Document o f

The World Bank

FOR OFFICIAL USE ONLY

Report No: 28314-KE

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT

IN THE AMOUNT OF SDR55.20 MILLION (USDSO MILLION EQUIVALENT)

T O THE

REPUBLIC OF KENYA FOR AN

ENERGY SECTOR RECOVERY PROJECT

June 10,2004

Energy Team Infrastructure Group Afr ica Regional Office

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

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CURRENCY EQUIVALENTS

(Exchange Rate Effective March 1,2004)

AFD CCGT CRP ESIA EIB EPC ERE3 ERC GDP GoK GNI ICB IDA IPPS KEBS KenGen KfW KPC KPLC KPRL kV kW kWh LPG MoE MSP M V A M W MWh NCC NDF NEMA NOCK PAPS PEAS PITS

PLC PPA PPIAF RTUs

Currency Unit = Kenya Shillings KSh75 = US$1

USfi1.4492 = SDR 1

FISCAL YEAR

July 1 - June30

ABBREVIATIONS AND ACRONYMS

Agence FranGaise de Dtveloppement (French Agency for Development) Combined Cycle Gas Turbine Corporate Recovery Program Environmental and Social Impact Assessment European Investment Bank Engineering, Procurement, and Construction Electric% Regulatory Board Energy Regulatory Commission Gross Domestic Product Government of Kenya Gross National Index International Competitive Bidding International Development Association Independent Power Producers Kenya Bureau of Standards Kenya Electricity Generating Company Kreditanstalt fur Wiederaufbau (The German Aid Agency) Kenya Pipeline Company Kenya Power and Lighting Company Kenya Petroleum Refineries Limited Kilovolt Kilowatt kilowatt hours Liquefied Petroleum Gas Ministry o f Energy Management Services Provider Mega Volt Amperes Megawatt Megawatt Hours National Control Center Nordic Development Fund National Environmental Management Authority National Oil Corporation of Kenya Project Affected Persons Project Executing Agencies Project Implementation Teams

Power Line Carrier Power Purchase Agreement Public-Private Infrastructure Advisory Facility Remote Terminal Units

SCADAiEMS Supervisory Control and Data AcquisitiodEnergy Management System S W A C Systems for Integrated Nehvork Dispatch and Control

Vice President: Cauisto Madavo

Sector Manager: Yusupha Crookes Country Director: Makhtar Diop

J Task Team Leader: Joel J. Maweni

KENYA FOR OFFICIAL USE ONLY Energy Sector Recovery Project

CONTENTS

Page Credit and Project Summary ........................................................................................................ v

A . Strategic Context and Rationale .......................................................................................... 1 1 . 2 . 3 .

Country and Sector Issues ................................................................................................... 1

Rationale for Bank Involvement ......................................................................................... 5

Higher Level Objectives to which the Project Contributes ................................................ 6

B . Project Description ............................................................................................................... 7

. ............................................................................................................. 1 Lending Instrument 7

2 . Project Development Objectives and K e y Indicators 7

3 . 4 . 5 .

......................................................... Project Components ............................................................................................................ 8

Lessons Learned and Reflected in the Project Design ...................................................... 11

Alternatives Considered and Reasons for Rejection ......................................................... 12

C . Implementation ................................................................................................................... 13

1 . Partnership Arrangements ................................................................................................. 13

2 . Institutional and Implementation Arrangements .............................................................. 13

3 . Monitoring and Evaluation o f OutcomesResults ............................................................. 15

4 . Sustainability ..................................................................................................................... 16

5 . Critical Risks and Possible Controversial Aspects .................................................................. 16

6 . Loadcredi t Conditions and Covenants ............................................................................ 18

* . .

D . Appraisal Summary ............................................................................................................ 19

1 . 2 . Technical ........................................................................................................................... 21

3 . Fiduciary ........................................................................................................................... 22

4 . Social ................................................................................................................................. 22

5 . Environment ...................................................................................................................... 23

6 . 7 .

Economic and Financial Analyses .................................................................................... 19

Safeguard Policies ............................................................................................................. 25

Policy Exceptions and Readiness ...................................................................................... 25

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

ANNEXES Page

Annex 1: Country and Sector Issues ..................................................................................... 27 Annex 2: Major Related Projects Financed by the Bank and or Other Agencies ................. 31

Annex 4: Detailed Project Description ................................................................................. 38

Annex 6: Implementation Arrangements .............................................................................. 54 Annex 7: Financial Management and Disbursement Arrangements .................................... 56 Annex 8: Procurement .......................................................................................................... 62 Annex 9: Economic and Financial Analysis ......................................................................... 68 Annex 10: Safeguard Policy Issues ....................................................................................... 82 Annex 1 1 : Project Preparation and Supervision ................................................................... 84 Annex 12: Documents in the Project Fi le ............................................................................. 85 Annex 13: Statement of Loans and Credits .......................................................................... 86 Annex 14: Country at a Glance ............................................................................................. 88

Annex 3: Results Framework and Monitoring ...................................................................... 32

Annex 5: Project Costs .......................................................................................................... 53

MAP: IBRD 33090 ............................................................................................................... 88

iv

KENYA

FY 04/05 Annual 3.00 Cumulative 0.00

ENERGY SECTOR RECOVERY PROJECT

05/06 06/07 07/08 08/09 09/10 21.00 29.00 12.00 10.00 5 .OO 24.00 53.00 65.00 75.00 80.00

CREDIT AND PROJECT SUMMARY

Date: June 10,2004 Country Director: Makhtar D iop Sector ManagerJDirector: Yusupha Crookes

Project ID: PO83 13 1

Lending Instrument: Specific Investment Loan

Team Leader: Joel J. Maweni Sectors: Power (99%);0il and Gas (1%) Themes: Corporate Governance (P); Infrastructure Services for private sector development(S) Environmental screening category: Partial Assessment Safeguard screening category: S2

Project Financing Data [ ] Loan [XI Credit [ ] Grant [ 3 Guarantee [ ] Other:

For LoansJCreditdOthers: Total Bank financing (US$m.): 80.00

I

AFD 25.00 NDF 12.00 IDA 80.00 Govemment (MoE, KPLC and KenGen) 19.46

Total Project Costs, excl. I D C

Borrower: Republic o f Kenya Responsible Agency: Responsible Agencies: Ministry o f Energy, Kenya Power and Lighting Company (KPLC), Kenya Electricity Generating Company (KenGen)

OthersJFinancing Gap 0.00 225.52

[ ]Yes [XINO Does the project depart f rom the CAS in content or other significant respects? [PAD A 71

Does the project require any exceptions f rom Bank policies? [PAD D7] [ ]Yes [XINO Have these been approved by Bank management? I s approval for any pol icy exception sought f rom the Board?

[ ]Yes [ IN0 [ ]Yes [ IN0

Does the project include any critical r isks rated “substantial” or “high”? [PAD C5] [ ]Yes [XINO

[ X I Y e s [ ] N o Does the project meet the Regional criteria for readiness for implementation? [PAD ~ 7 1

V

Project development objective [PAD B2]

The Project Development Objectives are to: (i) enhance the policy, institutional and regulatory environment for private sector participation and sector development; (ii) support efficient expansion o f power generation capacity to meet the economy’s projected supply deficits by FY2006107); and (iii) increase access to electricity in urban and peri-urban areas while and improving the efficiency, reliability and quality o f service to existing. Project description [one-sentence summaly of each component] Ref. PAD B.3.a, Technical Annex 4

Institutional and Capacity Building Component [Part A1 This component comprises: (i) implementation o f a comprehensive corporate recovery program (Part Al) to bring the Kenya Power and Lighting (KPLC) back to a sound operational and financial footing after years o f poor governance; (ii) strengthening the sector regulator’s capacity (Part A2) to review and set power tariffs, prepare secondary legislation and enforce regulations under the law, equipping the Kenya Bureau o f Standards (KEBS)with the skil ls, training and equipment necessary for effective setting and monitoring standards o f petroleum products at import entry points and at distribution points throughout the country; and (iii) upgrading staff skills in other sector entities (Part A3) (namely the Ministry o f Energy, and the Kenya Electricity Generating Company (KenGen)).

Feasibility Studies and Engineering Services Component (Part B). This will include Environmental and social impact assessments for Parts C and D o f the Project, and for the LPG import handling and storage facilities; Consultancy services to update the Kipevu Combined Cycle Plant feasibility (Part C o f the Project); Consultancy services for the Distribution Upgrade to better define the priority subcomponents, estimate costs, establish performance targets, and for a feasibility study and preliminary design o f the proposed LPG import handling and storage facilities project; A geothermal reservoir optimization study for the Olkaria I, I1 and IV sites; and Study to establish a Geothermal Development Company, and preparing a business plan to identify drilling sites, assess costs and seek sources o f financing for developments following Olkaria I, I1 and N sites.

Generation Component (Part C). The Olkaria I1 Extension Generation Component o f the Project comprises: (i) Civ i l Works construction for the extension o f the power house to: accommodate the third 35 MW turbo-generating units, the control panel and other ancillary equipment, the cooling tower, and the switch yard for installing the unit transformer, support bus-bar arrangement and the switchgear equipment; (ii) Steam gathering system fi-om Olkaria I and Olkaria I1 areas and connecting pipes to the generating units; (iii) Supply and Installation o f 35 MW turbo-generating unit; (iv) Supply and Installation o f 45 MVA 1 1/220kV step up unit transformer complete with switchgear equipment; and (v) Miscellaneous electrical and mechanical equipment including control room equipment, cables and other ancillary plant.

Distribution Component [Part DI. The Upgrade o f Existing and Construction o f N e w Substations; Reinforcement and Extension o f the Distribution System; Supply o f Energy Meters; and Upgrade o f S C A D N E M S system including a Trunking Radio System for Mt. Kenya region. The expected output would be reduction o f system losses by about 5% increase in customer connections by about 400,000 over the 5-year project implementation period. In addition quality o f power supply (voltage levels) will improve, and interruptions wil l be reduced.

Which safeguard policies are triggered, if any? Ref. PAD D.6, Technical Annex 10

Involuntary Resettlement (OPBP4.12) Environmental Assessment (OP/BP/GP 4.0 1

v i

Significant, non-standard conditions, if any, for: None Board presentation: July 13, 2004

Loadcredi t effectiveness:

(a)

(b)

(c)

All arrears o f the Ministries and Departments o f the Borrower outstanding as o f M a y 3 1,2004 to KPLC, o n account o f electricity consumption, shall have been paid; Project accounts shall have been opened by KPLC and KenGen and credited with init ial deposits o f local counterpart funding requirements covering at least three months o f expenditures; The Borrower shall have opened three Special Accounts in U S dollars: Special Account A to be managed by the Borrower for MOE, Special Account B to be managed by KenGen and Special Account C to be managed by KPLC; Execution o f a subsidiary loan agreement, satisfactory to IDA, between the G o K and KPLC and between the G o K and KenGen; and An Engineering Advisor and an overall Project CoordinatorMoE’s PIT Head shall have been selected, o n the basis o f terms o f reference satisfactory to the Association.

(d)

(e)

Covenants applicable to project implementation: (Ref. PAD C6)

vi i

A. Strategic Context and Rationale

1. Country and Sector Issues

1.1 In the past two decades, Kenya has experienced a slowdown in growth across a l l economic sectors, and increased poverty f rom 48 percent o f the population in 1990 to about 56 percent in 2003. Agriculture grew by just about 1 percent, manufacturing sector faced stagnating investment and negative productivity. The quality o f delivery o f energy and other infrastructure services declined. Only about 15 percent’ o f the population have access to electricity supply. The use o f household commercial fuels to substitute for fuel wood and biomass use, which is causing acute depletion o f the country’s forest resource, i s among the lowest in Sub-Sahara Africa o n per capita consumption basis. The combined effects o f poor economic govemance, weak enforcement o f accountability, and uncertain polit ical environment led to a significant decline in official donor assistance and private capital inflows, and perception o f high risk by private investors. T o turn economic performance around and reduce poverty, the Government that came into office in December 2002 has formulated an Economic Recovery Strategy for Wealth and Employment Creation (ERSWEC, March 2004) which emphasizes accelerated economic growth and employment creation, increased productivity across a l l sectors, provision o f basic needs and equitable distribution o f national income.

Sector Issues

1.2 The Government o f Kenya (GoK) recognizes that energy services are a critical input into economic activity and an important contributor to employment and fiscal revenues, and are, therefore, indispensable to the attainment o f the objectives o f its ERSWEC. Hence, i t has formulated a long-term vision and pol icy framework to address the several issues that currently constrain the efficient and effective operation and development o f the sector. The principal issues relate to the industry structure and performance, the weak legal and regulatory framework, and the l o w rate o f the population’s access to modem energy services.

1.3 generation i s dominated by the Kenya Electricity Generating Company (KenGen), a state-owned company with 88% o f the country’s generating capacity o f 1 124 MW. The balance o f capacity i s provided by Independent Power Producers (IPPs). The transmission network o f 2035 km o f 220 and 132kV lines i s owned and operated by the Kenya Power and Lighting Company (KPLC), a publ ic ly quoted company in which the public sector holds a 51% equity interest (GoK 41%; National Social Security Fund 10%). KPLC i s also the country’s sole licensed bulk power purchaser and distributor. I t also executes the rural electrification program o n behalf o f the Government. There i s n o effective competition in generation and bulk electricity supplies. IPP charges, f ixed at inception o f their supply contracts, reflect the high premiums required by investors to cover perceived risks with respect t o the country’s macroeconomic performance, the weak legal and regulatory framework in the power sector and the associated r isks o f default by KPLC. KenGen’s performance has been good, with high levels o f plant availability and operating efficiency. I t s financial performance has been satisfactory, largely reflecting l o w operating costs o f i t s mainly hydro system; but i t s abil ity t o maintain and grow i ts capacity i s increasingly limited. Given l imi ted remaining hydro potential, future capacity additions and replacements wil l be thermally-based, and i ts present bulk power prices do not make adequate provision for depreciation o f much o f the current historic asset base (mostly fully depreciated) let alone the change in future asset profi le and costs. Indeed, under pressure to relieve the deteriorating financial performance o f

Industry Structure and Performance. Kenya has a hybrid electricity industry structure. Power

‘ This estimate by the Min is t ry o f Energy i s based o n a statistical sample f r o m a recent household survey and i s higher than previous estimates o f around 9.5%.

KPLC, the bulk supply tar i f f was reduced from about US$0.03 l k W h to about US$O.O23kWh in June 2003. Further details o f the industry structure and performance are provided in Annex 1.

1.4 products. KPRL i s owned 50 percent by the GoK, and the remaining shares are owned by three private o i l companies, Shell, BP, and Caltex. The GoK, through the Kenya Pipeline Company (KPC), a fully state-owned company, runs the pipeline infrastructure f rom Mombasa to Nairobi, and western Kenya. The G o K i s also sole owner o f the National Oil Corporation o f Kenya (NOCK), which i s involved in petroleum exploration, and o i l products supply and distribution. Since the o i l products distribution market was liberalized in 1996, the petroleum distribution trade remains dominated, in terms o f market shares, by the major o i l companies- Shell, BP, Total, Caltex, Mobi l , Kobi l , and Kenol, although several small operators and retailers have entered the market. The main issues relate to: (i) the continued import protection o f KPRL, through tar i f f and quantitative measures, t o enable it to continue operating and providing the minimum domestic requirement for liquefied petroleum gas (LPG); (ii) limited market penetration o f modem fuels because o f policy, supply, and affordability constraints; and (iii) poor operational and financial performance o f NOCK’s downstream petroleum activities.

In the petroleum sector the Kenya Petroleum Refinery L imi ted (KPRL), refines petroleum

1.5 Weak Legal and Regulatory Framework. The current legal framework for the energy sector i s governed principally by the Electric Power Act, (1997) and the Petroleum Act, Cap 116. The Electric Power Ac t governs the generation, transmission and distribution o f electricity, including the funding for the rural electrification program, and it provides for the regulation o f the power sector through an autonomous body, the Electricity Regulatory Board (ERB). The Petroleum Act, Cap 116 regulates the importation, road transportation and storage o f petroleum products. The main weaknesses in the current legal and regulatory framework for the power sector include: (i) restriction on electric power producers from selling power to entities other than public electric suppliers, o f which the only licensed company i s KPLC; (ii) the non-exemption o f the ERE3 from the provisions o f the State Corporations A c t which exposes it to polit ical interference; (iii) absence o f light regulation for small systems, such as the requirement for licenses for a l l such systems; and (iv) the vesting o f authority to license operators and to resolve disputes in the Ministry o f Energy (MoE). These weaknesses represent potential constraints to private sector investment, both in large projects for the national grid, as wel l as in small systems in the rural and peri-urban areas. In addition to the weakness in the design o f the regulatory framework, the capacity o f the ERB to undertake i t s core functions o f tar i f f setting, reviewing power purchase agreements (PPAs), monitoring and enforcing environmental and safety regulations i s limited, partly because o f the high turnover o f management and staff.

1.6 In the petroleum subsector, apart f rom the Petroleum Act, Cap 1 16, there are several other statutes that govern various aspects o f petroleum products standards, marketing, and licensing. With the deregulation o f the petroleum importation, pricing and marketing, a number o f operators have entered the market and this has strained the l imi ted capacity o f local jurisdictions to regulate and monitor products standards, and compliance with safety and environmental requirements. Mixing o f motor fuels and kerosene for financial gain as kerosene commands low taxes relative to other products and evasion o f import duties, taxes and levies on products through diversion f rom the export to the domestic market, are issues o f concern.

1.7 have access to electricity, and the access rate i s only about 4 percent in the rural areas, which i s l o w by developing country standards, and i s both a reflection and a determinant o f the l o w standards o f living, and quality o f life. The objective o f expanding supply i s hindered by the requirement for significant financial resources, beyond the capability o f the public budget, especially given that rural electrification i s more costly and the per capita consumption and revenue generation more l imited than for urban centers. Further, the current institutional and financing framework for rural electrification depends largely o n

Limited Access to Modern Energy Services. At present, only about 15 percent of the population

2

KPLC for program design, implementation and operation and on the Rural Electrification Fund, central government budget and limited donor support for financing. K P L C i s ill equipped to serve outlying areas, because o f lack o f financing capability and the absence o f rural electrification design standards.

Sector R e f o r m Strategy

1.8 The GoK’s long-term vision and pol icy framework to address these issues i s based o n a number o f recent studies and workshops undertaken in collaboration with i t s development partners, in particular: (i) the Power Market Design and Pre-privatization Study completed by National Economic Research Associates (U.K.) in 2003, financed by Public-Private Infrastructure Advisory Facil ity (PPIAF) and executed by IDA; (ii) the draft Energy Sector Development Strategy undertaken by IDA in collaboration with the GoK; and (iii) the National Energy Policy Workshop conducted in February, 2004 with PPIAF funding support.

1.9 structure to remove the monopoly power o f KPLC in transmission and distribution, pave the way for more efficient development, and create the possibility o f a future power market characterized by an autonomous open access transmission company, multiple generators, distributor(s) and large customers, and integration o f the Kenya electricity system in the regional power market; (ii) revision o f the legal and regulatory framework to provide the legal basis for implementation o f the industry structure reforms and to provide the regulator with adequate autonomy to effectively regulate the sector; and (iii) creation o f an institutional framework for promoting expansion o f electricity services to peri-urban and rural areas; (iv) implementation o f pricing policies and investments to support market expansion o f commercial fuels, particularly LPG, to substitute for wood-based fuels; and (v) promotion o f regional integration of energy systems, particularly power, but also petroleum products transportation infrastructure.

The principal components o f the sector reform strategy are: (i) a transformation o f the industry

1.10 Transformation of the Power Industry Structure. The size o f the market i s a critical determinant o f the feasibility o f the envisaged long-term industry structure with multiple generators and distributors and large bulk customers. Hence, the period for the transition to the desired structure i s predicated o n the rate o f growth o f the domestic power market. Nevertheless, there are advantages in carrying out immediate internal corporate restructuring measures to create incentives for efficiency within KPLC. These include the formation o f a transmission business unit and distribution services units with separate tariffs and financial accounts. A power tar i f f study to be completed by June 30,2006 will provide the basis for: (i) establishing separate tariffs for transmission and revising the retail consumer tar i f f structures to better align them to the economic cost o f supply. The business units will be subjected to specific performance obligations under performance-based contracts with the GoK. Efficiency improvements, particularly in management o f distribution will help improve the financial performance o f KPLC, the reliabil i ty and quality o f power supply and the expansion o f services to the population. They wil l also reduce the KPLC default r isks to IPPs and thereby improve the environment for private sector investment in generation.

1.1 1 In addition, even with a small domestic market, a separate transmission company would offer both generators and consumers access to regional markets once the Kenyan system has been more strongly interconnected with other countries2. Given the l imi ted remaining hydro potential resources, integrating the power system with neighboring countries i s an important option for achieving least-cost power tariffs. Further, a corporate structure along business lines will prepare KPLC for unbundling

Currently Kenya i s only connected to Uganda by a 132 KV double circuit transmission l ine through which i t imports about 50 MW o f non-firm energy.

3

distribution into autonomous companies once the market size has increased3. The timing for privatization o f distribution will also be dependent on the readiness o f the intemational and domestic capital markets to invest in the sector, which i s also a function o f the development o f the legal and regulatory framework.

1.12 either not renewing expiring PPAs [two o f the four are expiring in 20041, or seeking mutually agreed changes with the private sponsors. For the future, the GoK’s strategy i s to f i rs t reduce the KPLC default risks by reforming the industry structure and to strengthen the legal and regulatory framework before seeking new private investment in generation. The bulk supply tariff for KenGen wil l be reviewed and proper industry-type power purchase agreements established with KPLC once a tariff study has been completed by June 30,2006. In recent years geothermal resource development has stalled for lack o f funding. To address this issue, the reform strategy includes the hiving-off o f this function from KenGen and placing i t in a special purpose company to be responsible for exploration, appraisal and production drilling, management o f reservoirs, and selling o f steam to concessionaires. These concessionaires will, over time, contribute to the increase in the number o f domestic generators as the power system grows.

In generation, the reform strategy will address the issue o f the high cost o f power from IPPs by

1.13 Petroleum Act, Cap I 16). The GoK’s reform strategy i s to transform the ERB into an autonomous Energy Regulatory Commission (ERC) for both the power and petroleum downstream activities. The ERC wil l be freed from the constraints o f the State Corporations Act, thus making it an autonomous agency, similar to the Central Bank o f Kenya. The rules related to the appointment o f commissioners, their security o f tenure, conflict o f interest provisions, etc, are being revised under the Energy Bill to enhance the independence o f the regulator. The authority for licensing power operators will be vested in the regulator, and so will the authority to promulgate secondary regulations for implementation o f the Energy Law, once i t has been passed. The Energy Bill will provide the legal basis for implementing the envisaged industry structure by allowing for generators to sel l power to bulk customers, thus opening the transmission system to become an open access facility. I t will also, amongst other measures: (i) provide for the establishment o f a rural electrification agency to promote expansion o f power to rural and peri- urban areas; (ii) allow dual licenses for generation and distribution; (iii) encourage, through automatic licensing without payment o f fees, small renewable systems and small hybrid systems below a stated threshold level to operate. The successful implementation o f the legal framework should, over time, help the sector to establish a track record as an attractive destination for both domestic and intemational investment.

Revision of the Legal and Regulatoly Framework (the Electric Power Act, 1997 and the

1.14 Creation of an Institutional Framework for Promoting Expansion of Electricity Services to Peri- urban and Rural Areas. The GoK’s goal i s to increase electricity service connections to rural households from the current 4% to 40% by 2020. The underlying policy objective i s to promote sustainable socio- economic development o f rural communities. To achieve this goal, the GoK will streamline the current institutional arrangements for the implementation o f the rural electrification program by: (i) creating a special purpose agency to manage the program, including formulation o f a roll ing rural electrification master plan; (ii) funding rural electrification activities on a cost-sharing basis with communities and the private sector, based on criteria reflecting least-cost supply options identified in the master plan; (iii) continuing to seek donor funding to augment local resources for the program; and (iv) establishing a regulatory framework for small power developers and utility service providers to operate in areas remote from the national grid. In addition, the GoK wil l privatize/concession the isolated power systems o f KenGen, KPLC, and MoE, and in consultation with ERB, establish and apply cost-reflective tariff structures to ensure the viability o f such schemes. The Bank wil l soon initiate economic and sector work to help the GoK in further detailing the policy framework for rural electrification, designing the legal and

NERA has estimated a customer requirement o f at least 700,000 for a distribution business to be viable compared to the current 600,000 customers for KPLC as a whole.

4

regulatory arrangements for light regulation, and the institutional and financing structures. This work wil l lay the foundation for the Bank to launch a rural electrification program in partnership with other development partners in the near future.

1.15 Petroleum Subsector Reform Strategy. The GoK intends to complete the deregulation o f the petroleum subsector by removing the import protection currently enjoyed by the KPRL, at enormous costs to the consumers. This requires installation o f LPG import handling and storage facilities at Mombasa and transportation to other distribution and storage (to be provided) points in other parts o f the country, to allow the replacement o f KPRL’s LPG output with imports. With respect to the limited market penetration o f modem commercial fuels to substitute for wood-based fuels, the GoK’s policy o f subsidizing kerosene i s providing adverse incentives for i t s use in mixing motor fuels and gasoline, products that are highly taxed. The Government intends to gradually transfer the subsidy from kerosene to LPG as a means o f promoting expansion o f LPG use in the rural areas. In the short-term, it will minimize adulteration by enforcing controls and instituting heavy fines. With regard to NOCK, the GoK’s policy envisages a withdrawal from commercial activities.

1.16 under drought conditions while thermal power based on imported fuel has tended to raise average retail tariffs to high levels relative to Kenya’s trade competitors. Therefore, to increase security o f power supply, the GoK i s seriously pursuing the option o f power imports from neighboring countries, including from the Southem Africa Power Pool as likely to be least-cost alongside i ts own domestic geothermal resource-based power. The Bank’s Country Assistance Strategy (CAS), that was discussed in June 2004, recognizes the importance o f cross border energy trade and indicates that Bank support would be considered once the ongoing dialogue among the countries has sufficiently advanced.

Regional Integration. Kenya’s largely hydropower system has exposed it to power shortages

2. Rationale for Bank Involvement

2.1 GoK that dates back from the early 1970s when the Board approved two loans for development o f hydropower facilities on the Tana Rwer. Since then, the Bank’s support to the sector has undergone changes from an initial focus on financing construction and equipment, to supporting institutional development, particularly on geothermal development, and to an emphasis which started in the early 1990’s, on sector reforms. The switch to a focus on sector reforms came about when it became evident that while implementation o f physical components was generally satisfactory, that o f institutional improvements was less so, and that major reforms were needed to provide a basis for efficient and sustainable development o f the sector.

The Bank’s involvement in the sector represents a continuing and evolving partnership with the

2.2 Thus, in the early 1990s, the Bank took the leading role among the GoK’s development partners in the dialogue on sector reforms. By the mid-I990s, the GoK and i ts development pamers had agreed on a package o f measures which included unbundling o f power generation, on one hand, from transmission and distribution, on the other; adjustment o f tariffs to long-run marginal costs; reform o f the legal and regulatory environment to open the power subsector to private investment; introduction o f the f i rs t PPs; and liberalization o f the petroleum products importation, pricing and marketing. It was, nevertheless, envisaged at the time, that a second generation o f reforms would be required to support further unbundling o f transmission from distribution, and to address the problem o f the low level o f the population’s access to power supply.

2.3 continued involvement in the sector i s required to support the GoK’s formulation and implementation o f the remaining policy agenda. Thus, as detailed above, the Bank has provided technical inputs, as

As the leading proponent o f sector reforms among the GoK’s development partners, the Bank’s

5

executing agency for the PPIAF funding, and through the preparation o f this Project, to the G o K in the development o f a sound and comprehensive energy policy. Further, the Bank continues to provide technical inputs into the preparation o f the Energy Bill.

2.4 Project will support the following specific reforms:

In addition to the above support provided by the Bank as part o f the Project preparation, the

(a) Transformation of the Power Industry. In support o f this pol icy aspect, the Credit wil l finance: (i) a management services contractor who will manage the performance tumaround o f KPLC as we l l as i t s intemal corporate restructuring into separate business units; (ii) management and staff development programs for KPLC managers and staff; and (iii) training for least-cost development planning for MoE, KPLC, KenGen and ERB staff. During implementation, Bank staff will provide technical inputs into the preparation o f a tar i f f study o n the basis o f which KenGen bulk supply tariffs, transmission wheeling charges and retail tariffs will be determined. Bank staff will also provide technical inputs o n the grid code and secondary legislation to be prepared by the ERC. In the past KPLC’s operational and financial performance and its ability to serve consumers efficiently has been hindered by corporate govemance issues as has been suggested by a recent G o K task force. The G o K i s pursuing the findings o f the task force through a recently launched forensic audit and parallel investigations by the Kenya Anti-Corruption Commission. T o avoid similar issues in future, managerial reforms involv ing a management services contract and a revamping o f procurement procedures at the national and corporate levels wil l help to improve corporate govemance and accountability, leading to improvements in the quality and reliabil i ty o f electricity supply in the interconnected power system, and expansion o f access to more consumers in urban, peri-urban and rural areas. KPLC which in the past year benefited f rom a major financial restructuring by the G o K to restore i t s solvency, i s not otherwise a recipient o f operating subsidies f rom the Govemment and will continue to be subjected to a hard budget constraint.

(b) Petroleum Subsector Reform. The Credit will finance: (i) feasibility and environmental studies for an LPG import handling, storage and transportation project which is essential to enable the G o K to remove the import protection for KPRL and reduce the high costs to the economy associated with domestically refined petroleum products; and (ii) building o f capacity in the Kenya Bureau of Standards (KEBS) for producing petroleum products specifications, product testing and monitoring compliance by operators. In addition, the preparation phase has supported the reduction in taxes o n LPG and LPG equipment (to be included in FY2005 budget) as part o f measures to facilitate the expansion o f LPG usage to substitute for wood-based fuels.

3. Higher Level Objectives to which the Project Contributes

3.1 The proposed Project will contribute to the objectives o f the GoK’s ERSWEC aimed at economic growth, equity and poverty reduction and improving govemance. The project will also support similar objectives o f the Bank’s draft C A S for the years FY 2004-2007. The ERSWEC identified infrastructure, including energy, roads, and water supply, as critical to lowering the costs o f doing business and improving the competitiveness o f Kenya’s products o n intemational markets. For the energy infrastructure, the main issues are identified as availability, reliabil i ty and affordability o f energy services. The primary strategies for addressing these issues are development o f a satisfactory legal and regulatory framework to increase private sector participation and investment in the sector, and privatization o f existing operations and improving operational efficiency.

3.2 the legal and regulatory framework, implementation o f a corporate recovery program for KPLC, and

The Project, through i t s facilitation o f the adoption o f a comprehensive energy policy, revisions to

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strengthening o f pol icy formulation and analysis, wi l l promote an enabling environment for increased private sector participation and for efficient least-cost energy pricing, leading to improved delivery o f energy services to the population.

B. Project Description

1. Lending Instrument

1.1 finance the expansion, rehabilitation and upgrading o f economic and institutional infrastructure. I t will also finance management and consultants services, and staff training to upgrade institutional performance, and studies to establish the technical, economic, financial, and environmental viabil ity o f future projects. The Credit proceeds will be disbursed against specific foreign and local expenditures. A sector wide approach could be adopted in future once financial management and procurement procedures have been agreed among the Government and development partners, and the necessary institutional capacity has been developed.

The Specific Investment Lending instrument has been selected for this Project as the Credit will

2. Project Development Objectives and Key Indicators

2.1 The Project Development Objectives are to: (i) enhance the policy, institutional and regulatory environment for private sector participation and sector development; (ii) support efficient expansion o f power generation capacity to meet the economy’s projected supply deficits by FY2006/07; and (iii) increase access to electricity in urban and peri-urban areas whi le improving the efficiency, reliabil i ty and quality o f service to existing consumers.

2.2 Progress towards achieving these objectives will be measured by the fol lowing indicators:

Policy, Institutional and Regulatory Environment

(a) An adequate national energy policy, consistent with efficient development and operation o f the sector adopted by the G o K and fol lowing implementation results achieved:

Separate transmission and distribution businesses with separate accounts established in KPLC by December 3 1,2006; Power transmission charges in effect for the transmissions service business by December 3 1,2006; and Appropriate power purchase agreement(s) established between KPLC and KenGen by December 3 1,2006.

(b) An adequate Energy Law, including adequate regulatory arrangements designed to effectively support implementation o f the national energy pol icy has been passed and the fol lowing implementation results achieved:

Energy Regulatory Commission established and becomes operational n o later than 90 days after enactment o f the Energy Law; and Secondary legislation, including rules for operation o f the grid, prepared no later than 180 days after establishment o f the Energy Regulatory Commission.

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Efficient Expansion of Power Generation Capacity

(a) About 276 GWh o f additional energy generated per annum (at plant load factor o f about 95%) representing an increase in national power production o f about 5%.

Increase in Access to Reliable and Quality Electricity

(a) About 400,000 new customers to be connected by FY2008/09, increasing access to electricity f rom the current 15% by an additional 5% o f the population by the same date;

(b) System losses reduced from about 18.7% in FY2003/04 to about 14.5% by FY2008109; and

(c) Availabil ity o f transmission lines to be improved and power outages reduced to levels considered reasonable for KPLC’s system as follows:

Number o f l ine intempt ions per l O O k m per month shall not exceed 0.19 for 220kV, 0.50 for 132 kV and 2.0 for 66kV; Availabil ity o f 220kV and 132 kV lines shall not be less than 97%; and Total monthly outages o f 11,000 (about 1.54 per 100 customers) to be reduced to n o more than 4000 (0.41 per 100 customers) by the Project Completion Date, September 30, 2009.

3. Project Components

3.1 provides a detailed description o f the components:

The proposed Project will consist o f four components, which are summarized below. Annex 4

Project Component A: Institutional and Capacity Building (US$6.11 million, US$5.8 million IDA)

3.2 (CRP) to bring KPLC back to sound operational efficiency (reduction in system losses to acceptable levels, reduced outages, improved voltage levels and increased access) and improved financial performance after years o f poor governance; (ii) strengthening the sector regulator’s capacity to review and set power tariffs, prepare secondary legislation and enforce regulations under the law, including equipping K E B S with the skills, training and equipment necessary for effective setting and monitoring o f the standards o f petroleum products at import entry points and at distribution points throughout the country; and (iii) upgrading staff skills in other sector entities (namely the M o E and KenGen).

This component comprises: (1) implementation o f a comprehensive corporate recovery program

3.3 Management Services Contract tasked to achieve specified operational and financial targets and to implement internal restructuring in the company; a Management Training Program to support the upgrading o f skills for KPLC’s current and prospective managers; and a StaffDevelopment Program for upgrading skills o f staff and technical personnel to be implemented by the Management Services Provider (MSP) after KPLC Board approval.

The KPLC corporate recovery subcomponent will consist o f a two-year performance-based

3.4 the Regulator’s Business Plan by financing consultants services to assist with preparation o f the following: (i) proposals for an organizational structure for the single sector regulatory agency, staffing requirements and j o b descriptions; (ii) power tar i f f setting guidelines and tar i f f reviews; (iii) guidelines for licensing operators and model licenses; (iv) secondary legislation for implementation o f the Energy

The subcomponent for strengthening sector regulatory capacity wil l support implementation o f

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Bill; (v) technical regulations for the petroleum downstream subsector; and (vi) a management information system appropriate for a modern regulatory agency. I t will also finance short-term advisory services to advise o n specialized issues as needed and study tours for commissionershoard members to familiarize themselves with the experiences o f other countries in regulating the energy sector. The Project will also provide training and equipment to K E B S through M o E to help them in establishing and enforcing product specifications for petroleum products.

3.5 training in key pr ior i ty areas where sk i l ls upgrading has been identified as necessary to meet the Project's Development Objectives, such as financial management, procurement, project management and evaluation; etc. I t also includes consultants services to assist M o E in implementing the Project, pol icy formulation and planning, and providing on-the-job-training to i t s staff.

The capacity building subcomponent for other sector entities (MoE and KenGen) comprise staff

Project Component B: Studies and Engineering Services (US$l0.4 million, US$9.5 million IDA)

3.6 Studies and Engineering services comprise:

Environmental and social impact assessments for Parts C and D o f the Project, and for the proposed L P G import handling and storage project; Study to update the Kipevu Combined Cycle Plant feasibility; Study for the Distribution Upgrade to better define the priority subcomponents, estimate costs, establish performance targets, and prepare bidding documents; Engineering services for the supervision o f major features o f the distribution upgrade component; Feasibility study and preliminary design o f the proposed LPG import handling and storage

project; A geothermal reservoir optimization study for the Olkaria I, I1 and I V sites; Study to establish a geothermal development company, and preparation o f a business plan to identify drilling sites, assess costs and seek sources o f financing for future developments fo l lowing Olkaria I and I1 sites; Engineering services for the design and supervision o f the Olkaria I1 Power Plant extension; Engineering services for supervision o f the S C A D N E M S (Part D4 o f the Project); and Consultancy services for studies for preparation o f future energy projects.

Project Component C: Generation, Olkaria 11 Power Plant Extension (US$53.5 million, 50% IDA)

3.7 combined cycle operation, in accordance with the G o K request o f July 15,2003. The conversion o f the gas turbines to combined cycle had been indicated as least-cost in 2000 and a feasibility study had been subsequently undertaken by independent consultants in 2002. However, when an update o f the feasibility study was carried out in 2003104, the estimated energy costs were shown to be high which l ed to a review of altemative generation options and the timing for additional generation capacity. A review o f the demand forecast and analysis o f the energy and capacity balance tables prepared by the GoK, confirmed the need for additional capacity o f n o less than 3 5 M W to meet a capacity shortfall by 2006107. The review indicated that adding a third unit at the recently completed Olkaria I1 Geothermal Power Plant i s the least-cost option. The layout for Olkaria I1 has already provided for extension of: (i) the powerhouse to house the steam turbine generator; (ii) the cooling tower; (iii) the switchyard for the additional generator transformer and bus-bar arrangement; and (iv) the control room and connecting cables. Thus, the generation component has been revised to include the addition o f a 35 MW unit at Olkaria I1 Geothermal Power Plant instead o f the conversion o f gas turbines to combined cycle at Kipevu. Annex 4

The Project Concept Note had included the conversion o f the 2x30 MW gas turbines at K ipevu to

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provides a detailed description o f the generation component and its rationale. The Olkaria I1 Extension Generation Component o f the Project comprises:

(a) Civ i l Works construction for the extension o f the power house to: (i) accommodate the third 35 MW steam turbine generating units, the control panel and other ancillary equipment, (ii) the cooling tower, and (iii) the switchyard for installing the generator transformer, support bus-bar arrangement and the switchgear equipment; Steam gathering system from Olkaria I and Olkaria I1 areas and connecting pipes to the generating units; Supply and Installation o f 35 MW steam turbine generating unit; Supply and Installation o f 45 MVA 11/220kV step up generator transformer, complete with switchgear equipment; and Supply and installation o f other electrical and mechanical equipment including control room equipment, cables and other equipment.

(b)

(c) (d)

(e)

Project Component D : Distribution Upgrading (US$142.77 million, US$38 million IDA)

3.8 The Upgrading o f the Distribution Network will reduce losses, now standing at 18.7%, improve the quality o f supply, as well as reduce frequency and duration o f interruptions caused in part by overloaded transformers and lines. I t wil l also provide power for the unmet demand, particularly by the peri-urban poor in the main cities and towns. The component detailed in a Feasibility Report4 would extend the distribution system and replace obsolete distribution and protection equipment in the main substations supplying the main load centers o f Nairobi, Mombasa, Westem Kenya and Mt. Kenya regions. The Supervisory Control and Data AcquisitiodEnergy Management System (SCADNEMS ) wil l also be upgraded to better manage load dispatching on a merit order basis.

3.9 The Distribution Upgrading Component comprises:

(a) (b) (c) (d)

Upgrade o f Existing and Construction o f New Substations; Reinforcement and Extension o f the Distribution System; Supply o f Energy Meters; and Upgrade o f SCADNEMS system including a Trunking Radio System for Mt. Kenya Region.

3.10 The Upgrade of the Existing and Construction of Substations (Part D1) provides for (a) the supply and installation of: (i) about 147 MVA 132/33 kV substation transformer capacity complete with associated switchgear and control equipment; (ii) 12.5 MVA 3311 1 kV substation transformer capacity with ancillary equipment; (iii) 594 MVA 66/11 kV substation transformer capacity with switchgear and control; and (b) for the supply o f replacement 132kV (about 8 in number) outdoor and 1 1 kV indoor (about 35 in number) metal clad switchgear, autoreclosers and 11 kV shunt capacitors, all to be installed and commissioned by KPLC.

3.1 1 Supply and Installation (Construction) of: (a) (i) 75 km o f 66 kV line; (ii) 43 km o f 33 kV line; (iii) 43.5 km of 11 kV line; and (b) the supply o f conductors for: (i) reconductoring the 276 km o f 33 kV 303 km o f 11 kV lines, to be carried by KPLC; and (ii) some 500 km o f conductor and hardware material for the low voltage reinforcement and expansion o f the Distribution system in all regions; about 800 (1 1000/415 V)

The Reinforcement and Extension of the Distribution System (Part D2) comprises: (i) The

Distribution Reinforcement and Upgrade (Draft) prepared for The Kenya Power & Lighting Company Ltd. by NORPLAN, March 2004.

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distribution transformers totaling 150 MVA. The items (b) (i) and (b) (ii) will be carried out by KPLC either directly or through local contracting.

3.12 meters for domestic customers at the rate o f about 80,000 annually for 5 years or as may be mutually agreed between the Bank and KPLC; (ii) 5000 three-phase energy meters for replacement o f o ld electromechanical meters; and (iii) about 100 special purpose meters (statistical or others) as may be specified by KPLC. The installation o f the meters will be carried out by KPLC.

The Supply of Energy Meters (Part D3) provides for the delivery of: (i) 400,000 energy (kWh)

3.13 Upgrade of the SCADMEMS System (Part D4) provides for: (i) the supply and installation o f hardware and software to upgrade and expand the existing system and raise the National Control Center and Area Control Centers to modem standards; and (ii) N e w Trunking Radio System for Mt. Kenya Region able to cover the region and thereby replace the o ld and obsolete existing system that has l imi ted coverage.

4. Lessons L e a r n e d and Reflected in the Project Design

4.1 investment both to help the country mobil ize the substantial resources required for investment and to help improve operational efficiency. Whi le several IPPs are n o w operating in the sector, the G o K i s concerned with the contractual terms under the PPAs, particularly the tariffs and escrow accounts arrangements, which it considers onerous. Kenya’s inabil ity to secure more favorable terms under the PPAs can be attributed to several factors, such as a fragile macro-economic environment, poor governance o f the sector, weak financial performance o f KPLC as the power offtaker under the PPAs, an inadequate track record with implementation o f an autonomous regulatory framework, and perceptions o f high resource risk in the case o f geothermal power development. All these factors gave rise to a perception o f the sector as high r isk for private sector investment, thus resulting in l o w competition and demands for high r isk premiums f rom those who submitted bids.

A major element o f the reform program initiated in the mid-1990s was to attract private sector

4.2 The above lesson has been incorporated in several ways in the design o f the Project. First, the comprehensive energy sector pol icy includes a road map leading to the break-up o f KPLC’s monopoly and in i t ia l steps for divestiture o f its distribution business(es). A management services contract will be secured to enhance the prospects for successful implementation o f the road map o f which KPLC’s CRP is a part. At the end o f the road map, the existence o f efficiently operated distribution systems wil l be expected to attract private sector investment in generation, and so will the creation o f an autonomous open access transmission company. Second, the requirement for the ERC to be less constrained from the constraints o f the State Corporation A c t will give it credibility as an autonomous regulator. The Project wil l provide financing for the ERC to secure consultants services to help it strengthen i t s regulatory capability as wel l as for training and study tours for its staff and commissioners. Third, with regard to resource risk, the experience with the private sector in geothermal power development has shown that the private sector is either unwilling to shoulder the resource r i s k given the characteristics o f Kenya’s geothermal resources or can only do so at considerable risk premiums. The Project will, therefore, support a new approach under which the G o K wil l carry out geothermal resource assessment activities (exploration, appraisal and production drilling) through a special purpose company to be hived o f f f rom KenGen, and then sell steam to viable private and/or public private partnership arrangements for power generation.

4.3 The Project has also taken into account the lessons learned f rom international experience with management contracts in utility industries l ike water and power. The experience o f Ghana under the National Electrification Project (Credit 2467-GH) i s il lustrative o f these lessons. The Implementation Completion Report for that project [Report 22417, June 29,20011 stated that the design o f management

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contracts need to pay special attention to the following factors: “ (i) that the contractor i s given autonomy to make key decisions and implement his proposed measures for improving performance; (ii) the payments to the contractor should be l inked to specific measurable outcomes consistent with the contract objectives; (iii) baseline performance indicators should be verified unambiguously to facilitate evaluation of performance and performance-based payments to the contractors; and (iv) in line with i tem (ii) the contract should preferably be self-financing. In addition, the management contract should be seen as part o f a transition to a longer term efficient management arrangement for the utility, such as privatization.” The Bank’s Infrastructure, Economics and Finance Department has recently commissioned a study o n the experience with management contracts, specifically in the power sector. They conf i rm that these lessons are consistent with international experience to date. The project has incorporated these lessons in the proposed management services contract for KPLC under which the M S P will have autonomy to manage the company so as to achieve agreed objectives and targets under a contract linking remuneration to performance, and the management services contract will be part o f a longer term strategy o f restructuring the power industry and privatizing distribution when the right conditions are achieved.

4.4 Project Executing Agencies (PEAs) to expedite processing o f payments and avoid interest costs o n delayed payments; (ii) establishing a clear arrangement for the PEAs to provide local counterpart hnding, such as dedicated project accounts; (iii) ,upfront training in procurement, and particularly contract administration for staff o f the PEAs involved in large infrastructure projects; and (iv) having the core staff t o be involved in management of the Project selected as early as possible after project appraisal. The Project design has incorporated these lessons.

Other lessons leamed are the importance of: (i) having separate special accounts operated by the

5. Alternatives Considered and Reasons for Rejection

5.1 Several institutional and technical alternatives were considered in the preparation o f the Project.

5.2 that would enable the company to overcome its current inertia and successfully upgrade i t s degraded power distribution infrastructure, connect more customers, and improve i t s operational and financial performance. The options considered included: (i) technical assistance targeted towards the company’s principal weak areas, such as distribution and customer services; (ii) disposal o f the public sector’s shareholding in KPLC to below 50% in order to free KPLC from the constraints o f the State Corporations A c t and place i t firmly under private sector management; and (iii) a management services contract to place the company under a performance-based private sector management arrangement pr ior to privatization. The technical assistance option was discarded as it would not address the issues o f management performance and govemment interference which have been at the center o f the company’s problems in the past. A combination o f option (ii) and (iii) was adopted as it would enable the G o K to first restructure the power industry before completing privatization.

Institutional Options. For KPLC, there was an extensive search for a viable institutional option

5.3 The alternative o f private sector development o f the generation component was considered and rejected for two reasons. First, it was considered necessary to improve the environment for private sector participation by addressing the r isk factors discussed above [weak regulatory environment, operational and financial viability o f the distribution systems; etc], so as to enable Kenya to secure reasonable terms, including tariffs, under future PPAs. Whi le an instrument l ike a partial risk guarantee could be deployed to mitigate against political risks, i t could not be used to cover default r isks arising f rom poor management o f KPLC. Second, the specific least-cost generation capacity addition selected for implementation under the Project, a third unit at Olkaria I1 Power Plant, will be based o n the steam f rom the Olkaria I and I1 fields which are being operated by KenGen to provide fuel for the existing Olkaria I and I1 Geothermal Power Plants. Independent consultants advised in 1995 that the Olkaria I and I1

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steamfield should b e operated by one entity as multiple operators would lead to possible disputes regarding resource use.

5.4 (i) installation o f a 34 MW Heat Recovery Boiler for the conversion o f existing 2x30 MW GTs at Kipevu to combined cycle plant; (ii) installation o f a 34 MW medium speed diesel at K ipevu or Lanet; (iii) rehabilitation o f K ipevu No. 7 Steam Plant o f 30 MW; and (iv) addition o f a 35 MW third unit at the recently commissioned Olkaria I1 power plant. The fourth option o f adding a third unit at Olkaria I1 Geothermal Power Plant was selected as the least-cost option. For the distribution upgrading component, consideration was given to having separate supply and installation contracts, but the supply and install option was selected for large items as it i s l ikely to result in speedier implementation and lower costs. However, smaller items will be provided under supply contracts with installation by K P L C and/or local contractors.

Technical Options. For the generation component the fo l lowing four options were considered:

C. Implementation

1. Partnership Arrangements

1.1 Investment Bank (EIB), Kreditanstalt fur Wiederaufdau (KfW) and IDA have financed the 64 MW Olkaria I1 Geothermal Power Plant (commissioned in October 2003) under the ongoing Energy Sector Reform and Power Development Project. Under the same project, the Japanese Bank for International Cooperation supported the 75 MW Kipevu I Thermal Power Plant which was commissioned in 1999. The Japanese Bank for International Cooperation i s also financing the ongoing Sondu Miriu Hydropower Project (60MW) which i s scheduled for commissioning in FY2006/07. The AFD, the Spanish Government, and the European Un ion are financing the Govemment’s rural electrification program. In addition to the EIB and IDA, this Project will attract more development partners to the sector; namely the AFD and the Nordic Development Fund (NDF) who wil l participate in financing the power distribution component, both under parallel financing arrangements. In addition to co-financing the power distribution component with AFD, EIB and NDF, IDA will also jo in t ly finance the expansion o f Olkaria I1 Power Plant with EIB. EIB wil l also finance a S C A D N E M S for KPLC. In the preparation o f this Project, IDA has played the role o f coordinating development partners f i o m the preparation o f a draft sector development strategy, jo in t preparation mission with AFD in December 2003 through to a jo in t pre-appraisal mission with the AFD, NDF and the EIB in March 2004. I t i s planned to move the coordination o f development partners to the next phase when the Govemment takes over the coordinating role starting in FY2004/05.

There are several development partners participating in the energy sector. The European

2. Institutional and Implementation Arrangements

2.1 The Project Executing Agencies (PEAS)--the MoE, KPLC and KenGen--wil l establish, by Board presentation, adequately staffed Project Implementation Teams (PITs) to implement their respective parts of the Project. T o avoid the creation o f special purpose organizational units for the l i f e of the Project, the PITs will be established within the organizational units that are normally responsible for implementing similar projects. This project implementation model i s based o n the workable arrangement adopted for the ongoing Energy Sector Reform and Power Development Project (Cr. 2966-KE). The PITs will have overall responsibility for monitoring their respective components o f the project, including preparation o f progress reports, updating o f project costs and financing plans, and ensuring that project implementation and procurement plans are kept up to date. They will, therefore, require to be adequately staffed for the duration o f the project with staff and/or consultants with experience and sk i l ls in the core functions o f

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project management (i.e. procurement, and accounting and financial management, and project monitoring). T o facilitate the implementation o f the Project, the PIT heads wil l be seasoned project management professionals, with convening power within their PEAs, or recruited consultants with similar experience in other organizations. The PIT heads wil l report t o the chief executives o f their organizations: i.e. for the K P L C components, init ially t o the Managing Director and later to the General Manager once the M S P has been recruited; and for the KenGen and M o E components, t o the Managing Director and Permanent Secretary respectively. In addition, to ensure effective implementation and accountability o f PITs, each P E A wil l establish a management oversight arrangement through which the PEA management will monitor implementation o f i ts project components.

2.2 (PCT) comprising the PIT Heads o f MoE, K P L C and KenGen will be established and will operate under the chair o f the overall Project Coordinator and MoE’s PIT head. Consultants recruited to the PITs, including the overall Project Coordinator, will be selected in accordance with the Bank’s guidelines for selection o f individual consultants and will be required to have substantial experience in their relevant disciplines. The PCT will consolidate project implementation progress reports and manage special audits o f the management services contract, and submit results to the Ministries o f Finance and Energy for decisions.

For the overall project coordination, monitoring, and reporting, a Project Coordination Team

2.3 executives and heads o f the PITs o f the PEAs to review project implementation and resolve any issues requiring the attention o f senior sector management. The overall Project Coordinator will serve as secretary at these meetings.

Periodically the Permanent Secretary o f the Ministry o f Energy wil l chair a meeting o f the chief

2.4 MoE’s PIT will also implement the activities for strengthening regulatory capacity, in particular, i t will handle a l l the accounting and procurement-related matters. The beneficiary agencies for the subcomponent for strengthening o f regulatory capacity, the ERB and the K E B S will each appoint a focal point person to be assisted by 2 or 3 other designated staff in liaising with the M o E to carry out their activities. For the KEBS, the Team Leader o f the Petroleum Standards Monitoring Unit will b e the focal point person. ERB/ERC will similarly appoint a focal point person.

2.5 During negotiations it was agreed that: (i) the establishment of fully and adequately staffed PITS is a condition for Board presentation, except that the selection of an Engineering Adviser and the overall Project Coordinator and MoE PIT Head, on the basis of terms of reference satisfactory to the Association, shall be completed by Credit effectiveness, and (ii) the terms of reference for the PITs and the skills and experience of the staffselected for the PITs shall be acceptable to the Bank.

Finan cia1 Management

2.6 The principal objective o f the project’s financial management system will be to support management in their deployment o f l imited resources with the purpose o f ensuring economy, efficiency and effectiveness in the delivery o f outputs required to achieve desired outcomes. Specifically, the system must be capable o f producing timely, understandable, relevant and reliable financial information that wi l l enable management to plan, implement, monitor and appraise the project’s overall progress towards the achievement o f i t s objectives.

2.7 Under the proposed institutional arrangements, PEAs shall prepare periodic fund accountability statements using existing accounting and internal control structures. Existing financial management and accounting manuals shall be used to guide reporting at respective levels. The respective PEAs financial officers shall be responsible for preparing quarterly Financial Monitor ing Reports (FMR) and project

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financial statements. During negotiations the following agreements were reached: (i) that MoE wi l l be required to prepare project financial statements comprising of a Statement of Cash Receipts and Payments (or Sources and Uses of Funds); n e Accounting Policies Adopted and Explanatory Notes and a Management Assertion that funds have been used for the intendedpurposes: ( io KenGen and KPLC wi l l prepare fu l l jkanc ia l statements (Balance Sheet, Income and Expenditure Statements) with adequate disclosure by way of notes or supporting schedule with suficient information on the sources and uses of project funds. The financial statements for each PEA wil l be prepared in accordance with consistently applied accounting standards acceptable to the Association and wil l be audited in accordance with consistently applied auditing standards acceptable to the Association, by independent auditors acceptable to the Association.

Disbursement Arrangements and Flow of Funds

2.8 To facilitate the flow of funds for purposes of meeting project expenditures, the following agreements were reached during negotiations: (i) that the GoK wi l l open three special accounts and authorize KenGen and KPLC, each to manage and operate one special account into which the proceeds of the I D A Credit w i l l be deposited from time to time and from which payments wi l l be made for eligible expenditures; (ii) the GoK wi l l manage and operate the third special account for eligible expenditures by MoE; (i i i) KPLC and KenGen wi l l each open a Project account into which they w i l l deposit, at the beginning of each quarter, the projected local counterpart funding requirements for the next quarter. I t was agreed that, as conditions for Credit effectiveness, the Borrower wi l l open the agreed three special accounts; and KPLC and KenGen wi l l make agreed initial deposits into their project accounts. I t was further agreed that KPLC and KenGen wi l l use the report based method of disbursement under which replenishments w i l l be made to their special accounts upon submission to the Bank of Financial Monitoring Reports to be prepared on a quarterly basis. MoE opted to use the transaction-based disbursement method, but may consider migrating to the FMR-based disbursement method at a later date.

3. Monitoring and Evaluation o f Outcomes/Results

3.1 Performance monitoring will take place at two levels. At the Project level, monitoring o f performance and o f the key indicators will be undertaken by the PITs of: (i) KPLC for the CRP and Distribution Component; (ii) M o E for the strengthening regulatory capacity subcomponent and for i t s part of the capacity building component; and (iii) KenGen for the generation component and i ts part o f the capacity building component. The PITs will each prepare quarterly progress reports summarizing, inter alia, the actual project outcomes in relation to targeted outcomes. For KPLC and KenGen, the offices responsible for performance monitoring (Chief Manager, Planning, Research and Performance Monitoring (KPLC) and Manager for Technical Assurance (KenGen) will audit the performance indicators stated in the quarterly progress reports for accuracy before submission o f the reports to the PCT for consolidation and distribution to the Ministr ies o f Energy and Finance and the development partners.

3.2 Corporate level performance will have significant impact on the achievement o f project outcome indicators; e.g. poor financial performance by KPLC may hinder expansion o f the distribution system and thereby result in failure to achieve customer connection targets. Hence, corporate level performance will be monitored and reported through the quarterly progress reports. In addition, corporate-level performance will be monitored and enforced though a system o f performance contracts (as may be modified through special management assistance contracts) to be concluded between the companies and the Government. Special audits by external auditors will be used to determine the companies’ compliance with their obligations under performance contracts.

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4. Sustainability

4.1 Project sustainability. This i s because the pol icy will require power prices to cover the full cost o f supply and, therefore, provide KPLC and KenGen with adequate resources for operating and maintaining the distribution system and the Olkaria I1 Geothermal Power plant respectively. The policy wil l further result in the full transfer, in the medium term, o f power distribution operations to private sector ownership and management. Large consumers wil l also have the option to purchase their power requirements f rom generators o f their choice, thus providing some degree o f competition and pressure for efficiency in the sector. In the short-term, the management services contract for KPLC will help to improve corporate governance and the company’s financial performance, thereby unlocking resources for KPLC to provide adequate counterpart funding for the Project.

Successful implementation o f the Government’s comprehensive energy pol icy will be key to

4.2 The sector entities have qualified and capable staff. Nevertheless, exposure to emerging international utility management and operating practices, pol icy analysis and regulatory sk i l ls i s required o n a continual basis. The Project will finance capacity building for the sector entities to help sustain and strengthen the sector’s human resource base. This will help to contribute towards sustaining the benefits o f the Project.

5. Critical R i s k s and Possible Controversial Aspects

5.1 and the associated mitigation measures are described below.

The overall risk rating for the project i s medium to high. The identif ied risk factors, their ratings

Risk

To Project Development Objectives KPLC management capacity does not improve to effectively maintain and operate the power distribution system

Retail power tariffs not maintained at levels adequate to cover the cost o f supply

H

H

Risk Mitigation Measure

. Performance-based Management Services Contract will be put in place pr ior to disbursement o f IDA funds for the distribution upgrade component. G o K to develop a strategy to communicate to KPLC staff, the rationale and benefits o f the CRP so as to achieve their buy-in and cooperation. Criteria for selection o f Management Services Contractor to include requirement for highly experienced personnel familiar with operating in similar environments

component included in the Project to support implementation o f management development program and training o f technical staff.

.

.

. A substantial capacity building

.

. Tariffs to be set by an autonomous Energy Regulatory Commission Financing and technical support to be Drovided under the Proiect for the

16

c Risk Rating

KenGen’ s bulk supply tar i f f recently reduced to aide K P L C financial recovery process becomes inadequate to cover the company’s poo l costs as more expensive new plants are added to i t s portfolio.

Delays in enactment o f the Energy L a w will delay the restructuring o f the power industry

Risk Mitigation Measure

L

KPLC capacity proves inadequate to connect 80,000 additional customers per

preparation o f tariff studies Preparation o f the Energy L a w i s at an advanced stage. Close monitoring by IDA missions to ensure early submission to Parliament.

year

I

Procurement and contract administration not efficiently handled.

allocated in a timely manner

t M preparation o f tariff studies . Appropriate industry-type PPA[s]to be prepared and approved by the ERC by December 3 1,2006. Financing and technical support to be provided under the Project to the

.

M . Project Procurement and Implementation plans have been prepared and agreed during negotiations. These will be closely monitored through quarterly progress reports to commence immediately after Board Presentation. Adequately staffed Project Implementation Teams to be formed by Board presentation. Engineering Consultants to be retained for both the generation and distribution upgrading components . Distribution Upgrading Component. Draf t Bid documents already prepared for most packages (May 2004). Consultants selected in accordance with the Bank’s guidelines for selection o f individual consultants, to be provided to M o E to assist with overall monitoring o f Project Implementation

.

.

M

M

M

KPLC to continue use o f contractors and to aggressively market services to potential customers connection policy to be agreed by I D A before disbursement for Part D of the Project begins Adequately qualified staffto be identified and assigned in the PITS pr ior to Board presentation . Advance assurance f rom Government followed by quarterly jo in t reviews with MOF, implementing entities and IDA Project accounts to be opened and initial deposits made by Credit effectiveness.

. 9

.

17

6. Loadcredit Conditions and Covenants

Effectiveness Conditions

(a)

(b)

(c)

All arrears o f the Ministr ies and Departments o f the Borrower outstanding as o f May 3 1,2004 to KPLC, on account o f electricity consumption, shall have been paid; Project accounts shall have been opened by KPLC and KenGen and credited with initial deposits o f local counterpart funding requirements covering at least three months o f expenditures; The Borrower shall have opened three Special Accounts in U S dollars: Special Account A to be managed by the Borrower for MOE, Special Account B to be managed by KenGen and Special Account C to be managed by KPLC; Execution o f a subsidiary loan agreement, satisfactory to IDA, between the GoK and KPLC and between the GoK and KenGen; and An Engineering Advisor and an overall Project Coordinator/MoE’s PIT Head shall have been selected, on the basis o f terms o f reference satisfactory to the Association.

(d)

(e)

Legal Covenants

Reforms

Award o f a management services contract for implementation o f KPLC’s CRP to a MSP wil l be a condition o f disbursement for Part D o f the Project; Preparation and adoption o f a tariff study by June 30,2006 and on the basis o f the study findings:

Establish separate tariffs for transmission and distribution by December 3 1, 2006; Design and adopt revised retail consumer tariff structures by December 3 1,2006;

Preparation o f appropriate PPA[s] between KPLC and KenGen, by December 3 1 , 2006, taking into account recommendations o f the tariff study; Submission to Parliament by December 2004 o f an Energy Bill, amending and consolidating the Electric Power Act No. 11 o f 1997 and the Petroleum Act (Cap 116) to strengthen the legislative and regulatory framework for the energy sector; Establishment o f separate business uni ts for transmission and distribution services within KPLC with separate accounts by December 3 1,2006; Establishment o f an Energy Regulatory Commission not later than 90 days after the enactment of the Energy Law; Preparation and adoption o f secondary legislation for implementation o f the Energy Law no later than 180 days after establishment o f the Energy Regulatory Commission; and Implementation o f a satisfactory customer connection policy prior to the disbursement o f the Credit proceeds for Part D o f the Project.

Financial

KPLC shall, starting in fiscal year 2004105:

(a)

(b) (c)

(d)

generate funds from internal sources equivalent to not less than 25% o f the three-year average o f i t s capital expenditures; maintain i ts accounts receivables from electricity sales at no more than 60 days at all times; ensure that the estimated net revenues will be at least 1.2 times the estimated maximum debt- service requirements; and maintain a ratio o f current assets to current liabilities o f not less than 1 .O.

18

I n addition, during negotiations, it was agreed that KPLC shall submit quarterly progress reports to the Association on settlement of electricity bills by the Borrower’s Ministries and Departments, and adopt appropriate measures to ensure compliance with the requirement to maintain its accounts receivable on electricity sales at or below 60 days revenue.

KenGen shall, starting in fiscal year 2004105:

(a)

(b)

(c)

generate funds f rom internal sources equivalent t o not less than 25% o f the three-year average o f i t s capital expenditures; ensure that the estimated net revenues will be at least 1.5 times the estimated maximum debt- service requirements; and maintain a ratio o f current assets to current liabilities o f not less than 1.5.

D. Appraisal Summary

1. Economic and Financial Analyses

Economic Analysis

1.1 The economic justification o f the Project has been analyzed for the three main physical components o f the Project: (i) the expansion o f the Olkaria I1 geothermal power station by adding a 35 MW unit; (ii) the power distribution upgrade; and (iii) the installation o f a modem SCADNEMS. Details o f the assumptions underlying the economic analyses, computations and results are provided in Annex 9.

The justification o f the Olkaria I1 station expansion was performed in three stages:

the need and timing for additional generation capacity to meet incremental demand, and to provide for adequate reserve margin to assure security and reliabil i ty o f supply. Based on the medium case electricity demand growth o f about 6% per year f rom 2002/03 to 2007/08, and average hydrological conditions for the hydropower production, additional generating capacity would be needed in the power system in 2006/07. Under the l o w case demand scenario predicated o n a lower Gross Domestic Product (GDP) growth, averaging about 2% per year in 2003-2007, additional generating capacity wil l b e required one year later, in FY2007/08. The demand and supply balance situation would be worse in the unlikely, but possible event o f dry hydrological conditions prevailing in the next four years, and would call for additions to the generation system much earlier.

o f the feasible generation candidates that could be developed, within the next four years, to provide the required additional capacity, the screening curve methodology was used to determine the least-cost option. The options considered were: (i) new geothermal power station; (ii) coal and oil-fired steam units; (iii) oil-fired gas turbine units; (iv) medium and l o w speed diesel units; and (v) the K ipevu GTs- combined-cycle conversion. The analysis showed that addition o f a third unit at Olkaria I1 power station i s the least-cost option.

the economic intemal rate o f retum (IRR) o n the investments for the third unit at Olkaria was calculated based o n a comparison o f quantifiable economic costs and benefits. For benefits the incremental sales o f about 214 GWH per annum to final consumers were valued at the prevailing average consumer electricity price o f about US$O.O99/kWh, as a proxy for willingness to pay. Sensitivity analyses was carried out for the fo l lowing scenarios: (i) a 10% increase in capital and

19

operating costs over and above the usual physical contingencies for projects o f this nature; (ii) an unexpected 10% decline in the output o f the power station; and (iii) a combination o f (i) and (ii). The results showed high and robust I R R s ranging f rom 19% for the base case to 15% for the worst case scenario.

1.3 for loss reduction, network reinforcement and expansion which wil l help to improve reliabil i ty and quality o f supply, and to increase sales to final consumers. T o achieve the same objectives, the alternative to the interventions under the Project would be to increase electricity generation to make up for the losses in the network and/or to l ive with supply deficits. The costs o f the alternatives were found to be much higher than the costs o f the Project. The R R on the aggregate o f the investments for the component was estimated o n a basis o f comparison o f economic costs and benefits. The overall economic meri t o f the proposed schemes i s strong with IRR in the 24%-30% range, aggregate pay-back per iod o f 5 years, and a benefit to cost ratio o f about 4 in present value terms.

The justification o f the distribution upgrade component was analyzed for a l l 58 sub-components

1.4 valued at the economic cost o f un-served energy o f U S $ 0 . 5 4 k w h in Kenya; (ii) reduction in transmission system losses valued at the average consumer tar i f f o f US$O.O99kWh, as a proxy for the willingness to pay; and (iii) improved efficiency o f the power generating system from short-term optimization, which would lead to better utilization o f generating plants and transmission system, and deferment o f investments, valued at the average consumer tariff. The estimated IRR i s about 3 1%, with a present value of net benefits o f U S 5 4 mill ion.

The quantifiable benefits o f the SCADA system would be (i) increased power system security

Macroeconomic Impacts

1.5 quality, reliable and cost-effective electricity supply to meet the growing demand, and to support economic growth, since electricity i s a significant input to the commercial and industrial sectors which account for about 80% o f GDP. These two sectors account for about 63% o f electricity consumption. Geothermal energy would substitute for the alternative o f oil-based generation, and would reduce the country’s o i l import bills by about US$lO mi l l ion per year.

The proposed Project would have positive impacts o n the economy. I t will provide improved

Financial Analysis

1.6 The financial performance o f the power sector was greatly affected by the prolonged drought during 1998-2000 which caused a power supply crisis in Kenya. As a result, f r om FY 1999-FY2002, KPLC, a key utility in the power sector, incurred substantial losses (totaling about Kshs16.5 bil l ion) and was in breach o f a l l the financial covenants under the current credit5. For the f i rs t time’ in four years, KPLC generated a net income o f Kshs380 mill ion, for a six months period ending December 3 1,2003, due largely to a reduction in bulk tariffs by KenGen and Iberafrica, one o f the IPPs and the conversion o f Kshs15.6 b i l l ion o f debt owed to KenGen and the GOK into preference shares6. As a result, KPLC’s self- financing ratio i s expected to improve f rom negative 137% in FY2002/03 to 64% in FY2003/04. I t ’ s debt-service coverage will reach 2.4, f rom negative 0.5 in FY2002/03.

The financial covenants require KPLC and KenGen to achieve self-financing ratios o f at least 25%, debt service coverage ratios o f at least 1.5 times and to maintain their accounts receivables at n o more than 60 days at a l l times.

KenGen’s preference shares in KPLC are non-convertible, redeemable at the option o f KPLC, and have no voting rights.

20

Projections’, o n the basis o f existing tariffs, indicate that K P L C will continue to generate profits during the project’s implementation period. However, while the company i s expected to meet the financial performance criteria until FY2007108, by FY2008/09, assuming n o increases in tariffs, the company’s self-financing rat io will fa l l below 25%. This i s because the projections assume that KPLC will be purchasing power f rom regional markets, starting FY2008/09, at higher prices than i t s bulk supply tar i f f from KenGen. Therefore, i t will be necessary to ensure that the retail tar i f fs remain adequate to cover the costs o f power purchases, including the negotiated costs o f imports so as to ensure i t s continued financial viability. The company wil l also need to adopt an aggressive collection pol icy to avoid large short-term borrowings to meet i t s working capital requirements. Furthermore, any adverse change in demand would cause KPLC to incur financial losses.

1.7 Whi le KenGen suffered severe liquidity constraints as a result o f KPLC’s di f f icul t situation in early 2000, the company remained profitable. The liquidity constraint was eased in FY2003/04 as KPLC was able to settle i ts debt within 40 days. Looking ahead over the project period, KenGen’s electricity sales are expected to increase slightly by about 2% annually. Even assuming that KenGen’s bulk supply tar i f f remains at Kshsl.76/kWh, the company will continue to maintain a satisfactory financial structure as indicated by i ts debtequity ratio o f 30/70 over the project implementation period. I t s self-financing ratios o f at least 25% per annum over the project implementation period, based o n the estimated capital expenditure program, are robust. T h i s also implies that i t s creditworthiness, as measured by the debt service coverage ratio, will continue to be satisfactory in the 2.3-3.1 range, and so wil l i t s working capital levels.

On-lending Terms

1.8 The G o K will on-lend about USS41.3 mi l l ion and USS26.5 m i l l i on to KPLC and KenGen, respectively. The interest rate will be 4.5% and the repayment terms wil l be 20 years, including a grace period of 5 years. KPLC and KenGen will bear the foreign exchange risks on the on-lent amounts.

Retroactive Financing

1.9 Credit amount, to finance eligible expenditures incurred after September 30,2003 and before credit approval.

The Credit will provide retroactive financing up to USS2.75 m i l l i on equivalent (or 3.4% ) o f the

2. Technical

2.1 Part C, the Generation Component. The alternatives considered for Part C included: various options for conversion o f a simple cycle gas turbine to a combined cycle operation, the least-cost o f which was compared with the alternatives o f a medium speed diesel and a geothermal power plant. Without taking into account the relative proximity o f a geothermal power plant to the main demand center o f Nairobi, the extension o f the recently commissioned Olkaria I1 power plant, by adding a third unit o f 35 MW capacity, was proven to be the cheaper option for meeting the additional demand. The other two competitors, namely the Combined Cycle Gas Turbine Plant installed at K ipevu and the medium speed diesel also at Kipevu, are disadvantaged with their reliance o n expensive imported fuel. The additional unit at Olkaria I1 uses locally available steam, and i s by far a more environmentally friendly source o f power. The stronger experience o f KenGen’s staff o n geothermal plant operation also favors the Olkaria I1 extension.

’ Financial projections for both KenGen and KPLC are available in Project Files.

21

2.2 include: (i) relieving overloaded substation and distribution transformers as wel l as reinforcing under- dimensioned distribution network, thereby improving poor voltage conditions and reducing losses; (ii) replacing obsolete switchgear and protection equipment, thereby rendering it possible to procure spares at reasonable prices, and improving reliabil i ty o f supply.

Part 0, Distribution Upgrade Component. The technical justification for Part D o f the Project

2.3 technically obsolete, and the equipment are a l l proprietary protocols. However, neither the S C A D A system nor the Remote Terminal Uni ts (RTUs) i s supported by the manufacturers any longer. Spare parts are either not available or very expensive, as they need to be manufactured upon request. The S C A D N E M S system, established before the recent unbundling o f generation and transmission & distribution, has also called for segregating operational responsibilities with direct impact o n the new functional requirements o f the technical features o f the S C A D A E M S system. The system should also cope with future unbundling and be flexible to the technical requirements o f regional interconnections which are expected to materialize in the medium term. The benefits o f modern S C A D A for dispatching efficient and least-cost power supply to the system needs emphasis with the growing sources o f supply.

In addition, the existing S C A D N E M S system (part o f the Distribution Upgrade component), i s

3. Fiduciary

3.1 An assessment of the financial management arrangements for the project in the PEAs (MOE, KPLC and KenGen) was carried out. The assessment included a review o f the systems o f accounting, reporting, auditing, flow o f funds and internal controls. The conclusion o f the assessment i s that project’s financial management arrangements are capable o f recording correctly a l l transactions and balances, supporting the preparation of regular and reliable financial statements and safeguarding assets. Therefore, the current financial management arrangements in the PEAs satisfy IDA’S minimum financial management requirements, subject t o the institution o f independent audit arrangements acceptable to the Bank.

3.2 procurement capacity assessments are rated Average (for the MOE, KPLC and KenGen). The performance o f the three agencies in processing procurement under the Energy Sector Reform and Power Development Project (Cr. 2966-KE) was satisfactory. Nevertheless, there were problems with contract administration and management under that Project. Thus, while there are adequately qualified staff in each agency who could be assigned to the PITs, additional training o n bank-financed procurement i s required. In i t ia l training was conducted during the appraisal mission and further advanced training will be carried out by the Country Office, particularly for the staff designated to work in the PITs. The draft Procurement Plans and Implementation Schedules, prepared by the three PEAs, in conformity with IDA’S revised rules, were reviewed and agreed with the Borrower during negotiations.

Similarly, procurement capacity assessments were carried out in the three PEAs. The overall

4. Social

4.1 substations and l o w voltage lines under the power distribution upgrade component; (ii) the positive benefits o f the extension of power supply to new consumers, especially in poor pen-urban areas; and (iii) the improvement in reliability and quality o f power to many existing customers. There i s no requirement for land acquisition for the generation component since the land required for expansion o f the Olkaria I1 Power Plant i s already provided for in the original design o f the plant. KPLC has we l l defined policies for land acquisition which require consultation with the Project Affected Persons (PAPS) and compensation o n the basis of market value o f properties where appropriate. The Environmental and Social Impact Assessment (ESIA) has indicated that there will be n o requirement for resettlement o f

The primary social impacts o f the Project will be: (i) the acquisition of land for construction o f

22

people, although there may be cases requiring compensation o f PAPS for loss o f crops and/or other assets. Since substations sites and line routings have not been determined in all cases, KPLC has prepared a Resettlement Policy Framework which lays out the procedures for consultations with PAPS, and the compensation guidelines, in the event this applies. In addition, KPLC will prepare individual resettlement action plans for specific substationsAine routings that involve resettlementkompensation for PAPS.

4.2 The distribution component will involve connection o f about 400,000 consumers (67% increase in 2002 KPLC customers) over a 5-year period which will increase access to electricity by 5% by Project completion date. A significant proportion o f the connections will involve poor and/or economically marginal areas, hence the Project will help to improve living conditions for the poor and to stimulate the informal sector (Jua Kalis). KPLC’s connection charges are known to be exorbitant, and unless changes are made, the ambitious connection rate w i l l not be achieved. The connection charge for prospective customers should, in general, be limited to a percentage o f the cost o f the service line. This will include the line from the nearest distribution network to the customer. Costs o f the main distribution l ine and distribution transformers should be included in the investment program o f the distribution system, and should not be included in connection charges except for isolated low load prospective customers. Favorable payment terms over a period o f years with monthly payments included in the electricity bills should be adopted. KPLC wil l submit a customer connection policy for all customer categories. During negotiations, it was agreed that disbursement of the IDA Credit for Part D of the Project wi l l be conditional on KPLC submitting to the Association, a satisfactory policy for customer connections.

4.3 The improvement in reliability and quality o f supply to existing customers will also help to increase output and improve productivity o f commercial and industrial enterprises. Local contractors will benefit from employment opportunities for the installation o f the network.

5. Environment

5.1 MoE, through its two main agencies, KPLC and KenGen has carried out two ESIAs, as they relate to their respective physical components: the power generation component for KenGen and the distribution component for KPLC. These studies, which were carried out in full compliance with the Kenyan and World Bank environmental and social safeguard guidelines, generated three separate reports: an ESIA from each o f the two agencies and a Resettlement Policy Framework from KPLC. All three studies were conducted by local consultant firms. The ESIA and Resettlement Policy Framework for the distribution component for KPLC were carried out by Log Associates and ESIA for the power generation component was carried by GIBB East Africa. All these safeguard instruments were reviewed and approved by the borrower’s National Environmental Management Authority (NEMA) and the Bank’s Africa Safeguards Policy Enhancement (ASPEN) team, and disclosed, in compliance with the Pelosi amendment, in-country and at Bank Infoshop, prior to appraisal.

5.2 The ESIA work, including public consultation with the various stakeholder groups began in January 2004 and carried on until their final approval and public disclosure in February 2004.

MoE assigned a team to both agencies to oversee the preparation o f the safeguard documents.

5.3 economic environments within which the project i s to be implemented. The fieldwork aimed at determining baseline conditions in the project intervention zone, assessing potential environmental and social impacts and identifying mitigation measures and the institutional arrangements for implementing and monitoring those measures. Prior to disclosure in-country and at Bank InfoShop, a workshop for both the distribution and generation components was organized, involving project implementation teams and stakeholder groups in the communities, civi l society and the private sector, with the intention o f

The main purpose o f the fieldwork was to gain full understanding o f the bio-physical socio-

23

presenting the results o f the ESIAs, fostering ownership and seeking their input in order to improve quality and soundness o f the ESIAs and Resettlement Policy Framework. Recommendations f rom a stakeholders' workshops were reflected in the reports.

Environmental Impacts Mitigation Measures

consumers

Noise (during ground preparation)

Interruption o f power supply to current disturbance to the public; provide advance notice to consumers before embarking o n the work.

K P L C to adhere more closely to set standards, rules and procedures Conduct c i v i l works during times that provide least

Displacement o f people for construction o f new Apply mitigation measures according to guidelines substations, due to land acquisition and/or loss o f set forth in the RPF (relocation; compensation o f economic activities RisWexposure to electric shock

project affected people (PAP) Strictly adhere to known safety procedures, when

Movement o f heavy equipment to work sites, which may pose danger to public

5.5 combined cycle operation, an option which has since been discarded in favor o f the addition o f a third unit at the recently completed Olkaria I1 Geothermal Power Plant. An ESIA was carried out for the development o f the entire Olkaria geothermal f ield in 1993 and a mitigation plan was developed and implemented under the Bank-financed Energy Sector Reform and Power Development Project, Credit 2966-which closes on June 30,2004. The ESMP under this Credit was satisfactorily implemented and was the subject of Bank supervision. The PSRs always indicated S rating for environmental management. In addition the Bank's website o n best practice on geothermal environmental impacts case studies provides a favorable comment o n KenGen's endeavors to comply with both national and international environmental laws/regulations, standards and global environmental challenges, through i ts fully-fledged environmental section, established in 1985. The section i s responsible for monitoring environmental impacts, erosion control, sites rehabilitation, monitoring o f micro-climatic changes and pollution control. The website further notes that KenGen has also retained, since 1995, the services o f Geothermal Board o f Consultants, which includes an environmental expert who has constantly evaluated and reviewed the progress made by KenGen staff in aspects o f environmental mitigation and monitoring.

The ESIA for the generation component was based o n the conversion o f gas turbines at K ipevu to

work i s in progress Ensure that existing work sites have a secure perimeter fence/ wall; mandatory public warning and precautions such as labels, sirens to accompany transportation o f heavy equipment.

5.6 house and o f the switchyard, and the transmission capacity to evacuate power to Nairobi i s adequate. The only possible adverse impact o f the third unit will be the additional hydrogen sulphide emissions. The emissions from the existing Olkaria I Power Plant have ranged f rom 0.05 to 1.25 ppm, which i s considered to be wel l within the work place health levels. Nevertheless, as a precautionary measure, during project preparation, KenGen retained an independent consultant t o review the environmental and social implications o f the proposed expansion and to conduct consultations with the local population in the project vicinity. The consultant issued an in i t ia l opinion in April 2004 that the environmental and

The original Olkaria I1 Geothermal Power Plant lay-out provided for extension o f the power

24

social impacts f rom the expansion are l ikely to be moderate to negligible and would be manageable given KenGen’s demonstrated capacity for environmental management. Further, i t i s important to note that the expansion o f geothermal generation uses a renewable and environmentally clean fuel.

5.7 Based o n the independent assessment that the environmental impact will be moderate to negligible and KenGen’s strong capacity for environmental management, it was agreed with the borrower that the independent consultant would complete the environmental and social impact assessment by about mid 2004, only as a precautionary measure to help define the mitigation measures to manage the possible negligible impacts. The ESIA o n the distribution component and the Kipeve combined cycle power plant (the latter component subsequently dropped f rom the Project) were completed and disclosed both at the Infoshop and in-country in Kenya in February 2004, after receiving clearances from the borrower’s national Environmental Management Agency and the Afr ica Region Safeguards staff.

5.8 construction activities and the potential for resettlement impacts. However, these impacts have been thoroughly analyzed in the ESIA and addressed through the Environmental and Social Management Plan and Resettlement Policy Framework. Institutional arrangements for the electrification access component wil l be designed to ensure that environmental considerations are taken into account throughout selection, planning, construction and operation o f new distribution gnds and power generation sources, and that social benefits are ensured through monitoring impacts o n identified project beneficiaries and affected people. Environmental and social considerations and impact mitigation planning will b e an integral part o f the implementation o f these project activities.

The project has been rated B since there are some adverse environmental impacts f rom

6. Safeguard Policies

Safeguard Policies Triggered by the Project Yes N o Environmental Assessment (OP/BP/GP 4.0 1) [X 1 E l Natural Habitats (OP/BP 4.04) [I [I Pest Management (OP 4.09) E l [X 1 Cultural Property (OPN 11.03, being revised as OP 4.1 1) [I [X 1 Involuntary Resettlement (OP/BP 4.12) [X 1 [I Indigenous Peoples (OD 4.20, being revised as OP 4.10) [I [ XI Forests (OP/BP 4.36) 11 [X 1 Safety o f Dams (OP/BP 4.37) [I XI Projects in Disputed Areas (OP/BP/GP 7.60)* [I XI Projects on International Waterways (OP/BP/GP 7.50) [I [X 1

7. Policy Exceptions and Readiness

The Project does not require any exceptions f rom Bank policies.

Regional Criteria for readiness for implementation:

(a) (b)

Financial Management Assessments have been completed and action plan prepared; Procurement Capacity Assessments have been completed, and procurement plans agreed during negotiations;

* By supporting theproposedproject, the Bank does not intend to prejudice the final determination of the parties‘ claims on the disputed areas

25

(c)

(d)

Disclosure Requirements: Environmental impact assessments and a resettlement pol icy framework for the Project’s distribution component were disclosed o n February 27,2004; and Project Implementation Teams have been established.

Joel Maweni Team Leader

Yusupha Crookes Sector Manager

Makhtar D i o p Country Director

26

Annex 1

C o u n t r y and Sector Issues

KENYA: E n e r g y Sector Recovery Project

1. In the past two decades, Kenya has experienced a slowdown in growth levels across a l l economic sectors, and increased poverty f rom 48 percent o f the population in 1990 to about 56 percent in 2003. Agriculture grew by just about 1 percent, manufacturing sector faced stagnating investment and negative productivity, and the quality o f delivery o f energy and other infrastructure services declined. Only about 15 per cent o f the population have access to electricity supply, and the use o f household commercial fuels to substitute for fuel wood and biomass use, which i s causing acute depletion o f the country’s forest resource, i s among the lowest in Sub-Sahara Afr ica on a per capita consumption basis. The combined effects o f poor economic governance, weak enforcement o f accountability, and uncertain polit ical environment l ed to significant decline in official donor assistance and private capital inflows, and perceptions o f high risk by private investors. In order to turn economic performance around, and to improve the well-being o f the population, the new Government that came into office in December 2002, has formulated an ERSWEC (March 2004) whose key pol icy objectives are accelerated economic growth and employment creation, increased productivity across a l l sectors, equitable distribution o f national income, reduction o f poverty through provision o f basic services to the population, and improved rural- urban balance.

2. The extent to which these objectives can be realized o n a sustainable basis and in an environmentally sound manner i s dependent on the degree and economic efficiency with which critical factors o f production are made available and combined with each other to produce the desired results. The realization o f these objectives i s only feasible if quality energy services are made available in a sustainable, cost effective and affordable manner to a l l sectors o f the economy ranging f rom manufacturing, services, mining, and agriculture to households. The G o K recognizes that for the energy sector to make the required contributions to achieving a sustained economic growth, and in reducing poverty, an integrated comprehensive national energy policy, which would clearly articulate the Government’s vision for the operations and development o f the energy sector over the long-term i s needed. Such a pol icy framework would provide the basis of development o f a comprehensive strategy, the legal, as we l l as the regulatory framework to guide the implementation o f the actions to meet the policy objectives over the long-term.

3. The energy sector i s a significant contributor to the economy, indirectly as a major input into economic activity, especially to the services and industrial sectors, and o f households, which account for nearly 80 percent o f GDP, and directly through employment, and contribution to fiscal revenues. The energy and related sectors employ nearly 16,000 people, and contribution f rom tax revenues account for 20 percent o f Government revenues, equivalent to about 4 percent o f GDP.

Sector Structure

4. KenGen and several IPPs; and the transmission and distribution company, KPLC. MoE’s role i s l imi ted to that o f making and articulating energy policies to create an enabling environment for efficient operation and growth o f the sector; preparation of the least cost development program for the power sector; overseeing implementation of the rural electrification program and facilitating the mobilization o f resources for the sector investment programs. The ERB was established in 1998 under the Electric Power Ac t with the mandate, inter alia, to set, review and adjust consumer tariffs, approve PPAs, promote competition in the sub-sector where feasible, resolve consumer complaints and enforce environmental, health, and safety regulations.

The main institutions in the power industry are: MoE, E M , the power generators comprising

27

Annex 1

5. Among the generators, KenGen, a whol ly state-owned company i s the dominant player accounting for about 88% o f the installed capacity whi le the IPPs account for about 12% and the G o K for the balance under i t s rural electrification program. K P L C i s currently the only licensed public electricity supplier and purchases power f rom KenGen and IPPs. KPLC i s a mixed sector company in which the public sector holds 5 1% o f shares while the private sector holds the balance.

6. The other institutions in the sector are the KPRL in which the Government owns 50 percent shares, and the remaining shares are owned by three private o i l companies, Shell, BP, and Caltex, and the o i l storage facilities in the same shareholding ratio. The G o K through the KPC, a fully state-owned company runs the pipeline infkastructure f rom Mombasa to Nairobi, and westem Kenya. The G o K i s also sole owner o f NOCK, which i s involved in petroleum exploration, and o i l products supply and distribution. Since the o i l products distribution market was liberalized in 1996, the petroleum distribution trade is dominated by the major o i l companies- Shell, BP, Total, Caltex, Mobil, Kenol, K o b i l and other small retailers.

Main Issues in the Sector and Actions

7. overstaffed, and financially weak. The G o K intends to reform the industry structure to remove the monopoly role o f KPLC by transforming the transmission system into an open access facil i ty that would al low large consumers to contract with generators o f their choice. With the future interconnection o f the Kenya grid with Tanzania and the Southem Afr ica Power Pool countries and the strengthening o f the link with Uganda, the policy o f an open access transmission regime would enhance market and supply options for both generators and large consumers. This open access transmission regime will entail the unbundling o f transmission services and their placement in an autonomous company. The remaining distribution services will be managed either as one company or several companies depending o n financial viabil ity considerations. On the generation side, through a spin-off f rom KenGen, geothermal resource assessment activities will be placed in a special purpose company which will take charge o f a l l such activities, including exploration, appraisal drilling production drilling, management o f reservoirs, and selling o f steam to concessionaires. The number o f generators wil l also increase as more IPPs enter the market, particularly in geothermal development under public-private partnership arrangements. The transition towards this industry structure will take place in three stages. In the first stage, corporate restructuring wil l be undertaken in KPLC to form a transmission business unit and several distribution services units which will be subjected to performance obligations under a system o f performance-based contracts with the GoK. Similarly, KenGen minus the geothermal resource assessment activities, will be subjected to performance based contracts. In the second stage the transmission business unit will be transformed into an autonomous enti ty and in the third stage the distribution services will be privatized as a single entity or several entities based on financial viabil ity criteria.

The current monopoly structure of K P L C i s a constraint to efficiency improvement. K P L C i s

8. The current legal and regulatory environment i s weak and not conducive to private sector involvement. The perception o f risk by the private sector i s high, and has been the ma in underlying factor for the high cost o f the IPP procured power in recent years. I t i s the intention o f the G o K to revise the existing Electric Power Ac t o f 1997, and to replace i t with an Energy A c t currently under preparation by the M o E to encompass the power sector and petroleum downstream activities. Under the new Bill, the autonomy and functions o f the ERB will be enhanced and expanded, and to provide for the environment that would serve to attract meaningful private sector participation. The ERB is yet to develop the capacity to enable it discharge its functions as a fully fledged regulatory agency. The expanded functions under the proposed new legislation will require reinforcement in capability and capacity. The G o K will strengthen the ERB, to make it a genuinely autonomous regulator by removing i t f rom the domain o f the

28

Annex 1

State Corporations Act and enhancing i ts capacity to formulate and enforce secondary legislation, including those related to environmental, health, and safety issues.

9. much lower, about 4 percent in the rural areas, which i s l o w by developing country standards, and i s a reflection o f the low standard o f living, and quality o f l i fe. However, expanding supply would require significant financial resources beyond the capability o f the GoK. The G o K recognizes the useful role that the private sector, and community involvement can play in expanding electricity supply and energy services to most o f the population. The GoK’s intention to create the environment to attract private investors i s a step in the right direction so as to mobilize additional resources for expansion o f rural access to energy. In addition, the G o K will create a dedicated rural electrification agency to facilitate development o f rural electrification.

Currently, only about 15 percent o f the population have access to electricity, and the access rate i s

10. Since Kenya i s an energy resource scarce country, and heavily dependent o n imports o f petroleum, energy prices will continue to be high. Existing geothermal and hydropower resources will be expensive to develop in the future. The G o K intends to place greater emphasis o n encouraging conservation measures, and institution o f demand-side measures. In addition, the G o K intends to secure cheaper sources o f energy through the participation in regional electricity markets, and to base future development on strictly economic least-cost criteria. Participation in the future regional power pools would help to lower intemal investment requirements, and the cost o f energy, which will in-tum enhance the competitiveness o f Kenya’s industry and tourism.

1 1. energy use as wel l as for resource mobil ization for the budget. In electricity, household tariffs are below the cost o f service due to the life-line rate offered, and the pol icy to make electricity more affordable. However, this places an undue burden o n other consumers, such as commercial and industry, who provide the cross subsidy. In l ine with the G o K policy to base tariffs o n cost o f service, tar i f f system needs to be rationalized to reflect cost of service by consumer category, in which case cross-subsidization would be intra-category. Electricity pr ic ing should be based o n the principle o f achieving economic efficiency, financial viability, and equity considerations. At the bulk supply level, industry type PPAs should be developed between KenGen, and KPLC, and within KPLC, between transmission operations, and distribution to promote efficiency, encourage commercial autonomy as a key step in the transition to a fully competitive market structure in the future.

On pricing, the pol icy o f the G o K i s to use pricing both as instrument for promoting efficiency o f

12. In petroleum, fo l lowing the liberalization, prices are set by market forces o f supply and demand. However, due to the price-leadership o f the large distributors, the margins for smaller distributors, who operate mostly in the rural areas are limited, which makes distribution o f the household fuels in the rural areas, such as kerosene financially unattractive. The GoK’s social pol icy o f levying relatively lower taxes on kerosene i s in-tum providing incentives for adulteration o f motor fuels which are highly taxed, by some transporters and retailers, resulting in frequent breakdown and high maintenance costs to vehicle owners, and transport operators and adverse macroeconomic impacts.

13. institute heavy fines, but over the medium term, to eliminate the pr ic ing disparity, and to transfer the subsidy to LPG so as to accelerate LPG use in the rural areas.

In the short-term, the emphasis o f the G o K to minimize the practice i s t o enforce controls, and

Linkage with Proposed Energy Sector Recovery Project

14. efforts to translate its intentions into concrete actions in: (i) improving the quality and reliabil i ty o f

The proposed operation, which i s largely focused o n the power sub-sector, will support the GoK’s

29

Annex 1

electricity supply in the interconnected power system; (ii) improving corporate governance and accountability especially in KPLC to turn-around i t s performance; (iii) establishing a strong, autonomous sector regulatory regime with adequate institutional capability t o discharge i t s functions, including the creation o f the enabling environment for meaningful private sector participation; ( iv) enhancing capacity in energy pol icy formulation, and analysis; and (v) instituting pricing regime to promote efficiency, and viability.

30

Annex 2

quality o f service to existing consumers Geothermal resource development and

M a j o r Related Projects Financed by the Bank and/or Other Agencies

Donor Project Name Spanish Rural Government Electrification AFD Rural

Electrification

KENYA: Energy Sector Recovery Project

Sector Issues Addressed Expansion o f access to rural populations

Expansion o f access to rural populations

Project

Kipevu I1 (IFC) Emergency Power Supply

Energy Sector Reform and Power Development

Geothermal Development and Preinvestment Tsavo Power (IFC Equity Investment) MIGA Guarantee for OrPower4 Geothermal Project

ljects Ongoing

within last

Cr. # or Proi. ID

Cr. 3425- KE

Cr. 2966- KE

Cr. 1973- KE

Sector Issues

~~~~

support efficient expansion o f power generation capacity to meet the economy’s projected supply deficits;

enhance the policy, institutional and regulatory environment for private sector participation and sector development; support efficient expansion o f power generation capacity to meet the economy’s projected supply deficits; increase access to electricity in urban, peri-urban and rural areas whi le and improving the efficiency, reliabil i ty and

5 ears ~

I

Power generation capacity expansion

Power generation capacity expansion

~

10 Rating

3

31

Annex 3

Results Framework and Monitor ing

KENYA: Energy Sector Recovery Project

PDO Enhance the policy, institutional and regulatory environment for private sector participation and sector development

Expand power generation capacity to meet the economy’s projected supply deficits by FY2006/07

Increase access to electricity in urban, and peri-urban areas while

Results Framework

Outcome An adequate national energy pol icy for efficient development and operation o f the sector is adopted and implemented by the G o K

An adequate Energy L a w to support implementation o f the National Energy Policy i s passed and implemented.

About 276 GWh o f energy to b e generated per annum (at 95% load factor) representing an increase in power production o f about 5%

About 400,000 new customers connected b y FY2008109

mation

m

B

B

B

B

m

Implementation o f an industry structure involving an open access transmission system wil l commence

Separate transmission and distribution businesses with separate accounts established in KPLC by December 3 1, 2006

Power transmission charges in effect for the transmissions service business by December 3 1,2006

T w o par t bulk-supply ta r i f f comprising capacity and energy charges established through a power purchase agreement between KPLC and KenGen

Energy Regulatory Commission established and becomes operational n o later than 90 days after enactment o f the Energy L a w

secondary legislation, including rules for operation o f the grid prepared by n o later than 180 days after establishment o f the Energy Regulatory Commission

T a r i f f studies prepared and separate transmission wheeling charges and retail tar i f f schedules established

Exercise rights under performance guarantee

Update demand forecast and least-cost development p lan

32

Annex 3

Improving the efficiency, reliability md quality o f service to existing :onsumers

Component One (A-Znstitutzonal and Capacity Building):

Award and satisfactory implementation o f a management services contract for KPLC

Removal o f the ERBlproposed Energy Commission from the regulation o f the State Corporations Act

~

representing an increase o f about 67% in KPLC’s consumers

System losses reduced from about 18.7% in FY2003/04 to about 14.5 % by FY2008109.

4vailability o f transmission lines improved as follows:

I Number o f l ine interruptions per l O O k m per month shall not exceed 0.19 for 220kV, 0.50 for 132 kV and 2.0 for 66kV Availability o f 220kV and 132 kV lines shall not be less than 97%; and

rota1 monthly outages o f 1 1,000 (about 1.54 per 100 customers) to be reduced to no more than 4000 ( 0.41 per 100 customers) by the Project Completion Date, September 30, 2009).

Component One (A):

a high performing KPLC meeting operational and financial targets agreed with Government

(i) Strong technical and economic regulation o f the sector (products pricing, health and safety improvements)

(ii) Quality standards set for a l l petroleum products in line wi th international best practice

(iii) Reduction in incidences o f adulteration o f fuels and diversion o f products destined for export markets to the domestic market

Component One (A):

If results are not being achieved review the performance o f the management assistance contract and take remedial action, including the option o f reducing the public sector shareholding to below 50%

Review capacity building strategy for the EREUERC, including possibility o f increased use o f resident experts

Enforce standards

Review and revise structure o f fue l prices to remove incentives for adulteration

33

Annex 3

Component Two (B-Studies and Engineering Services) :

Award and satisfactory completion o f contracts for the reservoir optimization study for Olkaria I and 11, EIA study update for Olkaria I1 and engineering supervision services

Component Three (C- Generation)

Award o f construction contract and satisfactory completion o f third unit o f Olkaria I1 Power Plant

Component Four (D- Distribution):

Distribution upgrading contracts awarded and under satisfactory implementation

Component Five (E- Preparation of Future Projects)

Completion o f Least-cost Power development Plan Prioritization o f petroleum sector investments

Component Two (B):

(i) Adequate steam i s confirmed for expansion o f Olkaria I1 (ii) Satisfactory design and tendering for Olkaria I1 expansion (iii) Determination o f environmental issues associated with expansion o f Olkaria I1 (if any)

Component Three (C):

Olkaria I1 Unit three operating at base load to produce about 276 GWh o f energy per annum

Component Four (D):

(i) System losses reduced by about 4.2 %

(ii) Availability o f transmission lines improved as follows:

. Number o f l ine interruptions per l O O k m per month shall not exceed 0.19 for 220kV, 0.50 for 132 kV and 2.0 for 66kV Availability o f 220kV and 132 kV lines shall not be less than 97%; and

. (iii) Total monthly outages o f 11,000 (about 1.54 per 100 customers) to be reduced to no more than 4000 ( 0.4 1 per 100 customers) by the Project Completion Date, September 30, 2009

(iv) About 400,000 additional customers connected by KPLC by FY2008109

Component Five (E)

Pre-feasibility and bankable feasibility and environmental impact assessment studies for new projects

Component Two (B):

Decision to proceed to tender stage for Olkaria I1 expansion

Implement additional mitigation plan measures to those already determined for Olkaria I1 without expansion (if any) Component Three (C):

Exercise rights under performance guarantee

Component Four (D):

revise customer connection policy, including contracting arrangements for connection o f new customers

Component Five (E):

Mobil ize funding from development partners and private investors as appropriate

34

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Annex 4

Detailed Project Description

KENYA: Energy Sector Recovery Project

Project Component A: Institutional and Capacity Building (US$6.11 million)

1. The Govemment recognizes the urgent need to: (i) implement a comprehensive corporate recovery program to bring K P L C back to a sound operational and financial footing after years o f poor governance; (ii) strengthen the power sector’s regulator, the ERB, to review and set tariffs, prepare secondary legislation, etc; (iii) equip the KEBS with the slulls, training and equipment necessary for them to effectively set and monitor the standards o f petroleum products at the import entry point and at distribution points throughout the country; and (iv) upgrade staff skills in other sector entities (namely MoE and KenGen). The institutional and capacity building component has been designed to achieve these objectives.

KPLC Corporate Recovery Program (US$3.44 million)

2. In the mid 1990s the G o K initiated reforms in the power sector with the objective of improving the investment, operational and financial performance o f the utilities and creating a legal and regulatory environment favorable to private sector investment First, generation assets on one hand, and transmission assets o n the other hand, were divested from the multiple entities then existing and pooled into two companies; the KenGenand KPLC. Second, the legal and regulatory framework was reformed to open the sector to private investment and a new regulatory body, the ERB was established in 1998. Third, the private sector was invited to produce power under power purchase arrangements with KPLC as the single buyer. Fourth, tariffs were gradually increased f rom 30% to about 100% o f long-run marginal cost by 1999. The gains f rom these reforms include: private sector investment in generation such that today the private sector accounts for about 12% o f the generation capacity compared to zero in 1995 and the establishment o f a regulatory infrastructure.

3. However, KPLC experienced a steady decline as system losses increased, reliabil i ty and quality o f services declined, backlog in customer connections increased and investments in rehabilitation o f existing assets and new long-term productive assets were neglected; a l l principally due to poor corporate governance. A devastating drought in year 2000 sent KPLC into a precipitous decline such that by year 2003, its capital base was severely eroded and the Government intervened to provide rel ief through debuequity conversions, interest re l ief on outstanding debt and a reduction in the bulk supply tar i f f charged by KenGen. KPLC’s own efforts, over the past several years, to implement a corporate recovery plan comprising system losses reduction, staff retrenchment and other measures to reduce an unsustainable operating cost structure, expand customer connections to increase revenue generation, and improve revenue collection have not yielded significant improvements.

4. undermines the GoK’s objective o f economic growth and service expansion to the poor. The perceived high cost o f unreliable power i s also a contributory factor to the high cost o f doing business in Kenya. Hence, the G o K has decided to reform the power sector in three stages. First, it intends to introduce performance-based corporate management contracts in the utilities with a v iew to achieving a rapid performance tumaround. Second, KPLC will be intemal ly restructured into a transmission services business unit and one or more distribution business units. A grid code for operation o f the interconnected power system wil l be prepared and introduced. Finally, the distribution business unit(s) will be privatized at appropriate times whi le the transmission company will be retained as a public sector utility operating on an open access regime.

The l o w quality and unreliable power i s a disincentive to private sector investment and thus

38

Annex 4

5. losses f rom the current high level o f 18.7% in FY2004 to about 14.5% by FY2008/2009; (ii) improve the rate o f consumer connections f rom about 50,000 to about 130,000 (including about 80,000 expected to result f rom the Proejct) per annum for the next f ive years, thereby improving access to electricity and expanding the company’s revenue base; (iii) reduce operating costs through improving work methods and productivity and optimizing the size and deployment o f the company’s workforce; (iv) working capital management; and (v) examine options for and implementing financial restructuring. System losses wil l be reduced through a combination o f short term actions targeted at reducing non-technical losses and some pr ior i ty distribution investments to reduce distribution system technical losses as detailed in Annex - 4. The distribution investments (substations, MV and LV lines and meters) to be funded under the Project wil l also help K P L C towards reaching i t s target of connecting 130,000 customers per annum as wel l as improving system reliability.

CRP which i s intended to support KPLC recovery comprises measures to: (i) reduce system

6. CRP, KPLC will take aggressive measures to improve collection o f revenues, such as decentralization o f customer management functions, systematic disconnection o f customers in default, installation o f prepayment meters for selected customer groups, prosecution o f those suspected o f power theft; etc. On i t s part the G o K has committed to pay a l l bills fall ing due to K P L C f rom i t s ministries, departments and agencies starting in March 2004, and to provide adequate budgetary provisions for each fiscal year, starting with FY2004/05, and finally to settle by Credit effectiveness (scheduled for September 30,2004), a l l arrears outstanding as o f M a y 3 1, 2004. Improving working management will also require synchronization o f KPLC’s credit policies to i t s customers to those extended to i t by KenGen and IPPs from w h o m it purchases power.

At times KPLC carries excessive amounts o f accounts receivables and inventories. Under the

7. capability to effectively implement the above operational and financial performance recovery measures. The subcomponent comprises three parts as follows:

The Project’s CRP subcomponent i s aimed at providing KPLC with the management and staffing

(a) Management Services Contract (US$3.0 million). This i s a two-year program designed to provide K P L C with the management capacity to implement i t s CRP. The G o K will appoint a M S P to occupy key l ine management positions in KPLC o n a two-year performance-based remuneration contract. The M S P will be expected to achieve operational and financial targets to be negotiated with KPLC Board o n the basis o f recommendations o f an independent consultant. The CFS as outlined above will provide a broad guide o n h o w the targets may be reached, but the MSP may suggest other measures, provided they do not require additional resources to those committed by donors and those to be generated f rom internal sources.

(b) Management Training Program (US$O. 12 million). This activity will support the upgrading o f sk i l ls o f KPLC’s managers and wil l be defined by the MSP.

(c) StaffDevelopment Program (US$0.32 million). The M S P wil l be required to implement, after KPLC Board approval, a results-oriented staff development program based o n M S P assessment o f the sk i l ls upgrading needs within the second quarter o f the assignment. In addition to the staff training, M S P i s expected to prepare short-term focused training program for the young engineering, administrative and technical personnel and implement by hiring training specialists f rom utilities or specialized training organizations to train at Training Institutes in Kenya or in the region. The M S P will also be expected to implement measures to optimize the size o f the company’s labor force and i t s deployment.

39

Annex 4

Regulatory Capacity Strengthening (US$1.35 million)

8. the responsibility for the economic and technical regulation o f the power and downstream petroleum subsectors. The existing Electricity Regulatory Board (ERB) would be reorganized and expanded to include the petroleum subsector. ERB’s draft business plan for FY 2004/05 through FY 2009/10 contains a detailed work program for the power subsector regulation and would require modification to incorporate activities related to regulation o f the petroleum downstream upon passage o f the Energy Bill.

The Energy Bill proposes establishment o f an Energy Regulatory Commission (ERC) to be given

9. building support t o ERB/ERC:

Support to the ERB/ERC (US$O. 70 million) This Project would provide the following capacity

(a) Business Plan Implementation Support (US$0.50 million). The ERB/ERC will retain consultants services to assist with preparation of: (i) proposals for an organizational structure for the single sector regulatory agency, staffing requirements and j o b descriptions; (ii) power tar i f f setting guidelines and tar i f f reviews; (iii) guidelines for licensing operators and model licenses; (iv) secondary legislation for implementation o f the Energy Bill; (v) technical regulations for the petroleum downstream subsector; and (vi) management information system appropriate for a modem regulatory agency.

(b) Advisory Services (US$O. I O million). Short-term advisory services will be availed to the ERB/ERC to enable it to call upon the services o f specialized experts during the business plan period fo l lowing the completion o f the business implementation plan contract.

(c) Study Tours (US$O.IO million). In view o f the highly technical nature o f regulatory functions, i t i s essential for the Board members, who come from diverse backgrounds, t o receive training as wel l to visit other countries with successful regulatory regimes in order to gain adequate knowledge for decision making. Whi le a number o f Board members have received training under the ongoing Energy Sector Reform and Power Development Project, due to changes in Board membership in the past few years, it i s necessary to continue training. This Project will provide leaming opportunities for several commissionershoard members through study visits t o one or more countries.

10. Support to the Kenya Bureau of Standards (USS0.65 million). In addition to the ERC’s responsibility for the regulation o f the petroleum downstream with respect t o licensing, health, safety and environmental matters, the K E B S will retain responsibility under The Standards Act, Cap 496, for establishing and enforcing product specifications for petroleum products. The deregulation o f the petroleum subsector in the mid-1990s has led to an increase in the number o f trading companies and, in the absence o f a strong regulatory framework, to several governance issues, such as unsafe dispensing outlets, mixing o f motor fuels with kerosene for financial gains associated with the lower taxes o n kerosene relative to other products, and diversion o f products meant for the export to the domestic market. This proposed subcomponent is intended to: (i) strengthen the K E B S capacity to establish product specifications for some products and to review the existing ones through staff training (US$40,000); (ii) provide product specifications testing equipment (US$0.39 million); and (iii) provide logistical support-- computers and vehicles(US$0.22 mill ion) -- to the proposed Petroleum Standard Monitor ing Unit within the KEBS.

Other Sector Entities (US$1.32 million)

1 1. follows:

The Project will also provide support for capacity building to the MoE and the KenGen as

40

Annex 4

(a) Ministry of Energy (US$I.O million). Under the ongoing Energy Sector Reform and Power Development Project support was provided to the M o E through training o f i ts staff and consultants services to i t s Project Implementation Support Group. The training o f financial management staff has helped to improve the processing o f withdrawal applications o n the IDA Credit and o f other staff to participate in the policy formation process leading to the preparation o f the Sessional Paper o n Energy’. Nevertheless, the high staff turnover in the MoE, as in government in general, makes continual training a necessity. A recent Service Del ivery Survey carried out by M o E indicates the need for further capacity building. M o E has identified, amongst others, the following key areas requiring more capacity building: financial management, procurement, legal, auditing, project planning, evaluation and management. A detailed training program has been prepared and will provide the basis for the preparation o f prioritized annual programs totaling US$0.49 million--over the five-year implementation period. In addition the Project will include: (i) a Project Coordinator to head MoE’s P I T and to chair the PCT charged with overall project coordination and monitoring; (ii) an engineering adviser to support the Permanent Secretary in managing the preparation o f a Least-Cost Power Development Plan, reviewing the reservoir optimization study for the Olkaria I and I1 fields and providing general technical support; (iii) a petroleum sector expert t o assist the Permanent Secretary in managing the studies for the proposed LPG Import and Distribution Infrastructure Project, the petroleum sector regulation component in liaison with KEBS, and providing other general technical support as required; (iv) a renewable energy specialist to help M o E develop policies for promotion o f renewable energy; and (v) a rural energy specialist to support MOE in implementing i ts policies o n rural energy as described in the Sessional Paper o n Energy; and (iv) short-term consultants’ services for tar i f f studies, workshops and other studies. The total cost for these services i s estimated at US$O. 51 million.

(b) Kenya Electricity Generating Company (US$O. 32 million). KenGen has prepared a comprehensive capacity building program comprising training for i t s management and staff in finance, procurement, partnering arrangements with other utilities. This will provide the basis for KenGen to prepare prioritized annual programs during the Project implementation period. The IDA Credit will include US$320,000 to help KenGen with financing o f the program over a five- year period.

Project Component B: Studies and Engineering Services (US$10.04 million)

12. This component comprises geothermal development studies, feasibility studies for power generation and distribution, environmental impact assessment studies and engineering services for project management (from design through to supervision).

Geothermal Development Studies (US$1.42 million)

(a) Geothermal Reservoir Optimization Study (US$O. 85 million). This study will determine the size, availability, and quality o f the Olkaria I and Olkaria I1 geothermal fields, and the adjacent Olkaria IV power plant. The study will: (i) refine the geothermal resource model o f the above and their expandable areas to determine their full and sustainable electrical power production potential; (ii) recommend the feasibility o f using these resources to stabilize the current generation needs; expand the installed capacity in general and address the immediate need to expand Olkaria I1 capacity by the addition o f a third unit; design a dnlling program to maintain production o f steam at the recommended level, including incorporating new extension o f the f ie ld to supply additional units; and optimize the size o f future generating units; (iii) cover the preparation o f a feasibility

’ The Sessional Paper o n Energy was approved by Cabinet o n M a y 13,2004 and submitted to Parliament.

41

Annex 4

report o f the optimization and stabilization o f the geothermal resources o f the above areas, and their effective utilization in and/or in additional power plants at sites to be identified as part o f the study, including their costs and scoping o f their potential environmental impacts; and (iv) assess the need for preparing a pre-feasibility study in potential geothermal sites and draw up terms o f reference.

Panel of Experts Board of Consultants(US$O. 07 million). KenGen will either re-appoint the Olkaria I1 Board o f Consultants or establish a new Board with the required expertise to: (i) in the f irst instance, provide an opinion, based on available information and documents, as to the availability o f adequate steam supply for the sustainable operation o f the Olkaria I and I1 plants, including the proposed third unit at Olkaria 11; (ii) fol low up the progress and review the findings o f the Optimization Study; and (iii) review the conceptual design o f the main features o f the third unit before the start o f the preparation o f the bidding documents.

Geothermal Business Plan (US$O,SO million). This sub-component would support the Government with management and financial advisory services to develop and launch a comprehensive prospectus o f the proposed Geothermal Development Special Purpose Company . This will cater for: (i) the public-private partnership to develop Olkaria I V or other sites identified by the geothermal reservoir optimization study; (ii) the development o f a medium-term program for geothermal resource exploration activities (appraisal o f the Longonot and Suswa Prospects plus exploration o f the Menengai, OL Banita, h s , Bogoria, and Eburu Prospects); (iii) indicative financing p lan for the company, talung into account the prospective funding sources; (iv) institutional capacity building requirements; and (v) corporate governance arrangements.

Power Generation and Distribution Feasibility Studies (US$I.UI million)

Distribution Upgrading (US$O. 19 million). The objective o f this study, which has just been completed, was to: (i) reduce losses from the current level o f about 18.7% to about 14.5% over a five-year period; (ii) to improve system reliability and performance; (iii) increase access to electricity; and (iv) restructure KPLC to ensure that i t operates commercially in al l spheres o f i t s activity. The study has established performance targets in order to monitor realization o f the objectives. The investment needed to reinforce the distribution system were assessed and the economic and financial impacts evaluated.

Generation (Kipevu Combined Cycle Gas Turbines-CCGT) (US$O. 12 million). The study which has also jus t been completed, had the objective o f determining the least cost option f rom a number o f conversion altematives considered by a previous study carried out in year 2000. Because o f high fuel operating costs, the findings o f the Update l ed to consideration o f other non- gas turbine sources o f generation. Expansion o f the recently completed Olkaria I1 Geothermal Power Plant, by adding a third unit was identified as the least-cost candidate for implementation.

LPG Study (US$O. 70 million). Assessment o f Kenya’s and the neighboring countries demand for LPG i s the main thrust of the planned study. Infrastructure needs to meet the demand forms also part o f the study. Selection o f the firm to carry out the study wil l be made fol lowing the evaluation o f consultants proposals which i s currently in progress.

Studies for Preparation of Future Projects (U531.5 million) provides for consultancy services to carry out studies and other analyses required for preparation o f future projects as may be identified by the least-cost development plan for power and other sources for other energy forms.

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Annex 4

Environmental Impact Assessment Studies (US$0.19 million)

13. The environmental impact o f the Generation component o f Kipevu combined cycle gas turbines has been camed out. Due to the results o f the Update Study which showed high costs o f the turbines, a cheaper near-term solution has been determined to be the replacement o f K ipevu by the third unit o f Olkaria 11. KenGen employed a consultant, on an urgent basis, to carry out an in i t ia l assessment o f the l ikely environmental and social impact o f the third unit. The consultants concluded that the impact i s l ikely to be moderate to negligible. A fuller ESIA i s in progress o n the basis o f terms o f reference cleared by NEMA, and the draft report i s expected to be submitted to the Bank by June 15,2004.

Engineering Services (US$3.92 million)

14. design for the extension o f the Power House, the cooling tower, the steam turbine generating sets taking due regard to n e w but proven technology, the generator transformer, and the switchgear and control equipment; (ii) prepare Specifications and Drawings, and Bidding Documents in accordance with the Bank’s guidelines, fo l lowing the review o f the conceptual design o f the Olkaria I1 extension by the Board o f Consultants. KenGen has prepared terms o f reference for the Engineering Services Consultant which, in addition to conceptual design will include supervision, for clearance by the Wor ld Bank.

Design and Supervision of Olkaria II. A consultant will be employed to: (i) prepare a conceptual

15. (US$2.0 million). Under Terms o f Reference to be prepared by KF’LC, a consultant wil l be employed to: (i) review or prepare detail design including drawings for the major substations (new or being upgraded) and the distribution network; and (ii) supervise the construction and commissioning o f substation plant and equipment as wel l as the distribution network; and (iii) prepare a completion report o n the Upgrade and Reinforcement component.

Detail Design and Supervision of the Distribution Upgrade and Reinforcement Component

16. prepare Terms o f Reference to employ a consultant to review and/or prepare a detail design o f the S C A D N E M S system described in the March 2004 o f the Fichtner Final Design Report and supervise the implementation o f software and hardware.

Detail Design and Supervision of the SCADA/EMS component (US$1.9 million). KPLC will

Project Component C: Generation Component (US853.5 million)

Background

17. For the Generation Component, the Project Concept Note had included the conversion o f the 2x30 MW Gas turbines at K ipevu to combined cycle operation, in accordance with the Government’s request o f July 15,2003. The request was based o n a Feasibility Study prepared for KenGen. However, as explained below the combined cycle gas turbine operation was found to be not the least cost solution following the analysis o n the findings o f an update.

18. Plan and projected for implementation starting in 2005. KenGen embarked o n a feasibility study to realize the benefits of combined cycle gas turbines , and employed independent consultants, Sinclair Knight Merz. The consultant’s findings, contained in the Final Reportg o f April 2002, indicated that the fired option would have a levelized economic cost ranging f rom 0.95 U S cents to 3.07 U S centskwh, the

This conversion has been recognized and incorporated in the Least Cost Power Development

The Kenya Electricity Generating Company Ltd: Feasibility Study on the conversion o f the Open Cycle Kipevu Gas Turbine Power Station to a combined Cycle Power Station by Sinclair Knight Merz.

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Annex 4

Project

Olkaria I1 Extension M S Diesel @ Kipevu Kip No. 7 Rehab Combined Cycle IJnfired

former providing 36 MW additional capacity and the latter 70 MW. The respective investment costs were U S $ l 5 m i l l i on and U S $ 3 6 mi l l ion respectively. With the background o f the 2000/2001 drought and the approaching expiry date o f the Westmont IPP contract with 44 MW capacity at Kipevu, the attractiveness o f the figures prompted an update o f the Sinclair Knight Merz feasibility study. The objective o f the update was to optimize the Sinclair Merz Feasibility Study and produce a clear recommendation o n the least cost option for the conversion.

Additional Capex F ixed Costs Fixed Costs Fuel & V a r Total

MW M i l l i o n @ 12%d.r. USc/kWh U S c k W h U S c k W h capacity US$ US$/kW/yr @0.8LF O & M costs

35 55 274 3.91 1 .o 4.91 34 30 146 2.09 4.26 6.35 30 12 112 1.60 6.32 7.92 34 39 210 3 .OO 5.73 8.73

19. chaired by the Permanent Secretary o f M o E and attended by the senior management and staff o f KenGen and KPLC, and members o f the Wor ld Bank Energy mission. Fichtner's assumptions o f capacity factor o f 80% was considered not representative for the operation o f the gas turbine in a heavily hydro/geothermal/thermal generation mix o f Kenya's power system. The incremental cost and incremental benefit approach was side-lined in favor o f total (existing plus new) capacity o f the turbines. The energy cost determined in the study for the least cost alternative lA, involv ing a 35 MW Heat Recovery Boi ler together with a new steam turbine generator-alternator placed near the existing Gas Turbine Plant i s very high, mainly due to the use o f the expensive industrial diesel o i l fuel for firing in the conversion process. Tables 1A through lD, which give capacity and energy balances under hydrological dry and average conditions, are available in the Project File.

The draft Update o f the Feasibility Study Report" was reviewed o n March 9,2004 at a meeting

Alternatives Considered

20. M o E therefore considered other options to determine an alternative or alternatives that would have lower energy costs. The options considered were the following:

The very high energy costs negate the G o K objective o f containingelectricity tariffs increases.

(a)

(b) (c) (d)

Install 34 MW Heat Recovery Boi ler for the conversion o f existing 2x30 MW GTs to combined cycle plant Install 34 MW M S Diesel at K ipevu or Lanet Rehab Kipevu No. 7 Steam Plant o f 30 MW Add 35 MW Geothermal Plant in the recently commissioned Olkaria I1 power plant, where adequate stem i s available

The tar i f f implications o f these four options are shown in the table below:

21. energy cost at 4.91 UScents/kWh. The main difference i s in the fuel cost column which gives the lowest

F rom the above table, extension o f Olkaria I1 with 35 MW additional unit provides the lowest

lo The Kenya Electricity Generating Company Ltd.: Kipevu Combined Cycle Power Plant, Update o f Feasibility Study Report, March 2004 by FICHTNER.

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Annex 4

Alternative 1 (without Project)

cost since adequate steam i s available to run Olkaria I1 third unit. A screening curve based on average incremental cost at 12% discount rate for the above options shows the combined cycle gas plant t o be a cheaper option for capacity factors below about 40%. For base load operation, i.e. within the average load factor o f the Kenya power system, geothermal i s the cheapest by a very wide margin.

Alternative 2 with CC 34 MW Alternative 3: with Geothermal 32 MW

22. The capacity and energy balance tables for the l i fe o f the Project indicated that the system will be capacity, and slightly energy, constrained for very dry hydrology conditions. For average hydrology, the constraint i s substantially reduced for capacity and is nil for energy. The need for thermal complementation during dry years needs n o proof for Kenya with the 1999/2000 drought and the emergency power supply measure sti l l vivid. The G o K therefore carried out further analysis amongst the fo l lowing three alternatives: (1) Retaining Westmont GT with n o Kipevu Combined Cycle and no Geothermal additional capacity ; (2) Retaining Westmont and adding Combined Cycle, and (3) Retaining Westmont and Adding Geothermal 32 MW. The Present Worth Cost o f these alternatives in United States Dollars i s estimated to be:

2,074,295,000 2,08 1,000,000 100.1% 100.4%

Table 4.2: Present Worth Costs of Considered Generation Options

2,072, 000,000 100%

23. the difference. The economic advantage o f the relative proximity o f Olkaria I1 to the load center i s not taken into account in the above figures.

Olkaria I1 extension (i.e. installation o f the third unit) i s the least-cost choice, however marginal

24. following the connection o f wells OW-32 and OW-34 under Credit 2966-KE, the steam available currently stands at an equivalent o f about 70 MW. There is surplus steam to generate 25 MW.

Steam Supply System. The Olkaria I power plant has an installed capacity o f 45 MW. However,

25. generate 70 MW, they have a better specific steam consumption than those at Olkaria I and therefore generate the power using less steam than originally envisaged. It i s estimated that the steam available at the Olkaria I1 power plant i s 98 MW. This indicates a surplus steam supply for 28 MW. The total estimated steam surplus between the two plants i s therefore equivalent t o 53 MW. The extra steam i s thus sufficient to drive the third unit o f 35 MW at Olkaria 11. The steam gathering systems f rom the two fields would be interconnected by linkmg wel l OW-32 from Olkaria I to wel l OW-726 at Olkaria I1 using a 1050" diameter dry steam line. A connection point will be provided in the new interconnection l ine to facilitate future make-up we l l connections that may be needed to replenish drawdown fkom production wells.

The Olkaria I1 power plant has a Nameplate capacity o f 64 MW. However, although the units can

26. and space for the extension of: (i) the power house to house the turbo-generator; (ii) the cooling tower; (iii) the switchyard for the additional unit transformer and bus-bar arrangement; and (iv) the control room and connecting cables.

The Power House and Equipment. Olkaria I1 Power plant has provided a bay for the third unit

27. During negotiations it was agreed that the contracting arrangement would be an Engineering Procurement and Construction Contract (EPC). KenGen has retained the engineering consultant for Olkaria 11 to prepare conceptual designs, specifications and bidding documents for the selection of the EPC contractor.

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Annex 4

1x35 MW generating unit and control Power house and switchyard extension Substation: generation transformer & switchgear Steam f ie ld interconnection

28. The M a i n features o f the Olkaria I1 extension are:

40,000,000 10,000,000 3,000,000 3,500,000

(a) (b) (c) (d) (e)

Civil works construction for the power house, the cooling tower and the switchyard. Steam gathering system from Olkaria I and I1 areas and connection to the third unit Procurement and installation o f the steam turbine generating unit Procurement and installation o f the generator transformer (1 1/220kV), and Procurement and installation o f cables and control room panels.

Engineering & supervision Total

29. we l l above the Engineer’s estimate, the cost estimate for the above features i s US$57.4 mi l l ion with a provisional breakdown o f the cost as follows:

Cost Estimate. Based on costs for the recently commissioned Olkaria I1 power plant, which were

3,866,000 57,386,000

Table 4.3: Breakdown of Estimated Costs for Olkaria 11 Extension

30. The tentative financing arrangements are that the Bank and the EIB wil l jo in t ly finance the foreign costs o f the physical part of the project o n a 50/50 basis, the Bank will finance the costs for consultants services and KenGen will provide the local counterpart funding requirements.

3 1. the selection o f engineering consultants under the Bank’s guidelines accounts for 3 1 weeks and the construction phase for the other 141 weeks. This i s about three years six months f rom the date disbursement i s available f rom the proposed credit. Assuming effectiveness to be end o f September 2004, the commissioning date i s estimated to be about March 2008.

Implementation Schedule. The total estimated period to commissioning i s 172 weeks, o f which

32. scenario and 95 MW with Average hydrology. The shortfall will be reduced through speedier implementation o f the Olkaria I1 extension under an EPC arrangement.

KPLC’s capacity balance shows a capacity shortfall o f 128 MW with the very dry hydrology

Project Component D: Distribution Upgrade (substations, lines and meters - US$115.15 million) and SCADAEMS (US$27.62 million).

33. losses to defined targets and increase access to electricity supply.

This component’s objective i s to improve the quality and reliabil i ty o f electricity supply, reduce

34. years. Some 5%-7% i s accounted for by non-technical losses. KPLC’s strategy i s aimed at reducing the losses by about 4% during the fol lowing f ive years through country-wide inspection o f customers’ premises to check and take corrective action on: incorrect meter reading, tampering with meters, non- metered supply, defective metering and unbil led consumptions. KPLC expects a revenue yield o f KShs200 mi l l ion yearly o n account o f the anticipated one percent annual reduction o f non-technical losses. The physical component o f the Distribution Upgrade component will address measures to reduce technical losses (including the need for segregating transmission and distribution losses), which largely i s

Electricity losses in generation, transmission and distribution averaged about 21% in the last three

46

Annex 4

contributed by overloaded networks including localized overloaded substation transformers, long distribution and transmission lines and sub-optimal and sub-standard maintenance o f distribution systems.

35. Nairobi area, 4% for Coastal area, 26.9% for Western Kenya, and 7.1% for all regions served by KPLC. The increase in connections for KPLC customers from 2002 to 2003 was 41,419. This number i s expected to increase to 130,000 per year (of which about 80,000 would be due to the Project), a challenging task with the expected impact on peak load and increase in technical losses unless counterbalanced by distribution reinforcement. In the short term the Distribution Upgrade Component will support the loss reduction measure and the procurement o f additional energy meters.

Five-year statistics show that customer connections have increased at an average rate o f 6.8% for

36. 2003/04 to 20% by the end o f the Project. These figures assume a connection rate o f about 130,000 customers annually during project implementation, compared to about 50,000 in FY2003/04. In addition to the need o f additional staffing to substantially increase the connection rate, KPLC needs to introduce a more customer friendly connection policy to accelerate access to electricity.

Access to electricity wil l increase from about 15%, based on the Household Energy Survey, in

37. System reliability (measured in terms o f number o f hours o f unplanned and planned interruptions), low voltage levels and voltage dips, steady supply frequency are important measures to monitor continuity and quality o f electricity supply. Statistical information on the important parameters needs to be sustained and appropriate targets established to gradually improve through technical system corrective measures. Data collection, analysis and recording are essential to set up appropriate monitoring systems. The response time to repair interruptions, the number o f calls per month per customer are the simplest indicators to introduce for monitoring local distribution system interruptions.

SCADA/EMS

38. The need for and the technical feasibility and economic viability o f upgrading KPLC's existing SCADNEMS system i s covered by a feasibility study carried out for KPLC by Fichtner". KPLC intends to replace and expand its SCADA system with the use o f the latest technology taking account o f future needs and the wider area coverage by the system. This will include connecting the Western Kenya Control Center to the NCC. The number o f substations connected to the area control centers will also be increased. Functionality of the SCADNEMS system will be further enhanced and software packages added for optimum operation and energy management o f the transmission network. The requirements o f the proposed regional interconnection that encourages power trading will also be borne in mind in designing the expansion of the SCADA system.

39. (SJNDAC) from Asea (now ABB) was commissioned in 1990. I t consists of:

The existing SCADA i s based on the Systems for Integrated Network Dispatch and Control

National Control Center supervises the 220kV and 132kV transmission systems and monitors Area Control Centers) and Nairobi Area Control Center Coast Area Control Center installed at Rabai substation acquires coast region data using seven Remote Terminal Units (RTUs) Kamburu Area Control Center installed at Kamburu substation acquires data from the seven forks hydro power stations and Mt Kenya Region via 6 RTUs.

~

The Kenya Power and Lighting Co. Ltd, Feasibility Study of the ReplacemedUpgrade and Expansion of the SCADA/EMS system, Final Design Report, March 2004.

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Annex 4

40. the respective areas.

All area control centers are responsible for the supervision o f the 66kV and 1 lKkV network in

41. station i s situated at Kamburu power station.

Mt Kenya region i s served by Becos 04 S C A D A system with two Indactic 33 RTUs. The master

42. system and four Indactic 33 RTUs manufactured by BBC. Kamburu power station also has a Becos 04 S C A D A system and two Indactic 33 RTUs. These two master stations are not connected to the S INDAC system. They are stand-alone systems.

Western Kenya i s served by Lessos substation control center. T h i s has a Becos 04 S C A D A

43. Their manufacturers n o longer support them. Further, a l l these systems use proprietary protocols for their RTUs forcing KPLC to rely o n the manufacturers when adding network extensions to the S C A D A system.

The S C A D A system central computers and the RTUs currently used by KPLC are obsolete.

44. for an increased bandwidth required by the proposed system.

The existing telecommunications system wil l be upgraded through the use o f fiber optics to cater

45. The fiber optic system will also be used for:

(a)

(b) (c) (d)

Protection -modern digital relays require more bandwidth than the Power L ine Carrier can provide KPLC Wide Area Network - currently using the Kenstream leased lines f rom Telkom Kenya Upgrade o f the operational telecommunication system Provision o f capacity to meet future communications needs

46. requirement o f U S 3 0 . 6 mi l l ion broken down as follows: Hardware and software 22.8%; Telecommunications network 40.7%; SCADA in substations 20.9%; Building extension, spares and training 8.3% and Engineering and Project management 7.3%.

The tentative findings o f a consultant, commissioned by KPLC, indicate an investment

Mt. Kenya Trunking Radio System

47. The primary means o f communications in KPLC between f ie ld staff and office staff are the radio systems. For security of staff and installations, VHF radio systems are used in daily operations in system control, transmission, distribution, construction and emergency services. The f ie ld personnel get verbal instructions f rom their supervisor and system control centers over the radio network. They in ~LU-I-I

execute the instruction and give feedback over the radio network.

48. maintain, as the spares required are scarce, expensive and often require special request f rom the manufacturers o f the system. This leads to l o w system availability. This has adversely affected operations.

The Mt. Kenya Radio has become old, obsolete, and very unreliable. I t i s very expensive to

49. controller therefore sometimes required to pass messages through a third party. This poses a safety risk.

The System i s not integrated and operates on 3 different stand alone Repeaters. The System

50. system to improve the radio system coverage, hence improve customer care and quality o f supply, in the Mt. Kenya region. The preliminary estimate for the system i s Ksh250,000,000 ( U S 3 . 8 million).

The existing Radio System would be replaced by an integrated system such as the Trunking

48

Annex 4

Description

Part D 1: Substations (including switchgear and control)

Nairobi Area

Nairobi North. Nairobi North substation i s supplied by 2x22OkV transmission lines. This i s stepped down to 66kV by 220/66kV substation transformers commissioned in 2003. The Project will finance 75km o f 66kV l ine on impregnated wooden poles to feed a number o f new and existing substations around Nairobi City. The outline o f the substations to be supplied by this line are:

1.

2.

3.

4.

5.

6. 7.

8.

Jevaniee substation. Uprating i t s capacity from 46MVA to 90MVA through installation o f 2x45MVA 6611 1kV transformers to meet the growing demand o f City Center load. Westlands substation (new). Installation o f 3x23 MVA 6611 1kV substation with 7 feeders. Gigiri substation. Installation o f 3x23 MVA 6611 1kV substation. Ngong Road substation (site to be identified). Installation o f 2x23MVA 6611 1 kV substation. Athi river quarries. Installation o f 1x23 MVA 6611 1kV substation Karen substation. Upgrade o f from 30 MVA to 46 MVA. Kileshewa substation. New circuit breakers and short cable to connect to O M line. Kitsuru substation. Circuit breaker and km feeders to connect to distribution network.

Cathedral and Ruaraka Substations, Refurbish by installing breakers and creating a double 66kV bus-bar arrangement at Ruaraka. (iii) Replace 13 panel 11kV switch board at Athi River Substation.

Nairobi South substation. Reinforcement by replacing 35 panel 1 1 kV switchboard, modifying existing 66kV busbar arrangement and installing 12 new 66kV switchgear units.

Specific Objectives and Expected Outputs

- The 66kV line will provide additional supply from the grid to overloaded transformers and to new substation. Wi l l help complete the 66kV Nairobi ring, thereby improving reliability o f supply. - Overloaded transformers at Jevanjee, Karen and Gigiri substations. Meeting growing load by building new substations. The actions will help reduce technical losses and improve voltage conditions in the main load areas o f the capital city. - Plans for Cathedral and Nairobi South will contribute to improving reliability o f supply in the City. - Loss reduction and voltage improvement

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Annex 4

Description

Mombasa (Coastal) Area

Mombasa area:. (i) Increase capacity o f the 45MVA 132/33kV substation by 23MVA to 68MVA; (ii) Reinforcement and upgrade o f Likoni 33/11kV substation from 8 M V A to 15MVA; (iii) Installation o f 3 new 33/11kV substations at Kanamai (1 x 7.5MVA), Watamu (1 x 7.5MVA)(includes 6km o f 33kV olhead l ine construction), & on the Island (1 x 23 MVA), and (iv) (iv) Install new 33111kV 7.5MVA substation at Kiembeni; and (v) Upgrading o f Voi’s 132/33kV substation from 5 M V A to 10MVA.

KPR substation. Installation o f 2x 33kV circuit breakers, lx7.5MVA 3311 IkV transformer and replacement o f obsolete 7-panel 1 l k V switchboard.

Western Kenya

(i) Lessos substation: Uprating the 132/33kVsubstation by installing 2x23MVA transformers; Establishing a new 2.5MVA, 3311 1kV substation at Butere; (ii) (i) Makutano and Cheranaani : Establish new 23MVA 132/33kV and 2.5MVA 3311 IkV substations. (ii) Establish new 23MVA 132/33kV and 2.5MVA 33/11kV

substations at Makutano and Cherangani respectively. (ii) Uprate 33/11kV substations at Lessos and Sondu by installing one additional 2.5MVA transformer at each station; (iii) Install a total o f 34MVA, 1 1 kV shunt capacitors at various substations (iv) Replace 22No. unserviceable autoreclosers. In Nakuru area: (i) Rehabilitate Naivasha and Lanet substations by

the installation o f a total o f 8No. 132kV Circuit Breakers (4No. at each station).

Install a total o f 34MVAr, l l k V shunt capacitors at various substations.

Replace 22 No. unserviceable autoreclosers. Mount Kenya Area

(i) Uprate Kamburu 132/33kV substation by 23MVA and Embori 3311 IkV substation to 2.5MVA (ii) Install Radio System able to cover region and thereby replace limited coverage, old and obsolete existine: svstem. All Areas

LV network. Reinforcement and construction o f some 2000 km o f low voltage network mainly in Nairobi and also in the regions.

Switchgear. Replace existing 1 1kV metal-clad indoor o i l circuit breakers (35 incomers, 17 bus-sections, 142 feeders and 93 metering arrangements) with more reliable vacuum or SF6 units,

Specific Objectives and Expected Outputs

To meet growing demand and improve reliability.

Improving reliability.

-Providing additional supply capacity and reduce technical losses, also by installing shunt capacitors at 11kV.

-Improving reliability o f supply *

Providing additional supply and improving voltage levels.

-To improve losses and connect new customers. -To increase access to electricity and avoid meter tampering. Reduction o f non-technical losses. -Improve reliability o f supply.

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Annex 4

1. Reconductor a total of 238km o f 33kV Ohead lines in Naukuru, Naivasha, Kisii, Sondu, Bondo areas;

2. Reconductor a total o f 1 17km o f l l k V overhead l ine in Nakuru, Miwani, Naivasha and Njoro iMolo areas; Construct a total o f 26km o f 33kV Ofhead l ine in Sondu, Cherangani and Eldama Ravine areas.

3. Construct a total o f 26km o f 33kV Ohead l ine in Sondu, Cherangani and Eldama Ravine areas.

1

' 4. Construct 1Okm o f 33kV overhead l ine in Butere.

I

Description

PART D 2: DISTRIBUTION L I N E S

Nairobi Area. Planned Reinforcement and construction o f new lines are:

1. Construction o f a total o f 75 km o f 66kV lines f rom Nairobi N o r t h

2. Reinforcement o f l l k V feeders through re-conductoring a total 57km existing lines and construction o f 12.5km o f new lines

3. Construct new 2.8km l l k V line and reconductoring 3.lkm l l k V line.

4. replacement o f 3.7km 66kV cable f rom Cathedral to Nairobi West substations.

5. Reconductor a total o f 59km o f l l k V O/H lines in Gigiri, Outering Rd/Mombasa Rd, DandoraKariobangi and City Center areas.

6. Reinforce the LV network in Marsabit by uprating conductors.

r

7. Purchase cable diagnostic equipment. Mombasa (Coastal Area)

1. Reconductor a total o f 8km o f 33kV l ine to 300 AAA conductor.

2. Reconductor totals o f 15km, 6km and lOkm o f l l k V overhead l ine feeders in Malindi, Bamburi and Kwa le areas. In Kwa le area, construction o f 3km o f 1 1 kV O/H l ine wil l also be reauired

Mount Kenya Area

Reconductor a total o f 66km o f 1 1 kV overhead lines in Makuyu and Chinga areas and 30km o f 33kV overhead lines in Tana and Embu area.

specific Objectives and Expected Outputs

-Increase supply :apability . -Reduce technical losses. Zonnect new customers.

-Improving reliability in City Center.

-Reduce technical losses and improve voltage levels.

Improve voltage levels and reduce losses.

Improve voltage levels and supply capability. Reduce technical losses and increase access.

Reduce losses.

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Annex 4

Description

Part D 2: Energy Meters

1. Installation o f 100 Energy Meters at locations where needed to segregate transmission and distribution loses.

2. Installation 100 energy meters o n 11kV and 33kV distribution feeders.

3. Replacement o f 5,000 electromechanical 3phase energy meters by electronic ones (continuation o f initiated activity).

4. Purchase o f 400,000 electronic meters to accelerate access to electricity.

Part D3: SCADA/EMS

1. T o Upgrade with application o f recent fast growing technology and expand the coverage o f the SCADA system through installation o f hardware and software, improving the telecommunications system including the use o f fiber optics, and widen coverage o f the substations.

2. Install new Radio System for Mt. Kenya Region Trunking Radio System able to cover region and thereby replace limited, o ld and obsolete existing system.

Specific Objectives and Expected Outputs To obviate meter losses and prevent tampering; to substantially increase access to electricity particularly to the urban poor, to be monitored in terms o f number o f customers connected annually. Quantification o f transmission losses will be monitored.

To monitor generation and transmission system performance and, in due course, manage the country’s grid code.

To improve the radio system coverage hence improve customer care and quality o f supply, in the Mt. Kenya region

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Annex 5

Project Costs

KENYA: Energy Sector Recovery Project

Project Cost By Component

1. Part A: Institutional and Capacity Building 2.Part B: Studies and Engineering Services 3.Part C: Olkaria I1 Extension 4.Part D: Distribution Upgrading

Total Baseline Costs Physical Contingencies

Price Contingencies Total Project Cost Total Financing Required (Excluding IDC)

Local 629,710

1,196,483 6,903,484

27,588,444 36,318,121 4,171,396 2,047,150

42,536,667 42,536,667

US$ Foreign

5,060,239 7,847,120

41,064,237 102,055,898 156,027,494

17,911,936 9,041,3 16

182,980,746 182,980,746

Total 5,689,949 9,043,603

47,967,721 129,644,342 192,345,615 22,083,332 11,088,466

225,517,413 225,517,413

Project Financing Plan

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Annex 6

Implementation Arrangements

KENYA: Energy Sector Recovery Project

1. staffed PITs to implement their respective parts o f the Project. T o avoid the creation o f special purpose organizational units for the l i fe o f the Project, the PITs wil l be established within the organizational units that are normally responsible for implementing similar projects. This project implementation model i s based o n the workable arrangement adopted for the ongoing Energy Sector Reform and Power Development Project. The PITs will have overall responsibility for monitoring their respective components o f the project, including preparation o f progress reports, updating o f project costs and financing plans, and ensuring that project and implementation plans are kept up to date. They will, therefore, require to be adequately staffed for the duration o f the project with staff and/or consultants with experience and skills in the core functions o f project management (i.e. procurement, and accounting and financial management, and project monitoring). T o facilitate the implementation o f the Project, the PIT heads will be seasoned project management professionals, with convening power within their PEAS, or recruited consultants with similar experience in other organizations. The P I T heads will report to the chief executives o f their organizations: i.e. for the KPLC components, init ially to the Managing Director and later to the General Manager once the M S P has been recruited; and for the KenGen and M o E components, t o the Managing Director and Permanent Secretary respectively. In addition, to ensure effective implementation and accountability o f PITs, each PEA will establish a management oversight arrangement through which the PEA management will monitor implementation o f its project components.

The PEAS--the MoE, K P L C and KenGen--will establish, by Board presentation, adequately

2. Fo r the overall project coordination, monitoring, and reporting, a Project Coordination Team PCT comprising the PIT Heads o f MoE, KPLC and KenGen will be established and wil l operate under the chair of the overall Project Coordinator and MoE’s PIT head. Consultants recruited to the PITs, including the overall Project Coordinator, will be selected in accordance with the Bank’s guidelines for selection o f individual consultants and will be required to have substantial experience in their relevant disciplines. The PCT will consolidate project implementation progress reports and manage special audits of the management services contract, and submit results to the Ministries o f Finance and Energy for decisions.

3. executives and heads o f the PITs o f the PEAS to review project implementation and resolve any issues requiring the attention o f senior sector management. The overall Project Coordinator will serve as secretary at these meetings.

Periodically the Permanent Secretary o f the Ministry o f Energy will chair a meeting o f the chief

4. MoE’s P I T will also implement the activities for strengthening regulatory capacity, in particular, it will handle a l l the accounting and procurement-related matters. The beneficiary agencies for the subcomponent for strengthening o f regulatory capacity, the ERB and the K E B S will each appoint a focal point person to be assisted by 2 or 3 other designated staff in liaising with the M o E to carry out their activities. For the KEBS, the Team Leader o f the P S M U will be the focal point person. ERB/ERC will similarly appoint a focal point person.

5. is a condition for Board, except that the selection of an Engineering Adviser and a Project Coordinator for MoE’s PIT, on the basis of terms of reference satisfactory to the Association, shall be completed by Credit effectiveness, and (ii) the terms of reference for the PITs and the skills and experience of the staff selected for the PITs shall be acceptable to the Bank.

During negotiations it was agreed that: (i) the establishment of fully and adequately staffed PITs

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Monitoring and Evaluation

6. Performance monitoring wi l l take place at two levels. At the Project level, monitoring o f performance and o f the key indicators will be undertaken by the Project Implementation Teams of: (i) K P L C for the Corporate Recovery Program and Distribution Component; (ii) the Ministry o f Energy for the strengthening regulatory capacity subcomponent and for the Ministry’s own capacity building activities; and (iii) KenGen for the generation component and its own capacity building components. The PITS will each prepare quarterly progress reports summarizing, inter alia, the actual project outcomes in relation to targeted outcomes. For K P L C and KenGen, the offices responsible for performance monitoring (Chief Manager, Planning, Research and Performance Monitoring (KPLC) and Manager for Technical Assurance (KenGen) will audit the performance indicators stated in the quarterly progress reports for accuracy before submission o f the reports to the Ministry o f Energy and the development partners.

7. Corporate level performance will have significant impact on the achievement o f project outcome indicators; e.g. poor financial performance by KPLC may hinder expansion o f the distribution system and thereby result in failure to achieve customer connection targets. Hence, corporate level performance will be monitored and reported through the quarterly progress reports. In addition, corporate-level performance will be monitored and enforced through a system o f performance contracts (as may be modified through special management assistance contracts) to be concluded between the companies and the Government. Special audits by external auditors will be used to determine the companies’ compliance with their obligations under performance contracts.

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Financial Management and Disbursement Arrangements

KENYA: Energy Sector Recovery Project

A. Financial Management Arrangements

Financial Management Assessment Summary

1. financed project, the Energy Sector Reform and Power Development Project. These systems are considered sufficiently capable o f proper financial management. A b r ie f o f the respective PEAS’ systems i s as follows:

The project builds on existing systems relied upon during implementation o f an ongoing IDA -

(a) KPLC is a public company quoted o n the Nairobi Stock Exchange, with majority shareholding by Government. I ts corporate governance and fiduciary compliance matters are subject to guidelines issued by the Capital Markets Authority, including provisions for the competence o f i t s board o f directors, accounting and internal control systems capable o f producing reliable and timely financial reports, an effective external audit function and a strong internal audit function supported by a board audit committee. K P L C prepares i t s financial statements on an accrual basis o f accounting in accordance with International Financial Reporting Standards. The company i s currently satisfactorily implementing major components o f an IDA - funded project. I t s latest financial statements audit report i s unqualified.

(b) KenGen i s a parastatal established following the split o f KPLC. I ts management, accounting and internal control systems are crafted along KPLC’s. KenGen prepares i ts financial statements o n an accrual basis of accounting in accordance with International Financial Reporting Standards (IFRS). The company i s currently satisfactorily implementing major components o f an IDA - funded project. I t s latest financial statements audit report does not present any major accounting and internal control anomalies.

(c) M o E is responsible for the overall financial management o f an ongoing IDA funded project, including components implemented by KPLC and KenGen. I t s own accounting systems have proven to be reliable and accurate. I t s latest project financial statements audit report i s unqualified.

Country Issues

2. The new Government that came into office in December 2002, has made a commitment to strengthen the financial management and control environment in order to achieve economy, efficiency and effectiveness in the use o f public funds. Thus, with the support o f a number o f donor assisted initiatives, including the IDA-funded Public Sector Management Technical Assistance Project (PSMTAP), the G o K i s seeking to rapidly enhance the financial accountability framework, particularly through strengthening the legislation related to public financial management and the Office o f the Controller and Auditor General.

3. that may impact on this operation at country level i s the Country Portfolio Performance Review (CPPR) carried out in January 2004. A new Country Assistance Strategy (CAS) has also just been completed in M a y 2004. Both these works reviewed government’s performance since the last CPPR (in 1997) and

The most recent piece of diagnostic work that provides an up to date crit ical assessment o f issues

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CAS ( in 1998). A recurring theme noted was that policy changes agreed under projects were not consistently implemented. The sustainability o f projects were also impeded by lack o f adequate and timely release o f budgetary allocations.

4. particularly in the last three years, and agreement was reached o n several key issues, some o f which have been applied in the design o f this operation. These include the use o f private auditors, and allowing funds to f l o w directly t o the project. In the meantime, a Country Financial Accountability Assessment (CFAA) update i s planned for fiscal 2005.

The CPPR especially highlighted the GoK’s commitment to improving portfolio performance,

Description o f Financial Management Systems

5. Internal Controls and Financial Management Manual - The project’s intemal controls are based o n the PEAs established accounting and intemal control systems and documented in the project financial operations manual. The manual has been subject to review by the IDA Financial Management Specialist and found satisfactory.

6. references to supporting documentation in the SOE supporting schedules in order to facilitate the inspection o f these schedules and improve the maintenance o f the project’s records.

The procedures used by the project to maintain its records include the requirement for cross

7. f l ow processes; the accounting records, supporting documents, computer files and specific accounts in the financial statements involved in the processing o f transactions; the l i s t o f accounting codes used to group transactions (chart o f accounts); the accounting processes from the init iation o f a transaction to i t s inclusion in the general ledger.

The manual describes the accounting system: the major transaction cycles o f the project; funds

8. Planning and Budgeting - Budgeting for the project has been undertaken centrally by MOE in consultation and with extensive detailed input by the respective PEAs. DA reporting guidelines provide for periodic activity, cash flow and procurement projection, analysis and review o n an ongoing basis. Responsible personnel have been trained.

9. Books of accounts and list of accounting codes - The project’s accounting records will be maintained o n the existing GOK and PEAs computerized systems. The codes relating to the project have been integrated in the PEAs Chart o f Accounts. This will match the classification financial statements; authorization procedures for transactions; the financial reporting process used to prepare the financial statements, including significant accounting estimates and disclosures; financial and accounting policies for the project; budgeting procedures; financial forecasting procedures; procurement and contract administration monitoring procedures; procedures undertaken for the replenishment o f the special account; and auditing arrangements.

Institutional and Financial Management Arrangements

10. the country issues described above and the experience with the ongoing Energy Sector Reform and Power Development Project as follows: (i) the project will uti l ize the existing financial management capacity f rom an ongoing IDA-financed project whose implementation progress i s rated satisfactory; (ii) annual audits for KPLC and KenGen’s financial statements, including project accounts will be subcontracted by the Controller and Auditor General to independent private auditors to ensure effectiveness and efficiency o f the audit process; (iii) a significant portion o f project costs relate to procurement o f goods and services

The design of this Project includes a number o f specific risk mitigation arrangements to address

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requiring prior review, and/or approval and direct payment by IDA; and (iv) regular IDA supervision missions will closely monitor performance and assist in the timely resolution o f issues.

11. T o improve the timely availability o f funds to the Project, the f l ow o f funds and reporting arrangements used for the ongoing Energy Sector Reform and Power Development Project wil l be modif ied in several respects as follows: (i) separate special accounts for the three PEAs will be opened by the borrower, and KPLC and KenGen will be authorized to manage and operate the special accounts for their components; (ii) KPLC and KenGen have opted for the report-based disbursement method and will therefore submit to IDA, through the Ministry o f Finance, periodic Financial Monitor ing Reports (FMRs), including additional reports to support replenishment o f their special accounts; (iii) M o E which has opted for the time being to use the traditional transactions-based disbursement method will have a special account for i t s component managed and operated by the borrower, and will prepare and submit to IDA F M R s for progress reporting purposes only; (iv) KPLC and KenGen will also each open a project account into which they will deposit their components’ local counterpart funding requirements quarterly based o n expenditure forecasts. KPLC and KenGen will deposit the agreed init ial amounts into their Project accounts by Credit effectiveness. The local counterpart funding requirements for the M o E component estimated at a modest US$200,000 over the project implementation period will be provided through the normal government budget process.

12. with the GoK for the funds that wil l be made available to finance their respective activities, at on-lending terms and conditions satisfactory to the Association.

Subsidialy Agreements - KPLC and KenGen will enter into subsidiary loan agreements

13. mission, Bank staff had provided training to the PEAs to familiarize them with the recently introduced Financial Monitoring Report (FMR) reporting guidelines. At negotiations the FMR formats were reviewed and agreed.

These arrangements were discussed and agreed during negotiations. During the appraisal

14. KPLC and KenGen will be responsible for the overall financial management o f the project, in accordance with sound and standard guidelines acceptable to IDA. They will oversee the management o f special and project accounts, the preparation of FMR and annual financial statements, Withdrawal Applications and other financial requirements o f IDA. MOE has assigned a Senior Accountant (also a member o f the PIT) and an Assistant Accountant to be responsible for project financial management who wil l report to the Ministry’s Permanent Secretary through the Head o f the Accounting Unit. The finance departments o f KPLC and KenGen are established along similar lines, with Chief Officers - Finance ultimately reporting to respective CEOs. Bo th have assigned accountants to their respective PITS.

Staffing - The Accounting Officer for MOE (Permanent Secretary) and the CEOs o f

Audit Arrangements

15. Internal Audit - KPLC and KenGen have established internal audit functions that are manned by duly qualified personnel and reporting to audit committees established within the Board o f Directors. The departments operate o n the basis of approved annual work plans. The internal audit function i s considered to be a reliable internal control process.

16. audit function i s provided by MOF seconded personnel. The Internal Auditor reviews a l l transactions before expenditures are incurred. However, the performance o f this function i s only l imi ted to the pre- audit inspection o f the project’s transactions, and n o internal audit reviews are undertaken to ensure, for instance, that internal control guidelines are complied with. The function i s therefore assessed as weak and is not normally relied upon by extemal auditors. However, the fiduciary risk presented by the

The MOE component i s subject to statutory internal audit regulations through which the internal

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absence o f an effective internal audit function is mitigated by external audits and IDA’S requirement for periodic project monitoring and reporting.

17. External Audit- The Off ice o f the Controller & Auditor General (CAG) i s primarily responsible for the auditing o f a l l government projects. There i s an option for the audit to be subcontracted to a firm o f private auditors, with the final report being issued by the CAG, based on tests carried out by the subcontracted firm. The G o K has agreed that the audits for KPLC and KenGen will be subcontracted to private auditors acceptable to IDA, so as to avoid delays in receipt o f audited financial statements, which have occurred in the past owing to the large volume o f work by the CAG and will be compounded by the recent requirement for audits of parastatals to be carried out by the same office.

Reporting and Monitoring

18. be generated f rom the financial management system have been developed and agreed during negotiations. There will be clear linkages between the information in these reports and the Chart o f Accounts. The financial reports have been designed to provide quality and timely information to project management, PEAS and various stakeholders o n project performance.

Financial Monitoring Reports - Formats o f the various periodic financial monitoring reports to

19. The fol lowing contents o f quarterly FMRs will be produced by the respective PEAS:-

’ Financial Reports:

0 0

Sources and Uses o f Funds by Funding Source Uses o f Funds by Project Activity/Component

. Procurement Report Physical Progress (Output Monitoring) Report

20. International Public Sector Accounting Standards (which inter alia includes the application o f the cash basis o f recognition o f transactions). KPLC and KenGen financial statements shall be prepared o n the accrual basis o f accounting in accordance with Intemational Financial Reporting Standards (IFRS) as i s existing practice. The IDA Credit Agreement requires the submission o f audited financial statements, taking into consideration the new Audit Policy Guidelines o f the W o r l d Bank, within six months after the year-end.

Financial Statements. The MOE financial statements shall be prepared in accordance with

Project Financial Statements will include:

A Statement of Sources and Uses of Funds /Cash Receipts and Payments for each funded period which recognizes a l l cash receipts, cash payments and cash balances controlled by the entity; and separately identifies payments by third parties o n behalf o f the entity.

The Accounting Policies Adopted and Explanatory Notes. The explanatory notes should be presented in a systematic manner with items o n the Statement o f Cash Receipts and Payments being cross referenced to any related information in the notes for each funded period. Examples o f this information include a summary o f f ixed assets by category o f assets, and a summary o f SOE Withdrawal Schedule, l isting individual withdrawal applications; and

A Management Assertion that Bank funds have been expended in accordance with the intended purposes as specified in the relevant Wor ld Bank legal agreement for each funded period.

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Indicative formats o f financial statements were agreed during negotiations.

Supervision Plan

22. include that o f ensuring that strong financial management systems are maintained for the project throughout i ts l i fe. A review will be carried out regularly to ensure that expenditures incurred by the project remain eligible for IDA funding.

A supervision mission wil l be conducted at least every six months. The mission’s objectives will

B. Disbursement Arrangements

23. Requests for disbursement f rom IDA for the KPLC and KenGen components will be made o n the basis o f approved work plans cash f low projections for eligible expenditures (report-based disbursements). IDA will make advance disbursement f rom the proceeds o f the Credit by depositing into the special accounts to be managed and operated by KPLC and KenGen to expedite project implementation. The advance to the special accounts wil l be used by the borrower to finance IDA’s share o f project expenditures under the proposed Credit bank’s Letter o f Credit.

24. effectiveness, the borrower wil l be required to submit a withdrawal application for an in i t ia l deposit to the special account, drawn f rom the IDA Credit, in the amount specified in the Development Credit Agreement. Replenishment o f funds from IDA to the special account will be made upon evidence o f satisfactory utilization o f the advance, reflected in SOEs and/or on full documentation for payments above SOE thresholds. Replenishment applications would be required to be submitted monthly. Another acceptable method o f withdrawing funds f rom the Credit i s the direct payment method, involv ing direct payments f rom the Credit to a third party for works, goods and services upon the borrower’s request. Payments may also be made to a commercial bank for expenditures against IDA special commitments covering a commercial bank’s Letter o f Credit. IDA ’s Disbursement Letter stipulates a minimum application value for direct payment and special commitment procedures.

For MoE, which has opted to use the transaction based disbursement method, upon credit

25. If ineligible expenditures are found to have been made f rom the special account, the borrower will be obligated to refund the same. If the special account remains inactive for more than six months, IDA request a refund o f the amount advanced to the special account. I t may also affect the opening o f special accounts for new projects.

26. disbursement o f the funds if reporting requirements are no t complied with.

IDA will have the right, as to be reflected in the Development Credit Agreement, to suspend

Financial Management Action Plan

27. FMR-based disbursements, and the dates that they are due to be completed.

The action plan below indicates the actions to be taken for the project to achieve eligibil i ty for

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2

Table 7.1: Financial Management Action Plan

I Action 1 DueDate I Remarks 1 1 Financial Monitoring Report formats I Negotiations I Formats reviewed and

for respective implementing entities agreed. MOF agreement to delegate the custody and maintenance o f special accounts to respective implementing agencies in order to facilitate foreign

3

Negotiations

currency payments. Project accounts opened and in i t ia l Effectiveness Condition o f Effectiveness

agreed during Negotiations

4

Agreed during Negotiations. Borrower to open the special accounts by Credit effectiveness

deposits o f counterpart funds made.

KPLC and KenGen in conjunction Annually Agreed during negotiations with M o E and the Office o f the Controller and Auditor General t o appoint external auditors acceptable to

Expenditure Cateaorv

Works: Supply and Installation

Amount in US$ million

45.45

Financing Percentage

100% o f foreign expenditures, 90% o f local

Allocation of Credit Proceeds

Goods

Consultant Services

28. The proposed Bank credit o f US$80.0 m i l l i on would be disbursed over f ive years f rom FY2004/05. The annual estimated disbursements are indicated in a table o n page v o f this Project Appraisal Document. The Project Completion Date i s September 30,2009 and the Project Closing Date i s March 31,2010. The proposed allocation o f the credit proceeds i s shown in Table 7.2.

expenditures 100% o f foreign expenditures, 90% o f local expenditures 100% o f foreign expenditures, 94 % o f local

12.06

13.17

Table 7.2: Allocation of Credit Proceeds

Training expenditures

1.31 100%

Total 80.00

Unallocated I 8.01 I

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Procurement

KENYA: Energy Sector Recovery Project

A. General Country Context

1. Following the findings and recommendations o f the CPAR, the Government o f Kenya (GOK) applied for the Bank’s support to implement the recommendations o f the CPAR, and subsequently received from the Bank an IDF grant which was approved in 1998. Using the proceeds o f the grant, GOK started a procurement reform program. One o f the main outcomes o f the reform program was the establishment o f the Directorate for Public Procurement and Appeals Tribunal and gazetted in March 200 1 and the National Public Procurement Regulations, which govern all public procuring entities, and production o f standard bidding documents for works and goods. The Public Procurement Regulations allow the Bank procedures to take precedence over any contrary provisions in the national regulations. The GOK’s standard bidding documents and procedures for N C B have been reviewed by the Bank and found to be acceptable.

The last Kenya Country Procurement Assessment Review (CPAR) was conducted in 1997.

2. “Guidelines: Procurement Under IBRD. Loans and IDA Credits” dated May 2004; and “Guidelines: Selection and Employment o f Consultants by World Bank Borrowers” dated May 2004, and the provisions stipulated in the Legal Agreement. The general description o f various items under different expenditure categories are described below. For each contract to be financed by the Credit, the different procurement methods or consultant selection methods, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank project team in the Procurement Plan. The Procurement Plan wil l be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity.

Procurement for the proposed project would be carried out in accordance with the World Bank’s

3. contracts procured under this project, would include: The Upgrade of the Existing and Construction of New Substations (Part D1) provides for (a) the supply and installation of: (i) about 147 MVA 132133 kV substation transformer capacity complete with associated switchgear and control equipment; (ii) 12.5 MVA 3311 1 kV substation transformer capacity with ancillary equipment; (iii) 594 MVA 6611 1 kV substation transformer capacity with switchgear and control; and (b) the supply for replacement 132kV (about 8 in number) outdoor and 1 l k V indoor (about 35 in number) metal clad switchgear, auto-reclosers and 11 kV shunt capacitors.

Procurement of Supply and Installation o f Plant and Equipment: Supply and Installation

4. Supply and Installation (Construction) o f (a) (i) 75 km o f 66 kV line; (ii) 43 km o f 33 kV line; (iii) 43.5 km o f 11 kV line; and (b) the supply o f conductors for: (i) reconductoring the 276 km o f 33 kV 303 km of 11 kV lines, to be carried by KPLC; and (ii) some 500 km o f conductor and hardware material for the reinforcement and expansion o f the Distribution system in al l regions; about 800 distribution transformers, total 150 MVA 110001415 v. The items (b) (i) and (b) (ii) will be carried out by KPLC either directly or through local contracting. IDA, the EIB, AFD and NDF will be financing the Distribution Upgrade and Reinforcement, Part D o f the Project. The procurement wil l be done using the Bank’s Standard Bidding Documents (SBD) for all ICB and National SBD agreed wi th (or satisfactory to) the Bank.

The Reinforcement and Extension of the Distribution System (Part D2) comprises: (i) The

5. The Upgrade of the SCADMEMS System (Part D4) provides for: (i) the supply and installation o f hard ware and software to upgrade and expand the existing system and raise the National Control Center and Area Control Centers to modem standards; and (ii) New Radio System for Mt. Kenya Region

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Trunking Radio System able to cover the region and thereby replace the o ld and obsolete existing system that has l imi ted coverage will be financed by the EIB, and the procurement method o f the EIB shall apply.

6. Component, Part C, of the Project, comprising: (a) the supply and installation o f a 35 MW steam turbine -generating unit; (b) the supply and installation o f 45 MVA 11/220kV step up generator transformer complete with switchgear equipment; (c) construction for the extension o f the power house to: (i) accommodate the third 35 MW steam turbine generating unit, the control panel and other ancillary equipment (ii) the cooling tower, (iii) the switch yard for installing the generator transformer, support bus-bar arrangement and the switchgear equipment; and (iv) Steam gathering system from Olkaria I and Olkaria I1 areas; and (d) Electrical and mechanical equipment including control r o o m equipment, cables and other ancillary plant and equipment.

Engineering, Procurement and Construction (EPC) for the Olkaria I1 Extension Generating

7. procurement method o f the Bank shall apply.

The Olkaria I1 Extension will be jointly financed by the Bank and the EIB, and the

8. Energy Meters (Part D3) provides for the delivery of: (i) 400,000 energy (kwh) meters for domestic customers at the rate o f about 80,000 annual for 5 years or as may be mutually agreed between the Bank and KPLC; (ii) 5000 three-phase energy meters for replacement o f o ld electromechanical meters; (iii) about 100 special purpose meters (statistical or others) as may be specified by KPLC; and (iv) Goods for KEBS. The installation o f the meters will be carried out directly by KPLC and/or through local contracting under the supervision o f KPLC. The procurement will be done using Bank’s SBD for ICB and National SBD satisfactory to the Bank.

Procurement of Goods: Goods procured under this project would include: The Supply of

9. will cover energy sector institutions associated with the project components. Overall strategy focuses o n on-the-job training and hiring consultants for developing training material, conducting training, and support for training activities through seminars, workshops and training in the region and abroad based o n individual needs as well as group requirements. All training and workshops will be carried out o n the basis o f programs, which shall have been approved by the Bank on an annual basis, and which shall, inter alia, identify: (a) the training and workshops envisaged; (b) the personnel to b e trained; (c) the institutions which will conduct the training; (d) the duration o f the proposed training; The detailed annual training program outline categories o f training, number o f trainees, duration o f training, staff months, timing and estimated cost.

Institutional Capacity Building and Training: The capacity building and training activities

B. Assessment of the Agency’s Capacity to Implement Procurement

10. beneficiaries o f the credit for capacity building and training only. The project’s procurement arrangements will be based o n the successful procedures already in place in KPLC, KenGen and the MOE. The day-to-day procurement management responsibilities (for Supply & Installation, Goods and C iv i l Works contracts) wi l l be handled by the Project Implementation Teams (PITs) o f the respective agencies. The MOE will implement consultants, and capacity building contracts only. The beneficiary agencies for the strengthening o f regulatory capacity subcomponent, the Electricity Regulatory BoardEnergy Commission and the K E B S will each appoint a focal point person to be assisted by other 2 or 3 designated staff in liaising with the Ministry o f Energy to carry out their activities. For the KEBS, the Team Leader o f the Petroleum Standards Monitor ing Unit will be the focal point person. ERE3/ERC will similarly appoint a focal point person. The main PITs will be established and be operational by Credit Effectiveness. The Borrower will have in place qualified professional staff who are familiar with

Procurement activities will be carried out by KPLC, KENGEN and MOE. ERE3 and KPC will be

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IDA-financed projects f rom KPLC, KENGEN and the MOE, complemented by appropriately qualified engineering consultants acceptable to IDA in the case o f the utilities.

1 1. been carried out by a Procurement Accredited Staff in March 2004. The assessment reviewed the organizational structure for implementing the project and the interaction between the project’s staff and the agencies relevant central units for administration and finance. The key staff o f MOE, KPLC and KenGen (the PITs) who will be involved in processing procurement are familiar with the Wor ld Bank procurement procedures and guidelines. The two beneficiaries o f the Credit for capacity building and training are ERB and KPC. The assessments conducted depict salient features o f the procurement arrangements, control systems and procurement methods and procedures, applicable to each component and the overall project.

An assessment o f the capacity o f the PEAS to implement procurement actions for the project has

12. The overall procurement capacity assessments are rated Average (for the MOE, K P L C and KenGen) and Fair (for KPC and ERB). In recent years, the agencies have participated in the implementation o f (i) Geothermal Development and Pre-Investment Project US$40.7 mi l l ion (Cr. 1973- KE) f rom 1989 to 1994; (ii) Emergency Power Supply - US$72.0 m i l l i on (Cr. 3425-KE) f rom 2000- 2001; and (iii) Energy Sector Reform and Power Development Project (including construction o f Olkaria I1 Power Station) - US$l25.0 mi l l ion (Cr. 2966-KE) f rom 1999-2004. M o E also participated in the implementation o f a l l three projects, particularly the execution o f institutional components.

13. Procurement, Data Management, and Financial Management. About 75 staff members including managers f rom a l l the f ive agencies participated in the training. These included the key staff who will be involved in the implementation arrangements and management o f the project. The training focused o n the preparation o f the agencies procurement plans for the project in accordance with the Bank’s procurement rules, and the revised Guidelines and SBDs which wil l be applicable to loans, credits and grants to be negotiated after M a y 1,2004. I t i s envisaged that the training would be instrumental in facilitating the procurement processing during the implementation o f the project. At the end o f the training, the participants were given a document o n procurement filing and the updated WB-Procurement Planning material as guidance for the PITs to prepare their f i rst year procurement plans. T o update the procurement knowledge o f the PITs, the recent revisions made to the WB-Guidelines and SBDs were disseminated to a l l participants.

During the appraisal mission, training was provided o n Wor ld Bank Basic Operations

14. have been identified and include staffing gaps in al l the agencies. This i s l ike ly to affect the timely processing o f procurement documents. There i s the need to strengthen contract administration and management and rebuild the capacity o f procurement staff in these agencies through training.

Most o f the issues/risks concerning the procurement component for implementation o f the project

15. bids and opening procedures, planning, contract administration and management, support and control systems, record keeping and staffing i s proposed as follows:

An action plan to support the objective to achieve acceptable standards o f transparency, receipt o f

0 As soon as possible, a l l the three agencies should review the ongoing receipt o f bids and opening arrangement which allows bids to be stored in tender boxes in inappropriate locations. The agencies should also not store different tenders in one tender b o x as this encourages human error and hence prevent transparency in the bid opening process. Selection o f Project Coordinator and Power Engineering Advisor for MoE’s PIT. The PITs staff will attend short training courses o n contract administration and management, and one or more o f the Wor ld Bank external procurement workshops held in the region.

0

0

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Annex 8

0

0

0

Staff who will be processing procurement under the proposed project, should familiarize themselves with the revised Wor ld Bank Guidelines (May 2004), procurement plans, and SBDs. Each PIT will ensure adequate arrangements for filing and monitoring al l procurement documents. PITS should acquaint themselves with the National Procurement Regulations.

16. The overall project risk for procurement i s Average for MOE, JSPLC and KenGen.

C. Procurement Plan

17. implementation which provides the basis for the procurement methods. This plan was discussed in detail during the negotiations and accepted by the Bank after making the necessary refinements. The G o K has agreed to the disclosure o f the agreed Procurement Plan o n the Bank’s public website after the Credit has been approved. The agreed procurement plan i s in the Project Files. The Procurement Plan shall b e updated by the Borrower on an annual basis and be disclosed after Bank’s approval o f the updated Plan. The plan includes relevant information o n supply and installation, goods, works and consulting services under the Project as wel l as the timing o f each milestone in the procurement process.

The Borrower, at appraisal, developed a Procurement Plan for the f i rs t 18 months for project

D. Frequency of Procurement Supervision

18. In addition, to the pr ior review supervision to be carried out f rom Bank offices, the Bank will, f rom t ime to time, carry out a capacity assessment o f the implementing agencies to assess their level o f risk. These include special procurement supervision for post-review/audits. Supervision missions wil l visit the f ie ld to carry out post review o f procurement actions.

19. Details o f the Procurement Arrangements involv ing competition i s given in Table A below.

Table A: Project Costs by Procurement Arrangements (US$ million equivalent)

Procurement Method’

Expenditure Category ICB NCB Other* N.B.F. Total Cost 1 .Works

la . Supply & 60.23 2.00 0.00 128.38 190.61 Installation (48.80) (2.00) (0.00) (0.00) (50 30)

Ib. Civil Works 0.00 0.00 2.00 0.00 2.00 (0.00) (0.00) (0.00) (0.00) (0.00)

2. Goods 16.00 0.00 0.00 0.00 16.00 (13.00) (0.00) (0.00) (0.00) (13.00)

3. Services 0.00 0.00 15.52 0.00 15.52 Consultants (0.00) (0.00) (15.00) (0.00) (15.00)

4. Training 0.00 0.00 1.38 0.00 1.38 (0.00) (0.00) (1.20) (0.00) (1.20)

Total Project Cost 76.23 2.00 18.90 128.38 225.51 Of which IDA-funded (61.80) (2.00) (16.20) (0.00) (80.00)

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Consultant Services Expenditure Category A. Firms

B. Individuals

Total

'Figures in parentheses are the amounts to be financed by the {LoadCreditiTrust Fund}. All costs include contingencies.

21ncludes c i v i l works and goods to b e procured through national shopping, consulting services, services o f contracted staff o f the project management office, training, technical assistance services, and incremental operating costs related to (i) managing the project, and (ii) re-lending project funds to local government units.

Selection Method Total QCBS QBS ss LCS CQ Other N.B.F. Cost'* 12.10 0.00 0.00 0.00 1.80 0.00 0.0 13.90

(1 1.40) (0.00) (0.00) (0.00) (1.80) (0.00) (0.00) (13.20) 0.00 0.00 0.70 0.50 0.00 1.80 0.00 3.00

(0.00) (0.00) (0.70) (0.50) (0.00) (1.80) (0.00) (3.00) 12.10 0.00 0.70 0.50 1.80 1.80 0.00 16.90

(1 1.40) (0.00) (0.70) (0.50) (1 30) (1 30) (0.00) (16.20)

Table A1 : Consultant Selection Arrangements (US$ m i l l i o n equivalent)

Note: QCBS = Quality- and Cost-Based Selection QBS = Quality Based Selection SS = Single Source L C S = Least-Cost Selection CQ Other = Selection o f individual consultants (per Section V o f Consultants Guidelines), Commercial Practices, etc. N.B.F. = N o t Bank-financed Figures in parentheses are the amounts to be financed by the Bank Credit.

= Selection Based o n Consultants' Qualifications

Review by IDA

20. Table B provides the pr ior review thresholds. Procurement o f IDA-financed supply and installation o f plant and equipment estimated to cost US$500,000 equivalent or more and each goods contracts estimated to cost US$250,000 equivalent or more per contract as wel l as consulting contracts o f US$lOO,OOO equivalent per contract; and US$50,000 equivalent for contract or more for individual consultants will be subject to pr ior review by IDA. All single-source selection o f consultants and terms o f reference for consulting services, irrespective o f the contract value, will be subject to IDA pr ior review. Post reviews o f contracts awarded below the above threshold levels will be carried out selectively by IDA during supervision missions and/or by an independent procurement auditor.

21. staff months, timing and estimated cost etc., will be submitted to IDA for review and approval pr ior to initiating the training process. The appropriate methods o f selection will be derived f rom the detailed training schedule. All training/workshops will be reviewed by the Bank.

Detailed training program giving categories o f training, number o f trainees, duration o f training,

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Annex 8

Procurement Method

ICB

NCB

Minor works based on quotations

ICB

NCB

IAPSO

ShouuindIAPSO

Table B: Thresholds for Procurement Methods and Prior Review1

Contracts Subject to Prior Review (US$)

All contracts greater than 500,000

First two NCB contracts

Al l post reviews

Al l contracts greater than or equal to250,OOO

First two NCB contracts

All post review

Al l uost review

Expenditure Category Works Supply & Installation

QCBS

CQJLCS

I C

I C

Minor Civil Works

A l l contracts greater than or equal to 100,000

Al l post review

Prior review

Al l post review

2. Goods

ss Various*

3. Services Consulting Firms

All contracts

Individuals

Contract Value Threshold (US$)

Greater than 500,000

Equal to or less than 500,000 but greater than 50,000

Less than 50,000

Greater than or equal to 250,000

Equal to 50,000 and less than 250,000

Less than 100,000

Less than or eaual to 50.000 Equal to or greater than

100,000

Less than 100,000

Greater than 50,000

Equal to or less than 50,000

No threshold (All)

Note:

IndividuaVFirms 4. Training/Workshop

months, timing and estimated cost etc., will be submitted to IDA for review and approval prior to initiating the training process. The appropriate methods o f selection will be derived f rom the detailed training schedule.

Total value o f contracts subject to pr ior review: US$63,000,000

Overall Procurement Risk Assessment: Average

ICB NCB IAPSO Isms QCBS CQ I C LCS ss

Intemational Competitive Bidding National Competitive Bidding Inter Agency Procurement Services Office IntemationaVNational Shopping Quality- and Cost-Based Selection Selection Based on Consultants’ Qualification Individual Consultants Least Cost Selection Single Source

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Annex 9

Economic and Financial Analysis

KENYA: Energy Sector Recovery Project

Analysis of Economic Justification

Introduction

1. The economic justification o f the Project i s based on assessment o f the economic viability o f the three main physical components, comprising (i) the expansion o f the Olkaria I1 geothermal power station by an additional 35 MW; (ii) the power distribution network rehabilitation, reinforcement, and expansion; and (iii) the installation o f a modem SCADMEMS system.

2. indicated by the projected demand and supply balance; (ii) that each o f the proposed components provides the most cost-effective means (least-cost) o f meeting the incremental demand; and (iii) the profitability o f each component as measured by the economic internal rate o f retum, based on the comparison o f economic costs and benefits. The economic benefits o f the institutional component, which are not readily quantifiable, and potential macroeconomic impacts o f the Project are also discussed.

The justification o f the physical components i s carried out in three stages: i) that there i s need as

Electricity Demand

3. the physical components o f the project. Electricity consumption in the past 5 years had stagnated as a result o f poor economic performance. Over that period, electricity consumption grew at annual average rate o f about 1%. There i s a strong correlation between economic growth, and electricity consumption with GDP elasticity o f about 1.2, and price elasticity o f negative 0.2. Forecasts o f electricity demand prepared by MoE, and KPLC are based on expected growth o f the economy as projected by the GoK over the medium term up 2006/2007, and expected growth in the consumer base through increases in the number o f household connections by 100,000 - 130,000 consumers per year beginning 2004/05 for next five years. Thereafter, demand i s expected to grow at the normal rate, including the connection o f about 40,000 new consumers each year in line with the Government policy to expand access to the wider population over time. Summary o f GDP growth rates, and demand projections i s provided in Table 9.1.

Analysis o f the electricity market, and i t s growth prospects provides the main basis o f need for

Table 9.1: Summary o f GDP Growth Rates and Demand Projections

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4. 2006107, under average hydrological conditions for hydropower production, as well as to provide for appropriate system reserve margin to assure reliability and security. Under the low case projected demand scenario, new supply additions to the system wi l l be required about one-two years later, about 2007109. These would come from additional generation, and incremental supply through loss reduction, and reinforcements in the distribution network, which confirm the need for the physical project components. Table 9.2 summarizes the supply and demand balance.

Projected supply and demand balance shows the need for incremental supply to meet demand in

Table 9.2: Projected Supply and Demand Balance (Average Hydrological Conditions)

Reserve margin I 165 1 165 I 158 I 164 I 158 I 158 1 170 Deficit I 148 I 70 I 97 1 9 I 24 I -44 1 -284

Least-Cost Justification

5. curve method, expansion o f Olkaria I1 Geothermal Power Station by additional 35 MW was established as the least-cost means o f generating capacity addition to the system. The other alternatives considered were: (i) Kipevu combined cycle conversion, (ii) medium and slow speed diesel power plants; (iii) gas turbines; (iv) o i l and coal fired steam units; and (v) new geothermal station. The costs comprised: capital, fixed operation and maintenance cost, fuel and other variable costs. Capital costs are based on competitive international prices, and fuel cost are based on import costs, and fuel cost reflect economic cost. The results, below show the life-cycle per kwh at 85% load factor, and confirms the comparative advantage o f the expansion o f Olkaria geothermal power station by an additional unit.

Based on cost comparison o f feasible generating plant candidates considered using the screening

Plant type Life-cycle cost ( US$/kwh)

Olkaria 11, Unit 3 O i l steam Coal steam Gas turbine Kipevu CC Medium Speed Diesel

0.055 1 0.0916 0.090 0.104 0.0834 0.0839

6. same expected results. The selected schemes were found to be the most cost-effective options.

For the distribution component, altemative schemes and configurations were examined to achieve

Economic Rates of Return Analysis

7. This involved the comparison o f quantifiable economic costs and benefits. The costs comprised, capital, fixed operation and maintenance costs, fuel and other variable costs, expressed in economic terms and in January 2004 prices. Details o f assumptions are as follows:

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Annex 9

NPV (US$ million at 12% DCF)

(a) Olkaria 11, Unit 3:

IRR (YO)

(i) Capital cost : US$57 million; fixed O&M: US$23.6kW/year; variable cost: US$O.O035kWh; steam re-injection cost: US$l .2 mill iodyear, associated incremental transmission and distribution cost: US$12 mill ion.

Base Case Sensitivity Analysis (i) 10% Capex increase (ii) 10% increase in Capex 10% reduction in output

(ii) benefits comprise incremental net power generation o f 276 GWh per year, adjusted for 15% transmission and distribution losses as final consumption, valued at the average electricity tariff, as a proxy for the consumers’ willingness to pay.

25.9 19

19.7 17 10.7 15

Results are summarized below. Details of assumptions and computations are provided in Attachments 1,2 & 3.

Base Case @, 12q0 DCF ( Y O )

246 30

(i) 20% decrease in total benefits (ii) 10% increase in Capex, and O&M combined with 20% benefits

(b) Distribution Component

179.5 26 170.7 24

The distribution component comprised about 5 8 sub-components, which were evaluated o n the basis of economic merits, aggregated for the overall economic merits o f the component.

(9

(ii)

costs comprised capital and fixed O&M, Capital costs are based o n estimates o f consultants, and KPLC. Fixed O&M are based o n actual records o f KPLC. Benefits comprise: (i) incremental sales valued at existing average electricity tariff; (ii) reduced losses valued at the average consumer tariff; and (iii) improved reliability, based estimated reduced number outages valued at the estimated economic cost o f un-served energy at US$0.54kWh.

The results are summarized below:

Table 9.4: Summary Results of Economic Analysis o f the Distribution Upgrade Component

I Sensitivitv Analvsis I I I

I reduction

(c) SCADA Component

(i) The capital cost estimates are based o n the draft feasibility report prepared by consultants. Total cost i s estimated at about US$3 1.5 mill ion, including physical contingencies, but

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Annex 9

excluding price contingencies. Construction will be over four years, 2004- 2007, and operational period o f 15 years. During operational period, an annual re-investment provision o f 1% o f capital cost i s made for software ,and hardware upgrade to maintain advances in technology.

(ii) The benefits, which are diff icult to quantify, always calls for approximations. The quantifiable benefits comprise (i) .increased power system reliability valued at the economic cost o f un-served energy; (ii) reduction in transmission losses valued at the economic cost o f supply or willingness to pay; (iii) increased output through improved optimization o f hydro- thermal coordination valued at the economic cost o f supply; and (iv) reduction in maintenance, due to better utilization o f generating plants and transmission network; and (v) savings fi-om deferment o f investment. The estimated IRR is about 31 %, and NPV of about US$54 million. The pay-back period is about 3 years.

Financial Analysis

Past Financial Performance

8. The financial performance o f the power sector was greatly affected by the prolonged drought in 1999-2000 which caused a power supply crisis for Kenya. F rom FY1999-FY2002, KPLC, an important utility in the power sector, incurred substantial losses (totaling about Kshs16.5 bil l ion) as a result o f decreased sales attributable to the drought conditions and KPLC’s inabil ity to rapidly adjust i ts cost structure. This situation was compounded by increased losses in the transmission and distribution systems as a higher proportion o f energy requirements had to be hauled over longer distances f rom the coast to the main load centers around Nairobi and as the proportion o f thermal generation increased resulting in more fuel costs not being recovered f rom customers. During the same period, there was a slow-down o f the economy as indicated by the GDP growth rates which averaged less than 1%. Finally, the introduction o f peak and off-peak tariffs led in 1999 to a change in consumption pattern with industries shifting production f rom daytime (peak) to nighttime (of f peak).

9. A s a result o f the above circumstances, KenGen and KPLC had serious liquidity constraints. In addition, K P L C had large financial losses and substantial amount o f resources invested in excess stocks and in receivables f rom customers. Consequently, KenGen’s liquidity problems arose f rom KPLC’s inabil ity to settle i t s receivables. Nevertheless, KenGen was s t i l l profitable. In view o f KPLC’s importance to the health o f the power sector, GOK decided to address KPLC’s profitabil ity problems through a financial recovery program which included: (i) organization, management and staffing reforms aimed at improving productivity, reducing operating costs and increasing responsiveness to customer needs; and (ii) review o f both the retail tariffs and the bulk supply tar i f f with KenGen. Al though the program focused o n the areas that needed improvements, the implementation o f the measures was neither adequate nor fast enough to foster a performance turnaround.

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Annex 9

KenGen Sales (GWh) Bulk Tariff (KshkWh) (wlo

Table 9.5: KPLC: Summary of K e y Historical Financial Performance Indicators

FY1998/99 F Y 1999/2000 FY2000/01 FY2001102 FY2002/03 3999 3831 2559 3229 3659 1.36 2.42 2.36 2.42 2.36

Table 9.6: KeGen: Summary o f K e y Historical Financial Performance Indicators

Revenues (Mn. Kshs) Operating Costs (Mn. Kshs) Net Income (Mn. Kshs) Current Ratio

7,407.9 15,574.5 1 3,488.0 10,252.1 10,108.8 6,44 8.2 10,628.4 11,241.3 6,743.2 5,788.2 240.2 4,030.0 1,702.8 2,280.4 2,5 19.9 1.2 1.4 1.5 3.0 2.4

Debt-service Coverage Ratio Self-financing Ratio e?) Debt-equity ratio

0.4 1.4 3.3 3.2 2.0 14 16 26 19 60 60140 40160 50150 3 0170 30170

Current Financial Performance

10. Starting July 1,2003, KenGen’s tariff decreased by about 25% from Kshs2.36kWh to Kshsl.76kWh. KPLC also negotiated a tariff reduction with Iberafixa, one o f the IPPs. By September 2004, the tariff will be reduced by 50% from the original tariff (i.e. from US$395/kW to US197.5kW).

11. As o f June 2003, KPLC owed KenGen Kshs12.26 billion. This amount was converted into preference shares, with a five-year moratorium (ending in FY2009/10) on payment o f dividends. Furthermore, Kshs3.64 mil l ion owed by KPLC to GOK was also converted into preference shares. At the same time, the Government converted about Kshs 15.5 bi l l ion debt o f KenGen into ordinary shares. KPLC’s financial performance has improved over the f i rs t six months o f the fiscal year (FY2003/04). The combination o f reduced bulk tariff and conversion o f KPLC’s debt have resulted in a modest half- year profit o f close to Kshs380 mil l ion compared to a loss o f Kshsl.2 bi l l ion over the same period in FY2002/03. By the end o f the fiscal year, a Kshs0.8 bil l ion profit i s projected, which would be the f i rs t one generated since FY 1998/99.

12. profit before tax o f about Kshs I .S bil l ion during the f i rs t six months o f the year. T h i s was achieved through a combination o f higher sales, higher generation from the hydro power stations and correspondingly lower generation costs. In order to compensate KenGen for the conversion o f i t s debt in KPLC into preference shares, the Government, in turn, converted Kshs 15.5 bi l l ion debts o f KenGen to GOK into ordinary shares. For FY2003/04 KenGen expects to se l l 4,062 GWh o f electricity to KPLC.

In spite o f the reduction in the bulk tariff, KenGen continues to be very profitable and recorded a

l3 The actual net loss before exceptional i tems and deferred taxation was Ksh 4.2 bil l ion in FY199912000. In addition, in spite o f losses, KPLC continued to pay dividend through FY2002103.

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Annex 9

KPLC Sales (GWh) Revenues (Mn. Kshs) Operating Costs (Mn.

This wi l l result in total revenues o f about Kshs8.8 bil l ion. After deducting operating and financial costs, the company wil l have a net income o f Kshsl.9 b i l l ion which represents a net prof i t margin o f about 26%.

FY2003/04 FY2004/05 FY2005/06 FY2006/07 FY2007/08 FY2008/09 4044 4279 4627 5019 5295 5588 24,919.1 25,911 .O 28,481.5 32,582.2 3 1,421.8 32,451.4 24,072.0 24,124.8 26,540.6 29,653.1 28,645.5 30,941.7

Future Fin an cia1 Performance

- Ratio Self-financing ratio (%) DebtiEquity Ratio

13. KPLC’s debt stock has decreased substantially and their debtiequity ratio i s currently 10/90 compared to 50/50 in FY2002. Whi le the company i s expected to meet the financial performance criteria until FY2007/08, by FY2008/09 the company’s self-financing ratio will fa l l below 25%. This i s because KPLC will be purchasing power f rom regional markets starting FY2008/09. Therefore, in negotiating with the suppliers, measures should be taken to ensure the continued financial viabil ity o f KPLC. The company wil l need to adopt an aggressive collection pol icy to avoid short-term borrowings to meet i t s working capital requirements. Furthermore, any adverse change in demand would cause KPLC to incur financial losses.

KPLC’s summary financial forecasts are shown in Table 9-7, and with the debt conversion,

64 53 45 52 34 16 10/90 10190 20/80 30170 40160 40160

Ghs) Net Income (Mn. Kshs) 1 884.4 [ 1,236.9 I 1,161.9 I 1,753.4 I 1,354.1 367.1 I Current Ratio 11.4 I 1.1 11 .2 I 1.2 I 1.4 1 1.3 Receivables (days) 1 70 I 60 I 60 I 55 I 50 I 50

I Debt-service Coverage I 2.7 I 4.4 I 4.7 I 3.6 t 2.2 11.3 I

14. Whi le the projections indicate that the company can service i t s future long-term obligations and finance the local portion o f the investment program f rom internal sources, the cash situation will need to be monitored closely. In FY2004, the cash position o f the company will remain negative, but i s expected to turn around as they implement stringent measures to improve collections f rom the current 75 days to about 60 days. This would be done in the context o f KPLC’s financial recovery program as the company works at maintaining their current ratio above 1 .O. Thus, the company will need over the project period

Maintain i t s accounts receivable level at no more than 60 days o f average daily electricity sales during the first two years o f the projected period to reach 50 days by FY2008/09. In order to meet this requirement, K P L C should issue monthly estimated b i l ls and give i t s customers 2 1 days to settle their bills. Any customer who would not settle their b i l ls within the given period would be disconnected and charged interest for the period they would be in arrears and their deposit increased at the time power i s restored. Every quarter, KPLC should issue an adjustment bill with the actual meter reading. KPLC should send to the Bank every quarter a status o f receivables by customer category, amount and age. I t i s important that KPLC ensure that the terms they receive f rom their suppliers are consistent with those applied to their customers; produce funds from internal sources equivalent t o not less than 25% o f the three-year average o f i ts capital expenditures. The self-financing rat io i s expected to be above the covenanted level over the projected period. However, there will be a downward pressure o n that ratio towards FY2008/09 as the company increases its purchasing o f power f rom regional markets. ensure that the estimated net revenues will b e at least 1.2 times the estimated maximum debt- service requirements; and

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Annex 9

KenGen Sales (GWh) Bulk Tariff

(d) maintain a current ratio o f not less than 1 .O. With the current ratio expected to average 1.2 over the projected period, any delay by KPLC’s customers would force the company to borrow to meet working capital requirements.

FY2003104 FY2004/05 FY2005/06 FY2006/07 FY2007/08 FY2008109 4062 4204 4350 4581 4613 4615 1.76 1.76 1.76 1.76 1.76 1.76

15. period (averaging 20/80), the company should not incur any debt that would cause the above ratios to fa l l below the covenanted level, unless otherwise agreed with the Bank.

Notwithstanding the fact that KPLC’s debt/equity ratio i s expected to be low over the projected

16. KenGen’s summaryfinancial forecasts are presented in Table 9-8. Looking ahead over the project period, electricity sales are expected to increase slightly by about 2% annually. KenGen’s bulk electricity tar i f f i s assumed, for the purposes o f the projections, to remain at the same level o f Kshsl .76kWh. After financing i ts capital expenditure program, KenGen will continue to maintain a satisfactory financial structure as indicated by i t s debt:equity ratio which will be maintained at 30/70 over the period. I t s self- financing ratios o f at least 25% per annum over the project implementation period based o n the estimated capital expenditure program, are robust. This also implies that i t s creditworthiness, as measured by the debt service coverage ratio, will also continue to be satisfactory in the 2.3-3.1 range, and so will its worlung capital levels.

Table 9.8: KenGen: Summary of Key Projected Financial Performance Indicators

Financial Performance Criteria

17. During negotiations, agreement was reached o n the following key financial performance targets: (a) KPLC to (i) Maintain i t s accounts receivable level at n o more than 60 days o f average daily electricity sales; (ii) generate funds from internal sources equivalent to not less than 25% o f the three-year average of i t s capital expenditures; (iii) ensure that the estimated net revenues will be a least 1.2 times the estimated maximum debt-service requirements; and (iv) maintain a ratio o f current assets to current liabilities o f not less than 1 .O, and (b) KenGen to: (i) generate funds f rom internal sources equivalent t o not less than 25% o f the three-year average o f i t s capital expenditures; (ii) ensure that the estimated net revenues will be a least 1.5 times the estimated maximum debt-service requirements; and (iii) maintain a ratio o f current assets to current liabilities o f not less than 1.5.

l4 Starting FY2005106, KenGen intends to pay dividends amounting to KShs 500 m i l l i o n annually t o GOK. Hence, from FY2005106 their net income i s reduced by this amount.

74

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Annex 10

Safeguard Policy Issues

KENYA: Energy Sector Recovery Project

1. In preparing of the Kenya Energy Recovery project, the Government o f Kenya carried out three important safeguard studies, namely: two Environmental and Social Impact Assessment studies: one for the power generation component and the other for the distribution component. There was also a Resettlement Policy Framework pertaining to the latter component. The studies have been conducted in order to assess project potential negative impacts resulting f rom project-related activities and determine mitigation measures designed to minimize those negative impacts.

1.1 The ESIA for the generation component (KenGen) was based on the conversion o f gas turbines at K ipevu to combined cycle operation, an option which has since been discarded in favor o f the addition o f a third unit at the recently completed Olkaria I1 Geothermal Power Plant. An ESIA was carried out for the development o f the entire Olkaria geothermal f ield in 1993 and a mitigation plan was developed and implemented under the Bank-financed Energy Sector Reform and Power Development Project, Credit 2966-which closes on June 30,2004. The ESMP under this Credit was satisfactorily implemented and was the subject o f Bank supervision. The PSRs always indicated S rating for environmental management. In addition the Bank’s website o n best practice on geothermal environmental impacts case studies provides a favorable comment on KenGen’s endeavors to comply with both national and international environmental laws/regulations, standards and global environmental challenges, through i t s fully-fledged environmental section, established in 1985. The section i s responsible for monitoring environmental impacts, erosion control, sites rehabilitation, monitoring o f micro-climatic changes and pollution control. The website further notes that KenGen has also retained, since 1995, the services o f Geothermal Board o f Consultants, which includes an environmental expert who has constantly evaluated and reviewed the progress made by KenGen staff in aspects o f environmental mitigation and monitoring.

1.2 house and o f the switchyard, and the transmission capacity to evacuate power to Nairobi i s adequate. The only possible adverse impact o f the third unit will be the additional hydrogen sulphide emissions. The emissions from the existing Olkaria I Power Plant have ranged f rom 0.05 to 1.25 ppm, which i s considered to be wel l within the work place health levels. Nevertheless, as a precautionary measure, during project preparation, KenGen retained an independent consultant to review the environmental and social implications o f the proposed expansion and to conduct consultations with the local population in the project vicinity. The consultant issued an in i t ia l opinion in April 2004 that the environmental and social impacts f rom the expansion are l ikely to be moderate to negligible and would be manageable given KenGen’s demonstrated capacity for environmental management. Further, i t i s important to note that the expansion o f geothermal generation uses a renewable and environmentally clean fuel.

The original Olkaria I1 Geothermal Power Plant lay-out provided for extension o f the power

1.3 Based on the independent assessment that the environmental impact will be moderate to negligible and KenGen’s strong capacity for environmental management, i t was agreed with the borrower that the independent consultant would complete the environmental and social impact assessment by about mid 2004, only as a precautionary measure to help define the mitigation measures to manage the possible negligible impacts.

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Annex 10

2. The three studies (including the for the Kipevu Combined Cycle Power plant) have been conducted by local consultant f irms, using a broad-based public consultation approach, involving stakeholder groups in Govemment organizations, private sector institutions, NGOs and local communities within project intervention zone. These f i r m s were: L o g Associates for the distribution component at KPLC and GIBB for the combined cycle component at KenGen.

3. All the three safeguard instruments applicable to the Kenya Energy Recovery project include a clear description o f project components, a significant baseline information, policy, legal, administrative and institutional framework within which the project i s to be implemented, an analysis o f potential positive and negative impacts, institutional arrangements, with clear roles and responsibilities for implementing and monitoring sub-projects, along with their capacity building requirements to effectively mitigate project negative impacts, as wel l as enhance i t s positive ones.

4. Prior to final approval and disclosure o f the three safeguard documents, stakeholder workshops were held that sought to foster ownership o n the part o f stakeholders and to seek their input in order to improve the reports. The reports, which reflected stakeholder comments and suggestions were reviewed and approved by both NEMA and ASPEN and, then, disclosed in-country and at the Bank’s InfoShop in February, 2004. All the identified mitigation actions have been costed and the costs are included in the project costs for the distribution component.

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Annex 11

Project Preparation and Supervision

KENYA: Energy Sector Recovery Project

Planned Actual PCN review February 13,2004 February 13,2004 Init ial PID to PIC Init ial ISDS to PIC Appraisal March 8, 2004 March 8,2004 Negotiations May 17-2 1,2004 May 24 - 28,2004 BoardRVP approval July 29,2004 July 13,2004 Planned date o f effectiveness September 30,2004 Planned date o f mid-term review September 2007 Planned closing date September 30,2010

March 3 1, 2004 March 3 1, 2004

Key institutions responsible for preparation o f the project:

Ministry o f Energy (MoE); Kenya Power and Light Corporation (KPLC); Kenya Generation Company (KenGen); Kenya Pipeline Company (KPC); and Energy Regulatory Board (EM)

Bank staff and consultants who worked on the project included:

Name Title Unit Joel Maweni Lead Financial Analyst and Team Leader AFTEG Samuel O'Brien-Kumi Sr. Energy Economist AFTEG Yolaine Joseph Cofinancing Officer TFO

Amarquaye Armar Lead Energy Specialist EWDEN Amadou Konare Consultant, Environmental Specialist AFTEG Assefa Telahun Consultant Power Engineer AFTEG Helena Kof i Procurement Analyst AFTEG Moses Wasike Financial Management Specialist AFCOS Josphat Sasia Sr. Operations Officer AFTTR Janine Speakman Sr. Program Assistant AFTEG Anne Odera Team Assistant AFCOS

Mourad Belguedj Lead Energy Specialist COCPO

The quality enhancement team comprised:

Istvan Dobozi, Lead Energy Economist, ECSIE Selina Shum, Lead Financial Analyst, EASEG Chnsantha Ratnayake, Senior Power Engineer, SASE1

Bank funds expended to date on project preparation: 1. Bank resources: US$195,200 2. Trust funds: none 3. Total: US$195,200

Estimated Approval and Supervision costs: US$285,200 1. Remaining costs to approval: US$90,000 2. Estimated annual supervision cost: US$90,000

84

Annex 12

Documents in the Project F i l e

KENYA: Energy Sector Recovery Project

1. prepared by Gibb (Eastern Africa).

Environmental Impact Assessment for the Kipevu Combined Cycle Plant, February 2004,

2. Upgrade Component, February 2004, prepared by Log Associates for the Kenya Power and Lighting Company, Ltd.

Environmental Impact Assessment in two volumes for the Distribution Reinforcement and

3. Combined Cycle Power Station, April 2002, prepared for KenGen by Sinclair Knight Merz.

Feasibility Study for the Conversion o f the Open Cycle Kipevu Gas Turbine Power Station to a

4. March 2004, prepared for KenGen by Fichtner.

Kipevu Combined Cycle Power Project (Kipevu CCPP) update o f Feasibility Study Report,

5. NORPLAN for Kenya Power and Lighting Company, Ltd.

Distribution Reinforcement and Upgrade, Feasibility Report March 2004, prepared by

6. Design Report, March 2004, prepared for KPLC by Fichtner.

Feasibility Study o f the ReplacementAJpgrade and Expansion o f the SCADNEMS system, Final

7.

8.

9.

10.

11.

12.

13.

14.

Draft Sessional Paper on Energy, May 2004, Government o f Kenya.

Draft Kenya Energy Sector Development Strategy, April ,2004, IDA.

KPLC: Historical and Projected Financial Statements for fiscal years 1998-2008

KenGen: Historical and Projected Financial Statements for fiscal years 1998-2008

Table 1A: Medium-term Capacity Balance for Very Dry Hydrology

Table 1B: Medium-term Capacity Balance for Average Hydrology

Table 1C: Medium-term Energy Balance for Average Hydrology

Table 1D: Medium-term Energy Balance for Dry Hydrology

85

Annex 13

Statement of Loans and Credits

KENYA: Energy Sector Recovery Project

Difference between expected and actual disbursements Original Amount in US$ Millions

Project ID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev’d

PO78209 2004

PO78058 2003

PO82378 2003

PO66490 2002

PO69501 2001

PO66486 2001

PO70718 2001

PO70920 2001

PO46871 1997

PO34180 1997

PO01344 1997

PO01319 1996

PO35691 1996

Development Leaming Centre - LIL

Kenya And Lands I1

Free Primary Educ. Support

PUB.SEC.MGMT.TA

Kenya Economic & Public Sector Reform

Decentr. Reprod. Health & HIV/AIDS

Regional Trade Fac. Proj. - Kenya

HIViAIDS Disaster Resp. (Umbrella)

KE-Lake Victoria Env. (GEF)

Early Childhood Dev.

KE ENERGY SECTOR REFORM

URBAN TRANSPORT

KENYA - NAIROBI MOMBASA ROAD

Total:

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

60.00

0.00

15.00

150.00

50.00

25.00

50.00

9.80

27.80

125.00

115.00

50.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

9.80

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

2.96

56.99

22.83

9.33

55.40

36.08

14.78

29.18

5.45

8.67

27.81

25.54

5.68

0.00

1.43

4.43

10.12

39.94

20.63

4.06

13.99

5.61

10.05

35.95

35.28

9.60

0.00

0.00

0.00

0.00

28.65

7.85

0.00

0.00

0.00

9.32

0.00

0.00

8.78

0.00 677.60 0.00 9.80 0.00 300.70 191.09 54.60

KENYA STATEMENT OF IFC’s

Held and Disbursed Portfolio In Millions o f U S Dollars

Committed Disbursed

IFC FY Approval Company Loan Equity Quasi

2000 AEF AAA 0.55 0.00 0.00

1998 AEF AAR Clinic 0.00 0.50 0.00

1997 AEF Ceres 0.93 0.00 0.00

1997 AEF Deras Ltd. 1 .OO 0.00 0.00

1996 AEF Equitea 0.28 0.12 0.00

Growers

1992

2000

1998

2000

1997

1997

1999

IFC

Partic. Loan Equity Quasi Partic.

0.00 0.55 0.00 0.00 0.00

0.00 0.00 0.50 0.00 0.00

0.00 0.93 0.00 0.00 0.00

0.00 1.00 0.00 0.00 0.00

0.00 0.28 0.12 0.00 0.00

AEF Future 0.13 0.00 0.00 0.00 0.13 0.00 0.00 0.00 Hotel

AEF Lesiolo 2.50 0.00 0.00 0.00 2.50 0.00 0.00 0.00

AEF Locland 0.32 0.00 0.00 0.00 0.32 0.00 0.00 0.00

AEF Magana 1.27 0.00 0.00 0.00 1.27 0.00 0.00 0.00

AEF Makini 0.23 0.00 0.00 0.00 0.23 0.00 0.00 0.00

AEF Redhill Flrs 0.25 0.00 0.00 0.00 0.25 0.00 0.00 0.00

AEF 0.06 0.00 0.00 0.00 0.06 0.00 0.00 0.00

86

Annex 13

Transenergy

1999 ANSPAR 2.00 0.67 0.00 0.00 2.00 0.67 0.00 0.00

1980/83/98 DBK 3.00 0.00 0.00 0.00 3.00 0.00 0.00 0.00

1982 Diamond Trust 0.00 0.80 0.00 0.00 0.00 0.80 0.00 0.00

1998 GBHL 3.30 0.00 3.00 0.00 3.30 0.00 3.00 0.00

2001 Gapco Kenya 15.00 0.00 0.00 0.00 10.00 0.00 0.00 0.00

IPS(K)-Allpack 0.00 0.3 1 0.00 0.00 0.00 0.31 0.00 0.00

IPS(K)-Frigoken 0.00 0.06 0.00 0.00 0.00 0.06 0.00 0.00

Food IPS(K)-Prem 0.00 0.1 1 0.00 0.00 0.00 0.11 0.00 0.00

1994 Intl Hotels-Ken 4.16 0.00 0.00 0.00 4.16 0.00 0.00 0.00

1996199 K-Rep Bank 0.00 0.43 0.00 0.00 0.00 0.12 0.00 0.00

2003 Kenair 15.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

1983191 LIK 0.00 0.03 0.00 0.00 0.00 0.03 0.00 0.00

2000 Mabati 5.50 0.00 4.50 0.00 5.50 0.00 4.50 0.00

1970174177179181188189194196199 Panafncan 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

1972 TPS (Kenya) 0.00 0.04 0.00 0.00 0.00 0.04 0.00 0.00

Tsavo Power 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 oioo

Total portfolio: 3.07 7.50 0.00 35.48 2.76 7.50 0.00 55.48

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic.

2002 Eberege Tea

2002 Itumbe Tea

2003 Kenair

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

Total pending commitment: 0.00 0.00 0.00 0.00

87

Annex 14

Country at a Glance

KENYA: Energy Sector Recovery Project

POVERTY and SOCIAL

2002

GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 1996-02

Population (%) 2.3 Labor force (744 2.9

M o s t recent es t imate ( la tes t year available, 1996-02)

Poverty (% of populafion belo wnafional po vertylhe) Urban papulation (%of fofalpopulation) 35 Life expectancyat birth (years) 46 Infant mortality(per 1,OOOlive births) ao Child malnutrition (%ofchildren under5) 22 Access to an improved water source (%ofpopulation) 57 llliteracy(%ofpopulafion age a+) 16 Gross primary enrollment (%of school-age population) 94

Male 95 Female 93

Kenya

3 13 360 113

Po puiat io n, m id-year (millions)

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1982 1992

GDP (US$ billions) 6.4 8.0

Gross domestic investmentlGDP 182 0.7

Gross domestic savings/GDP 14.5 0.7 Gross national savings/GDP i t a 9.7

Exports of goods and services/GDP 25.0 26.9

Current account balancelGDP -4.7 -2.3 Interest paymentslGDP 13 2.5

Total debt servicelexports 14.5 311 Present value of debVGDP Present value of debVexparts

Total debVGDP D.O 86.2

1982-92 1892-02 2001 (average annualgro Wh) GDP 4.4 2.1 11 GDP DercaDita 10 -0.4 -10

Sub- Saharan Low-

Af r i ca income

6aa 450 306

2.4 2.5

33 46 D5

5a

a6

ao

37

92

2001

114 Q.8 26.0 4.2 9.6

-2.8 0.7

49.5 0.9

146.6 38.7

2,495 430

to72

19 2.3

30 59 a i

76 37 95 a3 a7

2002

Q.l 14.8

8.7 25.5

0.1

0.5 511 9.8

2002 2002-06

l a 3.5 -0.2 1a

STRUCTURE of the ECONOMY

(%of GDP) Agriculture Industry

Services

Private consumption General government consumption Imports of goods and services

Manufacturing

(average annualgrolulh) Agriculture Industry

Services

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

Manufacturing

1982 1992

33.4 26.6 29.9 18.9 Q .2 111

46.7 54.5

67.1 70.2 18.4 16.1

28.7 26.9

1982-92 1992-02

2.7 16 4.3 16

4.9 2.9

5.1 2.2 3.6 6.6 1.5 4.3

5.7 5.5

5.1 i a

2001

8.0 18.2 Q.5

62.9

79.0

34.6 6.8

2001

12 0.7

13

-4.4 4.3 2.3 -12

0.8

Development diamond*

Life expectancy

GNI Gross per primary capita nroliment

Access to improvedwatersource

I -- Kenya

Low-income group

Economic ra t i os *

Trade

T

Indebtedness

e-.- Kenya

Lowincome group

2o02 1 Growth o f i nves tment and GDP (%) I 29.1 183 Q 7

626

811 0 2

Is

-5 -10

316 *--**GDI -GDP

2o02 1 Growth o f expor ts and impor t s ( O h ) I

88

Annex 14

Ken vu PRICES and GOVERNMENT FINANCE

Domes t i c p r i ces (%change) Consumer prices Implicit GDP deflator 11 7

Government f inance (%of GDP, includes current grants) Current revenue 25 1 Current budget balance - 15

1982

Overall surplusideficit -0 2

TRADE

(US$ millions) Total exports (fob)

Fuel Coffee Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (895=WO) import price index (895=WO) Terms of trade (895=WO)

B A L A N C E o f PAYMENTS

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

Net income Net current transfers

1982

894 223 227 0 7

14 15 83

523 250

77 1P 69

1982

1715 2,030

-3 ti

-254 63

Current account balance -305

Financing items (net) Changes in net reserves

139 6 7

Memo: Reserves including gold (US$ millions) 248 Conversion rate (DEC, /ocaNUS$) 0.9

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

1982

641 IBRD 0 ID A 0

Total debt service IBRD IDA

Compositionof net resourceflows Official grants Official creditors Private creditors Foreign direct investment Portfolio equity

World Bank program Commitments Disbursements Principal repayments

258 1 0

143 -15

-136 13 0

0 0 0

1992

27.3 8.5

27.5 13

-3.3

1992

10 0 89 P6 144

1866 156 4P 411

76 91 84

1992

2,149 2,152

-3

-355 68

-180

255 -75

182 32.2

1992

6,896 656 1411

670 259 B

376 255 20 6 0

V6 92 0 4

2001

3.9 113

22.5 15

-0.9

2001

1732 115 66

274 3,182 290 8 0 756

74 0 0 74

2001

2,966 3,939 -973

-60 761

-3 18

509 -SI

1,097 78.6

2001

5,644 24

2263

4 8 26 51

252 62

- 133 5 0

93 16 58

2002

5.0 4.9

22.4 2.4

-0.9

2002

f742 0 1 97

313 3,137 300 609 803

74 0 4 71

2002

3,001 3.850 -848

-70 576

256

1,84 78.7

2002

6,207 13

2,447

299 0 60

1 -18

2 66 54

In f la t ion ( O h ) 1

97 98 99 00 01

-- GDP deflator -CpI

Export and impor t levels (US$ mill.) (‘“““TI

96 97 98 99 00

Exports mlrmorts

Current account balance to GDP (%)

0

1

-2

-3

- 4

-5

’ Compos i t i on o f 2002 debt (US$ mill.)

A: I3 G 663

B 2,447

I D: 526

E- Bilatetal 1 A - IBRD 8-IDA D-Othermitilateral F-Rivate

1 C - I M F G- Short-terr

89