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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 ADDENDUM TO PROJECT APPRAISAL DOCUMENT ON THE PRIVATE SECTOR POWER GENERATION SUPPORT PROJECT (Report no: KE) Report No: KE FOR A PROPOSED PARTIAL RISK GUARANTEE IN THE AMOUNT EQUIVALENT TO US$5 MILLION IN SUPPORT OF SUB-PROJECT 4 b ORPOWER 4 GEOTHERMAL EPANSION (PLANT 3) Energy Unit Sustainable Development Department Africa Region IN THE REPUBLIC OF KENYA March 11, 2014 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 December 31, 2013) Currency Unit = Kenya Shillings (KSh) KSh = US$ 1 DR = US$ 1 ABBREVIATIONS AND ACRONYMS PRG IPP BOO KPLC PPA L/C GoK OEC OSL COD O&M PRG Partial Risk Guarantee Independent Power Producer Build, Own and Operate Kenya Power and Lighting Company Power Purchase Agreement Letter of Credit Government of Kenya Ormat Energy Converter Ormat Systems Ltd. Commissioning Date Operation and Maintenance Partial Risk Guarantee Vice President: Country Director: Sector Director: Sector Manager: Guarantee Manager: Task Team Leader: Makhtar Diop Diarietou Gaye Jamal Saghir Lucio Monari Pankaj Gupta Karan Capoor ii

3 KENYA ADDENDUM TO PRIVATE SECTOR POWER GENERATION SUPPORT PROJECT (Report no: KE) Sub-Project 4 b: OrPower4 Geothermal Expansion (Plant 3) TABLE OF CONTENTS Page I. STRATEGIC CONTET...1 A. Country Context... 1 B. Sector and Institutional Context... 1 II. PROJECT DEVELOPMENT OBJECTIVES...3 A. Project Beneficiaries... 3 B. PDO Level Results Indicators... 3 III. PROJECT DESCRIPTION...3 A. Sub-Project Cost and Financing... 5 B. Lending Instrument... 7 IV. IMPLEMENTATION...7 A. Institutional and Implementation Arrangements... 7 B. Results Monitoring and Evaluation... 8 C. Sustainability... 8 V. KEY RISKS AND MITIGATION MEASURES (SUB-project 4b)...9 A. Risk Ratings Summary Table... 9 B. Overall Risk Rating Explanation... 9 VI. APPRAISAL SUMMARY...10 A. Economic and Financial Analyses Financial Analysis of KPLC B. Technical Assessment of Sub-Project 4b: OrPower4 Geothermal Plant 3 expansion 12 C. Financial Management D. Procurement iii

4 E. Environment and Social (including Safeguards) Annex 1: Results Framework and Monitoring...17 Annex 2: Detailed Project Description...18 Annex 3: Implementation Arrangements...20 Annex 5: Implementation Support Plan...28 Annex 6: IDA PRG Term Sheet...30 iv

5 SUB-PROJECT DATA SHEET Kenya ADDENDUM TO PROJECT APPRAISAL DOCUMENT Private Sector Power Generation Support Project (Report no: KE) For Sub-Project 4b: OrPower4 Geothermal Expansion (Plant 3) Region Africa Unit - AFCE2 Basic Information Date: February 14, 2014 Sectors: Power (100%) Country Director: Diarietou Gaye Themes: Infrastructure services for private sector development (100%) Sector Director: Jamal Saghir EA Category: A (Full Assessment) Project ID: Lending Instrument: Team Leader(s): Joint IFC: No P IDA Partial Risk Guarantees Karan Capoor Borrower: Kenya Power and Lighting Company (KPLC) and Republic of Kenya Responsible Agency: Ministry of Energy (MoE) and Ministry of Finance (MoF) Contact: Eng. Joseph K. Njoroge Mrs. Felister Kivisi Dr. Ben Chumo Telephone No.: Title: Principal Secretary, Ministry of Energy & Petroleum Ag. Director, Debt Management Department, National Treasury Managing Director and CEO, Kenya Power & Lighting Company Ltd. ps@energymin.go.ke fkivisi@treasury.go.ke md@kplc.co.ke Project Implementation Period: Start Date: February 28, 2012 End Date: June 30, 2030 (Until the expiry of the last PRG) Expected Effectiveness Date: March 31, 2014 Expected Closing Date: December 31, 2016 [ ] Loan [ ] Grant [ ] Other [ ] Credit [ ] Guarantee For Loans/Credits/Others Project Financing Data(US$M) Total Project Cost: US$ 68.5 million Total Bank Financing : Total Co-financing: US$ 45.2 million Financing Gap : NA NA Financing Source Debt (OPIC) US$ 45.2 million Amount(US$M) v

6 Equity Total US$ 23.3 million US$ 68.5 million Expected Disbursements (in USD Million) Fiscal Year Annual NA NA NA NA NA NA Cumulative NA NA NA NA NA NA Project Development Objective(s) The Project Development Objective is to increase electricity generation through Independent Power Producers (IPP) in Kenya. Sub-Project description OrPower4 Geothermal Expansion (Total Cost Approx. US$68.5 million, IDA PRG US$5 million). The sub-project involves construction of a 16 MW expansion (also referred to as Plant 3), and its integration with an existing 84 MW baseload geothermal power plant at the Olkaria III Geothermal fields, increasing the total combined installed capacity to 100 MW. The sub-project is located within Hell s Gate National Park in the Kenyan Rift Valley, 90 kilometers northwest of Nairobi and is being developed by OrPower4 Inc. The PRG amount of US$5 million has already been approved by the Board in February 28, 2012 as part of the PRG series in Kenya Private Sector Power Generation Support Project (Report No: KE). At the time of the 2012 Board presentation, OrPower4 was only developing Plant 2 expansion, and therefore due diligence was limited to only this phase. The Board had noted then that appraisal of the Plant 3 expansion would be presented to the Board on an Absence of Objection basis after OrPower4 had exercised its option. Policy Compliance Does the project depart from the CAS in content or in other significant respects? Yes [ ] No [ ] Does the project require any waivers of Bank policies? Yes [ ] No [ ] Have these been approved by Bank management? Yes [ ] No [ ] Is approval for any policy waiver sought from the Board? Yes [ ] No [ ] Does the project meet the Regional criteria for readiness for implementation? Yes [ ] No [ ] Safeguard Policies Triggered by the Project Yes No Environmental Assessment OP/BP 4.01 Natural Habitats OP/BP 4.04 Forests OP/BP 4.36 Pest Management OP 4.09 Physical Cultural Resources OP/BP 4.11 Indigenous Peoples OP/BP 4.10 Involuntary Resettlement OP/BP 4.12 Safety of Dams OP/BP 4.37 Projects on International Waterways OP/BP 7.50 Projects in Disputed Areas OP/BP 7.60 Legal Covenants vi

7 . Name Recurrent Due Date Frequency (1) Republic of Kenya (2) Orpower4, Inc. Description of Covenant Yes N/A Ongoing Standards covenants related to the guarantee operations will be concluded with project participants. Bank Staff Team Composition Name Title Specialization Unit Bank Staff Name Title Specialization Unit Karan Capoor Senior Energy Finance Specialist Team Leader AFTG1 Teuta Kacaniku Infrastructure Financial Analyst Energy Finance Specialist TWIFS Kyran O Sullivan Senior Energy Specialist Energy Sector Specialist AFTG1 Laurencia Njagi Senior Energy Specialist Energy Sector Specialist AFTG1 Neil Ashar Senior Counsel Counsel LEGSO Monica Restrepo Senior Counsel Counsel LEGSO Sanjay Srivastava Lead Environmental Specialist Environmental Safeguards AFTEN Zarafshan Khawaja Lead Social Development Specialist Social Safeguards AFTCS Gibwa Kajubi Senior Social Development Specialist Social Safeguards AFTCS Noreen Beg Senior Environmental Specialist Environment and Social LCSEN Safeguards Wolfgang K.C. Koehling Senior Operations Officer Integrity Specialist INTSC Bernadette Milunga Program Assistant Project Processing AFTG1 Bassem Abou-Nehme Extended Term Consultant Energy Finance Specialist AFTG2 Note: This document is an Addendum to the Project Appraisal Document for the Kenya Private Sector Power Generation Support Project (Report No: KE). It represents an appraisal of the OrPower4 Plant 3 geothermal expansion sub-project at Olkaria III geothermal fields, which was part of the Partial Risk Guarantee series previously approved by the Board under the Kenya Private Sector Power Generation Support Project. Sections I and II of this Addendum provide any update(s) from the original Project PAD, whereas sections III through VI summarize the incremental due diligence conducted for the sub-project expansion (Plant 3). vii

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9 I. STRATEGIC CONTET A. Country Context 1. Kenya s growth and macroeconomic management have been strong in recent years. Real GDP growth in Kenya during the 4 years from 2010 to 2013 is projected to average 5%, among the highest average rates of growth for the country of any four year period during the last three decades. Fiscal performance has remained in line with the country s IMF program requirements. Tax revenue has improved as a share of GDP (driven by VAT and excise tax collections). Meanwhile, central government wages as a share of GDP remained stable which provided additional space in the budget for increased capital expenditure. Inflation, despite internal and external pressures and a number of spikes, has been kept to an average 8.1% during 2010 to 2013 (compared with 8.9% in the previous four years). Public debt, while still relatively high for an emerging economy, has fallen significantly and the financial system remains sound. While Kenya s economic performance over the past decade has lagged behind the average for sub-saharan Africa, there is a palpable sense that Kenya has turned a corner with peaceful elections in March 2013, and with the smooth transition of power in April It is estimated that Kenya s economic growth was at 5 percent in 2013, and the country enters 2014 with a strong outlook of sustaining that level of growth, supported by lower interest rates and higher investment. This sustained growth has been attributed to a stable macroeconomic environment, investments in infrastructure and education, and structural reforms in key sectors of the economy, which have created a strong foundation for Kenya s future. B. Sector and Institutional Context 2. The electricity sector s reform and Kenya Power and Lighting Company s (KPLC s) track record as a reliable off-taker have encouraged private participation in generation. Between 1996 and 2013, KPLC signed Power Purchase Agreements (PPAs) with twelve independent power producers (IPPs) for a combined capacity of 1,194 MW from a portfolio of different technologies and fuels, including diesel engines, gas turbines and geothermal. Of these IPPs, plants with a total capacity of 469 MW are currently in operation, while others are at various stages of development. In the process of negotiating and sustaining the first generation of IPPs, KPLC has developed a reputation as a reliable off-taker with a good payment record. The plants have generally operated with high availability rates and together, these IPPs have been able to supply electricity to meet a substantial part of demand, particularly during periods of shortfall due to drought. The first generation of IPPs was financed by Development Finance Institutions (DFIs) without the participation of commercial lenders. However, IPPs supported recently by the IDA Partial Risk Guarantee (PRG) instrument as part of the Kenya Private Sector Power Generation Support Project ( Project ), 1 including Thika Power Limited (TPL), Triumph Power Generation Company (TPGL), and Gulf Power Limited (GPL), successfully attracted long-term commercial financing. TPGC is being financed wholly by private capital. This series of IPPs has set new benchmarks for infrastructure financing in Kenya and has opened the market for long-term financing in the country. 1 Approved by the Board of the World Bank on February 28, 2012 (Appraisal Report no: KE) 1

10 3. The proposed expansion of OrPower4 is in line with the Government s program to diversify Kenya s energy generation mix and to reduce retail tariffs over time. The proposed geothermal expansion by OrPower4 Inc. ( OrPower4 or OrPower ), will increase the supply of affordable, reliable and renewable base load electricity generation from an indigenous and readily available resource with strong resilience to hydro variability. The proposed geothermal expansion is in line with the Government s Least Cost Power Development Plan (LCPDP) and its Second Medium Term Plan ( ) to develop additional 5,000MW+ of generation capacity by 2017, and is consistent with Kenya s long-standing efforts to support the development of an indigenous geothermal industry. (Box 1). The base-load capacity from the proposed plants will help stabilize the grid by providing adequate system reserves. Provided demand growth remains robust, Kenya s average tariffs are expected to decline over time as cheaper generation from wind, geothermal and regional hydro generation make up a greater share of the energy mix and as the relative share of oil-based thermal generation dispatched declines. Box 1: Geothermal Development in Kenya Status of Development. Geothermal resources in Kenya are located within the Rift Valley, spread over 14 prospective sites with an estimated potential capacity of over 7,000 MW. Two sites, Olkaria and Eburu are generating electricity, with over 240 MW operational in Development Models. Kenya has tried a number of different models to develop geothermal resources: (i) the Olkaria and Eburru sites were developed and operated by KenGen (a parastatal, partially privatized in 2006); (ii) Olkaria III, is operated by OrPower4, an Independent Power Producer (IPP); (iii) two sites, Longonot and Akiira were concessioned to private developers; and (iv) the state-owned Geothermal Development Company (GDC) was established in late 2008 to explore, exploit, develop, and supply steam at other geothermal fields, and was recently given a license for Suswa field. In mature geothermal fields such as Olkaria, GoK expects active private sector participation in resource development. In other fields, given upfront exploration risks, the GDC expects to undertake resource development. Engagement of the World Bank Group. The Bank Group has been a long-term partner in Kenya s geothermal development since the late 1970s, and has provided eight credits, MIGA guarantees and a Partial Risk Guarantee (PRG) to support activities across all stages of geothermal development. The Bank is coordinating the Global Geothermal Development Plan (GGDP) to mobilize Climate Investment Funds (CIFs) to support investment at the exploratory stage. At Menengai, IDA has financed a feasibility study for site development and is in discussion with GoK and GDC to help structure field development to facilitate private investment in generation. IDA is in discussion with GoK and KenGen to facilitate Public-Private Partnership (PPP) transactions to further develop the Olkaria fields. It is anticipated that the Menengai Second Phase and Bogoria-Silali fields will also be developed in PPP arrangements. C. Rationale for WBG Support 4. The proposed OrPower4 geothermal expansion, which will increase the supply of affordable, reliable and renewable base load electricity generation, is supported by the GoK s offer of a standard risk mitigation framework to support IPPs in Kenya. The WBG-designed risk 2

11 mitigation framework, when applied to well-designed investments, can provide comfort to private investors and lenders without resort to sovereign guarantees, thereby supporting the GoK to attract additional private sector investment in infrastructure, while maintaining sound monetary and fiscal policies. The issuance of the proposed IDA PRG will enable KPLC to replace expensive temporary security arrangements provided for OrPower4. II. PROJECT DEVELOPMENT OBJECTIVES 5. The Project Development Objective (PDO) is to increase electricity generation through Independent Power Producers (IPPs) in Kenya. 2 A. Project Beneficiaries 6. The immediate Project beneficiaries are current and prospective electricity consumers, including the poor, who face unreliable service due to generation, cost and access constraints. The GoK is also a key beneficiary since the proposed IPP will displace emergency diesel generation, thus providing savings in annual fuel costs. 3 B. PDO Level Results Indicators 7. The geothermal expansion sub-project (Plant 3) maintains the same PDO level results indicators identified in the Kenya Private Sector Power Generation Support Project ( Project ) (Report No: KE). The target values for renewable energy generated and the number of beneficiaries reflected in Annex 1 of this Addendum, represent the incremental results expected from Plant 3 expansion only. III. PROJECT DESCRIPTION Background 8. In February 2012, the Board approved the Kenya Private Sector Power Generation Support Project, which includes a series of IDA PRGs for a total amount of US$166 million, supporting four IPPs, namely: i) Thika Power Limited (sub-project 1); ii) Triumph Power Generation Company (sub-project 2); iii) Gulf Power Limited (sub-project 3); and iv) OrPower4 Olkaria III Geothermal Expansion (Sub-projects 4a and 4b). 9. A PRG was approved in 2012 for OrPower4 Inc. to support expansion of an existing geothermal facility at the Olkaria III field to an integrated 100 MW facility in two phases, namely, a 36 MW Plant 2 expansion (Sub-project 4a), and a 16 MW Plant 3 expansion (Subproject 4b). IDA obtained Board approval in 2012 for PRG amounts of US$26 million and 2 The PDO is unchanged as it applies to the Kenya Private Sector Power Generation Support project (Report No: KE). 3 The Project Beneficiaries are same identified in the PAD of the Kenya Private Sector Power Generation Support project (Report No: KE) 3

12 US$5 million for Plant 2 and Plant 3, respectively. However, at the time of the Board presentation, OrPower4 was developing only the Plant 2 expansion phase at the Olkaria III geothermal fields, and therefore IDA s due diligence for the Plant 3 expansion phase was not conducted at that time. The Board noted that the appraisal of the 16 MW geothermal expansion (Sub-project 4b) would be presented to the Board on an Absence of Objection basis after OrPower4 had exercised its Plant 3 expansion option. 4 OrPower4 notified the World Bank in late October 2013 that it had exercised its option to expand Plant 3 in June OrPower4 s geothermal energy facility at the Olkaria III geothermal field is located within Hell s Gate National Park in the Kenyan Rift Valley, 90 kilometers northwest from Nairobi. The development of the facility started in the late 1990s by OrPower4 Inc., a wholly owned subsidiary of Ormat Holding Corporation. 5 Since its inception, the geothermal project at Olkaria III has been developed in several stages. When the concession was first awarded to OrPower4 in 1998, the facility started with an initial installed capacity of about 13 MW, which was subsequently increased in several phases to 48 MW by It was underpinned by a 20 year PPA concluded in 1998 between KPLC and OrPower4, which was amended in March 2011 to allow for further expansion of the complex by an additional 52 MW to be undertaken in two phases, referred to as Plant 2 and Plant 3, respectively. OrPower4 successfully implemented and commissioned Plant 2 in April The proposed expansion of 16 MW (Plant 3) is the third stage of the integrated 100 MW facility. Once all three phases are completed, the integrated geothermal plant at Olkaria III will reach a combined capacity of 100 MW. The Proposed Plant 3 Expansion (Sub-project 4b) 11. The 16 MW Plant 3 expansion option was presented to the Board in February 2012, for which an amount of US$5 million of IDA PRG support was approved at that time. OrPower4 recently conducted an assessment of the capacity and stability of the geothermal reservoirs at Olkaria III to confirm if they would produce sufficient steam to support the added 16 MW generation capacity for Plant Feasibility studies conducted have revealed that the reservoir can support the total installed capacity of 100 MW. Based on these assessments, OrPower4 decided to exercise the option for Plant 3 expansion earlier than the expiration of its option period in September 2015, and has begun preparation for the implementation of Sub-project 4b. 12. The implementation of Sub-project 4b and the commissioning of Plant 3 will enable increased production of the facility by the addition of two Ormat Energy Converter (OEC) units. The development of the Plant 3, to be located adjacent to Plant 2, will include: i) two OEC units, of 12 MW and 4 MW, respectively; ii) auxiliaries for connection to Plant 2; iii) substation; and iv) steam supply line, brine supply and return lines. The required area for Plant 3 is already 4 From the MOP of Kenya Private Sector Power Generation Support Project: Regional Vice President (RVP) approval will be sought upon exercise of the option and completion of IDA due diligence. Following RVP approval, an appraisal document would be circulated to the Executive Directors on an Absence of Objection basis for a 10 day Board comment period at the end of which the approval would become effective. A Board discussion would be scheduled if at least three Executive Directors so request during the circulation period. 5 Both companies are incorporated in Cayman Islands, and OrPower4 Inc., has a branch office in Kenya. Ormat Holding is a member of the Ormat Group of Companies based in USA, and a recognized developer and owneroperator of geothermal projects worldwide. 4

13 compacted, and is ready for the laying of foundations. The commercial operation date (COD) for Plant 3 is expected in the first half of Sufficient observation of field and well output at Olkaria III has allowed OrPower4 to incrementally and prudently increase power production capacity over time. Recognizing the benefits of prudent geothermal reservoir management in securing clean and reliable power, OrPower4, together with KPLC and Ministry of Energy, are currently investigating an option for another future expansion of the Olkaria III facility in the range of about MW, utilizing the same technology as for Plant 1, 2 and The GoK has not yet requested the Bank to consider additional support for this option. If such an option is exercised, IDA would appraise the financial, economic, technical, environmental and social implications of such an expansion and seek approval of the Executive Directors for any requested additional IDA support. A. Sub-Project Cost and Financing 15. The total cost for Plant 3 expansion is estimated at US$ 68.5 million, which will be funded by a new equity contribution of US$ 23.3 million and the remainder through a US$ 45.2 million loan from the Overseas Private Insurance Corporation (OPIC). OPIC has already provided financing in amount of a US$ 45 million standby tranche for the expansion of Plant 3. Table 1: Proposed Financing Plan (US$ million) OrPower4 (Plant 3) at Olkaria III Equity ($) Equity % Debt ($) Total Debt % Total ($) PRG ($) % % Risk Allocation 16. The contractual structure of the project finance transaction and the allocation of the commercial, technical, and political risks among the relevant parties follow industry standards for limited recourse project financing. As is customary in project finance transactions, risks are allocated to the party best able to mitigate them. The allocation of key risks among the sponsor, lenders, KPLC, GoK, are summarized in Table 7 below as well as the risks that are expected to be backed by the IDA PRGs. The sponsors and lenders will assume the pre-construction, construction and operations risks. 17. The security package for the proposed Plant 3 expansion is part of the security package approved for Plant 2 expansion. The structure is expected to provide the lenders with security interests in all the assets of the project company, including plant and machinery, inventory and receivables, assignment of or a charge over the project s on-shore and off-shore accounts as well as a first ranking share pledge over the shares of the project company. The Lenders will enter into a Direct Agreement with KPLC for the enforceability of their security. Under the PPA, OrPower4 has undertaken to make available power capacity to KPLC and sell electrical outputs. KPLC, in turn, has take or pay obligations to make capacity payments for contracted capacity 5

14 up to a maximum available plant capacity of 96% (which will be charged on the basis of the available capacity of the plant irrespective of the amount of power actually dispatched), as well as energy charges for power that is dispatched and delivered. 18. Force Majeure (FM) risks 6 are allocated between the IPP, KPLC and GoK through the PPA and the GoK Letter of Support. KPLC s ongoing payment obligations include payments for capacity during FM events, even if the plant is unavailable (although with some adjustment to payment amounts in certain cases). IDA PRGs will back KPLC s ongoing payment obligations only (excluding termination payments) under the PPA. Table 2: IPP Risk Matrix and IDA Risk Mitigation Risk Phase Risks/Obligation Contractual Responsibility Mitigation IPP & Lenders KPLC GoK PRG Pre-Construction Site Plant design Debt & Equity Financing Construction Period Cost overruns Construction delays Operation Operation & Maintenance Power Capacity Availability Output Quality Specifications KPLC System Availability Payment of Energy and Capacity Payments * Force Majeure Events affecting KPLC Currency devaluation Concession Currency, Convertibility, Term Transferability Political Event (ongoing obligation) Other Force Majeure Events ** Termination Payment due to KPLC Default Termination Payment due to Political Event * For only 3 months of capacity and energy payments plus contingencies. ** For OrPower4, this risk will partially be borne by KPLC and IDA. *** Political Event may include War and Civil Disturbance, Expropriation, Changes in Law, Regulation, Taxes and Licensing Arrangements. 6 FM risks may be either political FM events such as war, change in law, expropriation, civil commotion or natural FM events such as act of God. 6

15 B. Lending Instrument 19. In 2012 the Board approved a series of IDA PRGs that included an amount of US$5 million to support Plant 3 expansion of the geothermal facility at Olkaria III by OrPower4. The scope of PRG coverage for Plant 3 is outlined in the Term Sheet (Annex 6) and includes coverage equivalent to three months of capacity and energy payments plus contingencies. Once approved, the PRG support for Plant 3 will become an integrated part of the PRG in support of OrPower4. Partial Risk Guarantee Structure 20. The IDA PRG structure in support of the OrPower4 geothermal facility will backstop KPLC s obligations deriving from a Revolving Standby Letter of Credit (L/C) issued by an L/C bank on behalf of KPLC, to OrPower4, as a beneficiary. The L/C will serve as a payment security for capacity and energy payments obligation of KPLC to OrPower4 under the PPA. The maximum amount available under the L/C will equal three months of the energy and capacity payments for the integrated operation of OrPower4 s geothermal facility, which includes the initial investment, Plant 2 expansion, and the proposed Plant 3 expansion. However, the amounts available for drawing for each year will be determined annually. The L/C will be issued for a period of 12 years from the effectiveness of PRG. The maximum term of this PRG will be the 12 years period plus an additional 14 months More specifically, the PRG will backstop the debt obligation of KPLC to a selected L/C bank for any amounts drawn by OrPower4 as a result of breach of payment obligation by KPLC. Following a drawing by OrPower4, KPLC is obliged under Reimbursement and Credit Agreement (entered between KPLC and the L/C bank), to make a repayment to the L/C bank for the amounts drawn under the L/C within a 12 month period. If KPLC makes the repayment within the agreed time-period, the L/C will be reinstated for the amounts repaid. However, in case of the failure by KPLC to make timely repayment, the L/C bank will have recourse to IDA PRG for the drawn amounts plus any accrued interest, under the Guarantee Agreement (entered between IDA and L/C bank). Under this scenario, the maximum L/C amount would be permanently reduced by the amounts paid by IDA. In the event of disputes, OrPower4 would be able to access the L/C, only after the dispute has been resolved in its favor (see Annex 5 for the IDA PRG for OrPower Term Sheet). IV. IMPLEMENTATION A. Institutional and Implementation Arrangements 22. The geothermal expansion is being developed by OrPower4 Inc., a special purpose company incorporated in the Cayman Islands, which was set up to develop, own, construct, and operate the Olkaria III sub-project. It was established in October 1997 and its activities are solely devoted to the project, which it has been operating for 16 years. OrPower4 has entered into arm s length fixed price, turnkey contracts with its Group companies for the construction and maintenance of the expansion facility. It has entered into a Supply Contract with Ormat 7 The additional 14 months consist of 12 months repayment period in case there is a drawdown under L/C in the last month of the L/C year, and 60 days required to make a payment under the IDA PRG. 7

16 Systems Ltd (OSL) or ORDA 6 Inc. (both Ormat Group companies), for the design of the power plant and for the supply of materials and equipment which will be backed by performance guarantees. In addition it has entered into a Pricing, Coordination and Security contract with another Group company, ORDA 9, under which it will guarantee the plant cost and any overruns for the supply, transportation and construction works. The electricity transmission connector from the OrPower4 substation to the KPLC switchyard was completed in 2008, and has been determined by KPLC as of sufficient capacity to accommodate the planned expansion (see more details in Annex 3). 23. With regards to the Operation and Maintenance (O&M) arrangements, OrPower4 has been operating the geothermal sub-project at Olkaria III from its inception, and will continue to operate Plant 3 as part of the integrated 100 MW facility. B. Results Monitoring and Evaluation 24. Overall monitoring of Project outcomes and result indicators will be done by KPLC (and KETRACO, where relevant). Data for monitoring project outcomes and results indicators will be generated by OrPower4 in regular progress reports as well as by Lenders Independent Engineer during the construction phase. IDA will monitor and supervise through the submission of reports by OrPower4 required under IDA s Project Agreement with OrPower4 and submission of relevant reports by KPLC required under IDA s Indemnity Agreement with GoK as well as through regular field visits until the expiry of PRG. Annex 1 presents the Project s Results Framework that defines specific outcomes and results to be monitored. C. Sustainability 25. The proposed geothermal expansion sub-project will help meet the Government s objectives of generating reliable and affordable electricity in Kenya to meet demand. GoK s Vision 2030, the Least Cost Power Development Plan (LCPDP), as well as the recent Medium Term Review support fast track development of new electricity generation capacity, prioritizing, in particular, increased base-load geothermal development. The proposed OrPower4 Plant 3 expansion at Olkaria III is therefore an integrated part of the plan to deploy new generation capacity needed to support the growing demand for reliable and affordable electricity in Kenya. It will contribute to reducing dependence on hydropower and oil based thermal generation and toward moderating the upward pressure on tariffs over time. The sub-project will provide much needed firm generation capacity within a short time-period in order to sustain economic growth and to maintain an acceptable margin of reserve generation capacity on the Kenyan power system. 26. There is strong stakeholder support for increasing Kenya s energy security and resilience, continued sector reform and the IPP Program. Kenya's fuel sources for electricity generation have historically been concentrated in hydropower, leaving Kenya s power supply vulnerable to concentration risk associated with poor hydrology, including vagaries of weather fluctuations. Extreme drought in recent years halved the country s hydro capacity for part of 2009, drastically reduced KPLC s revenues and impaired its ability to invest in replacement 8

17 assets as well as extend the power grid to serve new communities. The proposed Project will help increase Kenya s energy security and resilience to climate variability by reducing the economic and financial impacts of Kenya s dependence on hydropower. The IPP Program enjoys strong support from the GoK, which provides comfort for continuity going forward. 27. As part of the LCPDP, the firm power output of the sub-project is expected to be fully absorbed by electricity customers. Electricity supplied by the geothermal sub-project will cost less than US$0.10 cents per unit, which is competitive with electricity produced in KenGen s plants and is significantly lower cost than Kenya s oil-based generation. Geothermal power generated by the sub-project will provide additional affordable and reliable base-load energy capacity, which will gradually reduce the impact of volatile fuel prices on consumers. V. KEY RISKS AND MITIGATION MEASURES (SUB-PROJECT 4B) A. Risk Ratings Summary Table Stakeholder Risk Low Implementing Agency Risk - Capacity (OrPower4) Low - Capacity (KPLC) Moderate - Governance (OrPower4) Low Sub-Project Risk - Design (Technical) Low - Social and Environmental Low - Program and Donor (Timely Financial Closure) Low - Delivery Monitoring and Sustainability Moderate Overall Implementation Risk Low B. Overall Risk Rating Explanation 28. As an IDA PRG operation supporting IPPs in Kenya, there are no conventional financial management-related fiduciary issues, and there will be no World Bank-financed procurement or procurement-related disbursements under the Kenya Private Sector Power Generation Project. While KPLC s past experience with IPPs has been positive and it has established a good payment track record, its financial performance weakened in largely due to heavy investments in the distribution system in order to increase electricity access. However, the Government and the management of KPLC are determined to restore KPLC s track record and financial performance by implementing, both revenue-enhancement and cost-reduction measures. These measures include a three year tariff increase, which started on December 1, In addition, the World Bank has an active and on-going sector participation and dialogue with both KPLC and the GoK, and will be in position to monitor the implementation of these measures. 9

18 29. OrPower4, Inc., an Independent Power Producer, is the primary implementer of the proposed geothermal expansion sub-project at Olkaria III, with responsibility for managing its finances and implementation. IDA s due diligence of the project sponsor, a long-standing and active client with MIGA in Kenya, shows that it was selected based on a transparent and competitive procurement process, and is experienced and qualified to implement the geothermal expansion. The geothermal expansion sub-project is being developed by an already established project company with a good track record, which is currently operating and managing an 84 MW facility immediately adjacent to the proposed expansion. The proposed geothermal expansion sub-project will increase the amount of competitively priced geothermal energy that can be dispatched by KPLC, thereby moderating the impact of electricity prices on end-consumers. The overall risk for the proposed geothermal expansion is considered Low. VI. APPRAISAL SUMMARY A. Economic and Financial Analyses Economic Analysis of Sub-Project 4b: OrPower4 Geothermal Plant 3 expansion 30. The economic analysis conducted for Sub-Project 4b, the proposed OrPower geothermal expansion (Plant 3), is based on the previous analysis conducted for the Kenya Private Sector Power Generation Support Project, approved in February The analysis of Plant 3 expansion followed the approach that was used to value Plant 2. Plant 3 will operate as a baseload plant, generating 135 GWh per annum. This output is valued at the estimated long run marginal cost of generation of US$ 0.16 cents per kwh. On the cost side, in addition to the capital expenditures that occur during construction period (about US$68.5 million), expenditures for operations and maintenance (O&M) account for US$1.063 million annually. Aggregating these numbers during the period of the PPA is expected to yield an economic rate of return of 25% and a net present value of US$58 million using a 12%, discount rate. Hence, the project is justified from an economic point of view. This analysis is deemed conservative as the reduction in GHG emissions and royalties that accrue to the government were not part of the valuation. Financial Analysis of KPLC 31. At the time of appraisal of the Kenya Private Sector Power Generation Project, KPLC had undergone a process of steady growth, characterized by strong revenues, stable operating expenses and moderate financing costs which resulted in a satisfactory financial performance. During , as KPLC prioritized reinforcement of the distribution system and expansion of electricity access, its customer base grew by 92% (from 1.1 million to 2 million); however, energy sales increased by only 19% reflecting low household consumption levels and increased transmission and distribution losses. During the period, KPLC continued to report steady net profits after taxes, although the 2013 profit of KSh 4.3 billion was 6.5% lower than in 2012, due to increasing financing costs as a result of the shift toward greater levels of debt with shorter tenors and bank overdrafts with higher interest rates to finance long term investments associated mainly with new connections. 32. To address the decline in net profit, KPLC is focused on implementing a strategy to increase revenues, reduce energy losses, decrease costs and improve reliability of power supply. 10

19 On the revenue side, KPLC s retail tariff was increased in December 2013, the first such increase since The Energy Regulatory Commission approved the increase in retail electricity tariffs for a three year period, , and , respectively. The tariff increase is aimed chiefly to provide KPLC with additional revenue to meet payment requirements for the new power plants planned to be commissioned from 2013 to KPLC is also deploying new metering and billing technologies that will improve its collections from customers, thereby improving its cash collections and mitigating the risk of delayed or lost revenues. 33. KPLC s depreciation and financing costs are projected to increase significantly due to its planned annual capital investment program of about KSh 20 billion to be funded with incremental debt. Unless the company implements a cheaper strategy for funding its investment program, financing costs could rise steadily from KSh 2.5 billion in to KSh 3.9 billion in , and could reach as high as KSh 5.2 billion if bank overdrafts continue to be used to meet the cash gap. Sustaining KPLC s financial position will require refinancing of the company s commercial debt to reduce financing costs to manageable levels and the use of concessional resources to fund investments in new connections that are ring-fenced from KPLC s commercial operations. In this regard, KPLC is in dialogue with the Government and the World Bank on ways which would enable KPLC to access commercial borrowing for its capital investment program on better terms than it enjoys at present and how the electricity access program could be implemented in a manner that safeguards KPLC s financial position. Based on implementation of these revenue-enhancement and cost reduction measures, KPLC projects that the company s financial position over the next three years, including key financial ratios, and in particular the debt service coverage ratio, will exceed targets starting in (Table 3) Table 3: KPLC s Projected Key Financial Ratios Financial Ratios Actual Projected Target Values / / / / /16 Debt Service Coverage Current Ratio Self-financing Ratio 25% % 40% Accounts Receivables 50 days Source: KPLC projections, December 2013 Financial Analysis of Sub-Project 4b: OrPower4 Geothermal Plant 3 expansion 34. Incremental financial analysis of the projected stream of cash-flow for sub-project 4b (Plant 3) shows a robust rate of return based on a sound financial structure. The financial internal rate of return (IRR) is estimated at 17.3% and project NPV is estimated at US$34 million. The average Debt Service Coverage Ratio (DSCR) throughout the loan life is estimated 8 The target values reflect the financial covenant under the Kenya Electricity Expansion Project (KEEP) 11

20 at 2.3x demonstrating a strong basis of cash-flow, and limiting the risk of debt service default. Shareholders are expected to earn an IRR of 17.1% with a NPV of US$16.2 million. The sensitivity analysis highlights that due to its strong projected cash-flows, the project can sustain a variation in the range of 10%-20% increase in capital expenditures and O&M costs. B. Technical Assessment of Sub-Project 4b: OrPower4 Geothermal Plant 3 expansion 35. Design and Layout: Plant 3 will consist of two binary energy converter units with a total capacity of 16 MW. The plant will be connected to the wells by pipelines conveying single phase steam and water. The expansion would be less difficult since Ormat has adopted the use of similar and compatible technologies and configuration to those incorporated in the first and second plants, and will rely on the existing infrastructure. 36. Generation Equipment: The main equipment, including turbines, would be in accordance with applicable international norms to ensure that they would have the capacity (i) of operating under all variations of chemical and physical characteristics of geothermal steam; and (ii) of stable automatic transition to no load and of operating at no load for at least 15 minutes. 37. Electrical System and Substation: The plant would have a fiber optical communication system with terminal equipment that would allow the use of SCADA technology for the integration of KPLC s communication system. The operating and dispatching procedures are adequate and would allow KPLC to respond, in a professional manner, to the demand of the networks. The interconnection arrangement and the metering system are adequate and are in line with best practices. The generators of the plant would be equipped with individual step up transformers and then will be connected to the Olkaria II substation. The configuration would include a main metering system and a backup metering system. 38. Operations and Maintenance: The Plant will be tested and commissioned in accordance with prudent practices and applicable norms and standards to ensure a well-functioning and well performing system. Due to Ormat s operational experience, there is no issue foreseen on unusual scaling or fouling of the steam gathering system. Spent geothermal water will be re-injected into the ground appropriately to minimize disturbance to the geothermal reservoir. C. Financial Management 39. There are no conventional World Bank financial management-related fiduciary issues as there will be no World Bank-financed disbursements under the Kenya Private Sector Power Generation Project, including for Plant 3 expansion under sub-project 4b. OrPower4 will be the primary implementing agency, including responsibility for managing the finances of the subproject. OrPower4 s annual financial statements have been prepared using internationally accepted accounting principles and audited in accordance with accepted international auditing standards. The performance of the sub-project will be monitored through regular progress reports and audited annual financial statements to be submitted by OrPower4. In the event that the PRG is called, the World Bank would disburse to the relevant L/C bank, and the Government 12

21 would then be obligated to repay IDA in accordance with the terms of the Indemnity Agreement between the Government of Kenya and IDA. D. Procurement 40. The applicable Bank s procurement guidelines for IDA guarantees (World Bank s "Guidelines: Procurement under IBRD Loans and IDA Credits" dated May 2004, revised October 2006, May 2010, January 2011) require that goods and services must be procured with due regard to economy and efficiency. 41. As described in detail in the appraisal document of the Kenya Private Sector Power Generation Support Project (Report No: KE), a competitive international procurement process was conducted and the tender to develop a 64 MW geothermal facility at the Olkaria III geothermal resources area was awarded to Ormat International Inc. in November Ormat established OrPower4, Inc., a Special Purpose Company, for the sole purpose to create, construct, own, and operate the geothermal plant, which subsequently entered into a Power Purchase Agreement with KPLC. An 8 MW Early Generation Facility was commissioned in July 2000 and enhanced to 13 MW in December The early generation facility made use of then existing wells drilled by the Government. Appraisal of the geothermal field completed in June 2001 revealed that the field could only support a facility of 48 MW at the time (Plant 1), which was constructed in phases and commissioned in After gaining experience in operations, OrPower4 determined that the Olkaria III field could support a higher generation capacity than had been developed. Since OrPower4 was already operating at the site, it was determined that the PPA for the incremental expansion would be negotiated with OrPower4 at a savings to the original PPA, as some of the efficiencies from shared fixed costs would be passed on to the combined facility as a whole, including minimal escalation on the tariff under the original PPA. OrPower4 negotiated a Second Amendment PPA in 2011 with KPLC for extension of the plant to 100 MW in two phases of 36 MW (Plant 2) and 16 MW (the proposed Plant 3) respectively. Following approval by the World Bank Board in February 2012, OrPower4 successfully commissioned Plant 2 (sub-project 4 a) in April The Anti-Corruption Guidelines for World Bank Guarantee and Carbon Finance Transactions will apply to this Project. Furthermore, in this regard, project agreements will, inter alia, make warranties, representations and covenanted undertakings including those relating to sanctionable practices. E. Environment and Social (including Safeguards) 44. The Kenya Private Sector Power Generation Support Project (Report No: KE), approved by the Board in February 2012 was classified as Category A, because it entailed four separate IPP sub-projects with investments in different locations in Kenya. The proposed subproject 4b, supporting OrPower4 s 16 MW geothermal expansion (Plant 3) at the Olkaria III project site is located within Hell s Gate National Park, which was only established after the Olkaria geothermal fields had been gazetted for geothermal power production and the first power plant (Olkaria I) had been built. (The Park is now designated as a Category II protected area by IUCN). Nonetheless, as was noted in the World Bank s 2012 appraisal, OP 4.04 (Natural 13

22 Habitats) is triggered because of the location of the Olkaria III facility within the park. OP 4.01 (Environmental Assessment) is also triggered. 45. MIGA has guaranteed an investment in OrPower4 s geothermal plant at Olkaria III since March 2002, with a second guarantee offered for the second phase expansion in Therefore, information regarding WBG involvement in the project has been disclosed since The World Bank disclosed the original and revised Environmental Impact Assessment (EIA) during appraisal for the Kenya Private Sector Power Generation Support Project (Report No: KE), which examined the possible impacts to the environment, resulting from the construction and operation of the early generation facility and the plant of up to 100 MW power output, as well as the then most recently available third-party environmental audit of existing operations (see below): (a) (b) (c) The initial (August 2000) EIA, which noted that the project would be expanded in phases over time to 100 MW and was assessed from that perspective; The supplement to the EIA dated May 2001; and, The 2010 environmental audit of OrPower4 s operation of the Olkaria III geothermal power plant (prepared in January 2011). The initial EIA for Olkaria III considered cumulative impacts of the three existing geothermal fields in the park, including the proposed expansion of Olkaria III. The Kenyan environmental authorities on May 21, 2010, amended the September 14, 2007 EIA license for the project to approve expansion to 100 MW, as originally proposed in the 2000 EIA for the project. Regular environmental audits have been done to assess and evaluate the implementation effectiveness of the Environmental Management Plan (EMP), including all environmental regulatory requirements for plant operation to date. The most recent third-party audits for 2011 and 2012 operations were disclosed through the InfoShop in January The Bank s due diligence and field visit in mid-december 2013 confirmed that physical footprint of the proposed Sub-project 4b expansion (Plant 3) remains the same as was originally covered under the 2000/2001 EIA for the Olkaria III facility. The proposed 16 MW Plant 3 is located at the same site as Plant 1 and Plant 2, within the perimeter of the existing compound excavated for Plant 2 and inside the concession area in the western sector of Hells Gate National Park for which geothermal field development is permitted. Plant 3 expansion utilizes the same technology as was installed in Plant 1 and Plant 2 phases of the project. The entire geothermal well field from production through to re-injection is one system that serves all three plants. All the production wells feed into two separators, the separated steam and brine flow from the separators through the two plants (and will also flow through Plant 3), while the waste fluids from the plants are re-injected in common pipes through non-productive wells in a cold zone to a depth similar to those of the production wells to replenish the aquifer. In this respect, the system has had no change in baseline conditions since the 2000/2001 and the 2007 EIAs, and the increase to 100 MW does not require further change other than monitoring and prudent management due to the increased mass flow of geothermal fluids. Plant 3 will have no additional requirement for environmental compliance and OrPower4 is in full compliance of the regulatory clearances and permits for the constructions works of Plant 3. 14