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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY PROJECT PAPER ON A PROPOSED ADDITIONAL FINANCING IN THE AMOUNT OF 35.3 MILLION (US$48.0 MILLION EQUIVALENT) TO THE PORT OF RIJEKA AUTHORlTY Report No: HR WITH THE GUARANTEE OF THE REPUBLIC OF CROATIA FOR THE RIJEKA GATEWAY PROJECT (LOAN NO HR) Sustainable Development Department South Central Europe Country Unit Europe and Central Asia Region May 4,2007 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS (Exchange Rate Effective April 30,2007) Currency Unit = HRK (Kunas) HRK 1 = US$ US$1 = HRK = US$1.361 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS CAS ECA IBRD IFRs FMRs MSTTD NIA PRA SIL TEU Country Assistance Strategy Europe and Central Asia International Bank for Reconstruction and Development Interim Un-audited Financial Reports Financial Monitoring Reports Ministry of Sea, Transport, Tourism and Development Not Applicable Port of Rijeka Authority Specific Investment Loan Twenty foot equivalent unit - container Vice President: Country Director: Sector Director: Sector Manager: Task Team Leader: Shigeo Katsu Anand K. Seth Peter D. Thomson Motoo Konishi Gerald Ollivier

3 FOR OFFICIAL USE ONLY ADDITIONAL FINANCING FOR THE RIJEKA GATEWAY PROJECT CONTENTS Page A. Introduction B. Background and Rationale for Additional Financing ( 35.3 million)... 1 C. Proposed Changes... 4 D. Consistency with CAS E. Economic Analysis of Cost Overrun/Financing Gap... 6 F. Risks... 7 G. Financial Terms and Conditions For The Additional Financing This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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5 Date: May 4, 2007 Country: Croatia Project Name: Rijeka Gateway - Additional Financing Project ID: P Team Leader: Gerald Ollivier Sector Manager: Motoo Konishi Country Director: Anand K. Seth Environmental Category: A - Full Assessment (carried out for original project) FY Annual Cumulative Current closing date: 09/30/2009 Revised closing date: 12/3 1/2010 Does the restructured or scaled-up project require any exceptions from Bank policies? Have these been approved by Bank management? Is approval for any policy exception sought from the Board? No N/A No Revised project development objectives/outcomes. The project design, components, development objectives and expected outcomes would remain the same. For Additional Financing [XI Loan [ 3 Credit [ ] Grant Total Bank financing ( m.): 35.3 (US$m equivalent) Proposed terms: IBRD terms, with a maturity of 13 years, including a 4 year grace period, at the Bank s standard interest rate for a variable spread loan in Euro Source Borrower IBRD/IDA Others Total Financing Plan (US$m. Eauivalent) Local Foreign Total

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7 A. Introduction 1. This Project Paper seeks the approval of the Executive Directors to provide an additional loan in an amount of 35.3 million (US$48.0 million equivalent) to the Port of Rijeka Authority, with the guarantee of the Republic of Croatia for the Rijeka Gateway Project (P043195) and the corresponding Loan No HR. The financing is to be made available on IBRD terms with a maturity of 13 years, including a 4 year grace period, at the Bank s standard interest rate for a variable spread loan in Euro. 2. The proposed additional loan would help finance the cost associated with: (i) cost overrun in completing the construction of the main port component, the Zagrebacko Terminal ( 38.6 million); and (ii) financing gap in technical services to prepare the concession arrangements for the Zagrebacko Terminal ( 1.5 million). The project design, components, development objectives and expected outcomes would remain the same. 3. There will be no co-financing from other donors for this particular project. B. Background and Rationale for Additional Financing ( 35.3 million) 4. The original estimated value of the Rijeka Gateway Project was US$266.1 million, supported by three loans of respectively US$55.1 million to the Port of Rijeka Authority (PRA), US$84.1 million to the Croatian Roads, and US$17.3 million to the Croatian Motorways. The Croatian Road and Croatian Motonvays are in the final stage o f implementation of their respective components and would be able to complete their part of the project with the existing loan and their own funds. The first Loan (No.4715-HR) with PRA is the Loan for which Additional Financing is sought. 5. The Loan was approved on July 8, 2003 and became effective on October 10, The project s original objective was to improve the effectiveness of the transport chain through the Rijeka Gateway for both freight and passenger traffic by modernizing the port and road network connections, and privatizing port operations. The original objectives, design, or scope have not been modified with only one significant exception. Several warehouses, originally expected to be demolished under the project, were later on protected and preserved as buildings of historical significance. A review of progress toward meeting the project objectives is presented in the table below. 6. The Project has had solid performance in terms of outputs, outcomes and results, as confirmed by the October 2006 Mid-Term Review. Level of disbursement reached 61 percent of project funds and commitments 86 percent, with most remaining commitments expected within a year. The project is also on track to meet its project development objectives for all criteria. The Borrower is in compliance with the loan covenants.

8 Overview of Objectives and Outcome/Impact Obi ective: Outcome/Impact Indicators Between 2003 and 2006, percent and passenger tras cargo grew from 15,2 15 TE Increasing private sector involvement in financing and operating transport sector infrastructure and services Private sector participation in the port has been slower than anticipated, but progress is expected over the coming 18 months based on: (i) recent amendmen law on Seaport; and (ii) two new assignments being contra to secure additional private sector involvement in the pres ssionaire and in the new terminals under development. ajor private operators indicated their interest in participating. financial PRA fin ctations with an pected value of 200 Port/City environment is enhanced through The Port Authority and the City mad discussions regarding the DeltdPort ificant progress in their s redevelopment, privately financed urban development although by its nature and the range of constraints it faces, this aspect will require additional support and management attention to materialize. e Total road maint largely exceedin in the Project Po Sections of the R D404 were open expected to be ope1 to be met. vel of US$l55 mil 7. The Project Implementation Progress and Development Objectives have been satisfactory or better over the past 12 months: ISR 9 (04/03/06) IP and DO Highly Satisfactory - ISR 10 (10/31/06) IP and DO Satisfactory. The project does not face problems in terms of Fiduciary, Environmental, Social or other Safeguards aspects. The part managed by PRA, for which extension is required, is rated satisfactory on financial management, procurement and environment. 8. Cost Overrun-Civil Works. Soil conditions prevalent at the location of the Zagrebacko Terminal have proven to be much weaker than anticipated at the time of design and contracting the civil works, requiring soil consolidation works prior to proceeding with the terminal construction. Given the depth of the sea bottom (minus 35 meters) and the thickness of the soil strata requiring treatment (19 meters), only a few contractors worldwide have the capability and expertise required to accomplish the 2

9 needed soil consolidation works. The cost of required soil strengthening work is estimated at 25.5 million plus 5.5 million of contingencies. In addition, changes in market demand and construction code (alignment to EuroCode) call for strengthening the terminal for larger container vessels at a preliminarily estimated cost of 7.6 million. Since a contractor for the terminal construction is already in place, the borrower is incurring significant daily stand-by costs until a technical, financial and procurement solution for soil strengthening is secured. 9. Soil Conditions. The results and suitability of the tests carried out to ascertain soil conditions and characteristics have been confirmed by relevant and qualified specialists. As part of the revisions to the construction permit for the Zagrebacko Terminal, new soil investigations were requested by local reviewers in These indicated significantly weaker soil conditions than anticipated in the design phase. In consequence, PFU recruited, through the Project Engineer for the Terminal, an international expert to define and monitor a plan of soil investigation. A comprehensive set of investigations were carried out accordingly between March and October 2006, providing a full analysis in November The results of this analysis have been formally endorsed by all national and international technical parties working on the project as providing a sound representation of the soil condition. 10. Technical solutions/options. Following the confirmation of the soil conditions, PRA requested the international project designer to identify and compare the main applicable technical alternatives. Five alternatives were considered to consolidate the ground conditions: dredging and replacement, gravel compaction piles, deep concrete mixing, sand gravel drainage, and gravel piles/drains. Among those methods, the gravel compaction pile method is the option favored by PRA, the Designer and the Design Reviewers. Based on their inputs, it offers the following characteristics: (i) expected lower cost; (ii) technology known to reviewers and as such more likely to be approved; (iii) no critical environmental aspects (use of sand and gravel as main material) and in line with existing environmental impact assessment; (iv) more competition than for the second-best method; and (v) no major technical limitations to applicability. The Basic Design Report has been issued, and the project designer received feedback for inclusion in the preparation of the Detailed Design Financing Gap-Consultant Services. The project costs were all estimated in U S Dollars in 2003, at the time of the original project appraisal. Between 2003 and 2007, the exchange rate between the US Dollar and Euro dropped from a parity of US$O.9 for 1 to US$1.36 for 1. Since the loan was in US Dollars and several consultant contracts were awarded to European firms, the resulting consultant costs under the project became higher than originally anticipated, and almost all funds in the consultant category have been used. In consequence, additional funding is sought to prepare the technical documentation and arrange for a concession transaction for the Zagrebacko Terminal. This activity was part of the original project. 12. Rationale. The Borrower has requested the Bank to provide additional financing to complete these two components related to the Zagrebacko Terminal, which is central 3

10 to the project development objectives. The port of Rijeka will need new capacity to accommodate fast growth in container traffic (increased by 520 percent in four years) as soon as feasible. The concession of the terminal is also central to the Government policy of increasing private sector participation in the port sector, as demonstrated by amendments made to the Law on Seaport in December In addition, since a contractor for the construction of the Terminal is already mobilized, rapid resolution of the soil consolidation aspects is required to limit the level of stand-by cost. C. Proposed Changes 13. The Project development objective, design and scope would not be modified as a result of this additional financing, but the additional financing would enable objectives related to the Port Component to be achieved. 14. The additional financing will cover the financing gap coming from the cost overrun in the completion of the Zagrebacko Terminal ( 34 million from the loan) and the financing gap in technical services to prepare concession arrangements for the Zagrebacko Terminal ( 1.3 million from the loan). The present delays in securing a proper soil consolidation method are expected to lead to total delays in construction of about 15 months, with a corresponding postponement of the closing date for the original loan by 15 months, to December 3 lst, Summary of Complementary Changes 15. Institutional Arrangements. The additional loan will use the existing project management structure, strengthened with suitable expertise in large civil works implementation. While PRA has performed satisfactorily in terms of proj ect management with over 30 contracts to date, the present implementation team has limited experience in large civil works of this type, and as such will secure additional expertise for the team, in the form of specialized consulting services, considering the complex remedial marine works that need to be implemented. 16. Project Cost and Financing Plan. The total additional cost for the terminal is estimated at 38.6 million and the cost of the technical documentation and concession arrangements at 1.5 million for a total of 40.1 million. The Additional Loan will cover 35.3 million. The Ministry of Sea, Transport, Tourism and Development (MSTTD) will provide to PRA counterpart funding in the estimated amount o f 4.8 million to support the implementation of these two items. This is consistent with the original commitment of the State of Croatia in the Letter of Development Policy dated May 22, 2003 to provide an estimated HRK320 million to contribute to the Rijeka Gateway Project. MSTTD will also cover standby cost on the on-going construction contract. 4

11 Table 1. Cost and Financing Plan Amount in Euro (millions) Total State World Bank Cost Overrun 1.I Soil Improvement Strengthening of terminal to meet Eurocode and to handle containers I.3 Contingencies Financing Gap 1.4 Zagreb Pier Concession Arrangements Total Financial Management and Disbursement. The financial management functions of the additional financing will be handled by the Rijeka Port Authority PIU, and the PIU will be responsible for the flow of funds, accounting, reporting, and auditing. There would be no changes in financial management and disbursement arrangements except for the percentage of expenditures to be funded by the additional loan established at 88 percent. 18. The financial management arrangements of the Rijeka Gateway Project implemented by the Rijeka Port Authority have been reviewed periodically as part of project supervision and have been found satisfactory. According to the latest Financial Management supervision of Rijeka (September 2006), the financial management arrangements of the project continue to be satisfactory and the control procedures are in place. The client is in compliance with the audit covenant: all the audit reports have been received to date and there were no delays in submitting them to the Bank. For the project financial statements, the auditors have given unqualified opinion and there were no internal control issues in the management letter. For the entity, the auditors have given an unqualified opinion and there were several issues in the management letter, which have been addressed by the management. 19. The financial management arrangements of the project are acceptable to the Bank. The overall FM risk for the project is moderate. 20. Similar audit arrangements will be adopted for the additional financing, which will be included in the overall Rijeka project audit. The audit of the project will be conducted by independent private auditors acceptable to the Bank, on terms of reference acceptable to the Bank, and procured by Rijeka Port Authority. The annual audited project financial statements will be submitted to the Bank within six months of the end of each fiscal year and also at the closing of the project. The cost of the audit will be financed from the proceeds of the loan Project management-oriented Interim Un-audited Financial Reports (IFRs) - previously known as Financial Monitoring Reports (FMRs) - will be used for the additional financing monitoring and supervision. The existing formats of the IFRs will be used and the PIU will produce a full set of IFRs/FMRs every quarter throughout the life 5

12 of the project and will submit them to the Bank no later than 45 days after the quarter end. 22. Procurement. Procurement rules would remain unchanged. Given the size of the additional works, the procurement approach for the soil consolidation works would be reviewed formally by the Operations Procurement Review Committee of the Bank, prior to proceeding. 23. Environment. The proposed method of soil consolidation was foreseen in the original construction permit, and as such remains within the parameters presented in the original Environmental Assessment and Environmental Management Plan for the Rijeka Gateway project. Furthermore, based on consultation with ECA Safeguards team and as stipulated in the Guidance to Staff on Processing Additional Financing, there i s no need to issue an updated Integrated Safeguard Data Sheet since the technical aspects envisaged under this additional loan are covered under the existing Integrated Safeguard Data Sheet for the project. D. Consistency with CAS 24. The Rijeka Gateway Project supports a core pillar of the Country Assistance Strategy (No HR discussed by the Board on December 21St, 2004) by reducing the cost of doing business and improving the investment climate, in particular in the port sector. It contributes to the program of transport infrastructure modernization of the Croatian Government, which places a strong emphasis on increasing the capacity of Pan- European transport corridors. Those corridors carry the vast majority of trade, transit and tourist traffic between the EU and the Southeast European region and within the region. The inter-modal connectivity of the Rijeka Gateway to the Northeast Corridor Vb to Central Europe is one of the highest priorities. As indicated in the CAS Progress Report, the Government is also seeking a new loan in FY08 to support a follow- up phase for the Rijeka Gateway project, the Rijeka Gateway I1 project. This new project, building on an updated port masterplan, would support the next phase of development of the port. E. Economic Analysis of Cost Overrun/Financing Gap 25. The initial economic analysis carried out in the Project Appraisal Document of the Rijeka Gateway Project reflected the cost and benefits of an investment aiming to develop the Zagrebacko Pier as a multi-purpose terminal, mostly handling low valueadded timber traffic. In 2003, container traffic was too low to consider it a major source of economic benefits. The proposed investment was estimated to have an economic rate of return of 13.8 percent and a net present value of US$3 million with a 12 percent discount rate. 26. Traffic trends have changed significantly since the original project appraisal and provide the basis to support these additional investment costs in the Zagrebacko terminal. Containerized cargo through the port of Rijeka has been growing at over 20 percent a year for the past eight years and is expected to continue to grow rapidly, as transit from the Far East to Central European countries through the Northern Adriatic ports hrther 6

13 expands. Provided proper port capacity is in place, corridor transport cost savings from the Far East to Central European markets using Northern Adriatic ports compared to the Northern European ports are substantial. 27. Based on larger traffic volume and economic benefits coming from corridor cost savings in the use of the transport corridor through Rijeka to Central Europe instead of through Northern European ports, the completion of the Zagrebacko Terminal as a container terminal would offer a higher economic rate of return than originally foreseen, The investments in the Zagrebacko Terminal are estimated to have a net present value of 1 7 million (at 12 percent discount rate) and an economic rate of return of 15 percent. F. Risks 28. Marine Works Risks. Deep-sea marine works are inherently complex and a significant source of technical and financial risks. Highly specialized pieces of equipment need to be mobilized and are subject to high daily stand-by costs in case works can not be performed for reasons beyond the responsibility of the contractor or sub-contractor, such as weather related risks. To address this risk, PRA will expand its project implementation team to ensure proper capacity is in place to manage such complex works appropriately. The terminal designer for these works will be required to identify specifically the risks likely to emerge in the implementation of these works to facilitate their monitoring and identify remedial actions. 29. Withdrawal from Existing Contractor. While the existing contractor for the terminal construction has remained in place up to now, given the delays experienced to date and slow resolution of stand-by cost payments, the contractor may decide to withdraw from the ongoing contract and charge penalties specified in the existing contract. The addition of marine works as a subcontract considerably increases its risks. Accordingly the contractor will need to feel confident about the proposed contractual arrangements including the definition of liability for delays in marine works by its nominated sub-contractor, and the clarification in responsibility to cover existing and potential stand-by cost payments. To address this risk, PRA and the terminal designer will work closely together with the contractor when specifying the qualification requirements for the subcontractor in charge of soil consolidation works and contractual terms. In case the contractor decides to withdraw, the entire terminal construction would be re-tendered. 30. Permitting Process. Once the design for the soil consolidation technical solution is completed, PRA will need to amend the construction permit accordingly. In the past, these modifications have proven, at times, to be complicated and lengthy. They may lead to a postponement of the start of works until all aspects have been designed, reviewed and approved. The Ministry of Sea, Transport, Tourism and Development indicated it would follow up these aspects with the Ministry for Environment, Physical Planning & Construction to accelerate this process. 7

14 G. Financial Terms and Conditions For The Additional Financing 31. The additional loan would have BRD terms, with a maturity of 13 years, including a 4 year grace period, at the Bank s standard interest rate for a variable spread loan in Euro. The use of the Euro would enable a better match between local costs and sources of financing while the VSL offers a lower cost of borrowing to PRA than an alternative fixed spread loan. 8