Document of The World Bank FOR OFFICIAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION PROGRAM DOCUMENT FOR A PROPOSED CREDIT

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Africa Energy Team Sustainable Development Department Africa Region Document of The World Bank FOR OFFICIAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION PROGRAM DOCUMENT FOR A PROPOSED CREDIT IN THE AMOUNT OF SDR199.9 MILLION (US$300 MILLION EQUIVALENT) TO THE REPUBLIC OF UGANDA FOR A POWER SECTOR DEVELOPMENT OPERATION March 29, 2007 Report No: UG 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. i

2 CURRENCY EQUIVALENTS (Exchange Rate Effective February 28, 2007) Currency Unit = Uganda Shillings USh1,757 = US$1 US$ = SDR 1 FISCAL YEAR January 1 December 31 ADF ADO AfDB AUE BOT CIFA CFAA CPAR DP(s) DPL DSM EAC EE EIA EIB ERA ERT ESCO ESWG FINMAP FMR GDP GOU GTZ GWh HFO HIPC HIV/AIDS ICB IDA IMF IPP JAS KSW ABBREVIATIONS AND ACRONYMS African Development Fund Automotive Diesel Oil African Development Bank Avoided Unserved Energy Build-Operate-Transfer Country Integrated Fiduciary Assessment Country Financial Accountability Assessment Country Procurement Assessment Report Development Partner(s) Development Policy Loan Demand Side Management East African Community Energy Efficiency Environmental Impact Assessment European Investment Bank Electricity Regulatory Authority Energy for Rural Transformation Energy Service Companies Energy Sector Working Group Financial Management and Accountability Program Financial Management Reports Gross Domestic Product Government of Uganda Gesellschaft fuer Technische Zusammenarbeit Gigawatt Hour Heavy Fuel Oil Heavily Indebted Poor Country Human Immuno-deficiency Virus/Acquired Immuno-deficiency Syndrome International Competitive Bid International Development Organization International Monetary Fund Independent Power Producers Joint Assistance Strategy Kakira Sugar Company ii

3 kwh masl MDGs MDRI MEMD MIGA MoF MoFED MSD MWh NPV PDE PEAP PO PPA PPDA PRG PRGF PRSC PSI PSIA RE REA REF SEK SIDA SIL ToR UEB UEDCL UEGCL UETCL UJAS VAUE Kilowatt Hour Meters above sea level Millennium Development Goals Multilateral Debt Reduction Initiative Ministry of Energy and Mineral Development Multilateral Investment Guarantee Agency Ministry of Finance Ministry of Finance and Economic Development Medium Speed Diesel Megawatt Hour Net Present Value Procuring and Disposal Entity Poverty Eradication Action Plan Probability of Occurrence Power Purchase Agreement Public Procurement and Disposal of Public Assets Authority Partial Risk Guarantee Poverty Reduction and Growth Facility Poverty Reduction Strategy Credit Policy Support Instrument Poverty and Social Impact Analysis Rural Electrification Rural Electrification Agency Rural Electrification Fund Swedish Kronars Swedish International Development Agency Specific Investment Loan Terms of Reference Uganda Electricity Board Uganda Electricity Distribution Company Ltd. Uganda Electricity Generation Company Ltd. Uganda Electricity Transmission Company Ltd. Uganda Joint Assistance Strategy Value of Avoided Unserved Energy Acting Vice President: Hartwig Shafer (acting) Country Director: Judy O Connor Country Manager Grace Yabrudy Sector Manager: S. Vijay Iyer Task Team Leader: Malcolm Cosgrove-Davies iii

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5 UGANDA POWER SECTOR DEVELOPMENT OPERATION PROJECT APPRAISAL DOCUMENT AFRICA AFTEG Date: March 29, 2007 Team Leader: Malcolm Cosgrove-Davies Country Director: Judy M. O'Connor Sector Manager/Director: Subramaniam V. Iyer Sectors: Power (100%) Themes: Infrastructure services for private sector development (P) Project ID: P Environmental screening category: Partial Assessment Lending Instrument: Specific Investment Loan and Development Policy Loan Operation Financing Data [ ] Loan [X] Credit [ [ ] Other: ] Grant [ ] Guarantee For Loans/Credits/Others: Total Bank financing (US$m.): Proposed terms: Standard, with 40 years maturity Financing Plan (US$m) Source Local Foreign Total BORROWER/RECIPIENT INTERNATIONAL DEVELOPMENT ASSOCIATION SWEDEN: SWEDISH INTL. DEV. COOPERATION AGENCY (SIDA) Financing Gap Total: Borrower: Ministry of Energy and Mineral Development Amber House, P.O. Box 7270 Kampala Road Kampala Uganda Tel: Fax: Responsible Agency: UETCL Amber House Plot No. 29/33 Kampala Road P.O Box 7625 Kampala-Uganda Telephone /4 Fax: transco@uetcl.com iv

6 Estimated Disbursements (Bank FY/US$m) FY Annual Cumulative Project implementation period: Start: May 15, 2007 End: January 31, 2011 Expected effectiveness date: May 15, 2007 Expected closing date: July 31, 2011 Does the project depart from the CAS in content or other significant [ ]Yes [X] No respects? Ref. PAD A.3 Does the project require any exceptions from Bank policies? Ref. PAD D.7 Have these been approved by Bank management? Is approval for any policy exception sought from the Board? Does the operation include any critical risks rated substantial or high? Ref. PAD C.5 [ ]Yes [X] No [ ]Yes [ ] No [ ]Yes [X] No [ ]Yes [X] No Does the operation meet the Regional criteria for readiness for implementation? Ref. PAD D.7 Project development objective Ref. PAD B.2, Technical Annex 3 The primary objectives of the Operation are to reduce short-term power shortages and financial imbalances, and facilitate orderly longer-term expansion of electricity service. [X]Yes [ ] No In order to achieve these objectives, the Operation comprises: (a) a set of investments and policy measures designed to reduce the supply-demand gap until the Bujagali hydropower plant comes into service in 2011; (b) financial support for the Government to absorb a part of the high costs of short-term thermal power generation; and (c) policy measures aimed at making the sector financially viable, accelerating rural electrification, and moving towards a sector-wide approach for development. Project description [one-sentence summary of each component] Ref. PAD B.3.a, Technical Annex 4 This Operation combines a Policy Support Program (US$80 million) and a Specific Investment Loan (US$220 million). The proposed Policy Support Program covers three policy areas: (i) power shortages - which includes the preparation of an energy efficiency strategy and plan, to be implemented under the program; (ii) sector finances - which will focus on tariff increases to partially cover the high cost of thermal power; the clearing of GoU arrears owed to UETCL and UETCL arrears owed to generation companies; and (iii) longer term-sector expansion covering establishment of a joint Energy Sector Working Group; independent evaluation of the rural electrification framework and Rural Electrification Agency with subsequent legal modifications to the Agency s statutes by new legislation if required; daily monitoring of Lake Victoria water abstraction for power generation and reporting to EAC of these data, along with the amounts permitted by the Agreed Curve; and Participation in development of Regional and In-country Watershed Management Plans related to Lake Victoria. The project portion of the operation comprises two components. Component 1 will provide partial cofinancing towards the capacity and energy charges of a 50MW thermal plant to be installed at Mutundwe, Kampala. Component 2 will provide Technical Assistance and Energy Efficiency. Activities under this component will include: (a) Energy Efficiency and Demand Side Management ;(b) Independent Evaluation of the Rural Electrification Program; (c) Poverty and Social Impact Analysis (PSIA); (d) Power Sector Medium-term Investment Plan; (e) Lake Victoria Transmission Ring Pre-feasibility and v

7 Feasibility Studies; (f) Kalagala Offset Tourism Development Plan; and (g) Energy Sector Communications Strategy. Which safeguard policies are triggered, if any? Ref. PAD D.6, Technical Annex 10 Environmental Assessment (OP/BP 4.01) and Involuntary Resettlement (OP/BP 4.12). Significant, non-standard conditions, if any, for: Ref. PAD C.7 Board presentation: None. Loan/credit effectiveness: The main conditions of effectiveness are: The signing of a Subsidiary Agreement between GOU and UETCL in form and substance acceptable to the Association is a condition of effectiveness. Covenants applicable to project implementation: Government agrees to consult with IDA prior to decommissioning of any of the thermal power stations. Government (Department of Water Development) will periodically report the abstraction of water from Lake Victoria to the Nile Basin countries. Reporting will compare the actual abstraction to that allowed under the Agreed Curve. vi

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9 UGANDA POWER SECTOR DEVELOPMENT OPERATION TABLE OF CONTENTS Page I. INTRODUCTION...1 II. COUNTRY CONTEXT AND RATIONALE... 3 A. Recent Economic Developments in Uganda...3 B. Bank Group/Donor Support for PEAP and Power Sector...5 C. Debt Sustainability...8 D. IMF Assessment...9 III. POWER SECTOR CONTEXT AND RATIONALE... 9 A. Overall Government Strategy...9 B. Main Sector Issues and Government Responses...10 C. Rational for Bank Involvement...16 D. Higher Level Objecctives to which the Operation Contributes...16 IV. OPERATION DESCRIPTION A. Lending Instrument...17 B. Operation Development Objective and Key Indicators...17 C. The Operation...17 D. Lessons Learned and Reflected in the Operation Design...21 E. Alternatives Considered and Reasons for Rejection...21 F. Relationship to Other Bank Operations...22 V. IMPLEMENTATION A. Institutional and Implementation Arrangements...23 B. Monitoring and Evaluation of Outcomes/Results...24 C. Sustainability...24 D. Critical Risks and Possible Controversial Aspects...24 E. Loan/Credit Conditions and Covenants...27 F. Disbursement and Auditing...28 VI. APPRAISAL SUMMARY A. Economic and Financial Analyses...29 B. Technical (Project only; not required for Policy Support Program)...37 C. Fiduciary...37 D. Procurement...38 E. Poverty and Social Impacts...39 F. Environment...41 G. Safeguards...42 H. Policy Exceptions and Readiness...42 vii

10 ANNEXES Annex 1: Country and Sector Background Annex 2: Major Related Projects Financed by the Bank and/or Other Agencies Annex 3: Policy Matrix, Results Framework, and Monitoring Annex 4: Detailed Operation Description Annex 5: Project Costs Annex 6: Implementation Arrangements Annex 7: Financial Management and Disbursement Arrangements Annex 8: Procurement Arrangements Annex 9: Economic and Financial Analysis Annex 10: Poverty, Social and Environmental Aspects Annex 11: Operation Preparation and Supervision Annex 12: Documents in the Operation File Annex 13: Statement of Loans and Credits Annex 14: Country at a Glance Annex 15: Letter of Development Policy Annex 16: Lake Victoria Hydrology Annex 17: Fund Relations Note Annex 18: Maps (IBRD 35424) viii

11 I. INTRODUCTION 1. This Operation has two parts: a Policy Support Program (US$80 million), designed according to the Development Policy Loan (DPL) template, and an investment Project (US$220 million), designed according to the Specific Investment Loan (SIL) template. The hybrid nature of the Operation is dictated by the ground realities of the Ugandan power sector. Both support for policy changes and financing gaps, as well as short-term investments to overcome countrywide power shortages are needed at this time to stabilize the sector and promote its sustained future expansion. 2. Uganda s economy has performed well during the last two decades, signified by a stable macroeconomic environment and sustained growth in per capita incomes averaging 3.2 percent per annum. Agriculture has been a key driving factor. In order to build on this growth trend, and to absorb an ever-increasing work force, the Government is pushing to expand off-farm employment. Agro-processing and other such growth-oriented industries require a sound infrastructure base, including affordable and reliable electricity supply. Uganda s current very low rate of electrification (5 percent) compels an urgent emphasis on significant investments in the sector both for expanding access and increasing power supply. The Government has adopted a sector structure which features commercially oriented service provision, and emphasizes private sector investment that leverages public resources. The former Uganda Electricity Board has been unbundled, and the generation and distribution components have been privatized. The sector is overseen by the Electricity Regulatory Authority (ERA), which has established a sound track record of regulatory supervision. A Rural Electrification Agency has been established with a mandate to extend service to rural and other unserved areas. Uganda s well-developed sector structure, sound regulatory institution and process, and openness to private sector participation are unique in the sub-saharan context. 3. Notwithstanding the country s commendable progress on reforms and private investment, Uganda has suffered chronic power shortages over the past three years. The power crisis has slowed industrial production. The key factor underlying the crisis is the lack of sufficient generation capacity. The failure of the Bujagali hydropower plant to reach financial closure in 2003 and its subsequent abandonment by the private sector sponsor is a major cause of this shortage. The situation has been exacerbated by prolonged drought in the region, reducing the power that can be generated from the existing hydropower facilities. Sustained high oil prices and the logistical challenge and costs of transporting fuel for power generation into this landlocked country have made thermal generation a costly alternative. As demand continues to grow rapidly, even with the significant addition of short-term thermal generation capacity in 2005/06, the system is still unable to meet about 15-40% of its load, depending upon the time of the day. 4. The power supply situation and the accompanying financial crisis have affected growth and could now undermine the power sector reforms and advances achieved in Uganda s power sector. Most importantly, the fragile situation of the sector now threatens to reverse the gains made in securing private participation and future prospects for investment in the new Bujagali 1

12 hydropower project. The Bujagali project is now being prepared a second time with private sponsorship, commercial financing and broad-based support from donors, including the World Bank Group (Private Power Generation (Bujagali) Project). The project is expected to be commissioned in The power shortages have also led to lower retail electricity sales and revenues, which, in turn, have reduced the financial viability of the private distribution concessionaire, UMEME. When the company took over the distribution concession in March 2005, the energy supply available to UMEME was 1,900 GWh, while it is now 1,500 GWh. This reduction is affecting UMEME s ability to recover its fixed costs over fewer units of energy supplies. This situation has been exacerbated by high cost thermal generation, which has increased the retail tariff without increasing UMEME s net revenue. The Government of Uganda (GOU) restructured the distribution concession in December 2006 to compensate UMEME, but this has meant a drain on GOU s budget. If not addressed, the sector s vulnerable situation could therefore impact the sustainability of the UMEME concession. 6. The need for tariff increases to service the high costs of short term thermal generation has been addressed. ERA effected a 37.5% percent increase in tariffs in June 2006, followed by a further increase of 41% in November The average end-user tariff is now US$17.2 /kwh (excluding Value Added Tax [VAT]), which is high by regional and international standards. The life-line tariff rate for consumers using less than 15kWh per month has however remained steady, providing adequate protection for the poor. The tariff increase process has been well managed, both by the government and the regulator. Wide spread consultations with stakeholders and political leadership in orchestrating support for the increases have been remarkable. Continued power shortages and a weak sector situation could however reverse this public confidence and support, and pose risks to maintaining the reforms and regulatory framework already in place. 7. Despite the difficult challenges the Government has therefore taken very responsible measures - installing short-term generation capacity of 100 MW, allowing ERA the autonomy needed to raise tariffs in a pragmatic manner, while recognizing the affordability issue, and continuing on a course of pursuing private sector participation and investments. 8. The new Bujagali project will be the medium-term solution for the least cost power supply for Uganda once it is commissioned in The current tariffs are already at a level sufficient for full cost-recovery post-bujagali. Therefore, in the period leading up to 2011, the sector would need the Government s support, both to sustain the policy and institutional structure and from a financial standpoint. This project intends to provide both forms of support during this fragile period. The Policy Support Program supports the Government in consolidating and advancing sector reform while meeting some of the remaining financing gaps. The investment Project supports a specific capacity addition to maintain supply. 2

13 II. COUNTRY CONTEXT AND RATIONALE A. Recent Economic Developments in Uganda 9. Country Context. With per capita income of about US$280 in 2005, Uganda is one of the poorest countries in the world. Despite the progress in reducing the national level of poverty, from 56 percent in 1992 to 31 percent in 2006, the population in the rural areas as well as the Northern and Eastern regions remains vulnerable rural poverty accounts for 90 percent of the national level, and about 61 and 36 percent of the population in the North and East, respectively, live below the poverty line. Uganda s demographic characteristics pose a challenge to future growth. The country has the third fastest natural population growth rate in the world (3.5 percent in 2005); very high fertility (about 7 children per woman) and the world s highest dependency ratio (111 dependants per 100 working people and rising). Life expectancy is low 49 years at birth. Without commensurate growth in infrastructure, employment opportunities and productivity, these characteristics of Uganda s demographics could result in a reduction in savings, investment and growth. 10. Uganda has experienced robust macro-economic performance in recent years, with growth averaging 6.4 percent between 1990 and Domestic inflation was slightly above the 5 percent target for the third consecutive year due to pressures from weather, power shortages and energy price shocks. The Uganda Shilling (USh) depreciated by 4 percent against the US dollar due to higher demand for foreign exchange to finance the import bill. Overall, due to good macroeconomic management, there is an increase in savings, exports, and foreign direct investment. Within the region, Uganda has been a leader in the fight against HIV/AIDS, with prevalence dropping significantly during the past decade. The challenge for Uganda is now to deepen the reforms already underway and prevent their reversal. 11. To accelerate growth without widening the current account deficit, Uganda needs to increase exports, ideally developing new non-traditional exports to avoid export volatility. Export competitiveness is constrained by poor yet costly energy and transport services, suggesting a role for aid-financed public investments in infrastructure in the short term to attract foreign private investment in the medium term. In order to maintain macro stability while financing infrastructure and scaling up social services, the Government is seeking efficiency savings in public spending. 12. Although Uganda has made substantial progress towards achieving the Millennium Development Goals, more needs to be done to sustain progress and to improve the prospects for meeting all the goals. Special efforts will be needed to improve the quality of education services to ensure that children complete primary education and to eliminate gender disparity at the post-primary levels of education. Greater access to quality health services is also essential to significantly reduce child and maternal mortality rates. 3

14 13. Power Crisis Impacts on Economic Growth. Although economic growth and Uganda s external position were largely consistent with the Government s program for 2005/06, the ongoing electricity crisis has placed a significant strain on growth over the medium term. This crisis in the power sector consists of substantial power shortages that are attributable to delays in adding new generation capacity, a significant regional drought over the past few years, which has reduced the output of existing hydropower plants and annual demand growth for electricity of about 8%. As a consequence, businesses and consumers have been forced to endure prolonged service cuts, with some shifting production to times when power is available, and many larger businesses relying on high-cost back up generators. Manufacturing, high-value agriculture (e.g., flowers), and processing industries (e.g., fish) are most affected by power cuts, and profits in these industries are being squeezed. Other macroeconomic consequences from the current power crisis were inflation that was slightly above projections through September 2006 due to higher energy costs and a widening of the trade deficit due to higher oil prices and increases in diesel fuel import volumes for electricity purchased from thermal power plants. The present situation, with extensive load-shedding blackouts, is not sustainable and further delays in augmenting Uganda s electricity generation capacity could undermine the economy. The cost of unserved energy is estimated at US$38.9 /kwh. 14. Ugandan industrial growth has been constrained by spiraling energy and transportation costs, exacerbated by the current power shortages and both inadequate and poorly maintained infrastructure. By diversifying away from traditional exports and industries, such as the coffee sector, the Government is attempting to create a more stable and dynamic economic base. However, the infrastructure gap, particularly in energy and transportation, has placed extreme pressure on the cost of doing business in Uganda, especially for the manufacturing and horticultural sectors (see Box 1). 15. As an immediate priority, the Government is taking steps to resolve the ongoing electricity crisis. While this Operation supports GOU s short-term mitigation measures to end the crisis, it is important to note that the World Bank Group currently also supports GOU s long-term mitigation measures through the Private Power Generation (Bujagali) Project which will provide financing for the next least cost hydropower generation expansion in Uganda. 16. Uganda's Poverty Eradication Action Plan (PEAP). Uganda's development objectives are articulated in the 2004 PEAP, the third version of its poverty eradication action plan. The 2004 PEAP restates the country's ambitions of eradicating mass poverty and of becoming a middle income country in the next twenty years. It promotes a shift of policy focus from recovery to sustainable growth and structural transformation. The PEAP presents specific policies and measures to achieve its objectives, grouped under five pillars: (a) economic management; (b) enhancing competitiveness, production and incomes; (c) security, conflict resolution, and disaster management; (d) governance; and (e) human resources development. 4

15 B. Bank Group/Donor Support for PEAP and Power Sector 17. Uganda Joint Assistance Strategy (UJAS). The UJAS was approved by IDA s Board of Executive Directors in January 2006 as the country assistance strategy, which was jointly prepared with seven other development partners. The UJAS lays out the strategy for supporting the implementation of the third PEAP and achievement of the Millennium Development Goals. It promotes strong collaboration and harmonization among development partners and with the Government, as well as a stronger focus on results and outcomes. As part of the UJAS harmonization agenda, an exercise to ensure effective division of labor among development partners has been launched. 18. Power Generation Investments. Investments in power generation facilities will increase the reliability and lower the cost of electricity, thus contributing to the achievement of PEAP Pillar 2. This pillar has as a specific objective to strengthen infrastructure in support of increased production of goods and services. The UJAS aims to help create infrastructure that reduces the cost of doing business, links isolated areas of the country to the broader economy, and promotes regional integration. The proposed Power Sector Development Operation will contribute directly to this pillar (see Box 1). Box 1: Energy, Growth and Structural Transformation in Uganda The recently completed Country Economic Memorandum concludes that Uganda s low level of electricity use could put a significant brake on structural transformation, and hence on future growth. Much of the Ugandan economy is rural and does not use electricity in production, mainly because it is unavailable in most rural areas. Since the mid-1990s, agriculture has been shedding labor, which has been finding employment in off-farm rural enterprises (mainly trading, distribution and retail). Average labor productivity is higher outside of farming, and so this movement of labor has led to improvements in average output per worker. Food crop prices started to decline by more than the increase in agricultural productivity with poverty amongst farmers increasing between 1999 and 2002/03. This is due in part to the lack of significant industrial demand for processing Ugandan agricultural output. Another reason is that most of the labor which moved out of agriculture still lives in farming households, growing their own food. For significant structural transformation to occur, Uganda needs to develop its agro-processing industry to create more jobs for the increasing labor supply moving out of agriculture. Given Uganda s population growth rate and current age structure, the work force will more than double in the next 15 years. This makes it urgent to expand industry, tourism, and commercial services in order to create jobs for a growing labor force at higher average labor productivity, otherwise growth in average per capita income will slow down, reducing the prospects for poverty reduction. These sectors are currently the most energy intensive in Uganda and will therefore rely on a reliable, affordable and expanding supply of power. 5

16 19. Support beyond Poverty Reduction Strategy Credit (PRSC). The proposed support to the power sector is in addition to the funds that Uganda will receive via the PRSC program. PRSC6 is the second in a programmatic series that supports the PEAP with a focus on health, education and water programs; public sector management and anti-corruption efforts; and accelerated growth through rural development and a better investment climate. The Policy Support Program within the proposed Operation complements the PRSC through its support of reforms in the power sector. It responds to a crisis in the power sector whose roots lie in factors beyond Uganda s control, such as the failure to develop the Bujagali hydropower plant in a timely manner, drought, and high oil prices. 20. Since the unbundling of the power sector and following well managed substantial increases in electricity tariffs beginning in June 2001, the electricity sector in Uganda stayed financially self sustaining until At that time, drought conditions reduced the power generated from the country s hydropower facilities, reducing peak capacity from 300 MW to 120 MW currently. This compelled the Government to contract high cost, short-term thermal power. Despite the very high generation costs GOU followed its power sector reform strategy and supported the additional very substantial tariff increases implemented by ERA in June and November 2006 of 37.5 percent and 41 percent respectively. Despite the very high level of average retail tariffs (US$0.172/kWh), the revenues still will not allow the Uganda Electricity Transmission Company Limited (UETCL), the transmission company that is the single buyer of power, to fully recover its power purchase costs. The full cost recovery tariff has risen to around US$0.26/kWh. UETCL plays a vital role for the smooth functioning of the unbundled power sector. The Policy Support Program intends to support GOU s efforts to maintain the sector s well functioning structural attributes such as ERA sound regulatory process. It would further enable the sector s finances to stabilize over the medium term. 21. Amount of the Policy Support Program. The value of the program component is determined from additional financing needs for the budget arising from transfers to the electricity sector. The current estimates of the financial base case assumes the following sector costs to arise in GOU s FY 2006/2007 and 2007/2008: Table 1: Total Sector Requirements in FY06/07 and FY07/08 Total Sector Requirements in US$ million 2006/ /2008 Total Distribution, Transmission and Hydropower Generation costs: Total Thermal Power Generation costs: Total Sector requirements

17 22. A substantial part of the sector requirements will be satisfied by the tariff revenues at the new tariff levels. In addition to those revenues, a part of the thermal power generation costs in FY2007/2008 will be covered through the proposed Project, which is financing power output from the thermal power plant situated at Mutundwe and expected to be commissioned in August As indicated earlier, the available sector revenues still leave a financing shortfall. As indicated in Table 2, this is in the order of US$137 million in this current and the next fiscal year, according to the base case calculations applied in the sector financial model: Table 2: Sector Revenue Shortfall in FY06/07 and FY07/08 Sector Revenue Shortfall before GOU support in US$ million 2006/ /2008 Sector revenue requirements (245) (342) Sector revenues based on present tariffs Intended IDA Support for Thermal Plant under investment Project 0 76 Remaining shortfall (84) (53) 24. Prior to the targeted date of effectiveness of this proposed operation, the GOU will have provided US$56 million to UETCL in its current Fiscal Year in the form of additional resources to cover the estimated revenue shortfalls until then through its own budgetary resources. An additional financing need for the remainder of the government s current fiscal year ending on June 30, 2007 of $28 million has been projected. The proposed Policy Support Program will be structured in a single tranche that provides additional budgetary resources in an amount of US$ 80 million to alleviate the budgetary burden and avoid undue disruption of other government spending programs. Future financing needs from transfers to the energy sector estimated at $53 million for the government s FY2007/08 are expected to be covered in the context of general donor support (including PRSCs) and, if needed, expenditure reallocations. 25. As shown in Table 3 below, in order to meet the additional costs arising from the energy situation, the FY 2006/2007 budget for energy was more than doubled, and the share of energy rose from 3 to 8 percent of total expenditures. In the Medium Term Expenditure Framework (MTEF) for the 2007/2008 Budget, the energy share is expected to remain high at over 8 percent of total, with much of the increased budgetary burden related to the revenue shortfall. While the Government has been able to make expenditure reallocations, and revenues have continued to strengthen, the energy pressure is also reflected in a higher fiscal deficit. According to the latest International Monetary Fund (IMF) figures, the fiscal deficit is expected to increase from 7.5 percent of GDP in FY 2005/2006 to 8.8 percent of GDP in FY 2006/2007 and 7.9 percent in FY 2007/2008 (or from 0.9 percent to 2.2 percent and 2.8 percent, respectively, excluding grants). 7

18 The Policy Support Program represents an important component of this additional financing requirement for FY 2006/2007. Table 3: UGANDA: Energy Within Overall Budget 2005/ /08 (Data in % of GDP) Prov. * Budget MTEF 2005/ / /08 Total budget 20.6% 22.3% 22.0% On Energy and minerals 0.6% 1.3% 1.3% on Energy Fund 0.0% 0.5% 0.5% Total Revenues (Tax + Non Tax) 13.2% 13.6% 14.1% Fiscal Deficit Excluding Grants -7.5% -8.8% -7.9% Fiscal Deficit Including Grants -0.9% -2.2% -2.8% Policy Support Program** 0.7% ** * Outturn for donor project support not yet ready ** To cover 2006/2007 PRSC as % of GDP for 2005/2006, 2006/2007 and 2007/2008 are 1.4%, 1.1% and 1.2%, respectively Source: IMF Report No 07/29: "Uganda 2006 Article IV Consultation and Staff Report" Jan Functional classification data for Energy from MTEF. 26. Other Donors. IMF and World Bank staff maintain a close collaborative relationship in supporting the Government s structural reforms, including in the electricity sector. The IMF has confirmed the importance for the Ugandan economy of maintaining stability in the sector and restoring normal electricity supply. 27. Sida has agreed to provide parallel financing to this Operation for energy efficiency improvements. The Bank is also discussing with other donors, including the Japanese Government, the European Investment Bank (EIB) and the African Development Bank (AfDB), their interest in participating in other forms of assistance to the power sector. 28. Coordination with other donors will continue through periodic meetings and exchanges of information. This will be enhanced by GOU s recent establishment of a Sector Working Group to facilitate a joint approach by the development partners. C. Debt Sustainability 29. Uganda s risk of debt distress has been greatly reduced through the Multilateral Debt Reduction Initiative (MDRI), which cancelled 100 percent of debts outstanding to the IMF, African Development Fund (ADF), and IDA at end The MDRI reduced the net present value (NPV) of the external debt-to-exports ratio from a pre-mdri level of 229 percent (the 3-8

19 year average to 2004/2005) to 46 percent in 2005/2006, and this is estimated to have declined further to 33 percent in 2006/2007. The reduction in debt distress notwithstanding, prudent debt management and an efficient allocation of resources will still be critical to maintaining debt at sustainable levels over the long term. D. IMF Assessment 30. Macroeconomic Stability. Macroeconomic stability remains a cornerstone of Uganda s reform effort. Fiscal discipline, coupled with prudent monetary management, supported Uganda s robust growth and helped contain inflation to single digit levels over most of the past decade. These policies have also contributed to the accumulation of international reserves amounting to about 5.5 months worth of import cover in 2005/2006. Implementation of Uganda s PEAP, and ring-fencing of poverty-related expenditures in the budget under the Poverty Action Fund (PAF) have contributed to improvements in living conditions, although per capita income gains have been modest because of Uganda s high population growth rate. 31. New PSI. The IMF Board approved a new 3-year Policy Support Instrument (PSI) in December 2006, following the interim 18-month PSI approved in 2005, qualifying Uganda as a mature stabilizer. III. POWER SECTOR CONTEXT AND RATIONALE A. Overall Government Strategy 32. The GOU power sector strategy has been to: (a) promote legal, regulatory and structural sector reforms, including leveraging private sector investment; (b) provide adequate, reliable and least cost power generation with the goal to meet urban and industrial demand and increase access; and (c) scale up rural access to underpin broad based development. The World Bank Group and the donor community have supported the Government s power sector strategy and reformed policy framework, including catalyzing private sector management and capital. 33. Over the past seven years, the Government has: Promulgated a new Electricity Act; Created an independent Electricity Regulatory Authority (ERA), which has established a strong track record in ensuring the financial viability of the sector (see Annex 1); Unbundled the state-owned Uganda Electricity Board into separate entities responsible for generation, transmission and distribution, and concessioned the generation and distribution facilities to the private sector (see Annex 1 for details on the Government s comprehensive power sector reform program); 9

20 Increased the number of urban and rural households with direct access to electricity, promoted grid and off-grid private sector-led rural electrification and established a Rural Electrification Agency (REA); Pursued least cost power investments to provide adequate and reliable service; and Collaborated with the East Africa Community on regional power interconnection. This regional approach is expected to benefit all countries involved by diversifying supply sources and reducing investment costs. B. Main Sector Issues and Government Responses 34. In spite of the significant structural reforms implemented in the power sector, Uganda is confronted by a number of short and medium term challenges in this sector which are affecting growth. The main issues and the Government s responses are described below. Issue 1: Power Shortages 35. The lack of adequate and reliable power is consistently cited in private sector surveys as being among the top five constraints for Uganda s economic growth. Electricity service quality, availability and reliability have been major impediments to sustained investment and growth. 36. Government Actions Already Taken. To mitigate the shortages, the Government has taken action on three fronts: (a) augmenting supply; (b) improving transmission and distribution performance; and (c) reducing demand. 37. Augmenting Generation. The Government has taken the following steps: Thermal Power Installed an initial 50 MW power station at Lugogo in May 2005 on an Independent Power Producer (IPP) basis The average load factor for the Lugogo thermal station was increased from 75 percent to 90 percent. The plant is now also running on a 24 hour basis. These measures added an additional 10 MW of firm capacity. An additional 50 MW of thermal capacity was added at Kiira in November 2006, for a current total of 100 MW thermal power capacity. Bid evaluation is now underway for an International Competitive Bidding (ICB) tender issued by the GOU in July 2006 for a third 50 MW power station at Mutundwe. The purchase of electricity from this plant will be partly financed under the proposed Project. GOU also is currently procuring a 50 MW thermal plant on a BOT basis, which is expected to be commissioned in January 2008 for 15 years. This plant would operate on Heavy Fuel Oil (HFO), which is cheaper than the Automotive Diesel Oil (ADO) which is used for the three short-term thermal stations mentioned above. This HFO plant will 10

21 permit the retirement of the first 50 MW ADO unit, allowing Uganda to retain a total of 150 MW of thermal capacity until the commissioning of the Bujagali hydropower plant. Hydro Power The hydropower generation regime was optimized by using the available water more during the day, and less at night, thus reducing load shedding at times when commercial businesses and manufacturing industries need to run their operations. Renewable Energy The GOU entered into power supply arrangements with the Kilembe Mines to provide 2.3 MW of power to the grid for 24 hours per day and the Kakira Sugar Company (KSW) will supply 12 MW to the grid in the near future for 18 hours per day. Beyond this, KSW will also self-generate 6 MW for its internal use, so that this capacity is not required from the national grid. Additional mini-hydro schemes are under active development with the support of the Energy for Rural Transformation Project (ERT) (Credit 3588-UG). A Renewable Energy Policy Framework was prepared for Cabinet approval, which aims at promoting additional renewable energy development. By 2009, at least 3 mini-hydro transactions of a total capacity of 26 MW are expected to produce grid-based electricity. Indigenous geothermal investigations have been accelerated under the Power IV Project (Credit 3545-UG). Imports The GOU concluded an agreement with Kenya to import up to 10 MW on a non-firm capacity basis, i.e., depending upon availability. Some imports have already taken place. 38. Improving Power Transmission and Distribution Performance. In March 2005, UMEME, the private concessionaire, took over the operations of the distribution system under a concession agreement that includes financial incentives to increase the number of connections, reduce technical and non-technical losses, and increase the collection rate (see Annex 1). At the time of UMEME s takeover, system technical and non technical losses were around 38% (or 43% including 5% transmission losses through UETCL s transmission network). The billing/collection ratio was 80%, implying that prior to the UMEME concession only about 47% of the energy sent out to the national grid was paid for. Since March 2005, UMEME has improved the collection rate from 80% to 92% (although the rate dropped again to 82% in December 2006 since the June and November tariff increases), decreased technical and nontechnical losses to about 34%, and connected about 36,000 new customers. During the first 22 months of the concession, UMEME invested US$13.6 million in system improvements, and has committed to invest a total of US$65 million during the first five years of the concession. A new 11

22 billing system will be procured and installed by end In addition, IDA is providing US$11million (through the Power IV project) for new poles and transformers, and for 13,500 new customer connections. These investments will help to further reduce technical losses and improve collection rates. 39. UMEME s concession agreement contains targets for losses and non-collection rates for the first seven years and provides strong incentives for UMEME to reduce losses and improve billing collection. UMEME s forward-looking retail tariff assumes an annual 1 percent improvement in losses, and the benefits, to be shared between UMEME and Government, of any loss reductions in excess of this 1 percent would increase UMEME s rate of return. 40. Reducing Demand. Demand Side Management and Energy Efficiency interventions also help to reduce the supply-demand gap by reducing demand. MEMD already has an Energy Efficiency and Demand Side Management (DSM) program, which will be strengthened under this project. Under the Bank-supported ERT Project, MEMD expects to distribute, on a grant basis, 800,000 energy-efficient light bulbs, by April This will not only help poorer households to cope with the higher tariffs but also reduce the overall demand for electricity during peak hours and result in energy savings of about 10 MW (average) and 40 MW (during peak hours). 41. Further Measures Needed. As indicated above, the Government has taken extensive steps to mitigate power shortages. The main additional measure that the Government needs to undertake at this point is more aggressive promotion of DSM and energy efficiency, to reduce demand. Issue 2: Sector Finances 42. The advantage of the short-term thermal plants is that power is available quickly on a stop-gap basis. The disadvantage is that this power currently costs between US$ 0.22 and 0.24/kWh, which is more than twice the cost of hydropower. This is the main factor that has unsettled the sector s cost structure and finances. Further, the shortage of power has affected UMEME s financial viability, as it has fewer units available that can be used to recover fixed costs. 43. Government Actions Already Taken. The regulator has raised end-user power sector retail tariffs by a cumulative 94 percent to US$0.172/kWh in 2006 (and by a cumulative 151 percent since April 2005). These tariffs are high by regional and international standards, but they still do not cover the full costs of power purchased by UETCL. The Government has provided funds to UETCL to cover the shortfall, although not fully. Further, the Government has renegotiated its agreement with UMEME to address financial issues arising from the power crisis. The Government is committed to filling the financing gap as needed, which is a challenge, given other critical budget priorities. 12

23 44. Despite the fact that only 5 percent of Uganda s population has access to electricity and that only a very low level of power consumption is attributed to the poor (see Section E below), the proposed temporary subsidization of the electricity tariffs is justified for two main reasons: Cost of Doing Business. The current fully cost-reflective end user tariff would have to be around US$0.26/kWh. Such a tariff level would have negative implications on the opening of new businesses and thereby on the expansion of the industrial and commercial sectors; and Increase Access to Electricity. Fully cost-reflective tariffs would seriously hinder or even stop completely UMEME s ability to expand its customer base as unsubsidized tariffs would be unaffordable for a majority of potential new residential and non residential customers. 45. However, as the current financial sector model shows, the GOU subsidies should only be needed until the next least cost hydropower generation facility comes on stream, currently scheduled for early The much cheaper generation costs of this new Bank Group supported generation facility (Private Power Generation (Bujagali) Project) will help eliminate GOU subsidies to the sector in the medium term. 46. Further Measures Needed. The Government to stay current to UETCL and UETCL needs to stay current to the generation companies. Issue 3: Longer-term Sector Expansion 47. Uganda has made commendable progress towards establishing a sector framework that will promote sustainability and growth. However, the Government recognizes that more is needed to fulfill this goal for the longer term. In particular, the longer-term expansion of the sector requires that: (a) the generation facilities use Lake Victoria water in a sustainable manner; (b) the framework for rural electrification be strengthened; (c) a joint GOU-Development Partners Energy Sector Working Group be set up with an agreed mandate; and (d) the current sector structure (private generation and distribution companies, State-run transmissions company, and independent regulator) be maintained. 48. Sustainable Use of Lake Victoria Water. Uganda s main source of power is located at the Nalubaale and Kiira (previously called Owen Falls) 380MW 1 dam complex on Lake Victoria at the mouth of the Victoria Nile. Since 2000, Lake Victoria water levels have dropped by about 1.5 meters, bringing the lake in October 2006 to a level of 1, masl, 2 which is very close to the lowest ever measured level in March This fall has been partially attributed to three 1 The current commissioned capacity of the dam complex is 300 MW. Two additional 40MW units are scheduled for commissioning in April To convert meters above sea level (masl) to Jinja Gauge numbers, subtract 1,

24 years of drought and partially to over-abstraction of water, beyond the Agreed Curve, 3 by Uganda for hydropower generation. (See Annex 16 for additional details.) However, it is also important to note that, since then, the lake levels have increased to 1, masl (March 2007). 49. Government Actions Already Taken. The over-abstraction of water is not the result of Uganda pursuing a business-as-usual strategy in the face of a declining water level. To the contrary, in response to concerns about the lower level, Uganda reduced firm hydropower output from the dam complex at Nalubaale and Kiira from about 270 MW in 2002 to around 120 MW since August Adherence to the Agreed Curve at current water inflows into the lake would imply a further reduction in hydropower output to about 112 MW at current water levels. The Government of Uganda has signaled its intentions to return to releases consistent with the Agreed Curve as soon as possible. Further, Uganda as a whole not just its power sector - is participating in regional discussions related to a Regional Watershed Management Plan and to an in-country watershed management plan linked to Lake Victoria. These plans will help Uganda contribute to the efforts of the riparian countries to use Lake Victoria water sustainably. 50. Further Measures Needed. While Uganda s power sector is not the sole cause of decline in Lake Victoria s water level, it is clear that the sector must take steps to ensure that it uses this water in a responsible manner. A key element of this responsibility is monitoring and reporting on actual water abstraction, as well as the amount permitted by the Agreed Curve, to a suitable body, such as the East African Community (EAC). 51. Low Electricity Access Levels. Only about five percent of all households have direct electricity access, and Uganda has one of the lowest rates of electrification in the world. 52. Government Actions Already Taken. The GOU is implementing the Bank-supported ERT Program, which is a three-phase ten year program to significantly expand access to electricity. In keeping with the Electricity Act s emphasis on private participation, the project is designed to provide initial capital subsidies for rural access investments, which thereafter are operated on a commercial basis. The ERT is completing its first phase and has established a framework for expanding rural access, including creation of a Rural Electrification Agency (REA) to act as intermediary for the subsidies. Furthermore GOU has concessioned Uganda s distribution company to UMEME, which in its first 22 months of operation has already connected 36,000 new customers and made significant progress in assessing the overall needs of the distribution sector. UMEME is currently also supported by IDA and the Multilateral 3 The Agreed Curve describes a water discharge rating curve that emulates the natural relationship between Lake Victoria levels and the flow of the Nile River through the Nalubaale and Kiira hydropower dams. It depicts the management of the Nalubaale and Kiira dams in which the volume of water released would remain consistent with what would have occurred under natural conditions, thereby ensuring no change in downstream discharges. Since the Agreed Curve functions as an operating rule for water discharge, such water releases are a function of the lake level at any given period. The current water level of the Lake of 1, masl measured on March 18, 2007 would allow a water release at the Nalubaale/Kiira complex of a daily average m 3 /sec, whereas the power station was releasing a daily average of 750m 3 /sec. 14