have been included in the project costs and, hence, will be a part o f project implementation. Moldelectrica has appointed an Environmental Manager who will bear the primary responsibility, o n behalf o f Moldelectrica, for the execution o f mitigation, monitoring and training measures called for under the EMP. I t was agreed that the Borrower, Moldelectrica and Participating Municipalities would ensure that all measures to carry out the Environmental Management Plan are taken in a timelv manner and report on this in quarterly proaress reports.

6. Social: 6.1 Summarize key social issues relevant to the project objectives, and speci@ the project's social development outcomes.

See the social assessment in Annex 11, which i s summarized below in 6.2.

Key social issues include: (a) ensuring broad-based access to electricity throughout the country and in particular in poor rural areas, which are disproportionately impacted by system disruptions, (b) ensuring an

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adequate supply o f heat at the lowest cost in public facilities o f social significance (schools and hospitals), and (c) minimizing the impact on vulnerable groups o f increased cost recovery for electricity (although this impact i s expected to be minimal in view o f the small proposed increase in the retail tariff.)

6.2 Participatory Approach: How are key stakeholders participating in the project?

Power component: Moldelectrica i s the direct beneficiary o f the power component o f the project. The indirect beneficiaries are the generation and distribution companies and, as electricity i s the only universally available utility in Moldova, all consumers o f electricity. Consultations with the direct beneficiary and national government officials responsible for the energy sector were an integral part o f project development. Given the nation-wide character o f the indirect beneficiaries, the participatory approach in this case has been handled through conducting o f a social assessment and information disclosure and public consultations, as described above. The proposed renovation o f the transmission system i s expected to prevent the widespread negative social impact that would result from the failure o f the power system and i s not expected to generate any negative social consequences.

Heating; component: The direct beneficiaries o f the heating component are the municipalities in which the heating investments in public buildings will be made, and the users o f the services provided by these buildings (primary and secondary education and hospitals), which includes primarily children, patients in hospitals, and s ta f f working in these facilities. Indirectly, as sicknesses related to insufficient heat in the cold season should decline as a direct result o f this component, there will also be overall public health benefits (as the transmission o f contagious illnesses will be diminished.) The process o f selection o f municipalities and specific facilities in each municipality has been dnven by stakeholder participation on the basis o f i) expression o f interest in participating in the pilot program, and ii) recommendations o f critical facilities requiring improved heating by responsible officials on the municipal and national levels and in coordination with Bank teams working on reforms in the health and education sectors.

A nationwide household survey, focus groups and in-depth interviews have been conducted to elicit input from various social groups on energy-related problems, focusing on heating and energy efficiency options, their affordability and the potential participation o f households and home owners associations in implementing options considered under the heating component. Highlights o f results are provided below.

Social assessment o f households’ enerm consumption and enerw-related problems.

As part o f the project preparation, a social assessment using quantitative and qualitative research methods was carried out to examine a wide range o f energy-related issues including: (i) household access to utility services, (ii) household energy and fue l use pattems, (iii) quality and reliability o f utility services, (iv) strategies to cope with lack o f access to utility services and shortcomings in the provision o f these services, (v) patterns o f consumption, metering o f service supply, and conservation o f energy, (vi) expenditures for utilities and heating h e l s by different income groups, (vii) collections o f charges for utility services provided, cost recovery and indebtedness o f residential customers, (viii) affordability o f utility services and heating fuels (ix) price elasticity o f demand for utility services, and (x) willingness to pay for improvements in the provision o f utility services as well as measures to upgrade energy efficiency. Differences in the results for poor and non-poor households were studied with the use o f a relative poverty line constructed on the basis o f household expenditure data.

The qualitative research consisted o f in-depth interviews and focus group discussions with households; consultations with staf f from companies providing energy services to residential customers; city representatives; staff from social assistance offices; and c iv i l society stakeholders. The quantitative research was a nation-wide household survey o f 2,000 respondents carried out in April, 2000 by Moldovan

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researchers.

Consultations with key stakeholders on the national and local levels had a direct bearing on the final identification o f the two project components. Electricity i s the only universal utility service in Moldova, and a reliably functioning power system i s a basic requirement for a modem economy and economic growth. In addition to the human development aspect o f residential power service, the agricultural sector i s a major consumer o f electricity in Moldova, and the reliability o f service to this sector, which i s a major employer in rural locations where most of the nation's poor are concentrated, i s crucial for ensuring i t s position as an engine o f growth in Moldova.

The institutional framework for ensuring the viability o f investments to improve heating i s presently weak in Moldova, particularly as concems the legal basis o f home owner associations and the actual functional capacity o f those few home owner associations that exist. Further, survey results indicated that 80% o f the poor in Moldova (as defined by the relative poverty line) are not connected to the district heating (DH) system. These social factors, which emerged clearly in the process o f stakeholder consultations and from the household survey, underscored the conclusions o f the poor economic justification and questionable affordability o f wide-scale refurbishment of most DH networks in Moldova today. These are the fundamental reasons underlying the focus of the heating component on public buildings, which provide services to all members o f the population, including some, such as kindergartens and schools, that are likely disproportionately used by the poor (as described in the October 1999 poverty assessment, families with children are among the poorest group in Moldova.) From the point o f view o f economic efficiency (which in the case o f DH systems requires a cheap source o f heat and geographically a compact customer base) and affordability by the beneficiaries, on the basis o f existing information it appears that investments in the renovation o f existing DH networks would be feasible only in the city o f Chisinau, where average incomes are the highest in the country and cheap heat i s available from two Combined Heat and Power (CHI') plants.

6.3 H o w does the project involve consultations or collaboration with NGOs or other c iv i l society organizations?

NGOs participated in the public consultation that was held in May, 2001 (see 5.4)

6.4 What institutional arrangements have been provided to ensure the project achieves i t s social development outcomes?

Given the universal nature of electricity provision in Moldova, the most significant institutional arrangements are those that pertain directly to project implementation at Moldelectrica. The successful implementation o f the proposed investments will make it possible to avoid wide-scale system failure, from which socially vulnerable members o f the population would suffer disproportionately.

6.5 H o w will the project monitor performance in terms o f social development outcomes?

As described in Annex 1, explicit indicators of relevance to social development include primarily a reduction in power system failure, including in disproportionately poor areas such as rural locations. For the heating component, monitoring indicators include the increased levels o f heating and hot water provided to public buildings offering critical social services such as education and health services. A focused, follow-up social assessment among directly impacted beneficiaries could also be carried out at around the project mid-point to measure beneficiary satisfaction (or otherwise) with the project as it i s being implemented.

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7. Safeguard Policies:

7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies.

The only applicable safeguard policy i s Environmental Assessment, which i s described in detail under section 5 above.

F. Sustainability and Risks 1. Sustainability:

The sustainability o f the project depends largely on:

0 financial performance o f electricity distribution companies and their orderly payments to Moldelectrica for transmission and dispatch services;

maintaining Moldelectrica's tariffs at the cost-recovery level;

resolution o f electricity sector debt overhang;

long-term need for the buildings included in the heating rehabilitation program, and

the ability o f the agencies involved to finance h e 1 and other operating and maintenance costs for heating systems installed or upgraded by the project.

Good financial performance o f electricity distribution companies i s the key condition for the sustainability o f the entire power sector in general, and for Moldelectrica in particular, since Moldelectrica's revenues depend exclusively on payments from distribution companies (apart from possible fees which the company could earn from wheeling power to other countries). The performance o f distribution companies, including the level o f demand they will serve, reliability o f payments to Moldelectrica, and Moldelectrica's tariffs, are hndamental factors determining Moldelectrica's financial and business performance. In this context, the ability o f ANRE to regulate tariffs subject to technical and economic criteria and free o f political interference, will also be very important. Resolving the problem o f the sector's debts would remove the risk o f supply interruptions and asset claims from the creditors. The sustainability o f the heating component will be enhanced by selecting public buildings which will continue to be used as schools and hospitals and financed by the central and/or local budgets.

0

0

0

0

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2. Critical R isks (reflecting the failure o f critical assumptions found in the fourth column o f Annex 1):

S

S

Risk From Outputs to Objective Performance o f electricity distribution :ompanies.

Privatization o f distribution companies and improved commercial discipline.

Government's commitment to allow and encourage disconnection o f non-paying customers.

Maintain wholesale electricity trading rules which makes distribution companies responsible for contracting electricity.

Government's commitment to maintain subsidies aligned with budget revenues and targeting the neediest.

Government's non-payment o f subsidies and energy consumption o f budget organizations.

L o w tariffs for sector enterprises due to poor performance o f ANRE and political interference in i t s staffing and decision making.

Servicing energy sector debts.

S

S

S

Sufficient financial resources for budgetary agencies to operate heating systems. From Components to Outputs Meter reading and dispatch rules and procedures not followed.

Privatization o f distribution and strengthening regulation.

Financial strengthening o f Moldelectrica through tariff increase and full collection o f payments .

Adequate budgeting.

IInadequate system maintenance.

Inadequate maintenance o f the buildings, and the heat production and delivery systems.

Risk Rating I Risk Mitigation Measure

I

S

S

M

S

Technical assistance to ANRE provided by donors (USAID).

Most o f the historic debts separated from operating companies in the sector.

Technical assistance for auditing and restructuring o f the debts provided.

Commitment to maintain adequate budgets.

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Project implementation delays due to lack o f local financing and poor project management.

Overall Risk Rating

M

S

Local financing requirement minimized.

Upfront staffing o f project management units and their training.

Technical assistance for project management during implementation.

3. Possible Controversial Aspects:

None.

G. Main Loan Conditions 1. Effectiveness Condition

The Subsidiary Loan Agreement between Ministry of Finance and Moldelectrica, satisfactory to IDA, to be signed before Credit effectiveness. [C.4]

A Subsidiary Loan Agreement between the Ministry o f Finance and at least one local government to be signed before credit effectiveness. [C.4]

Signature and effectiveness o f SIDA Grant Agreement. [D.3]

2. Other [classify according to covenant types used in the Legal Agreements.]

Legal Covenants

The Borrower to maintain a legal, regulatory, policy and institutional framework for the energy sector conducive to efficient commercial operation, attracting private investments and ensuring reliable and affordable energy services [B.2]

By March 3 1, 2005, the Borrower will identify the specific investments under the heating component, in accordance with eligibility criteria defined in Annex 12. [C. 13

Non-budgetary facilities could be included into some pilot heating schemes only with agreement from IDA and after the appropriate legal, institutional, and regulatory framework, satisfactory to IDA, has been developed. [C. 11 Terms and conditions o f the Subsidiary Loan Agreements between Ministry o f Finance and Moldelectrica and between Ministry o f Finance and the rayon councils ('judet)/municipalities will be acceptable to IDA. ~ 4 1

The Borrower will establish, maintain and operate, in a commercial bank acceptable to IDA, under terms and conditions acceptable to IDA, a Special Account denominated in U S Dollars. [C.4, Annex 61

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The Borrower will maintain the P I U until completion o f the project, with staff, resources and Terms o f Reference acceptable to IDA. [C.4]

The Borrower, through the PIU, will provide, on a quarterly basis, 45 days after the end o f each quarter, consolidated reports on project implementation progress in the FMR format and draft annual action programs for the upcoming year will be included with the December reports for IDA'S review and comment. [C.4]

The Borrower will prepare a project mid-term report and submit to the Association by December 31, 2005, and review such report with IDA by March 3 1,2006. [C.4]

The Borrower will prepare a plan for operation o f the project and submit to IDA not later than 6 months after the Closing Date of the IDA Credit. [C.4]

Accounts receivable for Moldelectrica at the end o f each fiscal year will not exceed 60 days o f sales equivalent based o n the prior year's sales figures. [E.2]

The Borrower wil l ensure that assets or cash flow of Moldelectrica will not be pledged against historical energy debts o n the books o f Moldtranselectro. [E.2]

Moldelectrica will maintain a ratio o f current assets to current liabilities o f not less than 1.2. [E.2]

Moldelectrica will maintain a debt-service-coverage ratio o f not less than 1.5. [E.2]

The Borrower, Moldelectrica and Participating Municipalities shall ensure that al l measures to carry out the Environmental Management Plan are taken in a timely manner and report on this in quarterly progress reports. [E5.5]

The Borrower will maintain a financial management system, including records and accounts, and prepare financial statements in a format acceptable to IDA. The Borrower will also hmish to IDA Financial Monitoring Reports for each quarter. [Annex 61

The Borrower will have the project records, accounts and financial statements, including the Special Account, audited annually by independent auditors acceptable to IDA, and furnish the audit reports to IDA not later than 6 months after the close o f the fiscal year. Moldelectrica will also have i t s accounts audited annually and hrnish a copy of the audit report to IDA not later than 6 months after the close o f i t s fiscal year. [Annex 61

H. Readiness for Implementation [XI 1. a) The engineering design documents for the f i rs t year's activities are complete and ready for the start

o f project implementation. 0 1. b) No t applicable.

iXi 2. The procurement documents for the first year's activities are complete and ready for the start o f project implementation.

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El 3. The Project Implementation Plan has been appraised and found to be realistic and o f satisfactory

0 4. The fol lowing items are lacking and are discussed under loan conditions (Section G): quality.

The project is ready for implementation. Technical consultants for preparation o f bidding documents have been hired and are preparing bidding documents. Bidding documents for the f i rs t year o f project implementation are expected to be completed by credit effectiveness.

I. Compliance with Bank Policies El 1. T h i s project complies with a l l applicable Bank policies. 0 2. The fol lowing exceptions to Bank policies are recommended for approval. The project complies with

al l other applicable Bank policies.

Vladislav Vucetic Luca Barbone Team Leader Sector Managerhhector Country ManagerlDirector

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Annex 1: Project Design Summary MOLDOVA: Energy I1 Project

Hierarchy of Objectives Sector-related CAS Goal: Support private sector development, public sector reform and public debt management through improving energy infrastructure and assisting in rescheduling o f energy related intemal and extemal debts.

Project Development Objective: Improve the security and reliability o f the electricity transmission system and wholesale electricity supply and, therefore, facilitate unimpeded commercial operation o f the power system.

improve the availability, quality, and efficiency o f heating in selected priority public buildings.

Key Performance Indicators

Sector Indicators: Increased presence o f private investors in the energy sector.

Improved reliability o f electricity supply.

Improved heating in selectel public buildings (schools, hospitals).

Reduced and rescheduled historic debts o f the power sector.

Outcome I Impact Indicators: Reduced outage rates o f the high-voltage transmission lines and substations by 35%.

Reduced non-technical losses (through the upgraded metering) by 75%.

Reduced unserved energy by 200 MWh per year.

Reduced technical losses b j 5% from upgraded dispatch

[ncreased availability o f neating in the selected mildings from about 30 hys to 120 days per year.

Data Collection Strategy

5ectorl country reports: 3overnment's statistics.

l a t a f rom power sector :ompanies.

'roject Implementation ieports from the PIU.

'roject reports:

'roject Implementation Xeports from the PIU.

'reject Supervision Reports ?om IDA

ieports from the selected Uunicipalities and 3overnment Agencies.

hstomer survey on heating mprovements.

Critical Assumptions :from Goal to Bank Mission) Zontinued implementation i f the economic reform ?rogram.

[from Objective to Goal)

Government to maintain policies conducive to and supportive o f private investment; stronger law enforcement (including bankruptcies and anti- corruption measures).

More efficient public govemance and public institutions.

Prudent fiscal policies.

Supportive extemal investment environment.

Political stability in the country and the region.

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Iutput from each Zomponent: mproves metering o f :lectricity flows, and idministration and nanagement o f the vholesale electricity market.

:mproved power system lispatch and control.

3ottlenecks in the ransmission system -educed.

Specific heat consumption (space heating) o f the rehabilitated buildings [w/m2] before and after the project in the design conditions (temperature inside +18 oC/outside -1 6 oC); savings about 30 %.

Output Indicators:

Number o f meters installed: 400; plus one Metering Management System.

Installation o f Dispatch Center equipment.

Installation o f telecommunications equipment.

53 high-voltage circuit breakers at three major substations.

330-kv lines: replacement 01 repair o f 40 km o f conductors, 120 towers, 24( km o f earthwire.

110-kv lines: replacement 01 repair o f 5 km o f conductors, 65 towers, 45 km o f earthwire.

'roject reports:

'roject implementation eports f rom the PIU and mplementing agencies .

'roject supervision reports i-om IDA.

'roject supervision reports i-om co-financiers.

:Tom Outputs to Objective)

Leep improving 'erformance o f electricity .istribution companies maintain good collections nd keep reducing losses .nd operating costs).

;ovemment to pay energy onsumption subsidies and inergy consumption o f udget entities.

idequate tariffs.

Jnimpeded imports o f tlectricity by the exporting :ountries.

- 4 1 -

[mproved heating o f selected public buildings.

[mproved framework for ievelopment o f commercial ieating systems.

Jroject Components I 3u b-components: Rehabilitation and upgrade i f electricity system netering.

Rehabilitation and upgrade i f power system dispatch, :ontrol, and :ommunications.

?riority rehabilitation o f 3ower transmission ietwork, including :nvironmental mprovements.

:mprovement o f heating ;upply and demand in iublic buildings.

Number o f buildings included in the project: 80.

Institutional and regulatory framework for commercial heat supply to customers in the residential, services, industrial and public sectors developed and adopted.

Inputs: (budget for each component)

US$4.5 million.

US$ 12.1 million.

US$ 1 1.1 million.

US$ 9.2 million.

+eject reports:

?roject Implementation Xeports from the PIU and iroject beneficiaries.

?roject supervision reports ?-om IDA.

?roject supervision reports i-om co-financiers.

hd i t reports.

3overnment and Uunicipalities to have idequate budget for iperating heating systems.

[mplementation o f debt :estructuring plan.

(from Components to Outputs) Meter reading procedures followed.

System dispatch rules and procedures followed.

Adequate maintenance and operation.

Adequate maintenance o f buildings and the heat production and delivery systems.

Timely and full disbursement o f local

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Technical Assistance for Project Implementation and Sector Reforms.

Project Management and Administration.

US$ 1.6 million.

JS$ 1.4 million.

financing.

Maintaining competent and adequately staffed PIU

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Annex 2: Detailed Project Description MOLDOVA: Energy II Project

Project Concept. The unfinished agenda in rehabilitation and upgrade o f the power system and deteriorated heating o f public and residential buildings are the main problems in the Moldovan energy sector at this stage. This project i s designed to address these weaknesses. The project has four components:

I. electricity system upgrade (rehabilitation and upgrade o f metering, dispatch, telecommunications, and transmission systems);

11. heating supply and efficiency improvement;

111. technical assistance for project implementation and energy sector reforms, and

IV. project management and administration.

These components are described in more details next. As far as extemal financing i s concemed, IDA will cofinance al l project components.

By Component:

Project Component 1 - US$27.79 million

I. Electricity System Upgrade

The electricity component o f the project has the following subcomponents:

a. improvement o f metering in the electricity transmission network;

b. rehabilitation and upgrade o f power system dispatch;

c. rehabilitation and upgrade o f system telecommunications;

d. priority rehabilitation o f the transmission network, and

e. environmental upgrades in the transmission system.

(a) Rehabilitation and upgrade of metering

To allow for the proper measurement o f energy flows and sound commercial operations, energy metering must be installed at all interconnection points between the transmission grid and private distribution companies, power generation companies and international transfer lines. The number o f metering points was obtained by use o f the following principles:

For power stations, the energy output o f every generator, the auxiliary energy drawn from the gnd for station use, as well as the total energy exchanged with the grid must be metered.

For substations, the lower-voltage winding o f every transformer, representing a border between the transmission and distribution companies, must be metered.

Metering must be performed at all t ie lines with the grids o f neighboring countries.

0

0

0

In addition, energy meters must be provided at 1 10-kV interconnection points between distribution companies for ease o f energy balancing. The subcomponent will provide meters based on the assumption that the 35-kV system will belong to the distribution companies (as i s the case for RED'S South, Centru and Chisinau); such arrangement i s technically sound and reduces the number o f meters required by the transmission system.

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This subcomponent consists of:

0 A central Metering Management System with communication and application servers, consoles for data-base maintenance and report generation. Data l i n k s are foreseen for transfer and interchange o f data tohetween SCADA, the sales department, and market participants.

Metering data transfer through a separate radio system to be installed in each substation with metering points. Data shall be collected at (36) Regional Distribution Centers and sent further via radio to main substations or power stations with fiber-optic l i n k s to the NDC.

Energy meters to be installed at all above-defined metering points, fulfilling the requirements o f the wholesale electricity market. In particular the meters shall provide for:

9 Metering o f active and reactive power in both load f low directions (importlexport); 9 Metering at 15-min intervals; 9 Time-dependent tariff switching and determination o f maximum demand values; > Local storage o f data; P Remote data acquisition by data transmission interface; and 9 Local data collection via hand held reading devices.

0

0

0 Current and voltage transformers are to be replaced or installed anew at selected locations, to enable metering with adequate accuracy.

The metering system was designed to support a variety o f market arrangements, f rom bilateral contracts to short-term spot markets based on competitive bidding.

@) Rehabilitation and upgrade of dispatching system

This subcomponent aims to ensure a safe, reliable and efficient regime o f the electrical high voltage network considering the requirements o f a wholesale market. Taking into account the constraints in network operation, it i s important to ensure fast decision-making in real time. This i s only possible when the National Dispatch Center (NDC) operator has the necessary real-time information and tools at his disposal. This component includes installation o f the necessary hardware and software to enable real-time acquisition o f operational information from the main facilities (power stations and transmission system substations), analysis and monitoring o f the system status at the National Dispatch Center, and control and dispatch o f the power plants, load centers, and the transmission system, to maintain a reliable, secure and economic operation o f the system and facilitate the operation o f the wholesale electricity market. The total amount o f data the rehabilitated system will handle will be:

0

0 1,400 alarms, and 0 500 measurements.

1,200 status indications (single data points);

The hardware configuration at the NDC will include a System Control and Data Acquisition (SCADA) system consisting o f a distributed, redundant configuration with main computers for SCADA application software and database handling, graphic operator work stations, projection screen, printers, servers dedicated to network security assessment and energy management, and front-end computers to maintain the real time communication to the remote terminal units. Remote consoles for the dispatch and market manager are also foreseen as well as communication servers for data exchange with other market participants.

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The SCADA application software system will fulfill the following functions:

0 0 0 0

0 0

0

Administration o f data exchange with RTUs; Data base management and maintenance; Status indication, event and alarm processing, including sequential event recording; Acquisition and processing o f measurements with validation, alarming o f limit violations, calculation o f operational values, calculation o f trends, etc.; Network topology monitoring and coloring; Report generation for continuous printouts o f event and alarm logs, regular an spontaneous measurement reports, network and control system performance reports, and Historical-data storage and retrieval for post-mortem reviews, network and control system performance analysis, and statistics.

The Power applications software will provide the following capabilities: (a) state estimation; (b) load-flow and contingency analysis; (c) available transmission capacity; (d) on-line short-circuit calculation; (e) voltage-reactive power optimization; (f) interchange transaction scheduling and contract control, and (g) energy-flow control.

Remote Terminal Units ( R T U s ) . In order to collect and transmit the controls, indications, alarms and measurements from the periphery o f the transmission system to the SCADA system, new RTUs will be installed at substations. These installations will comprise: (a) 29 Remote Terminal Units (RTUs); (b) cabling between RTUs and the points where the data originate, and (c) wiring modifications, decoupling relays, analogue and digital transducers, interface terminal blocks, etc. At a l l transmission substations, safe DC power will be installed.

(c) Rehabilitation and upgrade of telecommunications

Reliable telecommunications, designed for the specific needs o f the transmission system, are indispensable for the operation o f the electrical network. The telecommunications network must perform transmission o f voice and SCADA data between the substations and power plants and the NDC, between the substations themselves (voice only), and between the NDC and other market participants.

In designing the configuration o f the telecommunications network, the following parameters were taken into account:

0

0

0

required number of channels for (a) voice transmission, (b) SCADA data transmission, and (c) metering data transmission; required transmission speeds (bandwidths) for SCADA data on the different sections of the transmission system; number o f connected stations and their geographical location; reliability, availability and redundancy requirements; possible reuse o f existing installations, and long-term requirements o f the telecommunications network.

The subcomponent envisages using fiber-optic (FO) and microwave (MW) links for a backbone ring connecting Straseni S/S, Chisinau S/S and CHP-2 with the NCC. Additional FO links are also envisaged to be installed on the HV transmission lines as an All-Dielectric Self Supporting (ADSS) cable, stretching from Vulcanesti S/S in the south to the backbone ring up to Donduseni in the north. The overall system

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will be enhanced through Power Line Carrier (PLC) links, to be installed at spur locations, and a new radio system replacing the outdated one existing today.

The fiber-optic network will be based on the plesiochronous digital hierarchy (PDH) with a transmission capacity o f 8 M b i t / s (120 x 64 kbit/s channels). Existing PLC equipment that i s s t i l l operational will be incorporated into the new telecommunication network as far as this i s technically possible. A private telephone network will also be installed consisting o f one main PABX, located at the NDC. Thus, both operations and administration calls will be routed through the same network, and h t u r e extensions can be done easily.

(d) Rehabilitation of substations and transmission lines

Network calculations prepared by Consultants indicate that the system performs well with regard to load flow and stability conditions. The main reason for this i s that the 330-kV network i s a ring-system (talung also into account the H-V lines in Ukraine), underpinned by an extensive under-laying 110-kV network. Most o f the disturbances at the 330-kV and 110-kV voltage level do not cause an interruption o f power supply to the consumers. To some extent, the presently very l o w utilization o f the system also contributes to the system’s performance but this margin will disappear as the demand and the line loading increases in the years ahead, at which time the system will be more severely stressed. The system has suffered from a lack o f regular maintenance, due to non-availability o f spare parts, and due to the age o f the installations. Most o f the equipment i s more than 20 years o ld and in some substations even older than 28 years, which i s considered by Moldelectrica as the maximum physical lifetime.

Moldelectrica identified a l i s t o f the most urgently needed rehabilitation measures that were confirmed by the Feasibility Study performed by Fichtner GmbH o f Germany in 2000. These include station batteries for selected substations, and 330-kV equipment for the Chisinau, Straseni and Bal t i substations, o f which the major component i s 53 circuit breakers at the 110-kV level. In addition, severe weather conditions, in November 2000 and March 2002, have caused serious damage to the 110-kV and 330-kV lines. On account o f this damage, rehabilitation o f the transmission system i s also to include the repair o f a number of 110-kV and 330-kV high-voltage lines. Environmental measures related to this component will also be included in the scope o f corresponding bidding documents.

(e) Environmental upgrades in the transmission system

In the context o f this rehabilitation project, no construction o f new transmission lines i s envisaged; therefore, no environmental impacts in this connection will occur. As outlined in the Environmental analysis, in Section E5, possible environmental concerns that are beyond the project-specific context include potential o i l leaks f rom transformers, circuit breakers and reactors with resulting possible contamination o f soil and groundwater. Another long-term concern stems from the 20,000 capacitors installed at substations in Moldova, potentially containing trichlorobiphenyl (usually referred to as poly-chlorinated biphenyls or PCBs), which i s a hazardous material. Since removal o f capacitors or renewal o f o ld ones i s not foreseen under the project, PCBs do not represent a r i sk within the present project. However, an amount o f $100,000 has been budgeted in the project for physical mitigation measures for appropriate protection o f the sites and disposal o f o ld PCB-containing condenser batteries, to be implemented when replacement o f the batteries i s required.

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Project Component 2 - US$9.16 million

11. Heating

This component includes improvements in supply and distribution o f heat and demand-side measures for heat and hot water consumption in selected public buildings (schools, hospitals, and residential buildings for disabled and other vulnerable groups). About 20 buildings, comprising the f irst investment batch, have been identified and technically appraised. An indicative l i s t o f additional buildings has been prepared, and includes about 95 buildings in 8 municipalities (Cantemir, Chisinau, Falesti, Floresti, Ialoveni, Soroca, Straseni and Ungeni; the municipalities may change during project implementation) and under the central Ministr ies o f Health and Education. The l i s t includes about 50 schools and lundergartens with more than 15,000 pupils and about 25 hospitals and clinics with more than 4000 beds. A detailed analysis during project implementation may result in some o f the objects being changed due to technical or financial reasons. The criteria for the selection o f the public buildings i s shown in Annex 12.

The heating and hot water improvements would include: (a) demand-side investments consisting o f energy efficiency rehabilitation o f building envelopes and rehabilitation o f building internal heat and hot water distribution systems to reduce heat losses; and (b) supply-side investments consisting o f rehabilitation o f external heat distribution pipes from the boiler houses to the buildings and installation o f new gas/L,PG-fired boilers (where necessary) with auxiliaries to reduce heat losses, improve heat generation efficiency and facilitate affordable heat and hot water supply.

The Energy I1 project could include some pilot schemes with residential buildings, provided that the legal, regulatory, and institutional framework i s sufficiently developed.

The heating component will be implemented in three batches: the first would include the already identified and appraised 20 buildings (including the pilot project in Ungeni); the second batch will be prepared (identified and appraised) with the assistance o f the Swedish and local consultants within 6-8 months f rom the start o f the project; and the third batch will be identified and appraised within 18-24 months from the start o f the project. For each batch, a technical and financial feasibility analysis o f the proposed investments will be completed. The investments should be least cost - i.e., the proposed technical solution should satisfy the required heating standards at minimum cost (investment plus operating costs). Environmental measures related to this component will also be included in the scope o f corresponding bidding documents.

Project Component 3 - US$ 1.60 million

111. Technical Assistance for Project Implementation and Energy Sector Reforms

Technical assistance (TA) will cover the following activities: (a) Project implementation; (b) PCB follow-up study; and (c) Technical Assistance for sector reforms. In more detail, these subcomponents are:

- 48 -

(a) Project implementation

This subcomponent comprises of the following two items:

(i) Implementation of the electricity component includes services o f external consultants for engineering design, procurement and project implementation o f the electricity component o f the project; and

(ii) Implementation of the heating component includes services o f external consultants for engineering design, procurement and project implementation o f the heating component o f the project. This component will be fbnded by SIDA.

(b) Environmental Study (electricity system)

The environmental assessment carried out in the context o f project preparation indicated that no appreciable adverse environmental impacts would result from the implementation o f the proposed electricity system upgrades. However, in order to strengthen i t s capacity to deal with the potential problem of condenser batteries containing PCBs located at substations throughout the country, the project envisages carrying out a follow-up study o f the issue, including the development o f recommendations for appropriate protection o f the sites and disposal o f o ld PCB-containing condenser batteries, to be implemented when replacement o f the batteries i s required. The study will also help the transmission company to develop a corporate policy in dealing with environmental issues.

(c) Technical assistance for sector reforms

The subcomponent includes provision o f selected technical assistance for improving institutional and regulatory framework in the energy sector, energy trading, privatization, and debt restructuring.

Project Component 4 - US$1.38 million

IV. Project Management and Administration

This component will cover the incremental expenses required for project implementation -- services o f the Project Implementation Unit and audits related to project implementation.

- 49 -

Annex 3: Estimated Project Costs MOLDOVA: Energy II Project

Transmission 0.95 8.80 9.74 Heating 4.1 9 4.97 9.16 Technical Assistance 0.00 1.60 1.60

lcomponnet II Local Foreign Totall

Sector Reforms I 0.00 0.30 CGi Project Management and Administration 0.94 0.44 Total Base Costs 7.66 28.97 36.6

Physical Contingencies 0.12 0.99

I I~(us$ million) (US$ million) (US$ million) IElectricity II 2.53 21.96 24.4d

Metering SCADA Telecommunications

0.91 3.06 0.43 5.09 0.25 5.01 5.2

Project implementation Heating Electricity

Environmental Management 0.6 0.1

0.00 1.20 0.00 0.60 0.00 0.60 0.00 0.10

Note: Cost.figzires for the electr ic iv components in Aiznex 2 include contingencies.

- 50 -

Annex 4: Cost-Benefit Analysis Summary

Summary of Benefits and Costs: The project has four main components: (i) upgrade and rehabilitation o f power system infrastructure; (ii) heat supply and consumption; (iii) technical assistance for sector reforms, and (iv) project management and administration. A separate economic analysis was conducted for the first two components, which account for the physical investments to be made and consequently, for the quantifiable benefits streams expected to result from the investments.

MOLDOVA: Energy I1 Project

Economic IRR for power system investments: Net Dresent value (NPV; $ million):

I) Power system infrastructure: this component accounts for the bulk o f the project costs. The power system infrastructure investments fall into four main categories: metering, dispatch, telecommunications and transmission. Following i s a summary o f the economic return expected from the power system infrastructure investments, with an indication o f the expected benefits. In addition, there are intangible benefits (such as an improvement in international trade due to improved telecommunications) and other benefits that could not be quantified due to the absence o f reliable data.

39.3 yo 69.2

Anticipated benefits: % total benefit

Reduct ion o f unserved energy

Reduct ion in transmission losses (dispatch) Avo ided collateral damages

84.4 10.2

2.6

As can be seen, the expected benefits from the power infrastructure component o f the project derive primarily from the reduction o f unserved energy resulting from investments in the transmission network. O n the basis o f information provided by Moldelectrica and the investigations conducted in the course o f the feasibility study, it was concluded that all o f the substations for which investments are proposed are in so grave a condition that unless the investments are made, they will suffer breakdowns in the coming years. The other investment components, while indicating a smaller share o f the total expected benefits, are necessary because they are integral parts o f power system functioning.

Improved telecommunications Reduct ion o f non-technical losses (metering)

Main Assumptions:

1.7 0.8

As noted above, the primary benefit o f the project i s expected to be a reduction o f unserved energy. Consequently, the main assumptions are those that bear most significantly on the calculations o f the value of this benefit. These are described below.

-51 -

Price of electricity: The economic price o f electricity was calculated on an average willingness-to-pay basis, that is, the average o f the calculated cost o f self-generation and the actual end-user tariff. Talung hr ther into consideration that the demand curve for electricity may not b e l inear but, rather, have a concave shape, this simple average o f the willingness-to-pay was then reduced by 20%, resulting in a shadow price for electricity o f 0.072 US$/kWh.

pe r iod 20% increase in total costs in each year o f

Degree of load left unserved: If the proposed investments in the batteries at the substations are not made, then it i s expected that the protection system and circuit breakers will malfunction before long, causing damage to equipment and leaving consumers without power. Since switching to a lower voltage level might s t i l l be possible in view o f Moldelectrica’s currently underutilized network, it has been conservatively assumed that only 50% o f the load at the high voltage level would be left unserved in the event o f a supply interruption.

36.5% 67.1

Probability of disruptive event occurring: The conservative assumption o f only 50% unserved load was further augmented with conservative assumptions as to the probability o f a disruptive event occurring. For the first three years o f benefits, the probability o f 20% was assumed. For the next five years, a probability of 50% was assumed, after which a probability o f 100% was assumed, as the system would collapse if the proposed investments are not made.

disbursements 20% reduction in overal l benefits in each

Growth rate of power demand: The analysis uses an estimate o f peak growth o f 3.9% p.a. for the period 2003-2005, 6.0% p.a. for the period 2006-2010, and 3.0% for the period 201 1-2022 on the basis o f a least-cost study prepared for Moldelectrica by intemational consultants.

35.4% 52.9

Sensitivity analysis / Switching values of critical items:

5.10 U S c e n t s k w h (end-user tariff) as shadow pr ice for electricity (base case: 7.2 1 U S c e n t s k w h ) For unserved energy, only 25% o f load le f t unserved in case o f supply interruption (base case: 50%) For unserved energy, 10% in i t ia l probability o f occurrence o f breakdown for f i rs t three years (base case: 20%). 14% discount rate (base case: 12%)

A sensitivity analysis was conducted o f the project’s most important assumptions that showed it to be robust even under significantly more pessimistic assumptions with respect to costs and benefits.

34.5% 48.4

29.2% 33.0

38.1% 67.4

41.3% 54.8

0% demand growth for entire project I 32.4% I 36.8

vear. I I

- 52 -

A switching analysis o f key variables was conducted to determine the values that render the net present value zero.

Variable

Total costs

Switching value (multiplier)

4.80

Total benefits Price o f electricitv

.20

.08

The switching analysis shows that the project’s economic viability i s sensitive only to very large shifts in the basic assumptions. Total costs would have to increase by a factor o f 4.8 before the net present value o f this component would equal zero (equivalently, total benefits would have to decrease to about one fifth o f the value calculated in the analysis). The derived shadow price o f electricity would have to drop to less than one-tenth o f i t s calculated value - that is, considerably below the actual distribution tariff, which i s an unrealistic scenario - before the project would cease to have a positive net present value. Instead o f the assumption o f 50% o f the load remaining unserved in the event o f a system failure, the percent o f the load unserved would have to be around 3.2% before the net present value o f the project would equal zero.

11. Heating component

The EIRR o f the heating component was not calculated as it would be very difficult to evaluate the benefits o f improved heating for the type o f the buildings included (schools, hospitals, etc.) due to the complex methodology and data requirements (the lost school-days and their value; the cost o f increased incidence o f illnesses o f staff, students, and patients; the cost o f poorer educational services and hospital care; inefficiencies and the costs o f the present-mode heating, etc.). Rather, the proposed investments have been selected on the basis o f the least-cost analysis conducted in the context o f the strategic heating options study, which concluded that heating provided through stand-alone boilers or through mini-networks for a cluster o f buildings i s the least-cost heating option for Moldova, except possibly for some areas o f the capital, Chisinau, in the proximity o f the Chisinau-2 CHP plant.

- 53 -

Annex 5: Financial Summary MOLDOVA Energy II Project

Foreign Inflation Domestic Inflation Exchange Rate (Lei per US$) -- Year Average

(a) Main Assumptions:

General:

2002 2003 2004 2005 2006 2007 2008 2009 2010 -1.40% 5.60% -0.30% 1.60% 1.20% 1.20% 1.20% 1.20% 1.20% 5.28% 8.00% 6.00% 6.00% 6.00% 6.00% 6.00% 6.00% 6.00%

13.57 14.41 15.19 15.95 16.74 17.47 18.24 19.79 20.61

Loans: Moldelectrica i s assumed to have no existing outstanding loans. A portion o f the IDA credit (approximately US$26.9 mi l l ion equivalent) would be on-lent to ME for a 20 year period, including 5 years of grace, at an interest rate equal to IBRD currency-pool rates (assumed to be 6.5 percent on average). Commitment fees were assumed to be zero, although under the proposed on-lending arrangements, ME would be obligated to compensate the Government in the event that commitment fees were imposed on IDA lending.

Income Statement: Gross Revenues: The projections o f the total electricity supplied to the network were developed by the consultants using a partial adjustment model in the Least Cost Study o f Moldova Energy Sector. Electricity delivered to consumers will grow at a slightly higher rate due to reductions in losses as a result o f the project.

Collections: It i s assumed that the current collection rate (close to 100%) will be sustained in the future, either by privatizing the remaining state owned distribution companies, or by keeping strict administrative control over them. A modest (5%) allowance for uncollectible accounts was included in the profit and loss statement.

Operating Expenses: In recent years, maintenance and repair expenditures have been l o w for ME. Maintenance expenses in 2003 are significantly increased to get closer to the real requirements. It i s assumed that these costs will continue to increase in real terms at the rate o f 5% a year. Administrative and staffing levels are assumed to remain constant, but wage rates are assumed to increase by 2 percent per annum in real terms. Depreciation expenses are based on a percentage o f gross revalued assets by generalized classification. Classifications and the average depreciation rates are: Lines - 2%, Substations (including transformers)-- 3.5%, Other assets - 8%.

Other: Interest during construction i s paid on amounts disbursed under the loans. Corporate income tax i s charged at a rate o f 20 percent.

Balance Sheet: Fixed Assets: As o f the end o f 2001, gross book value o f the fixed assets was considerably lower than their replacement cost. Results o f a study by independent consultants showed that the real gross value o f the assets, even if adjusted for older technology and some overcapacity, i s about two times i t s current gross book value. As a result, depreciation calculated o n the basis o f the undervalued assets did not generate sufficient funds for adequate capital maintenance expenses. Intemational accounting standards, which are accepted by legislation o f Moldova, do provide for revaluation o f assets in these circumstances, and it i s assumed that the assets would be revalued in 2002 and 2003, based on the recommendations o f the study on assets revaluation that was completed in April 2002. During 2002, the value o f net f ixed assets was adjusted upwards by 47 percent.

- 5 4 -

It was also assumed that thereafter, fixed assets are revalued with inflation on an annual basis, and depreciated at the rates shown above. In order to preserve the asset base, ME i s also assumed to reinvest an amount equal to depreciation in capitalized maintenance and asset replacement. However, the amount o f investments from the own sources varies. During the project implementation period IDA funds provide from 30% to 100% o f the required annual capital investments and it i s not expected that ME will reinvest the depreciation in full in those years. However, when the disbursements from the project come to an end, the amount o f investments from their own sources will increase to provide the full amount o f the required capital investments.

Current Assets: Accounts receivable for ME will average 45 days sales equivalent. Inventories will be revalued together with fixed assets and thereafter their value will increase with inflation. Prepaid expenses will remain constant and other assets increase with inflation.

Current Liabilities: Trade accounts payable will be in the constant proportion to the operating expenses. Payments to employees do not exceed 1 month o f salary and social expenditures. Other liabilities increase with inflation.

@) Tari f f Scenarios

Tariffs for ME are assumed to be set at the cost recovery levels using two different scenarios.

T h e j r s t scenario, (targs set to cover cash expenses), attempts to moderate tar i f f increases. I t can be argued that had the country been able to afford higher tariffs and get large cash flows for ME immediately, there would not have been any need for the IDA project in the transmission company. Therefore, this scenario assumes that the tariff covers only the cash expenses that the company incurs. That includes operating and maintenance costs (without depreciation), provisions for capital investment f rom the company's own sources (including own contribution to the Energy I1 project) and debt service (including both principal and interest). Within this transition period tariffs will gradually increase and after 5 years reach the same level as in the second scenario. As a result, ME will suffer losses during the project implementation period. However, the cash f low will remain positive, and the company will be able to finance i t s operating and investment expenses. Pro forma financial statements under the Cash F low Scenario are given in the Tables 5.1-5.3.

I n the second scenario full cost recovery targs) the tariffs cover O&M costs, depreciation o f the revalued assets. This scenario results in l o w profits and significant surplus cash flows during the project implementation period. The reason for the excess cash f low i s that depreciation component o f the revalued assets i s envisaged in the tariff, but much smaller amount o f cash i s being spent on the capital investment from own sources, since IDA on-lending provides most o f the cash for this purpose. In addition, during the first 5 years, there i s no significant debt service requirement which also contributes to the positive cash flow. Positive cash flow accumulated during this period can be set aside to cover negative cash flows during the early years o f loan repayment. Pro forma financial statements for the Full Cost Recovery Scenario are given in Tables 5.4-5.6.

Sensitivity and r isks :

Energy balance forecasts usually are not precise, therefore, for tar i f f adequacy monitoring purposes it i s better to use required revenues, rather than nominal tariffs, which are very sensitive to the power throughput assumptions.

- 55 -

Collections. One o f the main assumptions i s that collections from the distribution companies remain at or near 100%.

(c) Conclusions

After the study o n revaluation o f assets was completed in April 2002, ANRE increased Moldelectrica's tariffs to the level o f 3.52 bani per kwh (the increase took effect on September 1, 2002). This i s more than enough to cover cash operating expenses during the project implementation period. However, it does not reflect full depreciation on revalued assets and further tariff adjustment may be needed in future years to ensure full cost recovery. The Government made a commitment under the project to maintain a proper regulatory environment in the sector, including the authority o f the regulatory agency (ANRE) to maintain adequate tariffs. The Bank, through supervision o f the Second Energy project, will seek to ensure that this commitment i s maintained and tari f fs indeed are kept at a level which ensures that Modelectrica can recover the full cost o f i t s operations.

- 56 -

MFlUBe&eTpc

57% 3586 543 7 m la2ro 12348 12982 13,933

4,163 (45,441) am) 3p6 m741 =I 51,345 !X@i9

- 57 -

- 27,925 12211 ~67512

(4,976) 24754 17EU 17891 Z612 100281 lCW8 118,C83

- pJ29 23,740 24,158

87,636 97@5 1Q7B 111,8l6

123444 280s

- 58 -

Table 5.3 PreForma Financial Statements Moldelectrica - ’000 Lei Scenario 1, Cash Flow Based Tariffs BALANCE SHEET

(‘OM) Lei)

Current Assets Cash and Shm ten i n v e s M t s Pcmunts Recdrat.de -Trade Gomment Employee B Re”dt.de Supplies

Revaid Expeoses ma current Assets

Tolal Cunent A W

UABILITES 8 EQUrrY Sharehd- Equity

Initial Capital

Rmluatim R m Rebind Eamings Plus cunmt period WfIt

OthH resew3 TotalEquity

Current Liabilities Amwnts PayaMe -Trade Wages Soda1 insurance PayaHe ~ovemment Employee a other Nm BudHTaxes Payatk mer Current Liabilities S h d T m Bonowings Current Pation d L c q Term Detl

Total Currenf Liabil%es

Total L i a b i l i k and Equity

X I 1

1,0&1,578

(714273) 17,355

387,661

918

6,111

7,029

5,852

9.194 333

10,933

1.963 25

28.W

422.990

391 M 3

(172) 8,118

8,280 407,429

10,846

10,846

926

3,788

4,714

422,989

2002

1,519.512

(976,185)

20,454 563,781

1,794

167

1.961

5,451

18.985 118

17,415

641

259 42869

608,611

391 203

177.608

6.943 14271

590.025

5,604

5.604

7.955

4,581

446

12982

60861 1

2003

1.653.870

(1,110,132) 20,454

561.192

1.794

167

1,961

56.735

14,089

118 16,672

641

280

88,534

654.687

391 203

221,074

6,943 3,331

14271

635,822

5,604

5.604

9,470 1.385

924

482

12,261

654.687

m 2w5 2006

1,787.535 2,037,916 2,373,067

(1237283) (1.380.853) (1.5(4,966)

20,454 570,7m

1.794

167

1.961

56,740

8,642 118

18,019 641

297

84,657

657,324

391203

253.698

10274

(57”) 14271

611,796

27,905

5,604

3,509

1 0 , w 1.498

(292)

511

12019

657,324

20,454

677,518

1,794

167

1,961

56,733

13,473 118

20.543 €41

314

91.822

771,301

391 M 3

286,714

(47,376)

(43,322) 14271

601,453

151.51 2

(1.396) 5,604

155.720

11,546 1,619

386

541

14,092

771.301

20.454

848,555

1,794

167

1,961

56,743

19.303 118

23.921 641

333 101.m

951.575

391 203

326,137

(w-) (2934 14271

611.569

326.558

(8.931)

5.604 323,262

13200 1,751

1 PI

574

16,745

951.575

2W7

2,679,113

(1,699,378)

1,m,190 m.w

1,794

167

1,961

50.326 25,150

118 27,W7

€41

346

103,589

1,105,739

391 203

359.261

(120.043)

(4.976) 14271

639,716

455.754

(14 ,W 5.604

446,7C6

14,791

1,857 2,072

597

19,317

1,105,739

xK)8

2879,116

(1,867.733) 20,454

1,031,837

1.794

167

1,961

53,077

30,448 118

29,023 641

38)

113,667

1,147,465

391 203

398.451 (125.01 9)

20,754 14271

699.660

443258

(22.679) 5,604

426,183

16.178

1,970

2.854

621

21,622

1,147,465

X I 9

3.094.907

(2.051 291) 20,454

1.oM.070

1.794

167

1,961

53,116

32,011 118

31.198 641

375

117,455

1,183,490

391203

438.906

(104265) 17,623

14271

757,736

427,324

(30,486) 5.604

402442

17,717

2.090 2,859

645

23,311

1,183,490

2010

3,327.817

(2251,425) 20,454

1,096,846

1,794

167

1,961

53,093

34.367 118

33,546 641

390

122154

1,220,960

391 M 3

480.651

(86,W 17,891 14271

81 7,372

410,692

~38,012) 5.604

378,284

19,429 2217

2,988

67 1

25,305

1220,960

2011

3,579,301

(2,469,641) 20.454

1,130,113

1,794

167

1,961

53,090 36,918

118 36,081

641

405 127,253

1259,327

391 203

523,706

(68,753) 17.699 14271

878,127

393.342

(45.245) 5.604

353,700

21.333

2,352 3,117

698

27.m

1259,327

- 59 -

Table 5.4

ams an0

ws 2%

3295 35% 3815 4.cQ 4.33 491

4J33 5c6

4,495 488

4894 5333 483 4.7a

5333 518

97,137

4 m

114279 3714

a m 10,462

4867 5714 6620 7,744 93n 10,462 11823 12.761 13838

125786 147,lQ 178cBB

161056 178346 195319 214,185

4.163 12210 1 9 m 32573 5,719

2939 28265 27,166

4.163 2 1 3 2 4 5 0 4

1,123 833 0 0 1 0 1 1 0 1

NetRcltA&Tpc 8118 4,483 3331 1 1 2 2 3 4 0 3

- 60 -

Table 5.5

- 61 -

1,791 1.W 1731 1,791 1,791 1.791 1,791 1791

6111 la 167 167 161 16 167 l6l w 167 161

1.93 193 lgsr 7m lisl 193 1,937 lisl

918 1,791 1"

T c W h 7 , lm l961

56w 5821

$604

33.5%

925 7955 9,410

1385

Iw

l W 2

1,433

12%

IIM 1819

1510

14.m

1851

2201

16178

Igm

2181

17,7l7

2cB)

2an

194B

2217

2437

482 51 1 sll 514 SR 6n BB

13515

7l647l

15216 19446

111,167

am

- 62 -

Annex 6: Procurement and Disbursement Arrangements MOLDOVA Energy II Project

Procure me nt

Procurement o f goods and works will be done in accordance with World Bank Guidelines: Procurement under the IBRD Loans and IDA Credits (issued in January 1995, revised January and August 1996, September 1997, and January 1999). Consulting Services, technical assistance and training will be procured in accordance with the Guidelines - Selection and Employment of Consultants by World Bank Borrowers, January 1997, revised September 1997, January 1999, and M a y 2002. The Bank's Standard Bidding Documents, Request for Proposals and Forms o f Consultants' Contract will be used. An updated General Procurement Notice (GPN) was published in the UN Development Business on June 30,2002, and an updated GPN will be published in the UN Development Business in December 2003.

Procurement Responsibilities

The Project would be implemented at the local level by the Project Implementation Unit (PIU) in cooperation with project beneficiaries - Moldelectrica for the electricity investments, the municipalities and the Government ministries that are beneficiaries o f the heating component, and the Ministry o f Energy for the energy sector technical assistance. The P I U will include a project manager, a procurement specialist and a financial specialistlaccountant, two technical experts (one for electricity and the other for heating) and a few administrative staff. The procurement staff o f the P I U has received training in procurement under the First Energy Project financed by the World Bank (already completed). Additional training for the procurement s taf f and the manager will be provided, by Bank staff, through specialized seminars, and by the international consultant competitively hired through the PPF/Credit-financed component for Technical Assistance (the consultants are already working on preparing bidding documents under the contract hnded under the PPF). Procurement execution i s the responsibility o f the PIU, with technical execution the responsibility o f the beneficiaries.

Procurement Methods (Table A)

The project includes procurement o f works, goods, including installation, and consultant services. A detailed procurement plan for these needs has been prepared and i s included in the Project Implementation Plan (PIP). During project implementation, the procurement plan will be updated every six months.

The Project procurement arrangements are shown in Table A.

- 63 -

Procurement methods (Table A)

Procurement Methods (in US$ million)

ICB NCB IS Other NBF Tota

Supply & Install 19.66 19.66 (1 7.65) (17.65

Goods 11.69 0.03 11.72 (11.59) (0.03) (11.62

Works 2.65 0.40 0.12 1.73 4.90 (2.39) (0.36) (0.1 1) (2.86

Technical Assistance 1.09 0.60 1.69

Project Management and Administeration 0.56 0.56

(0.38) (0.38 Project Preparation Facility 1.40 1.40

(1.40) (1.40 TOTAL 33.99 0.40 0.03 3.17 2.33 39.93

(31.63) (0.36) (0.03) (2.98) (0.00) (35.00

(1.09) (1.09

Project Components and Subcomponents

1. Electricity System Upgrade. The electricity component o f the project i s estimated to cost (including contingencies) about US$ 27.5 million, and has the following packages (with total cost estimates, including contingencies, in parentheses):

Improvement of metering in the electricity transmission network (US$ 4.2 million): To allow for the proper measurement o f energy flows and sound commercial operations, energy metering will be procured and installed at al l interconnection points between the transmission grid and private distribution companies, power generation companies and intemational transfer lines. The procurement will include two packages -- one for the meters and associated communications equipment, and the other for current and voltage transformers.

Rehabilitation and upgrade of power system dispatch and telecommunications (US$ 12.2 million): This component includes installation o f the necessary hardware and software to enable real-time acquisition o f operational information fkom the main facilities (power stations and transmission system substations), analysis and monitoring o f the system status at the National Dispatch Center, and control and dispatch o f the power plants, load centers, and the transmission system. Bidders for dispatch and communications systems will be prequalified in accordance with provisions o f paragraphs 2.9 and 2.10 o f the Guidelines.

Priority rehabilitation of the transmission network ("$9.9 million) : This subcomponent includes the most urgently needed rehabilitation measures in substations and on transmission lines, including environmental measures (appropriate site protection and disposal o f o ld PCB-containing condenser batteries). Three procurement packages are envisaged -- for the substation equipment, for transmission lines, and for environmental protection measures.

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(d) Local Installation Work (US$ 1.5 million): This work will be completed by local contractors, and will include installation o f current and voltage transformers, and substation equipment, a l l financed by Borrower's funds (no IDA Credit money involved).

11. Heating and Hot-Water Improvements in Public Buildings (US$8.5 million). This component includes improvements in supply and consumption o f heating and hot water in selected public buildings (schools, hospitals, and residential buildings for disabled and other vulnerable groups). The heating and hot water improvements would include demand-side investments consisting o f energy efficiency rehabilitation of building envelopes and rehabilitation o f building internal heat and hot water distribution systems to reduce heat losses; and supply side investments consisting o f rehabilitation o f external heat distribution pipes from the boiler houses to the buildings and installation o f new gasLPG-fired boilers (where necessary) with auxiliaries to reduce heat losses, improve heat generation efficiency and facilitate affordable heat and hot water supply.

111. Technical Assistance for Project Implementation and Energy Sector Reforms (USS1.7 million) The project would include technical assistance for project implementation and continuing reforms and privatization o f the energy sector by funding consultants for some selected tasks o n energy sector refrom, preparation o f environmental management plan for Moldelectrica, and the annual financial audits o f Moldelectrica and the project financial statements. A second phase o f the consultant contract for project implementation assistance for the electricity component that was competitively procured through QCBS under the PPF i s planned to be financed from the Credit proceeds. SIDA i s providing a grant o f about US$0.6 mill ion to finance project implementation technical assistance for the heating component. Consultants for both the electricity and heating project implementation contracts are working on the bidding documents.

IV. Project Management and Administration (US$0.6 million). This component will cover the incremental expenses required for project implementation in terms o f local expenditures; more specifically, it will cover staff salaries, equipment (computers, telecoms, office space, car, fumiture, etc.), training, transport, miscellaneous operating expenses (telephone, utilities, supplies, bank services, etc.).

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Procurement Plan Table A1 presents details of the Procurement Plan, including estimated dates of procurement actions.

MOLDOVA -ENERGY II

- Notes: G goods: W-works: SI-supply and install: CF - consulting firms; CI - individual consultants

Procurement Method: ICB - international competitive bidding: NCB - national competitive bidding: IS - international shopping: NS - national shopping; SW - Small Works QCBS quality and cost based selection, QBCqualii based selection, FB-fixed budget, LC -least cost, CQ - consultant qualifications, SS -sole source, Ind- individual, NBF - Non-Bank Financed

= local works to be procured annually .. Project Implementation, electricity componenet - extension of the contract competitively selected under the PPF - Annual audit would be inkialiy contracted for b o yoears with the possibility of extension subject to satisfactory performance and project needs.

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Prior review thresholds (Table 6) Table B: Thresholds for Procurement Methods and Prior Review

Consultants

Procurement Methods Thresholds

Prior Review Ex-post review a l l other procurement

Civil Works Procurement GN.1 W<0.2 thresholds: W>0.2 (0.4) individual and aggregate, in ()

Prior Review Al l Al l

award QCBS QBS LCS Fixed Qualification- Sole Source Individuals

Selection Budget Based

>0.2 N/A <0.2 N/A <o. 1 Extension (phase 2) o f N . 0 5 (0.4) project implementation

contract, procured competitively under PPF

Al l NIA All N/A All NIA All Explain briefly the ex-post review mechanism: All remaining procurement packages w i l l be subject to ex-post review. Supervision missions wi l l include procurement specialist as needed, to assist the T M with ex-post reviews.

%qr- contract

Country Procurement Assessment Report or Country Procurement Strategy Paper status: A CPAR released on July 2,2003.

<0.05 (<0.2)

Are the bidding documents for the procurement actions o f the f i r s t year ready by negotiations?

items procured under the operating costs category, based on annually agreed budgevprocurement

Launch Workshop Fib. m

methods NIA All 100% except for operating

costs

General'Procurement procurement subject to Goods Notice: mandatory SPN in December2003 Development Business Yes X No

Yes X

Retroactive financing Yes No x

packages

The capacity o f the PIU, which w i l l implement the project, has been assessed. Based on the analysis compiled in the Section 2: Capacity of the Implementing Agency in Procurement and Technical Assistance requirements

Advance procurement Yes No X

-. - I YesX No Section 3: Training, Information and Development on Procurement

Estimated date of Proiect I Date of uublication o f I Indicate if there i s 1 Domestic Preference for I Domestic Preference for Works, if applicable

Yes X N o

the procurement plan and conducting ex-post reviews. Co-financing: Explain briefly the procurement arrangement under co-financing: There i s no joint financing o f foreign costs. The packages co-financed by project beneficiaries w i l l be procured under Bank

Indicate name o f Procurement Staff or Bank's staff Dart o f Task Team resuonsible for the urocurement in the Proiect Name: Ahmet Gokce, PS, Ext. 32505; Vladislav Vucetic, PAS, Ext. 33977 Exulain briefly the exuected role o f the Field Office in Procurement: Aproject oificer in the Resident Mission would be responsible for helping to supervise project implementation and would provide procurement support in which shehe w i l l have received training.

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Thresholds for Procurement Methods for Works, Goods and Technical Services

The following thresholds are proposed (see Table B):

(i) ICB for goods = U S $100,000 or more per contract

(ii) ICB for W o r k s = US $200,000 or more per contract

(iii) Small Works for Works = US$50,000 or less per contract

To the extent practicable, contracts shall be grouped in bid packages estimated to cost $200,000 equivalent or more each.

Consulting Services

Consultants’ Services will be selected in accordance with the Bank Guidelines issued in January 1997 and revised in 1997, 1999 and M a y 2002, and for this project will include QCBS selection for contracts over US$200,000. Assignments will be advertised in UN Development Business and in a national newspaper for expressions o f interest, from which a short l i s t will be drawn.

Bank’s P r i o r Review Thresholds (see Table B)

Prior review thresholds are as follows: a. Goods: All ICB; b. Works: All ICB; All NCB c. Consulting Services - Bank prior review will be required for al l terms o f reference, irrespective o f

the contract value; and d. All consultant contracts estimated at U S $ 100,000 or more per contract with f i rms, and

U S $ 50,000 or more per contract with indiv iduals (Full Review).

Post Review

All contracts not subject to the Bank’s prior review will be subject to ex-post review, on a selective basis. One out o f five contracts will be subject to ex-post review. Supervision missions will include a procurement specialist especially in the first year, whose main responsibility will be to conduct ex-post reviews o f the procurement process and documentation, and provide his or her findings and recommendation.

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force since 1997

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Prior Review Thresholds Proposed Goods US$ - 100,000- (equivalent ) Works US$ -200,000- (equivalent) Consulting US$ 50,000- (equivalent)

Post Review Ratio: One in 5 contracts

Frequency o f procurement supervision missions proposed: One every -6- months (includes special procurement supervision for post-review/audits)

Comments:

Because o f the general procurement environment, additional internal and external training will be necessary, including on the j o b training provided by foreign consultant employed by the PIU.

Overall Risk Assessment Uioh Y

Average Low

Form prepared by: V. Vucetic (Procurement Accredited s t a f f assigned to the project) Signature:

Date:

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Disbursement

Expenditure category Goods and equipment

Works Consulting services

Project Management and Administaftion Operating Costs Salaries

Allocation of credit proceeds (Table C)

IDA Credit (US$ m) Financing Percentage 27.57 100% of foreign expenditures

100% of local expenditures (ex-factory cost) 80% of other local expenditures

2.86 90% of exDenditures 1.09 100% of foreign expenditures

75% of local eXDenditUreS

0.14 90% in 2004 and 2005, 80% in 2006, 70% thereafter 0.24 75% for local individual consultants and local firms,

100% of eliaible sorial charaes PPF Refund 1.40 Unallocated 1.70 Total 35.00

Use of statements of expenditures (SOEs):

Special account: To facilitate timely project implementation, the P I U will establish, maintain, and operate, under conditions acceptable to IDA, a Special Account denominated in US$ in a commercial bank acceptable to IDA. The maximum authorized allocation o f the Special Account (SA) will be limited to US$0.5 million. However, during the initial stage o f the project, an amount limited to US$ 0.25 mi l l ion will be deposited in the Special Account. When the amount disbursed reaches US$3 million, the amount deposited in the SA may be increased to the full amount o f US$ 0.5 million. Replenishment applications could be submitted monthly, or more frequently if desired, but not later than quarterly, and must include reconciled bank statements as well as other appropriate supporting documents.

Use o f statements o f expenditures (SOEs): IDA will make disbursements on the basis o f SOE: (a) for contracts for goods, equipment and vehicles below US$lOO,OOO; (b) for consulting services contracts with f i rms below US$lOO,OOO and individuals below US$50,000, and (c) for project management and administration. Supporting SOE documentation will be maintained by the P I U and made available for review by auditors and Bank missions.

Financial Management Assessment Report Moldova - Energy I1 Project

1. Executive Summary and Conclusion

A review o f the financial management arrangements o f the project was carried out in June 2001 and subsequently updated in March 2002 and again in September 2003. The project’s financial management arrangements are acceptable to the Bank.

A draft Country Financial Accountability Assessment (CFAA) for Moldova has been prepared which concludes that there i s a need for substantial strengthening o f the overall public financial management framework. It further concludes that it would therefore be inappropriate for the Bank to place a blanket reliance on that framework for the purposes o f satisfying the Bank’s fiduciary financial management requirements. Reliance on any particular aspect o f the country’s financial management framework would need to be established on a case-by-case basis with reference to the specific financial management arrangements o f the institutions involved. The I-PRSP o f November 15, 2000 also confirms that improvement i s required in the management o f public expenditures, including the budget process and budget execution, as wel l as cash and debt management. Thus the PIU has developed policies and

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procedures that operate in addition to those o f the current public expenditure management framework to minimize project financial management risks. The Bank conducted a Country Portfolio Financial Management Review (CPFMR) o f a l l projects under implementation in Moldova and identified some common financial management issues; the Bank confirmed that al l such issues have been appropriately addressed in the design o f this project’s financial management arrangements.

Risk

The banking sector in Moldova i s relatively weak. However, the P I U has been operating satisfactorily i t s PPF Special Account in a commercial bank acceptable to the Bank whose financial status and statements are reviewed on an ongoing basis by the Bank. As these arrangements have been satisfactory, they will remain in place during the Second Energy project implementation.

Risk Comments/Risk Mitigating Measures Rating

2. Country Issues.

Inherent Risk Country Financial Management Risk M - S Project Financial Management Risk M Perceived Corruption S

Often contradictory and changing legislative system, CFAA work in final stages. Counterpart funding could be an issue. As with other countries in the region, Moldova has a high rate o f perceived corruption.

Overall Inherent Risk M-S

Control Risk

Implementing Entities M The PIU has successfully implemented a previous WB project and the same core staff will

A draft Country Financial Accountability Assessment (CFAA) for Moldova has been prepared which concludes that there i s a need for substantial strengthening o f the overall public financial management framework. It further concludes that it would therefore be inappropriate for the Bank to place a blanket reliance on that framework for the purposes o f satisfying the Bank’s fiduciary financial management requirements. Reliance on any particular aspect o f the country’s financial management framework would need to be established on a case-by-case basis with reference to the specific financial management arrangements o f the institutions involved. The I-PRSP o f November 15, 2000 also confirms that improvement i s required in the management o f public expenditures, including the budget process and budget execution, as wel l as cash and debt management. Thus the P I U has developed policies and procedures that operate in addition to those o f the current public expenditure management framework to minimize project financial management risks. The Bank conducted a Country Portfolio Financial Management Review (CPFMR) o f a l l projects under implementation in Moldova and identified some common financial management issues; the Bank confirmed that all such issues have been appropriately addressed in the design o f this project’s financial management arrangements.

The banking sector in Moldova i s relatively weak. However, the PIU has been operating satisfactorily i t s PPF Special Account in a commercial bank acceptable to the Bank whose financial status and statements are reviewed on an ongoing basis by the Bank. As these arrangements have been satisfactory, they will remain in place during the Second Energy project implementation.

3. Risk Analysis

The r isk analysis from the Financial Management Questionnaire i s as presented below. (Note: The project’s financial management r isks are not considered to be significant enough to warrant inclusion in section F2 o f the PAD).

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H-High S- Substantial M - Moderate N - Negligible or Low

4. Strengths and Weaknesses.

The strength o f the project financial management system l ies in the experience o f the PIU fi-om a previous WB project in combination with the introduction and implementation o f new software.

accounting

5. Implementing Entities.

The Project Implementation Unit: The project will be implemented by a Project Implementation Unit (PIU), an independent legal entity established under the government Decree 1276 o f December 21, 2000.

Moldelectrica: Moldelectrica, a state enterprise created by the Decree No. 1000 o f the Government of Moldova o f October 5, 2000 i s the executing agency that will implement the Electrical System Upgrade.

The Municipalities and the Ministries. The participating municipalities and two ministries (Health and Education) will execute the Heating Supply and Efficiency Improvement component.

6. Funds Flow.

The total project expenditures will be US$ 39.93 million, o f which US$35 mi l l ion would be financed fi-om the IDA credit, US$4.33 mi l l ion from internal cash generation and municipal contributions and US$0.6 mill ion from the Swedish Intemational Development Agency (SIDA).

The project’s funds will f low as shown in the f low chart below. Counterpart contributions will be made available by the selected municipalities through their existing Treasury current accounts and by Moldelectrica in i t s Project Account. The counterpart contribution records will be kept separate by the beneficiaries from their other activities and the P W will be informed on a regular basis in this respect.

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The procedures for replenishments and withdrawals from these accounts will be established by the PIU and the other parties involved at the local level.

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I I I I I I I I I I I I I

- 1

..... "

Contractom'

consult an^ i 7B 1 ... " ..... "" ..... "" .... ....... ".." .....

Munipalities o f Cantemir chisinau Faleshti Floresti Soroca

Ministr ies o f Health Education Environment and Territorial Development

Moldelectrica 1

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Descriptions:

l a . Submission of Invoice. The contractor (or consultant, supplier, etc.) submits the invoice to the PIU for processing and payment.

l b and IC. Invoice sent to service recipient for approval. The P I U sends the invoice to the recipient that has the contract with the contractor, i.e. Moldelectrica, one o f the participating municipalities, or one o f the government ministries. The service recipient checks the invoice against the contract, and makes sure that goods, services, etc. have been rendered. A copy o f the approved invoice i s thereafter sent back to the PIU. The original source documents will be kept by the end beneficiaries for their bookkeeping. With regard to fixed assets, the PIU will need to carry out a reconciliation o f i ts own accounting and that o f the end beneficiaries.

2a and 2b. Direct Payment. The PIU prepares the withdrawal form /payment order and submits it to the Bank. The Bank pays the contractor etc. based o n the payment request from the PIU.

3a, 3b and 3c. Special Account Replenishment Request. A Special Account replenishment request will be sent by the P I U to the Wor ld Bank's Loan Department on a monthly basis or when the balance on the Special Account falls below one-third o f the authorized allocated amount. The World Bank replenishes the Special Account based upon the documentation provided.

4a. Request for payments from the Special Account. The P I U requests the commercial bank at which the Special Account i s held to make payment (a) to contractors/suppliers/consultants or (b) to a local currency account designated for salaries (net o f tax) to PIU staff.

4b. Payments from the Special Account. The commercial bank at which the Special Account i s held will execute payments orders to contractors/ suppliers/ and consultants sent from the PIU.

4c. Local Currency Account (Net Salaries). The commercial bank will execute payments to the account designated for salary payments to PIU staff (net o f tax) in local currency.

5. Payment of salary taxes and social security payments. Before the salaries are paid from the Special Account to the Local Currency Account, the PIU must request (5a) the Ministry o f Finance to pay paid salary taxes and social security payments f rom the PIU Treasury Bank Account to the Account for Salary Taxes and Social Security Payments at the Ministry o f Finance. The Ministry o f Finance transfers (5b) fhds to cover the salary taxes and social security payments from the Treasury Account to the Account for Salary Taxes and Social Security Payments. The funds are transferred (5c) and confirmation o f this i s sent to the P I U via the Ministry o f Finance (5d). As soon as confirmation has been received by the PIU, the funds for P I U staff' salaries can be transferred from the Special Account to the Local Currency Account (4c).

6. The existing Treasury Accounts o f the Municipalities will be used for their counterpart contributions. The municipalities will be required to have available in their project accounts sufficient funds to meet local costs for the coming three months. The copies are to be kept by the P I U and original source documents will be sent to the municipalities for their book-keeping.

Treasury Accounts for the Municipalities.

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7. Project Account for Moldelectrica. A separate Project Account will be used for Moldelectrica’s contributions to the Project. The company will then be required to make deposits in the Project Account sufficient to meet local costs for the coming three months. The copies are to be kept by the P I U and original source documents will be sent to Moldelectrica for i t s book-keeping.

8. Funds from other Financiers (SIDA). SIDA’s financial contribution will be disbursed by the agencies directly to consultants. Following Bank procedures, all Project expenditures will be included in the project’s accounting and reporting system. SIDA will therefore submit information on a quarterly basis to the P I U about the expenditures disbursed.

7. Staffing.

The PIU includes a Director, an Accountant, a Procurement Specialist as wel l as other technical experts. The PIU was responsible for the implementation o f the Energy 1 project and therefore has considerable experience and knowledge o f the Bank’s financial management requirements and a proven track record in satisfying these requirements.

8. Accounting Policies and Procedures.

Project Implementation Unit. The P I U has prepared an Operating Manual containing the documented financial management and procurement procedures. The manual documents al l the project financial management procedures with the aid of flow charts and narrative description. The financial section o f the Operating Manual i s acceptable to IDA.

Copies o f a l l original source documents and contracts will be retained centrally at the PIU. This will greatly facilitate the work o f the many inspectors and auditors who are likely to review, inspect and audit the project because they will be able to do their work centrally without having to visit a l l o f the various organization involved in project implementation i.e. the PIU, Moldelectrica and the participating municipalities. Every month, the P I U will receive copies o f the original source documents and contracts from Moldelectrica and the participating municipalities.

The P I U would also make sure that all capital expenditures financed by the project are recorded in the Fixed Asset Register o f each o f the Beneficiaries. Agreement will be sought that the Beneficiaries shall supply the PIU with extracts from their Fixed Asset Registers on a monthly basis thereby enabling the project accountant to reconcile the records o f capital expenditures in the project accounting system with the corresponding records o f the Beneficiaries.

Moldelectrica: The main project beneficiary, the state-owned utility Moldelectrica, has a newly developed accounting system based o n the FoxPro 2.6 software. This database software was developed into an accounting system by a Moldovan consultancy company in 1998 and i s now in use in several large Moldovan companies. Moldelectrica i s now tailoring the accounting system software to i t s own use with the help o f the consultancy company. At the moment the system, which i s being built on a modular basis, consists o f General Ledger, Accounts Receivable, Accounts Payable, and Fixed Asset Register.

Municipalities: Accounting systems for municipalities are designed to keep track o f public expenditure approved in the Municipal Budget, and are therefore not suitable for project accounting. For this reason, the accounting system o f the participating municipalities would not be assessed. However, an agreement

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will be sought with the municipalities to keep the source documents and contracts for the Project available for inspection by the PIU and other interested parties throughout project implementation.

Entity (Moldelectrica) Project, SOE and Special Account

9. Internal Audit.

June30 o f the year following the fiscal year end June 30 o f the year following the fiscal year end

The P I U has no internal audit hnct ion and none i s considered necessary given the size o f the organization.

10. External Audit.

The audit arrangements for the predecessor Energy 1 project was satisfactory and the most recent audit report for that project was unqualified.

During project implementation, independent auditors acceptable to the Bank will audit the annual financial statements o f Moldelectrica prepared in accordance with International Financial Reporting Standard (IFRS) as wel l as the project’s financial statements in accordance with International Standards on Auditing (ISA). The audits will be financed from the Credit and the audit reports, together with accompanying audited financial statements, will be submitted to the Bank within six months o f the end o f the fiscal year.

I Audit ReDort I Due Date I

11. Reporting and Monitoring.

Financial Monitoring Reports (FMRs) in respect o f the project will be submitted quarterly to the Bank within 45 days o f the end o f each quarter in accordance with formats already agreed with the Bank and comprising the following:

1. 2. 3. 4. 5.

Discussion o f Project Progress (including Procurement Issues); Sources and Uses o f Funds; Uses o f Funds by Project Activity; Output Monitoring (Physical) Report; and Procurement Status Report - Goods and Works.

Annual Financial Statements: The Annual Project Financial Statements will comprise:.

1. 2. Statements o f Expenditures; and 3. Special Account.

Project Financial Statements (Sources and Uses o f Funds);

The Annual Entity Financial Statements from Moldelectrica will be prepared in accordance with International Financial Reporting Standards (IFRS).

12. Information Systems.

The accounting software used by the P I U worked well for Energy I, although satisfactory from an operational perspective, will not be used for Energy I1 for reasons o f cost. A new and more cost-effective

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accounting software solution has been purchased and implemented and i s already being successfully used to maintain the accounting books and records o f the PPF associated with the project. Minor fine-tuning o f the software will be completed by October 3 1,2003.

13. Disbursement Arrangements.

The Project will follow a transactional disbursement method with both direct disbursements and the use o f a Special Account as described earlier in the f low o f fimds section.

14. Supervision Plan.

Due to the number o f beneficiaries and the complexity o f the flow of project documentation and hnds, the financial management arrangements o f the project will be supervised fairly intensely during the first year or so after which it i s anticipated that the arrangements will have bedded down. Thereafter, the project’s financial management arrangements will be supervised approximately twice per annum.

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Annex 7: Project Processing Schedule MOLDOVA: Energy II Project

Project Schedule Planned Actual ITime taken to prepare the project (months) I I 48 I First Bank mission (identification)

Appraisal mission departure 0710711 999 0710711999 0311 112002 051 1412002

Negotiations

Planned Date of Effectiveness

Prepared by: Ministry o f Energy, Moldelectrica, Moldova Energy Projects Implementation Unit (MEPIU).

051 1412002 051 1612002 0212512004

The project was appraised and initially negotiated in M a y 2002. It was subsequently renegotiated in October 2003, to be presented to the Board in FY04.

Preparation assistance: A Japan PHRD grant for US$750,000 (TF025294) was received and used for project preparation work by the recipient to contract consulting services for the following preparation activities: (a) Project Preparation, including: (i) a feasibility study for the electricity system metering, dispatch, communications and transmission rehabilitation and environmental assessment; (ii), establishment o f the Project Preparation Unit, including operating costs, basic equipment costs and salaries o f PIU and financial managemenudisbursement training for the PIU's financial officer; and (iii) audits o f the PHRD grant for 2000 and 2001; @) Institutional Strengthening, including: (i) development o f a business plan and financial analysis o f Moldelectrica and debt restructuring plan o f Moldtranselectro; (ii) revaluation o f Moldelectrica's assets and tariff recalculations based on the revalued assets. Grant Implementation and Results: The Grant was successfully executed by the Project Implementing Agency. All planned outputs were completed and consultant performance was satisfactory, with significant transfer o f technical knowledge to the client. Both the P I U and Moldelectrica benefited f rom training programs carried out by the consultants, as well as gaining experience in program management and administration and international procurement.

A Sweden (SIDA) cofinancing grant for 3,266,000 SEK (approximately US$3 12,536) was received and used for project preparation work by the recipient to contract consulting services to carry out a study on "Strategic Heating Options for Moldova" and a second grant of 1,086,000 SEK (approximately US$103,923) was received by the recipient for consulting services to prepare technical specifications and bidding documents for supply and installation o f boilers and pipes in a pilot heating activity in the municipality o f Ungeni. Both the municipality o f Ungeni and the PIU benefited f rom on-the-job training carried out by the consultants.

A Project Preparation Facility Advance of US$1.5 million (Q-191-O-MD) was received and used for project preparation work by the recipient to contract consulting services and goods for the following preparation activities: supply and installation o f boilers and pipes as part o f the pi lot activity in the municipality o f Ungeni; consultant services for project implementation (preparation o f technical specifications and bidding documents for the electricity system upgrade, and assistance throughout the

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bidding and contracting process); development and installation o f a financial management system for the project; and operating costs o f the PKJ.

Name Vladislav Vucetic Pentti A ro Peka Kalevi Salminen Michael Haney Enar Wennerstrom Snezana Mitrovic Jann Masterson Vakhtang Kvekvetsia Zoe Kolovou John Ogallo David Freese Marina Lysiakova Bogdan Constantinescu Sandu Ghidirim Peggy Wilson Ahmet Gokce

Speciality Lead Energy Specialist Heat and Power Engineer Senior Energy Specialist Energy Specialist Senior Financial Analyst Senior Procurement Specialist Operations Officer Financial Specialist Senior Counsel Financial Management Specialist Senior Finance Officer Program Team Assistant Financial Management Specialist Consultant Consultant Senior Procurement Specialist

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Annex 8: Documents in the Project File* MOLDOVA: Energy It Project

A. Project Implementation Plan

Project Implementation Plan, dated May 2002, prepared by PIU.

B. Bank Staff Assessments

Financial Management Assessment, May 2002.

Procurement Capacity Assessment, March 2002.

C. Other

Feasibility Study for Rehabilitation of System Metering, Dispatch, Communications, and Transmission, Final Report, July 2000, Fichtner.

Feasibility Study for Rehabilitation o f System Metering, Dispatch, Communications, and Transmission: Environmental Analysis and Management Plan, March 200 1, Fichtner.

Expert Opinion on repair o f the 110- and 330-kV HV Transmission Lines, April 2002, Fichtner.

Strategic Heating Options for Moldova, Final Report, April 200 1, SwedPower and FVB.

Pilot Projects for Improved Heating o f Public and Residential Buildings, March 2001, SwedPower and FVB Feasibility Studies.

Moldova: Update o f Transmission tariff Projections for the Transmission and Dispatch Company Moldelectrica, April 2002, PricewaterhouseCoopers.

Environmental Assessment and Management Plan, Ministry o f Energy, Moldova, August 8,2001.

Operational Manual, dated May 2002, prepared by PIU.

*Including electronic files

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Annex 9: Statement of Loans and Credits MOLDOVA: Energy II Project

27-Oct-2003 Difference between exDected

Original Amount in US$ Millions and actual

disbursements' Project ID FY Purpose IBRD IDA Cancel. Undisb. Orig Frm Rev'd

PO73626 2003 TRADE a TRANS FACIL IN SE EUR 0.00 7.21 0.00 7.51 0.00 0.00 PO741 22 2003 AIDS CONTROL PO74469 2003 ws a SAN PO60434 2002 RURAL INV a SERVS (APL # I ) PO51174 2001 HEALTk INVST FUND PO44840 1999 SIF PO51173 1999 SOCPROT PO35771 1998 FIRST CADASTRE PO3581 1 1997 PSD 2

0.00 0.00 0.00 12.00 0.00 10.50 0.00 10.00 0.00 15.00 0.00 11.10 0.00 15.90 0.00 9.00

0.00 5.88 0.21 0.00 0.00 12.58 0.00 0.W 0.00 2.27 -7.35 0.00 0.00 8.80 3.87 0.24 0.00 0.91 -0.08 0.00 0.00 7.63 6.57 0.00 0.00 5.10 5.07 -0.32 0.00 2.33 2.48 0.00

PO08558 1997 GENEDUC 16.80 0.00 5.53 2.47 3.31 -0.43

Total: 16.80 90.71 5.53 55.47 14.10 -0.51

MOLDOVA STATEMENT OF IFC's

Held and Disbursed Portfolio June 30 - 2003

In Mi l l ions U S Dollars

Committed Disbursed

FY Approval 2000 1997 2002 2000 2000 2001 2001

Company FinComBank INCON MEC Bank Moldova MEC Moldova Moldindconbank UF Moldova Victonabank VoxTel

IFC Loan Equity Quasi Partic 1.50 0.00 0.00 0.00 4.93 2.00 0.00 0.00 0.00 1.37 0.00 0.00 0.00 0.10 0.90 0.00 2.44 0.00 0.00 0.00

25.00 0.00 0.00 0.00 4.00 0.00 0.00 0.00 0.00 0.00 0.13 0.00

IFC Loan Equity Quasi 1.50 0.00 0.00 4.93 2.00 0.00 0.00 0.00 0.00 0.00 0.10 0.90 2.44 0.00 0.00

10,oo 0.00 0.00 4.00 0.00 0.00 0.00 0.00 0.13

Partic 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

1999100101 Total Portfolio: 37.87 3.47 1.03 0.00 22.87 2.10 1.03 0.00

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic

Total Pending Commitment: 0.00 0.00 0.00 0.00

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Annex I O : Country at a Glance MOLDOVA Energy II Project

POVERTY and SOCIAL Moldova

EuroDe h Central

2002 Population. mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 1996-02

Population (%) Labor force (%)

Most recent estimate (latest year available, 1996-02) Poverty (% of population below national poverty line) Urban population (% of total population) Life expectancy at birth (years) Infant mottalii (per 1,000 live births) Chiid malnutrition (% of children under 5) Access to an improved water source (% ofpopulation) Illiteracy (% ofpopulation age f5+) Gross primary enrollment (% of school-age population)

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1982

GDP (US$ billions) Gross domestic investmenffGDP Exports of goods and serviceslGDP Gross domestic savings/GDP Gross national savings/GDP

Current account balancelGDP Interest paymentdGDP Total debffGDP Total debt service/exports Present value of debtlGDP Present value of debffexports

1982-92 1992-02 (average annual growth) GDP -1.3 -4.0 GDP oer caoita -2.0 -3.8

4.3 460 2.0

-0.3 0.3

23 42 67 26

92 1

84 84 84

1992

2.8 59.8 89.4 55.9

0.0 1.4 0.6

2001

6.1 6.3

Asia

476 2,160 1,030

0.1 0.4

63 69 25

91 3

102 103 101

2001

1.5 20.0 50.0 -4.4 12.7

-6.7 3.3

83.5 14.7 76.1 98.3

2002

7.2

Low- income

2,495 430

1,072

1.9 2.3

30 59 81

76 37 95

103 87

2002

1.6 20.2 49.3 4.9 13.3

2.6 86.4 22.3

2002-06

5.0 7.6 5.5

STRUCTURE of the ECONOMY

(% of GDP) Agriculture Industry

Services

Private consumption General government consumption Imports of goods and services

Manufacturing

(average annual growth) Agriculture industry

Services

Private consumption General government consumption Gross domestic investment Imports of goods and services

Manufacturing

1982

1982-92

1992 2001

50.9 26.0 31.5 24.1

18.2 17.6 49.8

25.9 92.1 18.2 12.3 93.3 74.4

1992-02 2001

-6.0 4.3 -8.4 17.5 -1.1 17.8 2.0 -0.5

8.8 8.2 -9.5 15.6

-12.3 -8.8 6.0 10.9

2002

25.1 24.2 18.2 50.7

91.1 13.8 74.4

2002

2.0 6.0 6.0 4.4

7.4 23.2 10.4 9.7

Life expectancy

GNI Gross per primary capita nroilment

Access to improved water source

Moldova - l - Low-income O~OUD

I Economic ratios.

Trade

Investment Domestic savings

Indebtedness

I Moldova Low-income arom

-

Growth of investment and GDP (%) 15

0

-15

-30 1 W G D I +GDP

1 Growth of exports and imports (%)

-Exports +imports I 'The diamonds show four key indicators in the country (in bold) compared with its income-group average. if data are missing, the diamond will be incomplete.

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Moldova PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall surplus/deficit

TRADE

(US$ millions) Total exports (fob)

Live animals and animal products Vegetable products Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (1995=100) Import price index (1995=100) Terms of trade (1995=100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services Imports of goods and services Resource balance

Net income Net current transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, local/US$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Composition of net resource flows Official grants Official creditors Private creditors Foreign direct investment Portfolio equity

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

1982

1982

1982

1982

1992

945.0

22.4 -2.6

-26.6

1992

868

905

1992

903 942 -39

15

6.80E-2

1992

39 0 0

5 0 0

1 30 0 0 0

0 0 0 0 0 0

2001

9.8 11.9

29.1 1.7

-0.1

2001

569 18 79

115 882

38 201 120

275 245 112

2001

739 1,101 -362

101 152

-99

108 -1 0

229 12.9

2001

1,235 181 113

168 17 1

54 -8 4

94 4

5 18 7

11 11 0

2002

4.4 8.1

28.6 -1.0 -2.9

2002

61 1 20 86

119 972

29 218 131

284 247 115

2002

805 1,215 -410

163 152

-28

273 13.6

2002

1,401 186 145

23 1 17

1

-4 -17

41 26

9 18 9 9

Inflation (%) 150 I 40

30 20 10 0

97 98 99 w 01 I -GDPdeflator *CPI

Export and import levels (US$ mlll.) I

I 96 97 98 99 00 01

II Exports Imports

Current account balance to GDP (%)

0

-5

-10

.15

-20

:omposition of 2002 debt (US$ mill.)

G:76 A 186

, - IBRD i - IDA D ~ Other muitllaterai F - Private : - IMF

E - Bilateral

G - Short-ter

Tore: I nis table was proaucea irom tne uevelopment tconomics central aatabase.

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Additional Annex 11

Social Assessment: Energy-Related Social Issues MOLDOVA: Energy II Project

As part o f project preparation, a social assessment using quantitative and qualitative research methods was carried out to examine energy-related social issues including: (i) household access to utility services, (ii) household energy and fue l use pattems, (iii) quality and reliability o f utility services, (iv) strategies to cope with lack o f access to utility services and shortcomings in the provision o f these services, (v) expenditures on and affordability o f utilities and heating fuels by different income groups, (vi) cost recovery and indebtedness o f residential customers, (vii) price elasticity o f demand for utility services, and (viii) willingness to pay for improvements in the provision o f utility services as well as measures to upgrade energy efficiency.

The qualitative research consisted o f in-depth interviews and focus group discussions with households; consultations with staff from energy service companies; city representatives; s taf f from social assistance offices; and c iv i l society stakeholders. The quantitative research was a nation-wide household survey o f 2,000 respondents carried out in April 2000 by Moldovan researchers. Differences in the results for poor and non-poor households were studied with the use o f a relative poverty line defined at two-thirds o f the monthly median household expenditures per equivalent adult, which resulted in an estimate o f 22% poverty nation-wide.

Consultations with national and local stakeholders had a direct bearing on the final identification o f the two project components. Electricity i s the only universal utility service in Moldova, and a reliably functioning power system i s a basic requirement for a modem economy and economic growth. In addition to the human development aspect o f residential power service, the agricultural sector i s a major consumer o f electricity in Moldova, and the reliability o f service to this sector, which i s a major employer in rural locations where most o f the nation’s poor are concentrated, i s crucial for ensuring i t s position as an engine o f growth in Moldova.

On the heating side, survey results indicated that 80% o f the poor in Moldova are not connected to the district heating (DH) system, and that those presently connected to a DH network are generally not willing to pay more even for improved service. In addition, the institutional framework for assuring the viability o f investments to improve heating in residential buildings i s weak in Moldova, particularly as concerns the legal basis of home owner associations and the functional capacity o f the few home owner associations that exist. These factors contributed to the conclusion o f the inadvisability o f wide-scale refurbishment o f most DH networks in Moldova today. The primary focus o f the heating component is, therefore, on public buildings, which provide services to al l members o f the population, including some, such as kindergartens and schools, that are likely disproportionately used by the poor (as described in the October 1999 poverty assessment, families with children are among the poorest groups in Moldova.) From the point o f view o f economic efficiency (which in the case o f DH systems requires a cheap source o f heat and a compact customer base) and affordability by the beneficiaries, it appears that investments in the renovation of existing DH networks would be feasible only in the city o f Chisinau, where average incomes are the highest in the country and cheap heat is available from two Combined Heat and Power (CHP) plants.

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A detailed report o f the household survey results was presented by the consultants who carried out the research; following are highlights o f the survey findings.

Utilitv expenditures, arrears and poverty. In general, poor households pay larger shares o f their total household expenditures for their main heating fuels and utility services than non-poor households. Among DH users throughout the country, the share o f the DH bill in total household expenditures i s twice as great for poor users as for non-poor users. The same ratio holds for wood among poor and non-poor users, but to a considerably lesser extent for coal users (16% vs. 13% for poor and non-poor users, respectively). An analysis o f household expenditures by quintiles per equivalent adult showed that among DH/DHW customers, households in the poorest quintile spent 61% o f their total expenditures o n utilities, while households in the richest quintile spent 22% o f their total expenditures on utilities.

Household access to utilities. Electricity i s the only utility service that i s universally available in Moldova: 98% o f households are connected to the power grid. Access to telephone service i s relatively high at 61% nation-wide, followed by access to cold water and sewerage (51%) and network gas (49%). The non-availability o f cold water and sewerage service affects primarily rural areas. Hot water service i s provided in connection with district heating and as such i s available exclusively in urban areas, and only to 16% o f the national population. In Chisinau, 62% o f households have district heating, and of these most have hot water service; 38% o f Chisinau households have neither district heating nor hot water services.

Electricity: qualitv of supply:. Households reported having 15 hours o f power supply per day, on average. Anecdotal evidence indicates that scheduled outages affect rural locations and small towns disproportionately, which means that these power service disruptions affect lower income households disproportionately. (When power systems become unreliable due to the shortage o f working capital and lack o f maintenance, governments typically try to protect the services provided to high-priority users in the capital and other large cities, where the incidence o f poverty tends to be lower. People in large cities are also more vocal politically, and governments respond to this by spreading disruptions unevenly across the country.) Interruptions o f electricity supply, as reported at the time o f the survey, lasted on average about 7 hours.

Space heatinp: fuels and network services used, determinants of choice, and poverty. As space heating i s generally the single largest component o f the overall household bill for he1 and utilities, five discrete types of households were distinguished on the basis o f the main type o f space heating used. As can be seen in Table 1, for most residents o f Moldova, the main type o f space heating used i s determined f irst by place o f residence (with the exception o f those who use network gas) and second, by income and possibly other more subjective factors. DH users are exclusively urban dwellers, while those who use solid fuels (commercial and non-commercial) to provide for their heating needs overwhelmingly reside in rural locations.

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Table 1. M a i n type o f space heating, residence and poverty status, and share o f fue l and utilities in total household expenditures (in % as indicated).

a Level o f urbanization for entire country. b Average result reflecting 22% relative poverty rate.

Almost al l residential users o f solid fuels use a combination o f fuels to meet their space heating needs. In addition, in view o f the generally poor quality o f heat provided, many DH customers also turned to electric heaters and gas ranges for supplementary heat. Wood i s the single most frequently used fue l for residential space heating (used by 59% o f households), followed by coal (28%), DH (27%), plant residual (22%), network gas (20%), and tizic (15%); for most users, however, wood remains a supplementary source o f heat.

Among residents o f rural locations, those who choose coal over wood and biomass appear to be relatively better-off: the cost o f coal comprises a relatively high share o f total household expenditures, but the share o f poor among the coal users i s the second lowest o f the five groups presented here. The users o f wood and biomass are disproportionately poor, but also pay the smallest share o f total household expenditures on the fuel they use (because they consume less than other residential consumers, and do not pay for a significant share o f the solid fue l they use, either collecting it themselves or receiving it free from others). They also have the lowest rate o f connection to the cold water network (19%, vs. 51% nationwide). In contrast, o f the five groups, DWDHW users pay the largest share o f their total household expenditures o n their fue l and utilities bill, but they are also the least l ikely to be poor. Table 1 also indicates that 80% o f the poor do not have access to a district heating network.

District heatinp: aualitv. reliabilitv and Dossible alternatives. Most DH customers (74%) reported that it was too cold in their flats. Residential customers gave strongly negative assessments o f the quality o f their DH service, with more than 60% o f the households considering the service quality bad or very bad. However, only 18% o f all residential DH customers expressed a willingness to pay more than the actual tariff charges if the quality o f the DH service would be considerably improved. A majority o f DH customers expressed a preference for installing “stand-alone” mini-boilers in their apartment buildings.

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Additional Annex 12: Criteria for the Selection of Buildings for the Heating Improvement Component

MOLDOVA: Energy II Project

Selection o f objects for heating improvement projects for public buildings will be performed based on proposals of ministries and local public authorities, which administrate the respective institutions.

Preliminarily, initial data shall be collected, systematized according to certain standard forms, which will reflect the sphere o f activity o f the institutions, technical state o f the buildings and engineering systems, and necessary measures o f improvement. ARer processing the initial data by MEPIU the proposals concerning the l i s t o f buildings for the following phase o f the Project will be presented for approval to the Supervisory Board o f MEPIU. Development o f proposals and the final decision shall be based on the following criteria:

1. ministry under subordination of which i s the respective public building.

Buildings are proposed for the Project by Rayon (Judet) Councils, municipalities or the

2. The social character of the institution (organization) for which heating improvement i s proposed. Participation shall be limited to institutions from the spheres o f healthcare, education and social assistance for vulnerable categories o f the population (hospitals, schools, kindergartens, orphanages, nursing homes for old people, etc.).

3. Time continuity of the social functions of the institution. Objects, which will preserve their hnctions for at least 15 years, shall be examined. Institutions, for which there are plans o f changing the sphere of activity or o f privatization, will not be admitted.

4. Form of ownership of the institution. Public institutions financed from the State Budget or from the budgets o f Rayon Councils and Municipalities shall be admitted. Private institutions will not be examined.

5. Number of people who, as a result of the project implementation, will benefit from improvement of treatment, education, etc. conditions. Objects, which serve a larger number o f people and, among those - with a larger number o f socially vulnerable people (handicapped, pensioners, children), shall be selected.

6. Existence of possibilities to correlate actions of the Project with other actions planned by the Government or by the local authorities. These are: local programs o f restructuring centralized heating systems, improving the metering and payment for consumption, energy saving, o f establishing certain socially oriented subsidy systems and other programs and actions o f this kind. The possibility o f supplying heat to residential buildings from the sources installed for social objects will be examined.

7. Geographic location of the object. The final l i s t o f objects selected for project preparation should include institutions from different citiedtowns and different geographical regions o f Moldova. At the same time joining efforts for resolving in complex the heating problem for several objects within a micro-project in the respective settlement will be pursued. The number o f participating Municipalities shall be limited to 10.

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8. Willingness of respective Municipalities or Ministries to participate in financing of equipment procurement and installation works. Financing from the IDA credit intended for the implementation o f the heating projects will be possible with the condition that 10-15% o f the expenses to be covered from local sources (State Budget or local budgets o f the municipalities). A letter o f commitment f rom the Municipalities to the Supervisory Board o f MEPIU i s required.-

9. Ensuring an acceptable level of cooperation of the respective institution with MEPIU and experts involved in preparation of heating projects. MEPKJ and the experts who have the task o f preparing technical and financial documents for the projects should receive necessary technical and economic data f rom the h tu re beneficiaries and have access to the objects for examining the technical state o f the buildings and objects.

10. Positive impact of the proposed projects on the budgets. Debt service obligations shall be analyzed (annual payments of principle and interest over the l ife o f the project), local contributions to project costs, and total costs of heat supply for public buildings o n completion o f the project, and it shall be confirmed that maximum annual payments are consistent with the Municipality’s ability to pay for heat supply. Besides, information regarding financial status o f the participating Municipality and the heating company which will operate the equipment procured and installed within the Project, shall be submitted by municipalities and analyzed. Participating Municipalities will include a l ine item to the budget for each year o f the project which shall cover the local contribution debt service and O&M costs o f the project.

11. Confirmation by the Rayon (Judet) administration of the willingness of the Rayon (Judet) Council to be a party to an on-lending agreement between the Ministry of Finance, Rayon (Judet) Council and Municipality of the towdcity for the estimated amount of the loan.

12. The basic data about buildings should include a short description o f present heating method, typical length o f heating season (daydyear), annual amount o f he1)s) used, efficiency o f the heating system and annual heating costs o f the buildings at present and description o f estimated changes after the project has been implemented. Structural soundness o f the buildings should be confirmed through a specialist’s opinion to be issued by a qualified and licensed civ i l engineer after inspection o f the building. This specialist’s opinion should be vetted by the Consulting firm performing the design o f the heating projects under the SIDA technical assistance.

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