report no. 19053 - world bank no. 19053 implementation ... scada = supervisory control and data...

Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No. 19053

IMPLEMENTATION COMPLETION REPORT

POLAND

ENERGY RESOURCE DEVELOPMENT PROJECT

(LOAN 3215 - POL)

March 31, 1999

Energy Sector UnitEurope and Central Asia Region

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit = Polish Zloty (ZI) until 1994New Polish Zloty (PLN) as of 1995 (1 PLN = 10,000 ZI)

Average Exchange RatesZloty/US$

1990 1991 1992 1993 1994 1995 1996 1997 July 19989,500 11,100 13,630 17,000 22,720 2.43 2.70 3.28 3.49

WEIGHTS AND MEASURES

BCM = billion cubic meterBCMY = billion cubic meter per yearBTU = British thermal unitCM = cubic meter ( = 35.31 cubic feet)CMD = cubic meter per daykcal = kilocalorie ( = 3.968 BTU)MMBTU = million BTUMMCMD = million CMD

ABBREVIATIONS AND ACRONYMS

CHP = Combined Heat and PowerECU = European Currency UnitEIB = European Investment BankEOR = Enhanced Oil RecoveryERR = Economic Rate of ReturnEU = European UnionGNP = Gross National ProductHMNG = High Methane Natural GasICB = International Competitive BiddingLMNG = Low Methane Natural GasPGNiG Polskie G6rnictwo Naftowe i Gazownictwo S.A. (Polish Oil and

Gas Company)SCADA = Supervisory Control and Data AcquisitionSECAL = Sector Adjustment Loan

FISCAL YEAR OF BORROWERJanuary 1 -December 31

Vice President : Johannes Linn, ECAVPCountry Director : Basil Kavalsky, ECCPLSector Director Hossein Razavi, ECSEGSector Leader : Henk Busz, ECSEGResponsible Staff : Julius Wilberg, ECSEG

Hannachi Morsli, EMTOGAnton Smit, Consultant

FOR OFFICIAL USE ONLYIMPLEMENTATION COMPLETION REPORT

POLAND


(LOAN 3215 - POL)

Contents

PAGEPREFACE ....................................................... i

EVALUATION SUMMARY ........................................................ ii

PART L. PROJECT IMPLEMENTATION ASSESSMENT ......................................................... 1

A. INTRODUCTION ......................................................... 1B. STATEMENT AND EVALUATION OF OBJECTIVES ........................................................ 2C. ACHIEVEMENT OF OBJECTIVES ........................................................ 3D. MAJOR FACTORS AFFECTING THE PROJECT ........................................................ 6E. PROJECT SUSTAINABILITY ......................................................... 8F. BANK PERFORMANCE ......................................................... 9G. PERFORMANCE OF THE BORROWER ......................................................... 9H. ASSESSMENT OF OUTCOME ......................................................... 10I. FUTURE PROJECT OPERATION ........................................................ 10J. KEY LESSONS LEARNED ......................................................... 1.1

PART II - STATISTICAL TABLES ........................................................ 12

TABLE 1: SUMMARY OF ASSESSMENT ........................................................ 1 3TABLE 2: RELATED BANK LOANS ........................................................ 14TABLE 3: PROJECT TIME TABLE ........................................................ 14TABLE 4: LOAN DISBURSEMENTS ........................................................ 1 4TABLE 5: PGNIG PERFORMANCE INDICATORS ........................................................ 1 5TABLE 6: PGNIG ORGANIZATION CHART ........................................................ 16TABLE 7: STUDIES INCLUDED IN THE PROJECT ....................... ................................. 17TABLE 8A: PROJECT COST ........................................................ 18TABLE 8B: PROJECT FINANCING ........................................................ 19TABLE 9: GAS PRICE LEVELS ........................................................ 19TABLE 10: ECONOMIC EVALUATION ........................................................ 20TABLE 11: STATUS OF LEGAL COVENANTS ........................................................ 21TABLE 12: BANK RESOURCES: MISSIONS ........................................................ 23TABLE 13: BANK RESOURCES: STAFF INPUT ........................................................ 24

APPENDIX A: Borrower's Contribution to the ICR

MAP - IBRD 30111

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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POLAND

ENERGY RESOURCE DEVELOPMENT PROJECT(Loan 3215-POL)

PREFACE

This is the Implementation Completion Report (ICR) for the Poland Energy ResourceDevelopment Project (Loan No. 3215-POL, US$250 million equivalent) approved on June 5,1990. The Polish Oil and Gas Company (PGNiG) was the Borrower and the Republic of Polandwas the Guarantor. The project was co-financed by the European Investment Bank (EIB) for anamount of ECU 50 million.

The IBRD loan was closed on June 30, 1998, two and a half years behind the originalschedule. The last disbursement for the loan took place on September 28, 1998. From theoriginal amount of US$250 million, about US$1.8 million remained undisbursed. The EIB loanclosed in December 1995.

The ICR was prepared by Julius Wilberg (Senior Financial Analyst), Hannachi Morsli,(Principal Petroleum Engineer), and Anton Smit (Petroleum Exploration and ProductionConsultant). It is based on the Staff Appraisal Report, the Loan and Guarantee Agreements,supervision reports, a visit to Poland in October 1998 and the Borrowers contribution reportprepared by the PGNiG (Appendix A). The report was reviewed and edited by Peter Law (SeniorEnergy Specialist, Energy, Mining and Telecommunications Department), and reviewed by HenkBusz (Energy Sector Leader, Europe and Central Asia Region).

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POLAND


EVALUATION SUMmARY

Introduction

1. The Energy Resource Development Project was IBRD's first project to support the Polishenergy sector. The project aimed to assist a Government program introduced in early 1990,aimed at stabilizing the country's creditworthiness. Under this program, special attention wasgiven to the improvement of local energy efficiency and increased production of domestic naturalgas in order to slow the decline in hard coal available for export - the country's single largestsource of foreign currency earnings. At this time, Poland was about three times less energy-efficient than other countries at a similar level of economic development. By conserving energyand substituting natural gas for coal, there would also be a contribution towards reduction of thesevere environmental problems that Poland experienced. To support the implementation of thisprogram, the Government of Poland requested Bank assistance for the project.

Project Objectives

2. The objectives of the project were to: (a) improve the energy-related convertible currencyearnings of Poland by: (i) increasing domestic production of natural gas; and (ii) encouragingenergy conservation for all forms of energy and fuel substitution through supporting energy pricereform; (b) contribute to a reduction of environmental pollution related to energy use; and (c)improve the competitive, regulatory and financial framework of the sector entities by supportingthe implementation of appropriate restructuring programs. In parallel with the project, theBank/UNDP's Energy Sector Management Assistance Program (ESMAP) was to: (a) implementenergy sector restructuring studies and a gas pricing study; (b) implement studies to optimizefurther development of the gas sector and assess its environmental impact; and (c) assist inpreparing a contractual framework to facilitate participation of foreign and domestic privatesector enterprises in developing the petroleum sector.

3. To meet these objectives, the project's main components consisted of: (a) investments inequipment and materials to increase the production of natural gas through (i) development andrehabilitation of existing gas fields; (ii) procurement and installation of field gas compression;(iii) delineation and evaluation of gas fields discovered in recent years; (iv) expansion oftransmission; (v) development of underground storage facilities to respond to load fluctuations;(vi) procurement and installation of gas purification facilities; and (b) technical assistancethrough consultancy services, training and studies.

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4. The project objectives contained in para. 2 were well designed. However, the design ofparallel objective (a), which concerned the ESMAP restructuring study, included agreement inthe SAR that the Government should start to implement the restructuring program in 1991. Thisobjective presupposed the Government would accept the restructuring program and be preparedto fully implement it within the project timescale.

Implementation Experience and Results

5. The Polish Oil and Gas Company (PGNiG) was the Borrower of the US$250 millionIBRD loan, and the Republic of Poland was the Guarantor. The project was co-financed by theEuropean Investment Bank (EIB) for ECU 50 million, and the EIB loan was closed in December1995. The IBRD loan was closed on June 30, 1998, two and a half years behind the originalschedule, with the last disbursement on September 28, 1998. The gas purification component ofthe project (para. 3, item (vi)) was not implemented due to the fall in gas demand between 1990and 1994 caused by the economic downturn in Poland. Also, the SCADA part of thetransmission component (para. 3, item (iv)) was not implemented since a feasibility study'showed the cost would be substantially higher than the US$ 20.7 million estimated at appraisal,and PGNiG decided that a more economic solution would be to use the telecommunicationsfacilities of existing system operators (the Polish Power Grid Company (PPGC) and the PolishTelecommunications Company (PPGC)). The funds originally allocated for the SCADA wereused for the underground storage (para. 3, item (v)) which had a higher cost than originallyenvisaged to achieve the same scope. The delay in project completion was primarily due to thelonger than anticipated time required to develop the underground storage facilities. From theUS$250 million loan, about US$1.8 million remained undisbursed after the four-month graceperiod following the closing date, and was cancelled effective October 31, 1998.

6. The project made a significant contribution to the Government of Poland's program toincrease production of domestic natural gas in order to slow the decline in hard coal available forexport. The project contributed to first arresting, and subsequently reversing the decline inproduction of natural gas, and substantially increasing the reserves. Incremental natural gasproduction from the project reached 1.85 BCMY, about 50% of PGNiG's total production.Without the project, the total gas production would have decreased from 3.0 BCMY at the timeof appraisal, to 1.9 BCMY by 1997. The project's cumulative incremental gas production isexpected to exceed the original estimate by 17%. The project had the potential to achieve evenhigher incremental production, but this was constrained due to: (a) the yearly shut in of morethan one third of the domestic gas production due to the lack of load management facilities; (b)difficulties in obtaining the right-of-way from landowners for construction of wells and facilities;(c) failure of PGNiG to exploit the potential demand for Low Methane Natural Gas (LMNG)when the project's field appraisal yielded more gas reserves than anticipated. In addition, theGovernment and Senior Management of PGNiG did not appear to give high priority to removingthese constraints and developing domestic production as a self-standing business, but rather gavepriority to large natural gas import schemes. Based on the reserves already established and the

1 The SCADA feasibility study was prepared by British Gas in 1993.

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modem technologies introduced, the project's incremental gas production is highly likely to besustained over the project's lifetime.

7. Without the project's incremental gas production, most consumers would have needed touse coal instead. On this basis, the project is credited with an annual emissions reduction fromcoal burning of about: (a) 250,000 tons of ash; (b) 65,000 tons of sulfur dioxide; (c) 25,000 tonsof nitrogen oxide; (d) 12,000 tons of carbon monoxide; and (e) 250,000 tons of carbon dioxide.In addition, the project introduced international best practice in environmental management ofPGNiG's field operations and effluent disposal.

8. The timescale for the institutional reformns under the project proved over-ambitious andPGNiG is the last remaining fully integrated monopoly in the energy sector. The restructuring ofPGNiG is taking longer than anticipated due to the resistance to implement restructuring fromwithin PGNiG (including the Workers Council), a lack of decisive action from the Government,and the reluctance of both to implement any restructuring which might allow Gazexport (Russia)to gain a foothold in the Polish gas market. Nevertheless, significant progress was made in that:(i) PGNiG was transformed from a state enterprise to a corporation; and (ii) non-core-activitiesand service companies were transformed into limited liability companies and prepared for spin-off. Improvements were achieved within PGNiG with regard to corporate management, financialperformance, corporate planning and operational skills of field personnel.

9. Under the project, the Bank's dialogue with the Government directly contributed to theformulation of the Geological and Mining Law which was passed in 1994, as well as thesignificant private participation in petroleum and gas exploration which has now been achievedin Poland. The overall reform objectives of the project were consistent with and supported bythose sought under the Heat Supply Project's SECAL (Ln. 3377-POL) which, inter alia,contributed to the enactment of the new Energy Law, and in 1988 to the establishment of the newEnergy Sector Regulatory Agency, and which also supported the internal restructuring andcommercialization of PGNiG. This overall strengthening of the legal and regulatory frameworkwill help Poland achieve compliance with energy sector requirements for EU membership, andwill accelerate the restructuring of PGNiG initiated under the project through compliance withEU requirements for price transparency and competition.

10. The project's agreements to raise gas prices were supported by those reached under theSAL (Ln-32470-POL), and the SECAL. The gas prices to industry were supposed to reach paritywith those in West European countries by December 1992; this was achieved in 1994. Forhouseholds, gas prices were supposed to reach industrial prices by December 1991 (achieved in1992), and then raised to reflect additional delivery costs by December 1995. While this appearsto have been largely achieved, there is some uncertainty concerning the level of additionaldelivery costs, since PGNiG did not have the technical capability to accurately calculate thedistribution costs to be allocated to different consumer groups based on the principles ofeconomic tariff setting. Notwithstanding this, the price increases achieved under the project werea major achievement for Poland and have undoubtedly resulted in energy conservation at theconsumer level. The Energy Law requires gas prices to be liberalized by the year 2000, whichwill further sustain progress towards full cost-based gas pricing.

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11. The project has achieved all its key physical objectives, although at a slower pace thanoriginally anticipated, and was highly successful in introducing modem gas development andproduction technology to PGNiG, and resulted in first arresting, and subsequently reversing theproduction decline, and substantially increasing the reserves. The project has partially reached itsinstitutional reform objective, with the corporatization of PGNiG and the transformation of theancillary companies in preparation for eventual spin-off. Without the project, PGNiG would haveneeded to seek alternative sources of financing (including from the private sector) to undertakethe same field rehabilitation programs. However, it is highly unlikely that the private sectorwould have been interested to participate in this activity due to the age of the fields (some being40 years old) and their small size, dispersed locations, and uncertain remaining reserves. PGNiGcould have engaged in joint venture programs with private partners to explore new areas earlierthan it did, but Poland is not a highly prospective country for hydrocarbons; even under anoptimistic scenario it would not have attracted enough private investment to achieve theincremental gas production that was achieved under the project. Neither would the restructuringof PGNiG have been accelerated, since the slow pace of restructuring was caused primarily byreasons other than those related to incremental domestic production (para. 8). The project isexpected to generate an economic rate of return very close to that estimated at project appraisalby yielding sustainable production over its lifetime. The outcome of the project is rated assatisfactory.

Summary of Findings and Key Lessons Learned

12. The key findings are: (a) implementation of the restructuring of PGNiG was slow andonly partially accomplished; (b) obtaining right-of-way for construction of well-gathering andother transmission lines required lengthy negotiations with landowners, which delayed fieldproduction and irreversibly damaged some reservoirs; (c) lack of underground storage and loadmanagement facilities caused periodic shut-in of one third of production for half of the year; (d)PGNiG field inventory included a number of marginal producing fields which were noteconomically viable; (e) PGNiG's inventory included a large number of older shut-in gas wellswithout proper abandonment facilities, causing a safety hazard to the environment; (f) thereluctance of PGNiG to enter into long term gas supply arrangements for potential consumers ofLow Methane Natural Gas (LMNG) inhibited the market development for this gas; and (g)contracting some of the field operations to highly specialized international contractors improvedfield operations through transfer of technology.

13. The key lessons learned from the project are: (a) setting as a project objective theimplementation of TA restructuring studies for which the results were not known at appraisal,presupposed acceptance of the results by the borrower, and such major policy reform might havebeen better left to a subsequent and separate lending vehicle; (b) effective restructuring of gassector entities is more likely if the entities (and not just the government) actively participate inthe TA, so that the entities support the recommendations of the studies; (c) the gas pricesincreases achieved under the project were valuable to provide the right economic signals toconsumers and improve the financial situation of the beneficiary; (d) to minimize the difficultiesin obtaining the right-of-way, it is best to reach agreement with land owners prior to well drilling,

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and use multi-directional and slanted drilling techniques to reduce field development cost; (e) aload management analysis should be a prerequisite to embarking on a field developmentprogram; (f) frequent and consistent supervision, to large extent by the same Bank team, is apositive factor in project success; and (g) co-financing with EIB worked well, and benefited fromcooperation and exchange of information between the two institutions throughout projectpreparation and implementation, including a number ofjoint missions.

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IMPLEMENTATION COMPLETION REPORTPOLAND


PART I - PROJECT IMPLEMENTATION ASSESSMENT

A. INTRODUCTION

1. This report evaluates the implementation of the Energy Resource Development Project,which was financed by an IBRD loan of US$250 million and EIB confinancing of ECU 50million. The Borrower was the Polish Oil and Gas Company (PGNiG) and the Guarantor was theRepublic of Poland.

2. At the time of project appraisal, Poland was still a centrally planned economy facing asevere economic crisis, which had resulted in a major convertible currency debt problem. TheGovernment introduced a program in early 1990 aimed at stabilizing the country'screditworthiness. Under this program, special attention was given to the improvement of energyefficiency and increased production of domestic natural gas in order to slow the decline in hardcoal available for export -- the country's single largest source of foreign currency earnings. In1991, Poland's natural gas consumption was about 9.6 billion cubic meters per year (BCMY) ofwhich 3 BCMY was produced domestically and the remainder imported from Russia. Domesticproduction peaked in 1978 at about 8 BCMY and then started to decline due to natural depletionand insufficient maintenance of the gas fields. This despite the fact that the country hadsubstantial reserves estimated at about 160 BCM. At the same time, the high level of coalconsumption was making Poland one of the most polluted countries in Europe, with an estimated470 million tons of carbon dioxide emissions per year. By conserving energy and substitutingnatural gas for coal, there would be a marked contribution towards reduction of the severeenvironmental problems that Poland had experienced. In order to support the implementation ofits program, the Government of Poland requested Bank's assistance for the project.

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B. STATEMENT AND EVALUATION OF OBJECTIVES

The Project Objectives

3. The objectives of the project were to: (a) improve Poland's energy-related convertiblecurrency earnings by (i) increasing domestic production of natural gas, and (ii) encouragingenergy conservation for all forms of energy and fuel substitution through supporting energy pricereform; (b) contribute to a reduction of environmental pollution related to energy use; and (c)improve the competitive, regulatory and financial framework of the sector entities by supportingthe implementation of appropriate restructuring programns for the coal, gas, power, lignite andheat sectors.

4. In parallel with the project, the BankfUSNDP's Energy Sector Management AssistanceProgram (ESMAP) was to: (a) implement energy sector restructuring studies2 and (undertake) agas pricing study; (b) implement (undertake) studies to optimize further development of the gassector and assess its environmental impact; and (c) assist in preparing a contractual framework tofacilitate participation of foreign and domestic private sector enterprises in developing thepetroleum sector.

5. To meet these objectives, the project's main components consisted of: (a) investments inequipment and materials to increase the production of natural gas through (i) development andrehabilitation of existing gas fields; (ii) procurement and installation of field gas compressorstations; (iii) delineation and evaluation of gas fields discovered in recent years; (iv) expansion oftransmission; (v) development of underground storage facilities to respond to load fluctuations;and (vi) procurement and installation of gas purification facilities; and (b) technical assistancethrough consultancy services, training, and studies.

Evaluation of Objectives

6. The project objectives were consistent with the Government's development priorities andstrongly supported the Government's creditworthiness and sustainable growth program byreducing the rate of increase in gas imports and curbing environmental pollution. The objectiveswere also well aligned with the Bank strategies for sector reforms, pricing policies and reductionof environmental pollution. However, the intended institutional reforms with respect to gassector restructuring within the timescale envisaged proved too ambitious in a country which hadbeen subjected to centrally-controlled regulations for over forty years, and where measures aimedat the restructuring of state companies could only be gradually introduced. Nevertheless, theconcepts of enterprise restructuring, price reforms and reform-driven legal frameworks weresupported by the Government of Poland. Likewise, the timescale envisaged to introduce themajor gas price increases for residential consumers proved difficult in a society accustomed to

2 The SAR notes the Government's agreement to implement the restructuring programs for gas(and other subsectors) starting June 30, 1991, after consultation with the Bank.

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receiving large state subsidies and where energy price increases, especially to residentialconsumers, are politically sensitive.

7. The project implementation period was originally expected to span from early 1991 toDecember 1995, but this proved to be too short, and the implementation period needed to beextended by two and a half years. The primary cause was a delay in the development of theMogilno underground storage (drilling, disposal of salt water, installation of surface facilities),this being the first storage facility of its type ever constructed in Poland. Delays were alsoexperienced due to legal difficulties in obtaining access to landowners' properties required forthe construction of key facilities under the project, and poor staffing within PGNiG's ProjectImplementation Unit during the first two years of the project. The EIB was able to close out itsloan in 1995 primarily because it financed relatively quick disbursing components such as wellappraisal drilling and field development equipment.

8. The actual project cost increased from US$616.4 million estimated at appraisal, toUS$708.1 million, which represents an increase of 15%. This was primarily due to: (i) increaseof US$12.9 million for upgrade of seismic equipment and data processing facilities; (ii)US$166.3 million to cover right of way payments for land and crop compensation (suchpayments were not practiced in Poland at the time of appraisal, but had become normal practiceby 1994); and (iii) increase of US$77.9 million for underground storage. These increases wereoffset by non-implementation of the gas purification facility (US$28.7 million), and the SCADApart of the transmission component (US$20.7 million).

C. ACHIEVEMENT OF OBJECTIVES

9. The project was highly successful in introducing modem gas development and productiontechnology to PGNiG, and contributed to first arresting and then reversing the productiondecline, while substantially increasing the reserves. The project generated an economic rate ofreturn very close to that estimated at project appraisal (35.6% compared to 37.1%). The projectwas partially successful in implementing institutional restructuring reform within the timescaleenvisaged, but it paved the way for implementing those reforms which are required for EUaccession.

10. The objective of increasing domestic natural gas production was fully achieved. By thesecond year of project implementation (1992), PGNiG had increased its overall gas productionby one third. In 1998, the incremental gas production under the project reached 1.85 BCMY,about 50% of PGNiG's total domestic output. Without the project, the total gas production inPoland would have decreased from 3.0 BCMY at the time of appraisal, to 1.9 BCMY by 1997.When all project drilled wells are put on stream in 1999, the project's contribution to PGNG'sgas production will be about 2.4 BCMY -- about 65% of Poland's total production. The project'scumulative incremental gas production is expected to reach about 34 BCM (high methaneequivalent) by 2010, exceeding its original estimates by about 17%. An additional 6 BCM islikely from ongoing field appraisal work initiated under the project. In terms of gas supply and

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demand, the contribution of the project to Poland's overall gas balance is summarized in Table 1.The gas production due to the project, as shown in Table 1, represents a constrained productiondue to the factors noted in paras. 20-23 below.

Table 1: Poland Gas Supply - Demand Projections(BCMY)

1991 1997 2000 2005 2010Gas Demand 9.6 11.4 12.3 15.8 20.9Domestic Gas Production 3.0 3.7 4.1 5.2 5.2( - of which from project) (0) (1.8) (2.3) (1.8) (1.3)Gas Imports 6.6 7.7 8.2 10.6 15.7

11. Without the project, PGNiG would have needed to seek alternative sources of financing(including from the private sector) to undertake the same field rehabilitation programs. However,it is highly unlikely that the private sector would have been interested to participate in this due tothe age of the fields (some being 40 years old) and their small size, dispersed locations, anduncertain remaining reserves. PGNiG could have engaged in joint venture programs with privatepartners to explore new areas earlier than it did, but Poland is not a highly prospective countryfor hydrocarbons; even under an optimistic scenario it would not have attracted enough privateinvestments to achieve the incremental gas production that was achieved under the project.Without the project's incremental gas production, most consumers would have needed to usecoal instead. Based on such displacement of coal (assuming 1% sulfur content), the project iscredited with an annual emissions reduction of about: (a) 250,000 tons of ash; (b) 65,000 tons ofsulfur dioxide; (c) 25,000 tons of nitrogen oxide; (d) 12,000 tons of carbon monoxide; and (e)250,000 tons of carbon dioxide. The project partially contributed to Poland's overall reduction ofcarbon dioxide emissions, which were estimated by recent official publications to be around 360million tons per year compared to 470 million tons per year at project appraisal. In addition, theproject introduced international best practice in environmental management of PGNiG fieldoperations and effluent disposal.

12. The environmental benefits under the project would have been even greater if LMNG hadbeen used for power generation (para. 23).

13. The institutional reforms under the project proved too ambitious and the restructuring ofPGNiG was much slower than had been anticipated. This was partly due to the resistance torestructuring from within PGNiG (from both senior management and the Workers Council; thelatter sought an allocation of shares for employees based on an unrestructured PGNiG, as acondition for moving ahead with restructuring), and also to lack of decisive action from theGovernment. There also appeared to be a reluctance by PGNiG management and Government toallow any restructuring which might enable Gazexport to gain a meaningful degree of control ofthe gas market in Poland. The ESMAP restructuring study (prepared in 1991), had recommendedto create two Exploration and Production companies, a single national transmission company,and six regional distribution companies, with the privatization phase to follow the restructuringphase. In fact, a restructuring program for PGNiG was only approved by the Council of Ministers

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on April 6, 1996. The proposed three-stage process included: (i) transformation of PGNiG into astate-owned corporation; (ii) commercialization and privatization of the thirteen non-core drillingand geophysical companies; and (iii) creation of PGN S.A. to be responsible for upstreamprospecting and production, and PGAZ S.A. for downstream activities (transmission, storage anddistribution), both under PGNiG S.A. as a holding company. In 1996, stage (i) of the aboverestructuring was carried out. Following this, stage (ii) was partially completed throughtransformation of PGNiG's non-core-activities and service companies into limited liabilitycompanies as preparation for spin-off. Substantial improvements were achieved within thetransformed PGNiG, particularly with regard to corporate management, financial performance,corporate planning and operational skills. An intensive training program allowed PGNiG's fieldpersonnel to acquire proficient operating skills to operate the project's equipment and applymodem technology.

14. Under the project, a reservoir policy management study was successfully completedwhich helped PGNiG to introduce modem gas reserve management techniques, includingoptimized long-term gas field development plans. A number of PGNiG technical staff were sentto the consultant's headquarters overseas to participate in implementing the study, which provedto be an effective method for technology and know-how transfer. The experience gained hasenabled PGNiG to design its own reservoir model with independently purchased software. Theoverseas technical training program was successful, partly because of early attention todevelopment of language skills, which proved to be a major contributing factor.

15. Until the passage of the Geological and Mining Law in 1994, PGNiG had the monopolyin oil and gas exploration and development. Since then, the Government has adopted veryfavorable petroleum exploration and development contractual terms to attract foreign investors inthe upstream activities - as attractive as any other country in Europe. This was deemed necessarybecause Poland is not considered a highly prospective country by international comparison, withonly the less prospective areas being made available for exploration by foreign companies (themost prospective areas were reserved for PGNiG). To date, some thirteen foreign companieshave signed licensing agreements, covering three quarters of Poland's prospective acreage, andPGNiG has begun to pursue Joint Venture arrangements with foreign companies for explorationand development within their own reserved areas. Private participation remains insignificant inthe downstream area of gas transmission, storage, and distribution, where PGNiG still holds thedefacto monopoly. The lack of implementing regulations for the gas sector, and the reluctance ofPGNiG management to fully embrace private partnerships, are considered the major reasons forthis.

16. With regard to gas pricing, under the project the Government gradually increased gasprices to end-use consumers3 . Gas prices to industry were supposed to reach parity with those inWest European countries in 1992, and this was actually achieved in 1994. For residentialconsumers, gas prices were supposed to reach industrial prices by December 1991 (achieved in1992), and then raised to reflect distribution costs by December 1995. However, it is uncertain

3 The gas pricing conditionalities were consistent with those under the 1990 SAL (Ln. 32470-POL), and the 1991 Heat Restructuring Project's SECAL (Ln. 3377-POL).

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whether the latter increase was actually achieved, since PGNiG did not have the technicalcapability to calculate with accuracy the distribution costs which should be allocated to differentconsumer groups based on the principles of economic tariff setting. Gas prices to residentialconsumers in Poland are still substantially below those in West Europe4 , but the latter were inany case only intended as a broad benchmark in the absence of adequate data, rather than aprecise target. Notwithstanding this, the price increases achieved during the project for bothindustrial and residential users are a major achievement for Poland, and have undoubtedlyresulted in energy conservation at the consumer level.

17. Under the project, the Bank's dialogue with the Government directly contributed to theformulation of the Geological and Mining Law which was passed in 1994, as well as thesignificant private participation in petroleum and gas exploration which has now been achieved.The overall reform objectives of the project were consistent with and supported by those soughtunder the Heat Supply Project's SECAL (Ln 3377-POL). The latter contributed to theestablishment of the new Energy Sector Regulatory Agency (created under the new Energy Lawof 1998) and also supported the internal restructuring and commercialization of PGNiG. Keyfeatures of the Energy Law related to gas are: (a) the provision of third party access (open access)in gas transmission for domestic producers; (b) creation of the Energy Sector Regulatory Agencyto oversee the overall development of the energy sector; and (c) gas prices to be set by theMinistry of Finance until their liberalization in the year 2000. The measures taken to strengthenthe legal and regulatory framework will help Poland achieve compliance with energy sectorrequirements for EU membership, and will accelerate the restructuring of PGNiG initiated underthe project due to the compliance with EU requirements for price transparency and competitionin the sector.

18. The energy sector studies funded by ESMAP in the areas of industry restructuring, gaspncing, environmental issues in gas development, were all valuable in influencing theGovernment's and the Borrower's thinking with regard to formulation of gas-related policyissues. However, the recommendations of the ESMAP restructuring study have not been fullyimplemented to date (see para. 24).

D. MAJOR FACTORS AFFECTING THE PROJECT

19. As noted in para. 7, the project suffered a two and a half year delay primarily due to thelonger than anticipated time to develop the Mogilno underground storage facility. A majordifficulty related to the disposal of the brine generated by the leaching process. Dunrng projectappraisal in 1990, the local chemical industry agreed to use the brine as a feedstock for theproduction of chlorine and caustic. However, by the time the cavem leaching started in 1993-94,the chemical industry was affected by the Poland's economic downturn and could not process thequantity of brine originally planned. The only other means of disposal would have been thedrilling of deep disposal wells, which require much more time than the reduced withdrawal pace

4 Ref. Table 10, Part II - Statistical Tables.

7

by the chemical industry, and PGNiG had no other alternative for accelerating the developmentof Mogilno underground gas storage

20. The biggest obstacle to achieving the sector's optimum domestic gas production capacitywas that PGNiG had to shut in more than one third of the domestic gas production during thesummer months due to the lack of load management and underground gas storage facilities. Withthe very low gas demand in the summer and lack of flexibility in gas import contracts, PGNiGhad no alternative but to close down its own production, thereby increasing overall productioncost. At the same time, domestic field deliverability could not meet the high winter gas demand(25 MMCMD higher than in summer). The higher demand for gas in the winter could only havebeen met by domestically produced gas if there been sufficient load management and gas storagefacilities.

21. Unless PGNiG can accelerate a US$700 million field conversion program which has beenunder consideration for several years, lack of underground gas storage capacity is expected toaffect Poland's gas sector for several years to come. While the project made a substantialcontribution towards generating underground gas storage capacity, much more is required. Withthe commissioning under the project of 4 cavems out of an ongoing 20 cavem-program, thelimited storage capacity in depleted fields and the ratio of summer gas production capacity tosummer gas demand higher than 3:1, PGNiG can only meet less than one third of its current gasstorage requirements.

22. Most of the wells drilled since 1991 were subject to lengthy negotiations with landownersbefore they could be connected to the gas transmission network. The right-of-way forconstruction of well locations and wellhead gathering lines proved to be a major obstacle to theproject as land owners were reluctant to allow gas lines to transit within their properties -- inspite of fair compensation. Poland's land surface rights laws and regulations require approval ofsuch land use by municipalities, which in turn require owner consent. The law does not explicitlyprovide the terms under which owners can refuse granting the right-of-way. As a result, some ofthe landowners simply refused to have gas lines within their properties. This meant that a numberof wells could not be accessed. Several cases were submitted to courts, which orderedlandowners to grant the right-of-way since the underground resources belong to the state andprivate landowners are not supposed to deny the state access to these resources. However, mostof court orders were repeatedly appealed against by landowners that continued to refuse access tothe wells. In fact, about one third of the project's productive gas wells, with a productionpotential of 1 BCMY, remained closed at the time of the loan closing date.

23. Due to low energy content and low combustion efficiency of LMNG compared toHMNG, the marketing of LMNG requires special efforts. When the project's field appraisalprogram yielded much more gas reserves than anticipated, a number of industrial andcommercial gas users stated they could use much of the LMNG, if provided with the rightincentives. These incentives would have to include a firm commitment by PGNiG to long-termdelivery contracts and delivery of gas directly to the consumers. However, PGNiG was reluctantto commit to long term contracts, and so the potential demand for LMNG failed to materializeand was insufficient to justify the construction of the planned desulfurization plant under the

8

project. In consultation with the Government and the Bank, PGNiG decided not to proceed withthe construction of the desulfurization plant under the project and to use the savings from this forthe underground gas storage component. Nevertheless, the project still managed to meet some ofthe objectives related to LMNG development. Through the project, LMNG reserves wereestablished that could meet potential industrial, residential and commercial demand for LMNG inthe Lower Silesia region, including the conversion from coal and lignite to LMNG of someexisting power plants in this region.

24. The ESMAP restructuring study was well executed and provided a good blueprint for therestructuring of PGNiG. However, the study would have benefited through a more activeparticipation of PGNiG in the study, since this would likely have led to more "ownership" byPGNiG of the study's final recommendations.

E. PROJECT SUSTAINABILITY

25. It is highly likely that the achievements generated during project implementation will bemaintained throughout the project lifetime (up to 2010), particularly with regard to the majorphysical components. The modern gasfield equipment, which was introduced under the project,was conceived to be productive for the project's lifetime. To ensure proper operations andmaintenance of project financed equipment, all necessary measures were taken by PGNiG tocontinue building on the know-how acquired in modem gas technologies under the project'stechnical assistance, particularly with regard to technical competence and field operating skills.

26. Based on the reserves already established, the project's incremental gas productionachievement is highly likely to be sustained throughout the project's lifetime. Some 40 BCM ofrecoverable gas reserves were established under the project, of which about 34 BCM can beconsidered as proven and an additional 6 BCM still under appraisal. New reserve managementtechniques, introduced under the project, will further support the sustainability of gas productionby substantially improving the gas field deliverability and optimizing the overall gas reserverecovery. The project's incremental gas production, currently at 1.85 BCMY, is scheduled toincrease to about 2.4 BCMY in 1999, when all gas wells financed under the project are put intoproduction.

27. Improved load management capability, including underground gas storage capacity, isrequired to ensure the long-term sustainability of the project's gas production capability. To date,the only underground gas storage development that has proceeded satisfactorily is the Mogilnounderground gas storage facility under the Bank financed project. The development of the otherunderground gas storage facilities, particularly those in the depleted gas fields of Wierzchowiceand Husow, needs to quickly get underway to address the load management problems associatedwith the seasonal fluctuations.

28. The sustainability of the project's achievement in reducing environmental emissionsthrough displacement of coal by natural gas, could well exceed the appraisal estimate. The highlevel of environmental pollution experienced by Poland over recent years, particularly from the

9

atmospheric emissions of potentially harmful pollutants derived from the use of coal, increasedthe importance of economic substitution by natural gas and other clean fuels. New environmentalprotection regulations were issued in 1994, which will further support the project'senvironmental pollution reduction objective. However, the sustainability of reducedenvironmental pollution is based on the assumption that the necessary infrastructure for gasdeliveries (e.g., gas storage facilities) will be made available to meet the seasonal demand.

29. With regard to gas sector restructuring, the project objectives were too ambitious withinthe timescale originally envisaged. To date, stage one has been completed and stage two partiallycompleted. However, it is highly likely that significant further and sustainable progress will bemade on the restructuring in the near future, since the Government is committed to transparencyand competition in the gas sector to meet the European Union's (EU) accession requirements, inparticular the EU Gas Directive (98/30/EC). This will require the gas industry to adopt astructure which is transparent between the core activities of Exploration and Production, gastransmission, storage and distribution, and which differentiates between the cost of thecommodity and the cost of service in gas transactions. It will also require PGNiG to substantiallyopen the gas markets to competition. With regard to gas pricing, it is noted that the Energy Lawrequires gas prices to be liberalized by the year 2000 when responsibility for overseeing gasprices will pass from the Ministry of Finance to the Energy Sector Regulatory Agency. Thisshould ensure sustainability in progressing toward reaching gas prices which ensure full costrecovery. Also, Poland has become a signatory of both the European Energy Charter and theEuropean Energy Charter Treaty.

F. BANK PERFORMANCE

30. The Bank carried out project identification, preparation and appraisal in a comprehensiveand satisfactory manner. Continuity in the composition of the project team was maintained duringthe implementation phase. This resulted in consistency in recommendations to the Borrowerregarding the execution of the physical and institutional components of the project as well asregarding the sector reforn agenda.

G. PERFORMANCE OF THE BORROWER

31. The performance of the Borrower was satisfactory during project preparation, appraisaland implementation. Despite the delay in project implementation, once implementation gotunderway the Borrower took strong ownership of all matters related to the project.

32. The performance of PGNiG as implementer of the project was satisfactory. Staff and localcurrency funds were made available on time and training schedules covered all the necessarydisciplines required for carrying out the technical tasks for the project.

33. In the years covered by the SAR forecast (1991 to 1996), the company achieved a netprofit in each year except 1996, ranging from US$118 million (1992) to US$126 million

10

equivalent (1995). However, the true picture was masked by de facto subsidies received from theGovernment through release of payment obligations for imported Jamburg gas (about US$160million per year), without which the financial performance of PGNiG would have been verypoor. The net loss in 1996 was mainly due to higher depreciation charges caused by an almostfourfold revaluation of assets during the previous year as well as high exploration andmaintenance costs. Net internal cash generation was sufficient each year to cover a substantialportion of PGNiG's investment program, and the covenanted "Contribution to Investment Ratio"of not less than 30% was fulfilled throughout project execution. Additionally, the Debt ServiceCoverage Ratio ranged from to 9.5 times the debt service (1991) to 2.1 times (1996) against acovenanted target of 1.3 times, which is satisfactory.

H. ASSESSMENT OF OUTCOME

34. The outcome of the project is rated as satisfactory. The project has achieved its majorphysical objectives and is highly likely to maintain satisfactory results. The incremental domesticgas production and enhanced underground storage capacity achieved by the project has helpedslow down the rate of Poland's increasing dependence on gas imports. Without the project'sincremental gas production, consumers would have needed to use coal instead, which would haveled to increased polluting emissions in Silesia and Western Poland. In addition, the project madesignificant contributions to Poland's energy sector reform agenda. During projectimplementation, the Bank's dialogue with the Government directly contributed to the formulationof the Geological and Mining Law, as well as the increased private participation achieved inpetroleum and gas exploration. The overall reform objectives of the project were consistent withand supported by those under the SAL and the SECAL, including the successful raising of gasprices to industrial and residential consumers, and the internal restructuring andcommercialization of PGNiG.

35. While the project contributed to Poland's domestic gas production, the country continuesto be dependent on Russian imports to meet demand. Gas consumption is expected to increasesharply in the next 5-10 years driven by the need for natural gas for power generation (includingCHP) plants. Therefore, in spite of the recent important discoveries of both gas and oil inWestern Poland, gas imports are likely to increase over the medium term. To this end, Poland ispursuing development of the Yamal gas project which will transport gas from Russia to WesternEurope. The EUROPOLGAZ company has been set up to develop the Polish section of theproject (with participation from PGNiG, Gazprom, and private sponsors) and the project wouldmake substantial volumes of gas available for use in Poland. PGNiG is also actively seeking todiversify its import sources through new import arrangements with producers such as Norwayand the Netherlands.

I. FUTURE PROJECT OPERATION

36. The project established sufficient gas reserves to sustain the projected gas productionfrom existing fields. No additional investment would be required to produce the established gasreserves except for improved load management facilities including underground storage capacity

11

expansion. In this regard, PGNiG agreed to: (i) continue Mogilno's first phase development,consisting of increasing the number of caverns to twenty by the year 2010; and (ii) accelerate theconversion of the depleted gas field, Wierzchowice, into a large gas storage facility. Tomaximize the project's benefits, PGNiG agreed to take all the necessary measures to promote theuse of LMNG, particularly for the power sector.

37. Implementation of policy requirements for effective operation and maintenance of theproject, initiated in 1996, is expected to continue as part of the Government's commitment torestructure the gas sector to meet the conditions for accession to the EU.

J. KEY LESSONS LEARNED

38. The key lessons learned from the project are: (a) setting as a project objective theimplementation of TA restructuring studies for which the results were not known at appraisal,presupposed acceptance of the results by the borrower/beneficiary, and such major policy reformnmight have been better left to a subsequent and separate lending vehicle; (b) effectiverestructuring of sector entities is more likely if the entities (and not just the Government) activelyparticipate in the TA, so that the entities support the recommendations of the studies; (c) the gasprice increases achieved under the project were valuable to provide the right economic signals toconsumers and improve the financial situation of the beneficiary; (d) to minimize the difficultiesin obtaining the right-of-way, it is best to reach agreement with land owners prior to well drilling,and use multi-directional and slanted drilling techniques to reduce field development cost; (e) aload management analysis should be a prerequisite to embarking on a field developmentprogram; (f) frequent and consistent supervision, to large extent by the same Bank team, is apositive factor in project success; and (g) co-financing with EIB worked well, and benefited fromcooperation and exchange of information between the two institutions throughout projectpreparation and implementation, including a number of joint missions.

12


POLAND


PART II - STATISTICAL TABLES

13

TABLE 1: SUMMARY OF ASSESSMENT

A. Achievement of Substantial Partial Negligible NotObjectives Applicable

Macro Policies XSector Policies X

Financial Objectives X

Institutional Development X

Physical Objectives X

Poverty Reduction X

Gender Issues XOther Social Issues XEnvironmental Issues XPublic Sector Management X

Private Sector Management X

B. Project Sustainability Likely Unlikely | Uncertain

C. Bank Performance HighlySatisfactory Deficient

Identification X

Preparation Assistance XAppraisal X

Supervision X

D. Borrower Performance HighlySatisfactory Satisfactory Deficient

Preparation X

Implementation X

Covenant Compliance X

E. Assessment of Outcome Highly HighlySatisfactory Satisfactory Unsatisfactory

Satisfactory UnsatisfactoryX

14

TABLE 2: RELATED BANK LOANS

There were no prior Bank Loans in the sector

TABLE 3: PROJECT TIME TABLE

Steps in Project Cycle Planned Date Actual DateIdentification (Executive Project Summary) September 1987 January 1988Pre-Appraisal September 1989Appraisal February 1990Negotiations May 1990Board Presentation June 1990Signing June 1990Effectiveness November 1990Project Completion December 31, 1995 June 30, 1998Loan Closing June 30, 1996 June 30, 1998

TABLE 4: LOAN DISBURSEMENTS

FY (Cumulative) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999IBRD Appraisal estimate 0.0 23.4 71.6 127.0 179.7 225.5 250.0 250.0 250.0 250.0

Actual (*) 19.3 54.0 147.2 170.2 174.1 192.5 206.2 244.8 248.2Actual as % ofestimate 82.5 75.4 115.9 94.7 77.2 77.0 82.5 97.9 99.3Last Disbursement 9/98

EIB Appraisal estirnate(**) _ _ _ __ _ _ _ _ _ _ _ _ _

Actual (*) 0.0 12.9 30.6 34.0 51.9 63.4Actual as % ofestimate

(*) FY91 disbursement FY91 includes Special Account (US$17.0 million)(**) No separate disbursement estimate was made for this loan at appraisal

15

TABLE 5: PGNiG PERFORMANCE INDICATORS'

[Year I 19911 19921 1993 19941 1995| 19961 19971 1998

PGNIG CORPORATIONtotal gas to system (BCM) 9.64 9.18 9.27 9.37 10.43 10.96 11.38 11.93

- of which: imports 6.61 6.24 5.28 5.81 6.77 7.35 7.68 8.21

: local production (HM+LM) 3.03 2.94 3.79 3.56 3.66 3.61 3.70 3.72

No. of Employees 42,536 41,848 43,919 44,319 45,346 46,546 47,300

- of which: in production 6,892 6,669 6,628 6,661 6,693 6,919 5,830 5,850

in exploration and field serivces 9,717 8,923 8,995 8,866 8,775 8,748 9,117

in transm and distribution 19,263 21,308 22,261 23,389 24,638 26,346 27,321 27,505

- sales per employee (total gas 100OM3/employee in corp) 226.63 219.36 211.07 211A2 230.00 235A6 240.59

- of which for: exploration and development 143,437.6 178,248.1 194,874.6 203,832.4 231,356.2 229,927.7 176,298.5 174,363.1

: production 31,465.6 30,790.1 43,560.2 58,423.9 78,328.7 79,176.7 75,926.6 63,375.8

unit production costs (US$/IWOOM3) 46.7 57.2 51.9 60.8 69.2 70.0 55.9 51.7

- of which for: exploration and development 38.3 48.8 42.4 47.2 51.7 52.0 39.1 37.9

: production 8.4 8.4 9.5 13.5 17.5 17.9 16.8 13.8

- productivity (O00OM3/employee in production) 543.4 548.1 693.3 648.0 668.2 638.6 774.3 786.1

local production costs (in US$1000) 174,903.2 209,038.2 238,434.8 262,256.3 309,684.9 309,104.4 252,225.1 237,738.9

TRANSMISSION and DISTRIBUTION- supply interruptions 176 46 9 8 1 31 0 n.a.

- length of T&D system (km) 67,265.0 76,575.0 83,672.9 90,858.0 95,700.0 100,496.3 104,729.5 n.a.

- interruptions/lOOOkm 2.617 0.601 0.108 0.088 0.010 0.308 0.000 n.a.

- annual losses including own uses (mln M3) 588.3 546.8 880.4 594.5 190.3 1041.3 434.2 n.a.

-losses including own uses (100OM3/km) 8.746 7.141 10.522 6.543 1.989 10.362 4.146 n.a.

- losses including own uses (%) 5.716 5.569 8.838 5.931 1.712 9.018 3.621 na..

gas sales (B M3 of HM+LM gas) 9.04 8.63 8.39 8.77 10.23 9.96 10.98 11.23

- of which to households (BCM) 4.47 4.32 4.22 4.20 4.23 4.00 4.20 4.58

number of customers (000) 6,005 6,202 6,351 6,475 6,500 6,639 6,705 6,771

- of which household consumers (000) 5,877 6,072 6,190 6,330 6,435 6,508 6,570 6,632

- of which industrial and other customers 128 130 161 145 65 131 135 139

- consumption per customer (in 1000 M3) 1,745.88 1,571.11 1,469.75 1,434.42 1,589.28 1,478.74 1,576.93 1,659.19

- sales (100OM3/employee in T&D) 544.26 457.29 419.32 397.11 419.28 372.65 387.02 408.47

- ratio (customers/employee in T&D)2 311.74 291.06 285.30 276.84 263.82 252.00 245.43 246.18

PRIMARY ENERGY CONSUMPTION (in PJ) 4,110 4,060 4,113 3,990 4,084 4,515 4,303 n.a.

- of which: solid fuels 3,200 3,150 3,102 2,954 3,140 3,379 3,133 n.a.

liquid fuels 560 580 625 650 560 733 768 n.a.

gas fuels 350 330 335 341 375 400 402 n.a.

gas fuels (%) 8.5 8.1 8.2 8.5 9.2 8.9 9.3 n.a.

Notes:1. All volumes quoted as HMNG equivalent.2. Increase of employees in T+D due to progressive expansion of residential consumer base and higher network maintenance.

Gas nstflOulofSUCwdlarY

BO GowaftIlGPS - h -rz --

. S~~~~~~~~~~Warsziw

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UPP Sksa GCGP C$O v I I Entprise- _ :

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*-~~~~~~~~~~~~~~~~~~Eirs Za Sao

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GP ChO s.. ________________ C1~~~oJ~~fpf~e J E-Iormonn and Dr!fling

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CGas Producion Ent-eris- GP S n 4 t @ escral Roiand G45 r | [ -K(rcsno

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| Gas Production Ent.-imse 0. >----:/j

| ! ~~~~-Zleloaa Gcra ! : /

~~~ez1sn ~ ~ ~ ~ ~ ~ ~ ~

G~~~~~~~parS -h -,nGas >g" G Jdansk rnst Gas ducs niG .. H

| Gimr and Surfc FadhesA - WA erlaro-Zabze-, ,,, t'

z~~~~~~~~~~~~~~ Fi euwdpnwnt E.tprmiso.-

G? ICoi h | _ _ _ _ _ _ _ - _

., , I 0

G. s:gm hleull.I. z

_____________ .. . uaon ~rp L |.and RcpaJr U KIr

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GP1 . , ;.:, W ~~~~~~~~~Gsa. an . Tnacak iUeTrurk-A-Repaipm-arz

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GP Lu5m _l

G'g Fusa L t GEVtA W-2a

17

TABLE 7: STUDIES INCLUDED IN THE PROJECT

Study Purpose as Defined at Status T Impact_ _ _ _ Appraisal I I . _I

l ESMAP Implement energy sector Study has been carried out. Restructuring of the gas sector hasrestructuring studies and a gas started. Price adjustments have beenpricing study. implemented.

ESMAP Implement studies to optimize Study has been carried out.further development of the gassector and assess theenvironmental impact

ESMAP Assist in preparing a Study has been carried out and a After approval of a geological andcontractual framework to contractual framework prepared mining law in 1994, procedures forfacilitate participation of in 1992 foreign participation in petroleumforeign and domestic private exploration/development have beensector enterprises in conceived and licensing starteddeveloping the petroleumsector

LNG Detailed design of LNG Study was not carried out Discussions were held with Statoilfacilities if import of LNG is but import of LNG was not foundfound to be economical economical

MIS Introduce a suitable Requirements for financial, Computer systems and software wereManagement Infornation accounting, acquired for all functions and areSystem (MIS), study of a data production/transmission and fully operational. Dedicated stationsprocessing master plan sales, human resources computer and software were installed and are

based administration were being used regularly by the Borrowercarried out by PGNiG. A study for evaluation of reserves based onon reservoir management was SSI technologydone by SSI (Scientific SoftwareIntercomp, UK)

Additional Supplies of natural gas up to Ministry of Industry and Trade Used for economic evaluation of thethe year 2010 project

Additional Legal procedures for the Anti Monopoly Office Used in policy dialogue for PGNiGdivision of the Polish Oil and restructuringGas Company

Additional Laws for the public enterprise Ministry of Industry and Trade Used in policy dialogue for PGNiGPolish Oil and Gas Company restructuring

Additional Environmental perspectives Study by Brocoff, Jack C. Used in environmental policy(World Bank energy 1 &2 dialogueprojects)

Desulphuri- Study on technologies for Study by Lurgi (Germany) Results used in design ofzation removal of H2 S and CO2 from desulphurization plants

natural gas

18

TABLE 8A: PROJECT COST

(US$ million)

Estimiate at Appraisal Actuallocal foreign total local foreign total

COSTS

Seismic* 0.0 28.8 28.8 166.3 41.7 208.0

Gas Production 172.0 149.5 321.5 154.4 173.7 328.1- Infill Development and Compression 131.0 99.5 230.5 121.6 159.4 281.0- Appraisal Drilling and Evaluation of 41.0 50.0 91.0 32.8 14.3 47.1

Recent Discoveries

- Gas Treatment/Sulphur Recovery 10.0 18.7 28.7 0.0 0.1 0.1

Transmission and Distribution 54.5 55.7 110.2 74.4 92.1 166.5-Molgino Underground Storage 19.3 13.9 33.2 47.5 63.6 111.1- SCADA** 6.7 14.0 20.7 0.4 1.4 1.8- Transmission 25.5 22.0 47.5 24.5 23.7 48.2-Compression 3.0 5.8 8.8 2.0 3.4 5.4

Technical Assistance and Training 2.7 6.1 8.8 1.4 4.0 5.4

- Physical Contingencies 5% 12.0 13.1 25.1 0.0 0.0 0.0- Price Contingencies at 4.4 %/year 45.5 47.8 93.3 0.0 0.0 0.0

Total Contingencies 57.5 60.9 118.4 0.0 0.0 0.0

(*) The foreign cost component increased from US$ 28.8 million to US$ 41.7 million due to: (i)an upgrade of seismic equipment from low to high resolution, and (ii) the requirement for twonew data processing centers for high resolution seismic which were not foreseen at the time ofappraisal. The local cost of US$166.3 million was needed to cover land and crop compensationpayments. Such payments were not practiced in Poland at the time of appraisal, but had becomenormal practice by 1994.

(**) During 1993, a feasibility study for the SCADA system was completed by consultants(British Gas), which concluded that required investments of US$87 million would be needed,compared to US$20.7 estimated at appraisal. After this, PGNiG decided it would be a moreeconomic solution to use the facilities offered by existing system operators, PPGC and PolishTelecom Company (TPSA), with PGNiG financing the fiber optic connections to the systemfrom its own resources. In 1994 the funds for the SCADA were reallocated to storage.

19

TABLE 8B: PROJECT FINANCING(US$ million)

Estimate at appraisal | Actual

local foreign total local foreign total

IBRD 0.0 250.0 250.0 0.0 248.2 248.2EIB (ECU 50.0 million equivalent) 0.0 60.0 60.0 0.0 63.4 63.4PGNiG 296.7 9.7 306.4 396.5 0.0 396.5

TABLE 9: GAS PRICE LEVELS

(in US$/1000"'3 of 8200 kcallm3, all prices without VAT)

Industrial Consumers Household Consumers

Costs Prices Prices Distrib. Margin

Over Cost toYear Prod. & trans. Poland W. Europe Poland Costs Industry1990 n.a. 77.35 116.38 15.09 n.a. -62.261991 79.10 130.08 132.59 62.70 21.13 -67.381992 77.30 123.10 131.28 130.53 20.59 7.431993 83.90 115.05 118.55 136.52 29.30 21.471994 105.90 122.34 118.70 141.36 31.10 19.021995 100.95 130.62 131.08 174.33 37.98 43.711996 113.33 136.29 126.80 181.99 51.87** 45.701997 101.83 127.28 123.21 167.02 35.17 39.741998* 105.00 137.06 121.93 180.26 34.70 43.20

Based on information from "Energy Prices and Taxes" 1st quarter 1998. All prices without VAT.* Forecast.* Distribution costs 1996 contained extra costs for the change-over from town gas and coke gasto High Methane Natural Gas in several towns.

Notes:1) Gas prices for industrial consumers in Poland should have reached those for W. Europeanindustry by December 31, 1992. This was actually achieved by 1994.2) Prices for household consumers were to reach those paid by Polish industrial consumers byDecember 31,1991. This was achieved in 1992. Prices for household consumers were to reachlevels exceeding those for domestic industry by a margin sufficient to cover distribution costs byDecember 31, 1995. This was achieved.3) Prices for households in 1998 were around 45% of those in W. Europe.

20

TABLE 10: ECONOMic EVALUATION

BASE CASE(At Appraisal)YEAR Total 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

INVESTMENT(US$ 498 0 81.4 123.5 114.7 97.3 81.1million)

BENEFITSGas(BCM) 29.04 0 0 0.17 1.3 1.83 1.92 2.36 2.27 2.11 1.94 1.8 1.65 1.6 1.55 1.5 1.44 1.32 1.2 1.15 0.98 0.95

Condensate (000 tons) 370 0 0 0 0 0 0 40 39 36 33 30 28 25 23 21 19 18 16 15 14 13

OUTPUT VALUEGas ($/1000 M3) 0 80 80 80 80 80 80 80 80 80 80 80 80 80 80 80 80 80 80 80 80

Condensate ($/ton) 0 135 135 135 135 135 135 135 135 135 135 135 135 135 135 135 135 135 135 135 135

Total Benefits (US$ million) 2373.2 0.0 0.0 13.6 104.0 146.4 153.6 194.2 186.9 173.7 159.7 148.1 135.8 131.4 127.1 122.8 117.8 108.0 98.2 94.0 80.3 77.8

NetBenefits(US$million) 1875.2 0.0 -81.4 -109.9 -10.7 49.1 72.5 194.2 186.9 173.7 159.7 148.1 135.8 131.4 127.1 122.8 117.8 108.0 98.2 94.0 80.3 77.8

Project IRR 37.1%

ACTUAL CASE(At Conclusion)YEAR Total 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

INVESTMENT (US$million) 708.1 0 80.6 124.2 130.1 86.6 64.8 64.8 87.5 69.5

BENEFITSgas (BCM) 31.50 0.00 0.01 0.29 0.76 1.01 1.50 1.70 1.77 1.85 2.41 2.31 2.20 2.10 2.06 1.93 1.84 1.75 1.66 1.56 1.46 1.33

condensate (000 tons) 783.10 0.00 0.00 8.00 13.10 18.50 12.70 36.30 31.00 26.50 35.00 45.00 44.00 60.00 58.00 58.00 57.00 57.00 56.00 55.00 56.00 56.00

undergr. gas storage (BCM) 0.143 0.185 0.251 0.337 0.422 0.422 0.422 0.422 0.422 0.422 0.422 0.422 0.422

oil (000 tons). 750.0 750.0 750.0 750.0 750.0 750.0 750.0 750.0 750.0 750.0 750.0 750.0

OUTPUT VALUEGas ($/1000 M3) 0 87.3 115.1 101.7 94.6 98.1 102.3 96.1 95 95 95 95 95 95 95 95 95 95 95 95 95

Condes($/ton) 0 187 158 140 131 139 162 156 156 156 156 156- 156 156 156 156 156 156 156 156 156

Storage($/1000 M3) 70 70 70 70 70 70 70 70 70 70 70 70 70

Oil ($/ton) 60 60 60 60 60 60 60 60 60 60 60 60

Total Benefits (US$million) 4013.4 0.0 0.9 34.6 79.1 98.0 148.9 179.8 174.9 189.9 292.3 289.0 284.5 283.4 279.3 266.9 258.2 249.7 241.0 231.3 222.0 209.6

NetBenefits (US$million) 3305.3 0.0 -79.7 -89.6 -51.0 11.4 84.1 115.0 87.4 120.4 292.3 289.0 284.5 283.4 279.3 266.9 258.2 249.7 241.0 231.3 222.0 209.6

Project IRR 35.6%

Notes:Additional gas sales from the Mogilno UGS are calculated as the product of yearly storage volume times the price differential between the average gas sales price and gas import price.

Sales of oil discovered tinder the project and starting in 1999 are taken into consideration: it is assumed that 750,000 tons will be produced annually.

21

TABLE 11: STATUS OF LEGAL COVENANTS

Agreement Text Covenant Status Original Revised Description of Covenant CommentsReference Class Fulfill Date Fulfill Date lIl

Loan 3.02 (a) 10 C n.a. n.a. Borrower to employ Consultants were employedconsultants

Loan 3.02 (b) 10 C n.a. n.a. Borrower to maintain Coordinating Unit wasCoordinating Unit maintained

Loan 3.03 10 C n.a. n.a. Procurement to be Procurement was carried outgoverned by Schedule 4 as per schedule 4

Loan 4.01 5 C n.a. n.a. Borrower to operate under Sound standards weresound standards maintained throughout

implementationLoan 4.02 5 C n.a. n.a. Borrower to operate plants Plants, machinery and

and machinery with sound equipment were in goodpractices working order

Loan 4.03 5 C n.a. n.a. Borrower to take out Insurance was taken outinsurance where appropriate

Loan 5.01 (a) 1 C n.a. n.a. Borrower to maintain Adequate records and(i) records and accounts to accounts were maintained

adequately reflectoperations and financialcondition

Loan 5.01 (a) I C 12/31/91 n.a. Borrower to apply Such accounting practices(ii) accounting practices for gas were applied

exploration activities towhich the Bank agrees

Loan 5.01 (b) I C from start yearly Borrower to have yearly Audits were performed as(i) of project audits of financial requested

statements and specialaccounts

Loan 5.01 (b) 1 C from start yearly Borrower to send copies of Such copies were received,(ii) of project audit reports to Bank within sometimes with delays (not

seven months of end of exceeding 30 days)fiscal year

Loan 5.01 (b) 1 C from start when re- Borrower to supply Such information was made(iii) of project quested additional financial available when requested

informationLoan 5.01 (c) 1 C from start continuously Borrower to maintain and Such records and accounts

of project retain records/accounts in were maintained andrespect of all withdrawals retainedfrom Loan Account

Loan 5.02 (a) I C from F/Y yearly Borrower to generate funds Internal cash generation of1991 from internal sources 30% was achieved at all

equivalent to at least 30% times.of 3 year average capitalexpenditures

Loan 5.02 (b) 1 C before yearly Borrower to review Forecasts were receivedSept/30 compliance with ref 5.02 timely

(a)Loan 5.02 (c) 1 C na n.a. Borrower to take measures Situation did not occur_F ~___________ __________ _________ _______ __________to ensure meeting 5.02 (a)

Table 12 continued overleaf

22

TABLE 11: Status of Legal Covenants(Continued)

Agreement Text Covenant Status Original 1 Revised 1 Description of Covenant CommentsI Reference Class Fulfill Date Fulfill Date _

Loan 5.03 (a) 1 C from start continuously Borrower not to incur debt Condition was met at allof project unless net revenues are at times

least 1.3 times max. debtservice

Guarantee 3.01 (a) 2 C by Dec 31, Gas prices for local This condition was met from1992 industrial consumers to be 1994 onwards

equivalent to those for ind.consumers in EC byDecember 31, 1992

Guarantee 3.01 (b) 2 CP by Dec 3 1, Gradually adjust gas prices The first level was reached1991 for households to reach during 1992, the second

by Dec 31, those for industrial level by 1995.1995 consumers by December

31,1991 and later (byDecember 31, 1995) alsocover additionaldistribution costs

Guarantee 3.01 (c) 2 CP from Nov at six month Guarantor to review with Reviews were held and30, 1990 interval Bank measures to meet actions were taken although

3.01 (a,b) full price implementationlagged

Guarantee 3.02 (a) 5 C by Dec Guarantor to carry out Studies carried out by31,1990 studies on restructurization Cooper Lybrand

of energy sectorGuarantee 3.02 (b) 5 C n.a. n.a. Afford time for review of Time was afforded and

these studies by Bank and studies were discussedBorrower

Guarantee 3.02 (c) 5 CP by June 30, Initiate implementation of Recommendations were1991 3.02 (a,b) implemented only partially,

restructuring is continuing ingas, power, district heatingand coal sectors.

Covenant class: Status:1 = Account/audits C = Covenant complied with2 = Financial performance/revenue CP = Covenant partially complied with

generation from beneficiaries TS = Temporarily suspended

23

TABLE 12: BANK RESOURCES: MISSIONS

Performance Rafing2)

Stage of Project Month/ No. of Days in Implementation Development P 3

Cycle Year Persons Field Specialization 1 ) Status Objectives Problems3

Through appraisal 10/89 12 22 Multiple

Appraisal-BoardApproval

Board Approval-Effectiveness

Supervision I 11/90 2 9 N,N

Supervision II 3/91 2 3 N,N 1 1

Supervision III 6/91 4 7 F,N,N 2 1 T,M

Supervision IV 12/91 1 2 N 2 1 P

Supervision V 5/92 3 13 F,N,N 2 2 T

Supervision VI 12/92 3 14 F,N,N 2 2 M,T

Supervision VII 4/93 3 18 F,N,N 2 2 M,T

Supervision VIII 5/93 3 18 F,N,N 2 2M,T

Supervision IX 4/94 4 8 F,N,N,N 2 2 M,T,P

Supervision X 10/94 4 13 F,N,N,N 2 2 M,T

Supervision X! 5/95 4 12 F,N,N,N 2 2 M,T

Supervision XII 3/96 4 12 F,N,N,N 2 2 M,T

Supervision XIII 10/96 1 2 F 2 2 M,T

Supervision XIV 5/97 2 6 F,N 2 2 M,T

Supervision XV 9/97 2 6 F,N 2 2 M,T

Supervision XVI 5/98 2 4 F,N 2 2 M,T

Implementation 10/98 3 12 F,N,NCompletion ___I

I) - Specialisation 2) - Performance Rating 3) - Type of ProblemsE = Economist I = Minor or No Problems F = Financial

F = Financial Analyst 2 = Moderate Problems P = Procurement

N Engineer 3 = Major Problems T = Technical

S = Energy Specialist M = Managerial

24

TABLE 13: BANK RESOURCES - STAFF INPUT

Stage of Planned Revised ActualProject Cycle Weeks US$ '000 Weeks US$ '000 Weeks US$ '000

ThroughAppraisal 80.5 161.9

Negotiations toEffective 33.8 77.9Supervision > 90.0 201.7 646.3

Completion * 13.5 60.5 13.5 38.0

TOTAL > 103.5 60.5 0.0 0.0 329.5 924.1

* until October 30, 1998

APPENDIX A

POLISH OIL AND GAS COMPANY


POLAND


(LOAN 3215-POL)

Warsaw, October 30,1998


POLAND


Loan 3215-POL

Prepared by: Polskie Gornictwo Naftowe i Gazownictwo S.A. (PGNiG)

Project Name: Energy Resource Development Project

Loan Number: 3215 - POL

Signature Date: July 02, 1990

Total Loan Amount: USD 250,000,000

Co-financing: European Investment BankFinance Contract No. 1.4746

Signature Date: July 30, 1990

Total loan Amount: ECU 50,000,000


POLAND


CONTENTS

PAGE

A. PROJECT OBJECTIVES 1

B. IMPLEMENTION OF OBJECTIVES 2

C. PROJECT IMPLEMENTATION AND MAIN FACTORS IMPACTINGSUCH IMPLEMENTATION 2

Cl Project organization 2C2 Procurement 2C3 Technical assistance and training 3C4 Development and production 4C5 Mogilno gas storage 10C6 SCADA I1C7 PGNiG Restructurization 12

D. PROJECT SUSTAINABILITY 13

E. EVALUATION OF BANK'S PERFORMANCE 13

F. EVALUATION OF PGNiG's PERGORMANCE 13

G. EVALUATION OF RESULTS 14

H. CONCLUSIONS/LESSONS 15

Appendix APage 1 of 15


POLAND


Loan 3215-POL

A. PROJECT OBJECTIVES

The objectives of the Project were as follows:

(a) Improve the energy related convertible currency earnings of Poland by:* increasing domestic production of natural gas; and* encouraging energy conservation for all forms of energy and fuel substitution through

supporting energy price reform.

(b) Contribute to a reduction of environmental pollution related to energy use; and

(c) improve the competitive, regulatory and financial framework of the sector entities bysupporting the implementation of appropriate restructuring programs for the gas sector.

In parallel with the Project, the Bank/UNDP's Energy Sector Management AssistanceProgram (ESMAP) was provided to:

(a) implement energy sector restructuring studies and a gas pricing study;

(b) implement studies to optimize further development of the gas sector and assess itsenvironmental impact; and

(c) assist in preparation of a contractual framework to facilitate participation of foreign anddomestic private sector enterprises in developing the petroleum sector.

Appendix APage 2of 15

B. IMPLEMENTATION OF OBJECTIVES

The Project fulfilled its main objectives. It enabled PGNiG to increment gas and oilproduction mostly as a result of a replacement of equipment for exploration, drilling, seismics,geophysics, workover and extensive training program. This allowed PGNiG improve efficiency ofoperations and the quality of offered services. The Project also enabled PGNiG to performimportant studies on the gas sector restructuring in Poland as well to start introduction of tariffchanges.

The Project contributed to reduction of environmental pollution related to energy use by themeans of:

* increased use of natural gas instead of other more pollutant fuels; and* using the latest technology equipment bought under the Project, that meets the strictest world

environmental standards.

C. PROJECT IMPLEMENTATION AND MAIN FACTORS IMPACTING SUCHIMPLEMENTATION

C 1. Project organization

The loan agreements with the World Bank and the European Investment Bank were signedby PGNiG (as the borrower) and the Ministry of Finance on behalf of the Polish Government (as theguarantor) in 1990.

On December, 31, 1990, World Bank Project and Foreign Relations Bureau (BOBS) wasestablished for the implementation of the project . The bureau reported directly to the GeneralDirector. Special units or plenipotentiaries for WB/EIB Project were established in PGNiGenterprises.

C 2. Procurement

BOBS was responsible for coordination of:

* preparation of tender documents,* evaluation of tenders,* contract preparation and negotiations,* financial settlements,. reporting.

BOBS realised procurement under the loans according to "Guidelines: Procurement underIBRD Loans and IDA Credits". Procurement covered i.e. equipment for seismics, drilling, testingand materials for fields exploration and development. The loan financed also the engineering designand construction of the surface installation of the underground gas storage in Mogilno.

Appendix APage3of 15

Most of the procurement was carried out under International Competitive BiddingProcedures.

Tenders became a common practice leading to competition among suppliers/contractors andthis had an advantageous impact upon the prices, the performance, and the contracted completiondates.

We have to add that all of these procedures were introduced by PGNiG for the Project a fewyears before a state law on Public Procurement had been established.

Special account in Bank Handlowy w Warszawie - London Branch was opened for financialservice of the World Bank loan (transfers, letters of credit), through which payments up to 4 milliondollars were executed. Payments exceeding this amount were made directly by the World Bank,upon presentation of documents issued by BOBg.

Special account in Bank Handlowy International in Luxembourg was opened to financialservice of the European Investment Bank loan.

C3. Technical Assistance/Training

Due to the fact that PGNiG did not provide comprehensive training for its employees due tolack of funds to introduce new methods and technologies used in oil and gas acquisition and supplyin the world, training was considered a vital Project component. The training allowed PGNiG to:

- develop a flexible training program in order to respond to specific needs; and* determine specifications for training aids which have been provided under the Project (drilling

simulators, laboratory equipment, various models of equipment and manuals for the instructorsas well as for the trainees).

In parallel with the Project, five studies have been performed by the Natural GasDevelopment Unit of ESMAP. They included:

* Study 1- SOFREGAZ-BEICIP (Bureau d'Etudes et de Cooperation de l'InstitutFran9ais du Petrole): Study on gas development plan,

* Study 2- NERA (National Economic Research Associates): Gas pricing and tariffstudy,

* Study 3- Coopers and Lybrand Deloitte: Study in POGC restructuring,* Study 4- T.J. Gorton, P.D. Cameron, A.G. Kemp, W.T. Onorato: Legal and contractual

framework for petroleum activities,* Study 5- Coopers and Lybrand Deloitte: Environmental assessment of the gas

development plan for Poland.

Appendix APage 4of 15

Project included also four studies prepared by following companies:

* SOFREGAZ-BEICIP (Bureau d'Etudes et de Cooperation de l'Institut Fran9ais du Petrole)-Underground Gas Storage Project in Salt Caverns,

* British Gas- Control of the Gas Transmission System in Poland,* Scientific Software Intercomp (SSI)- Reservoir Management Policy Study,* Lurgi Gas- Desulfurization of the Fields.

The loans obtained from The World Bank and European Investment Bank, the position ofwhich has been allotted for training purposes both abroad and in Poland, using foreign lecturers,provided PGNiG's personnel with the following opportunities:

* acquaintance with advanced methods and techniques used in oil and gas sector,* contacts with leading companies of similar business profile,* change of mentality among the managing and technical staff by allowing access to the newest

trends in management, planning, marketing etc.,* broadening of horizon among the managing and technical staff, which yielded positive results in

a number of subsidiary companies, where organisational structures, operational procedures andbefore all, exploration (e.g. 3D) and production methods have been changed,

* permanent contacts with foreign companies have resulted in better command of English, which,in turn, made these contacts easier and facilitated to establish new links with foreign partners.

Large number of trainees have regularly been receiving invitations or notices about variouscourses, seminars, exhibitions etc. That gives further possibilities for improvement of theirknowledge.

It is difficult to asses the above mentioned features in strictly financial terms, but they arethe source of intangible values that have positively resulted in the broadening of horizon and inchanging of mental attitudes. PGNiG employees already carry out works in foreign market e.g. inSakhalin (Russia), India and Pakistan. In the future they should raise the ranking of PGNiG in theworld oil-gas market.

C 4. Development and Production

The evaluation covers a period from 1991 until the end of September 1998, i.e. the eightyears' period of project implementation.The SAR Project assumed incremental production of 11.43 BCM for natural gas and 106 thousandtons for condensate.

The following quantities have been achieved in this period: incremental gas production of8.38 BCM which corresponds to 73.3% of the assumptions and incremental condensate productionof 140 thousand tons i.e. 131.4%.The reasons for non-attainment of the incremental quantities assumed for natural gas production areanalysed below.


Infill Drilling

The Project assumed incremental gas production of 3.28 BCM, while 3.17 BCM have beenattained which corresponds to 96.6%.The realisation of this increase broken down into regions of Poland is presented as follows:

South of Poland - 1.63 BCM were expected to be achieved, 0.7 BCM have beenachieved, i.e. 42.9%

West of Poland - 1.65 BCM were expected to be achieved, 2.47 BCM have beenachieved, i.e. 149.7%.

In the West of Poland the greater than expected incremental gas production was achievedmainly due to development and commissioning of two fields: Radlin and Paproc. The incrementalproduction form these fields accounts for 96% of the incremental production attained form infilldrilling in this part of Poland. In case of these two fields, as well as Aleksandr6wka and Werzowicefields, Banks loan provided for a part of their development cost. The surface and sub-surfaceequipment as well as automatics for the mine allowed modemisation of gas production process(production process control and measurements).

In the South of Poland, out of 160 wells planned, only 66 have been drilled, while gasproduction has been attained in 57 of them and only 33 have been connected to the transmissionsystem.

The full scope of drilling was renounced for the following reasons:

* low or very low productivity, in the range of few cubic meters/ min. were attained in some of theinitially drilled wells,

* 9 negative wells were drilled in the first phase of infill drilling (without production).

The analysis of recoverable resources in this area, performed by PGNiG specialists with co-operation of SSI, showed that these resources are approximately 44% smaller than proven resourceswhich were the basis for infill drilling project.

The reason why not all the wells have been connected to the transmission system were theright-of-way problems as landowners did not agree for their land to be used for construction of gaspipelines and production facilities. The lack of such authorisation was also to some extent a reasonfor reduced scope of infill drilling.

Low efficiency of infill drilling in the South of Poland made it necessary to replace some ofthe infill drilling with appraisal drilling.

PGNiG specialists with co-operation of SSI performed an analysis of recoverable resourcesof selected fields of the Western Poland. Recoverable resources were confirmed in 78% of thoseproven.


Appraisal Drilling

The Project assumed that incremental gas production of 1.96 BCM would be attained, ofwhich 0.9 BCM in the South of Poland and 1.06 BCM in the West.

Incremental production has been attained solely in the South of Poland and it amounted to0.58 BCM of gas which corresponds to 64.4% of the quantity expected to be produced in thisregion.

In the South of Poland the number of appraisal wells was increased from 10 (according toSAR) to 67. This increase was due to shifting of some of the infill drilling to appraisal drilling. 20wells have been put into production which corresponds to 45% of all positive appraisal wells. Thereason why not all of the wells have been connected to the transmission system are, similarly as forthe infill drilling, right-of-way problems and long time needed to settle formal and legal issues.

Main reason for non-connection of the 25 wells and in consequence lack of gas andcondensate incremental production in the West of Poland were prolonged negotiations withpotential consumers of the gas (HPP in Zielona G6ra, Paper-mill in Kostrzyn).

Due to relatively low methane content of the gas and presence of hydrogen sulfide, the gascan be used locally, out of the transmission system.

Gas supplies to the above consumers are expected to take place in 2000 and 2001.

During the project implementation a large gas-condensate-oil field named BMB (Barn6wko-Mostno-Buszewo) was discovered in western Poland. Seismic tests performed with the equipmentpurchased with Banks loan contributed in great extent to the discovery of that field. The field is alsoenlarged with drilling equipment purchased with the loan funds. Even though this field was notincluded in the SAR Project, it was discovered and made available with the equipment andapparatus purchased with the loan and we suggest to consider the incremental gas, oil andcondensate production as a result of the SAR Project implementation.

Proven reserves amount to: 30 BCM of gas and 66 million tons of oil, recoverable reservesrespectively: 10 BCM and 10-12 million tons.

Workover

The SAR Project assumed workover activities for the total of 1000 gas wells, of which 450wells in the South of Poland and 550 wells in the West of Poland. Out of the quantities projected,form the beginning of the project implementation until the end of the 3d quarter, 1998 the total of457 wells have been worked over and incremental gas and oil production was attained only in 191wells. The overall workover efficiency was therefore 41.8%.


In the South of Poland, out of 450 wells planned the workover was performed at 311 wellsand incremental production was attained in 165 wells, i.e. 53. 1% of the wells rehabilitated. Theincremental gas production for that period amounted to 0.46 BCM which represents 96% comparingto the expected 0.48 BCM.

The results of the workover activities in the West of Poland are much more inferior. In thatregion, out of 550 wells scheduled, 146 were rehabilitated and production was attained only in 26i.e., 17.8% of the wells. The total incremental production form those wells from the beginning ofthe Project implementation amounted to 0.39 BCM (converted to high methane) which represents30% in respect to the expected 1.30 BCM.

While analysing the reasons why the expected incremental gas production resulting fromworkover has not been achieved, it should be pointed out that in the South of Poland, althoughproduction was attained in only half of the rehabilitated wells, the total quantity is close to theexpectations and around the year 2000 we should achieve 100% of the incremental productionexpected in that time.

In the West of Poland the main reasons for the lack of expected workover results should beattributed to the fact that minor simulation operations, which were to be included in the workover inG6ra-Wroniniec, Tarchaly, Wik6w fields were not performed and the full scope of workover insuch fields as Bogdaj-Uciech6w, Zuchl6w and Borzecin was not realised.

The estimation analysis of recoverable resources performed using the SSI method at G6ra-Wroniniec, Wilk6w and Tarchaly fields, i.e. those where minor simulation operations wererenounced, showed that the resources thereof are lower in respect to the balance resources byrespectively 70%, 35% and 80%.

GAS COMPRESSION

The Project assumed that between 1991 and the end of September 1998 incremental gasproduction resulting from gas compression of 4.41 BCM would be attained. Actually 3.78 BCM i.e.,85.7% were compressed and supplied to the transmission grid in that period.

Although the full projected incremental production has not been achieved yet, in two recentyears and this year the quantities of the compressed gas are greater than assumed in the project.

The quantities planned were not realised due to problems in implementation of the contractfor compressors purchase for the Zuchl6w field (delivery delay) and because gas compressing atWierzchowice field was stopped as it was decided to use it for UGS.


Summar

The main project objective was to attain additional production of gas and condensate as aresult of certain ventures that would consist in increase of production from already operated fields(infill drilling, workover of existing wells, gas compression) and identification of resources anddevelopment of new oil and gas fields (appraisal drilling and stimulation).

The objective was possible to achieve only though modernisation and replacement of theobsolete equipment and appliances for geophysics, drilling and operation and also through acquiringof new technologies and training of specialists.

The projected level of total incremental production is expected to be achieved around 2002and the achieved results, though postponed, are going to exceed the assumptions.

It should be added that the conditions of the Project implementation were more difficult thanoriginally expected. The above mentioned delivery delay (compressors) occurred and moreover, thedifficulties which arose during the first phase of the Project stemmed also from lack of experienceof the PGNiG staff in preparation and implementation of such task, as well as the fact that theassumptions were based on the data available at that time which did not account for the modemmethod used in the world oil industry. This affected field assessment methods and operationtechniques, as well as gas sales (marketing).

According to the PGNiG information on the developed resource quantities, the resourceshad been depleted at very low rate - 4-5% per year. It was the basis for development of infilldrilling and workover program.

Purchases made with Banks loan and implementation of modem resource assessmentsoftware permitted new resource analysis and establishing of the actual resource quantities. Thisanalysis showed that the resources of the operated fields are 44% smaller in the South of Poland and22% smaller in the West in relation to the proven reserves. This evaluation explains why infilldrilling and workover were not realised in their full quantitative scope.

Purchases of modem equipment for drilling and operational enterprises (i.e., drilling, rigs,testing equipment, etc.) were a very important decision both by PGNiG and the World Bank. Somepieces were completely new to the Polish oil industry. In particular, nitrogen units and CTU.

Generally, the newly purchased equipment allowed to gradually phase out obsolete,inefficient pieces (mainly drilling equipment) and to reduce the time needed to perform drilling andworkover. Measurement accuracy and quality control have been improved significantly (stimulationand surface testing). In all cases the new system enhanced work safety, especially for works at fieldswith hydrogen sulfide (nitrogen unit).

Despite the best efforts, PGNiG still cannot solve problems with well connection to thetransmission system because of the rights-of-way difficulties. This problem is particularly acute inthe South of Poland (Zalesie, Tarn6w), it seems, however, that the solution is out of PGNiGauthority.


On the other hand, in the West of Poland, impossibility to use the entire productionpotential of the fields is a major problem. The shrinking low methane gas market (conversion ofconsumers to high methane) makes it necessary to negotiate with potential consumers out of thesystem. ZZGNiG has been involved in such negotiations since 1991 and so far they resulted in gassupplies to minor local consumers as, among others Copper Works in Orsk, ZNTK andmunicipalities gasified from local fields without a guarantee of supply continuity.

Contract for gas delivery, mainly from BMB field (260 million m3 /y), has been also signedwith heat and power plant in Gorz6w. In progress is preparation of contracts with HHP ZielonaG6ra and Paper-mill in Kostrzyn for deliveries form fields in Kogcian, Kargowa, G6rzyca andDebno fields.

In the last three years (1995-1997) the use of production capacity for gas fields in the Southof Poland was on average 95% in each year.

The difference between production capacity and the actual production over this three years'period is on average 92,6 MCM.

In our opinion, it is optimal use taking into account the time needed- according to theGeological and Mining Law- every year to shut down the wells which is necessary for staticpressures to stabilise.

In general, the implementation of the Project can be considered successful. The realisationof only 73% of the expected result in the given period can be attributed to:

- smaller recoverable resources quantities of the fields in respect to those assumed at projectformation. If the resource assessment had been carried out before the project formation, thequantitative relation of the works performed (infill drilling, workovers) would have been morerealistic.

- unexpected difficulties with well development and connection.Had we foreseen this, the assumed production growth rate would have been initially slower.

- delays in equipment delivery, especially for drilling and operation (well testing and stimulationequipment, compressors).

Despite initial difficulties, in our view it is possible to realise the objective i.e., to obtain bythe end of 2010 at least 30 BCM of gas and around 600 thousand tons of condensate (oil).

The production potential - 0,9 BCM in 90 unconnected wells proves our opinion is correct.65 wells are planned to be connected by the end of 2000 i.e., 72% of the unconnected wells. Theproduction potential of these wells corresponds to 67% of the potential that has not been put intoproduction yet.


C 5. Mogilno Gas Storage

Underground Cavern Gas Storage Mogilno has been constructed by creating (leaching) ofsalt formation chambers in so called salt dome in the region of Mogilno.

Location of the storage was related in particular to existing salt cavern, its central position ofthe region in the country gas system and possibilities of utilisation of branching, which istransported by pipelines to near-by Inowroclaw Sodium Plant.

Construction of UCGS Mogilno is to be carried in two stages: the first stage includingconstruction of the gas storage of 416 million m3 working capacity based on 8 storage chambers,and the second stage including development of the storage by another 12 chambers, and reachingworking capacity of 1,154 million m3 . The first stage is to be completed in 2002. Starting of thesecond stage of construction depends on obtaining positive performance results by the storageconstructed in the first stage as well as on future peak power consumption by gas system.

Within the first stage of construction of UCGS Mogilno the following investment projectsare underway:

- UGS Mogilno including:* underground part - storage caverns,* surface facilities for gas injection and withdrawal.

- DN 700 gas line, working pressure = 8.4 MPa, 82 km long, connecting UGS Mogilno with thecountry gas system via Wloclawek gas branching station WRG II.

• Wloclawek gas branching station WRG II.

The following works and supplies were financed from the Bank's loan:

1. Supply of DN 700 pipes and fittings for the construction of Mogilno-Wioclawek pipeline.

2. Supply of fittings, meter runs and filters for the construction of Gas Branching StationWloclawek II.

3. Construction of UGS surface facilities for gas injection and withdrawal (EPC contract).

4. Consultants services.

The total value of investment financed from the World bank loan amounts to USD 86,6million i.e., PLN 240 million.

The portion financed from PGNiG own resources amounted to PLN 248 million as ofSeptember 30, 1998.

Appendix APagel 1 of 15

Current Status of the Project

* Leaching and gas injection into 4 chambers of 180 million m 3 total working capacity has beencompleted. Leaching of the remaining 4 chambers has been partially completed (20-90%).

* All surface facilities, both technological and operational, envisaged in the first stage have beenconstructed. Installed facilities allow for 0.25 million m3 /h capacity of gas injection to chambersand 0.66 million m3 /h (target 1.15 million m3/h)

* DN 700 Mogilno-Wloclawek pipeline, 82 km long, has been constructed and started operating.

* Assembly works for technological installation of Gas Branching Station Wloclawek II have beencompleted. Works connected with installation of up-to-date control system of branching stationare almost completed.

C 6. SCADA

In the framework of the SCADA and Telecommunications, the following projects have beenfinanced from the Project funds:

- elaboration of the Feasibility Study for the SCADA system,- procurement and installation of the PABX system.

The Feasibility Study has been elaborated by The British Gas. The Study included problemsof technique of measurements, processing of measurement data, monitoring of the gas system up tothe advanced software for simulation and optimisation. The Study covered also problems of thetelecommunications system.

Considering technique of measurement, recommendations included in the Study have beenimplemented by establishing of the standard transmission protocol, and construction of theLaboratory of Standards equipped with up-to-date standards as well as calibration rigs for thecalibration of turbine meters. The construction of the Laboratory has been financed from PGNiGfunds. Implementation of the above mentioned projects resulted in the unification of the gasmeasurements systems based on the traceability concept as well as the increase of the accuracy ofgas measurement.

Considering the SCADA system, implementing some recommendations of the FeasibilityStudy, PGNiG prepared with the assistance of PLE, the Technical Specification for the SCADAsystem. After the tender procedure, the Landis & Gyr has been selected as the contractor for the turnkey SCADA project. Presently, the SCADA system subject to the contract is being prepared for thefactory acceptance test. The completion of the project, financed by the PGNiG is foreseen at thesecond half of 1999 year. Some elements of the software installed in advance (simulation programs)have been already efficiently used.


Considering the telecommunications svstem, PGNiG making use of the Feasibility Study,elaborated the Technical Specification and the design for the installation of the PABX system. As aresult of the tender procedure the contractor Polish firm DGT has been selected. The contractorsupplied and installed 8 PABX systems. After the installation, PGNiG from its own funds,constructed fibre optic access cables to the TP S.A. and Polish Power Grid telecommunicationnodes. Continuing the extension of the PABX system, PGNiG installed next 6 PABX system.Thanks to the new PABX systems, the telephone traffic between PGNiG offices and installationsand public telecommunication network has been substantially improved, whereas implementation ofthe billing systems resulted in lowering telephone bills.

C 7. PGNiG's Restructurization

When the loan was granted PGNiG was state-owned public utility company which coveredthe whole upstream and downstream activities in Poland.

The studies and projects developed by ESMAP were used in particular for:

(a) governmental programs of restructuring and demonopolization of the gas sector

(b) specialised analysis and business plans of the companies to be set up out some of PGNiG assets.

In line with ESMAP recommendations and the Letter of Intent signed between the WorldBank and the Polish Government pertaining to the restructuring of the fuel and energy sector,PGNiG was transformed into a Treasury owned company (commercialised) by a resolution of thePrime Minister. Sincel996, well over ten independent companies have been set up in geophysical,drilling, construction, assembling and manufacturing activities. Fourteen thousand employees andassets worth about 200 million PLN were transferred to those companies. The privatization of thosecompanies is continuing.

The loan made it possible to replace equipment and machinery, especially those used indrilling and geophysics, with state-of-the-art pieces which allowed the companies to achieve bettereconomic results.

It enabled as well an increase of technological level and created opportunities to compete inthe foreign markets.At the same time, the companies entered into competition in the foreign markets.

ESMAP studies and recommendations are still applied in works on the restructuring of thegas sub-sector. A project of separation of the trunk transmission system and establishing 8-12regional gas distribution companies and their subsequent privatisation is being prepared. In linewith ESMAP recommendations, regarding downstream, PGNiG intends to model its organisationalstructure on similar foreign companies and deal directly only with transmission and storage incompliance with the provisions of the Energy Law, including the schedule for introduction of theTPA principle for gas producers in Poland.


D. PROJECT SUSTAINABILITY

The major objective of the Project i.e., gas and oil incremental production has beenachieved.

Sustainability of the objectives shall be obtained by:

* continuity of implementation of the Project objectives,* effective use of equipment/technology procured under the Project,* increase of gas and oil production in old and newly discovered fields,* increased knowledge and experience of PGNiG staff,* adhering to the Project Operational Plan and its strict monitoring by PGNiG headquarter,i considerable improvement of assurance of uninterruptible gas supplies to the Polish customers

as a result of construction of the first stage of UGS Mogilno.

E. EVALUATION OF BANK'S PERFORMANCE

The Bank's performance - in our view - was more than satisfactory. Since 1992 the sametask manager and the project team were responsible for the Project implementation. Supervisionmissions were conducted with appropriate frequency and were supportive in implementation of theProject by sharing their experience and knowledge.

Good working relationship and understanding have been established between Bank's staffand the personnel of PGNiG which influenced positively completion of the Project.

The flexible position of the Bank positively affected smooth implementation of the wholeProject and enabled final allocation of almost all loan funds.

F. EVALUATION OF PGNiG's PERFORMANCE

A great number of PGNiG specialists, both from the headquarters and field companies, havebeen involved in the project. They made every effort, especially at the definition phase, to make theProject successful.

PGNiG set up Project Implementation Unit /BOBS/ that handled co-ordination of allProject-related issues. Co-operation between PIU and field companies/divisions was excellent in allrespects.

Tendering process was carried out in an efficient and timely manner.

Appendix APage l4of 15

PGNiG confirmed that it is able to adapt to market conditions and it may competeinternationally with respect to upstream services.

PGNiG managed to introduce in a relatively short time technologies, methods and tools usedin the oil and gas industry world-wide, which increased efficiency of operations as well ascompetitiveness of the company.

G. EVALUATION OF RESULTS

* The Project was closed by 30 June 1998. PGNiG fulfilled all basic objectives of the Project,therefore we consider that Project implementation was a success.

* Oil and gas sector was developed and reached a satisfactory progress through the Projectimplementation. PGNiG acquired modern equipment, training, technology and know-howwhich improved operations and competitiveness of the company. We believe that this process ofprogress can be sustained by projects and investments to be implemented in the future. PGNiG-as a result of its fleet modernization-commenced international operations through acquisition offoreign concessions and sale of its services /seismic, drilling and intensification/ abroad.

v 99.4% of the loan was disbursed.

a Project requirements on gas pricing became an impulse to introduction of changes in the stategas pricing policy for the end-users.

* Capacity of UGS Mogilno /1-st stage/ eliminates gas supplies interruptions that were imposedbefore on large industrial consumers during winter peaks.

* Environmental matters have become one of the major factors for decision-making with respectto new projects.

* PGNiG professionals involved in Project implementation participated in the number of trainingprograms aimed not only at introduction of the World Bank procedures necessary to carry outthe Project, but also at valuable insights into international accounting standards, investmentviability analysis or financial forecasting.

* The Project is deemed by PGNiG as successful and the experiences learned during the Projectwill be usefully applied by the company in the future projects.


H. CONCLUSIONS\ LESSONS

PGNiG has gained many experiences during project implementation and the key conclusionsare as follows:

* Good and thorough preparation of Project is of utmost importance because only this approachcan secure efficient implementation.

* PGNiG learned and implemented international procurement practices both for the Project andPGNiG's own projects. We consider that tendering practices are very useful to achieve lowerprices, good quality and performance.

* Strict cooperation among involved Parties is one of the most important factor for the Projectimplementation.

- PGNiG has employed external consultants in addition to own specialists which heavilysupported the adequate completion of large subprojects e.g., Mogilno UGS.

- Cooperation between the Banks and PGNiG was deemed to be very satisfactory throughout theproject life cycle. The missions brought their experience and knowledge to the Projectcompletion. PGNiG believes that the approval procedures for procurement issues are quite rigidand bureaucratic in the World Bank.Therefore it is proposed that Borrowers be treated in a different manner and more reliableclients be given a greater degree of flexibility. Due to the pool units, it is very difficult toprepare a reliable plan for the interest payable even on short term, and the amount of extraexpenses due to changes in cross - currency can not be estimated.

World Bank User\\StreetTalk\Projects@Files@ECA\POLAND\ENERGY\ENERDEV\71CR\APPENDXA.DOC03/16/99 4:29 PM

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report no. 19053 - world bank no. 19053 implementation ... scada = supervisory control and data...

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