HU r5fp. Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY. Report No TUN. Public Disclosure Authorized

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1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY HU r5fp Report No TUN Public Disclosure Authorized STAFF APPRAISAL REPORT Public Disclosure Authorized TUNISIA SECOND NATURAL GAS PIPELINE PROJECT Public Disclosure Authorized May 1, 1980 Energy Department (Petroleum Projects) Europe, Middle East and North Africa Regional Office 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 I Tunisian Dinar (DT) = US$2.5 1 US Dollar = 0.4 DT FISCAL YEAR January 1 to December 31 1c WEIGHTS AND MEASURES 1 kilometer (km) = 0.62 miles 1 metric ton (tonne) = 2,204 lb 1 ton(ne) of oil equivalent (t.o.e. or tep) = 39.7 million British Thermal Units (Btu) 0 1 tonne crude oil (36 API) = 7.45 barrels 1 barrel of oil = 42 US gallons 3 1 cubic meter (m ) = 35.3 cubic feet 1 billion cubic meters/annum = 96,700 cubic feet/day 1 million cubic meters Hassi R' Mel gas = 1000 t.o.e. 1 million cubic meters El Borma gas = 1100 t.o.e. 1 Megawatt (MW) = 1000 kilowatts 0 API = measure of specific gravity of oil 1 US gallon = litres 1 tonne gasoline = 357 gallons I tonne fuel oil = 6.62 barrels Note: All volumes are based on 1 atmosphere pressure and 15 degrees Celsius PRINCIPAL ABBREVIATIONS AND ACRONYMS USED LNG - Liquified Natural Gas LPG - Liquified Petroleum Gas (a mixture of propane and butane) ETAP - Entreprise Tunisienne d'activites Petrolieres SNDP - Societe Nationale de Distribution Petroliere STEG - Societe Tunisienne de l'electricite et du Gaz STIR - Societe Tunisienne des Industries de Raffinage SITEI] - Societe Italo-Tunisienne d'exploitation Petroliere CFTP - Compagnie Franco-Tunisienne des Petroles SEREEPT - Societe de Recherches et d'exploitation des Petroles de Tunisie SONATRACH - Societe Nationale pour la Recherche, la Production, le Transport, la Transformation et la Commercialisation des Hydrocarbures SOFREGAZ - Societe Francaise d'etudes et de Realisations d'equipements Gaziers TESA - Societe Tunisie Engineering (S.A.) ENI - Ente Nazionale Idrocarburi OTC - Office de Topographie et de Cartographie

3 FOR OFFICIAL USE ONLY TUNISIA NATURAL GAS PIPELINE PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. I. ENERGY SECTOR... I Energy context Energy resources Supply and demand patterns... 3 Development prospects Sectoral organization and structure... 6 Sector investments and financial resources... 8 Sector policies... 8 Role of the Bank II. THE PROJECT... 1i... Background: Developments in Algeria and Italy Institutional framework Gas availability The intercontinental pipeline Project description - Tunisia's pipeline Status of project preparation Project implementation Project costs * Project financing plan Procurement and disbursement Ecology and safety Project risks III. BENEFICIARY Organization and management Recruitment and training Accounting, auditing and insurance IV. FINANCIAL ASPECTS Future Pricing of Natural Gas Future Performance: The Natural Gas Accounts (Algerian Gas) Past Performance: STEG Electricity Future Performance: STEG Electricity... * The staff appraisal report was prepared by Messrs. E. S. Daffern, P. Moulin, and S. A. Moussa, and Miss D. Robert (Energy Department). This document hu a restricted distribution and may be used by recipients only in the performance of their official duties. ls contents may not otherwise be disclosed without World Bank authorization.

4 -2- Page No. V. ECONOMIC ASPECTS Background The Market * * * * * * * * * * Development and operating costs Value of sales Project profitability Benefits to the economy VI. RECOMMENDATIONS a List of Annexes :1.01 Analysis of demand :1.02 Demand and supply for energy Refinery capacity :1.04 Sector investments and financial sources :1.05 Resource development :1.06 Petroleum prices 2.01 Project schedule 2.02 Estimated schedule of disbursements 3.01 Present organization chart 4.01 Assumptions 4.02 STEG's past performance 4.03 Projections - gas division 4.04 Projections - electricity division 5.Ol Economic analysis - I 5.i02 Economic analysis - I and II 6.01 Documents on project file Map IBRD 14849

5 TUNISIA I. ENERGY SECTOR Energy Context 1.01 The energy sector in Tunisia is dominated by use of hydrocarbons, mainly oil which comprises 81% of the commercial energy market, and natural gas a further 14%; the remainder is met by hydro (1%) and imported coal and coke (4%). The opportunities for greater use of hydroelectricity and coal are limited Tunisia is a net exporter of oil (exporting 5 million tons of crude oil and products compared with imports of 2 million tons) 1/ and relies on the income from petroleum for more than a quarter of its export earnings. Consumption has been growing at 8% per annum through the 1970's and is now 1.8 million tons per year (33,000 barrels/day); domestic production in 1978 was 5 million tons. However, production from known reserves will decline through the 1980's, and this, when taken with the expected growth in consumption, will result in a dimunition in export earnings. While recent discoveries have been promising in that they have indicated petroleum reserves and promising potential in rocks of a different geological age, the exploitation of these reserves is unlikely before the mid-1980s The construction of the Algeria/Tunisia/Italy pipeline has opened up a new opportunity for Tunisia. Natural gas could potentially meet 50% of Tunisia's energy demand, particularly in electricity generation and heavy industry. The availability of gas from the Algeria-Italy pipeline in the early 1980s at an import cost less than imported fuel oil, could slow, but not reverse, the expected reduction in exports. Further quantities are expected to be available from Algeria in the longer term, and can be supplemented through development of the Miskar offshore gas field. Transfer of Tunisia's heavy industry and electricity generation to a new energy source (gas) is a major undertaking, requiring development of a national energy strategy and careful appraisal of policy options and project economics. Tunisia has recognized this need and is taking steps to organize itself accordingly. Energy Resources 1.04 Proven oil and gas reserves are concentrated almost entirely in three fields. El Borma was discovered by AGIP in 1964 and is owned by SITEP 2/, a 50/50 subsidiary of AGIP and the Government. Elf Aquitaine I/ Tunisian oil is of good quality (low sulphur) and the majority is currently exported at a premium. For operation of the present refinery, the country imports lower priced high sulphur crude, thus making a financial gain. 2/ Societe Italo-Tunisienne d'exploitation Petroliere.

6 -2- discovered the two other major fields, Ashtart (1971) and Miskar (1974), offshore in the Gulf of Gabes. Ashtart oil is being produced under a 50/50 joint venture with ETAP, 1/ the state oil company, and Miskar is expected to be majority owned by the Government with Elf Aquitaine having a minor share Indigenous proven reserves are estimated to be: Proven Reserves as at December 1978 Original Cumulative Remaining 1978 in Place Production Recoverable Production Oil - million tons El Borma (42 API) Ashtart (29 0 API) Others (6) Gas - billion cubic meters Proven Reserves Original Cumulative Remaining 1978 in Place Production Recoverable Production El Borma Miskar Others (6) There is also one oil field in disputed territory near the Libyan border Oil production from the major fields is progressing satisfactorily. Water is being injected at both El Borma and Ashtart to enhance recovery output is expected to be 12% above that for 1978, at 5.6 million tons, but with a fall to below pre 1978 production levels by Both fields should produce substantial but declining quantities through the 1980's and into the 1990's. The other proven oil fields will cease production between the mid-1980's and mid-1990's Commercial gas production is from three fields, of which the significant one is the El Borma oil field. Following a recommendation by the Bank, STEG 2/ has agreed to purchase gas from the Algerian portion of El Borma. Despite this, the El Borma gas supply is expected to cease by As discussed subsequently in Chaper II, there are no firm plans to produce Miskar gas in the 1980's. The Bank agrees with this position. 1/ Entreprise Tunisienne d'activites Petrolieres. 2/ Societe Tunisienne de l'electricite et du Gaz.

7 Other Resources. Hydroelectricity is currently limited to one 25MW plant, with a similar plant under construction. The lignite deposits on Cap Bon have not been explored but are not believed to be large. Coal required for the steel industry is imported. Because of the climate, crops and farming methods and location of population, the possibilities for non-commercial energy are believed to be small, although possibly significant for isolated areas. Supply and Demand Patterns 1.09 Since 1971, commercial energy consumption has increased on average by 9% per annum from 1.2 million tons oil equivalent (toe) to 2.3 million toe in GDP increased over this period at a similar rate, giving an energy/ GDP growth in line with the norm for middle-income countries. During the same period Tunisia's crude oil and gas production has increased by 1.2 million tons, permitting an increase in net exports The energy supply/demand situation is summarized below: Thousand tons of oil equivalent Consumption Proportion by Source Oil products % Gas % Hydro % Coal and coke % Met by % Domestic production Oil Gas Hydro Imports Less Exports & stock changes Gas oil demand has been growing at 13% annually, meeting 40% of petroleum demand and Tunisia is now dependent on imports for more than 50% of its requirements. Fuel oil, supplying 35% of total petroleum needs, is imported to the extent of 30%, and all jet kerosene is imported. The main supplying countries are Greece, Italy and Libya. The growth in gas oil demand and the substitution possibilities for fuel oil are major factors in considering future refinery options, and are the dominant factors in refinery design.

8 For most of the 1970's, data on the use made of Tunisia's energy is incomplete and is concentrated primarily on power and large scale industry. An energy use analysis for Tunisia as a whole is available for 1977 and The power and industrial sectors use all of the hydro, gas and coal, 94% of the fuel oil and 28% of the gas oil, in total 56% of total energy, a proportion which has been growing during the 1970's. Their share of the total is expected to grow further in the 1980's. Apart from power, the major users of energy are the construction, chemical and extractive industries. Details are in Annex The refinery (at Bizerte) has a nominal capacity of 1 million tons/year and has limited catalytic reforming facilities. It has operated above the nominal rating throughout the 1970's (see Annex 1.03 for an analysis of output). The refinery was designed for and operates on imported high sulphur Iraqi crudes, allowing virtually the whole of Tunisia's own crudes to be exported. Tunisia's (El Borma) Zarzaitine crude attracts a quality premium; Ashtart crude is conveniently located for export. Given that the refinery now meets only 2/3 of Tunisia's needs, and that product exports are virtually nil, there is no advantage in making modifications to the existing refinery configuration. The solution is to design the refinery expansion to reflect future needs. The expanded refinery (discussed below) will initially use Tunisian crude. Development Prospects 1.14 Despite the availability of a relatively large supply of energy compared to current requirements, the energy sector in Tunisia is at a turning point where decisions made now will affect the long term through the end of the century. For its industrial energy strategy Tunisia could: (i) continue to base its strategy on oil. (ii) rely on royalty gas 1/ and imports, both coming from the Algeria-Italy gas pipeline. (iii) develop its natural gas resources. The Government chose option (ii), the use of Algerian supplies The choice between the three above options, or a combination thereof, involve complex technical, financial, economic and political considerations, and projections on an international basis which must inevitably be speculative. The Government gave lengthy consideration to the choice and decided in favor of relying on Algerian gas for the 1980's, both on economic grounds and in relation to the longer term energy policy options. Development of Miskar at this time was seen to pose difficult energy supply problems for the later 1/ Royalties are payable by Italy for the right to transport gas by pipeline across Tunisia. They may be taken in the form of cash or as gas.

9 's when production would be declining, and to involve a particularly large financial investment in a single resource. In the meantime, the Government has agreed to undertake a study on ways of using offshore associated gas. The study will emphasize the possibility of a floating power plant and will include other possible ways of using the gas. The study will be commissioned shortly and wnen completed will be discussed with the Bank The Government's intention is to use natural gas to the maximum possible extent, and to contract accordingly for large quantities of gas, leaving little safety margin. Consequently, to avoid excessive payments for gas not taken, it is imperative for the energy forecasts to be sufficiently accurate since the gas will be purchased on a take or pay basis Apart from STEG's power forecasts, Tunisia has no proven experience of energy forecasting. This should be remedied through the energy planning work with Gordian Associates discussed subsequently (paragraph 1.36). The Bank has examined and accepted the forecasts for fuel for power generation. In relation to industrial use, the Bank has examined and accepted forecasts based on existing consumers (about 30) plus new plants under construction, making no specific allowance for other new plants. This is a conservative approach to supply and demand matching. Overall consumption is expected to grow more slowly than in the 1970's, yet in relation to GDP, at a slightly faster rate. The Tunisian current (5th) Development Plan is markedly different from its predecessor in its emphasis on heavy industry. Supply and demand is summarized below. Year by year forecasts of supply and demand are included in Annex 1.02, together with a breakdown of the sources of supply. Thousand tons of oil equivalent Average Annual supply Growth Oil products % (of which substitutable by gas) (617) (580) (165) (190) Gas % Hydro % Coal & coke _ Demand % Transport % Commercial/household % Industry % Power % %

10 - 6 - it will be seen that, despite the tremendous increase in the use of gas, the consumption of oil products is expected to stabilize only through the middle 1980's and pick up thereafter. The prospects for further substitution by 1990 are small, and are essentially limited to the hotel industry and domestic supplies. The coal and coke and most of the gas will be imported. By 1985 almost all potential substitution of fuel oil and gas oil by natural gas will have taken place. Less than 7% of potential substitution in power and industry will remain. Natural gas will then supply 79% of power and industrial demand, coal and hydro together will supply 5%, and 9% will be away from the supply pipelines or otherwise unsuitable for convenient substitution by gas. Gas oil and heating oil, used for trucking, local shipping, agricultural pumps and smaall scale heating, will form 54% of oil products demand, gasolines and aviation fuel 16%, kerosene and LPG (used for heating, cooking and lighting 15% and fuel oil, used for shipping and for consumers away from the gas pipelines, 15% (see Annex 1.02) Detailed analysis product by product indicates a potential gas surplus in the years 1986 to 1989, during which some royalty gas would have to be taken as cash. Should the growth in energy demand for power and industry average less than 6% against 10% and 7% used respectively in the forecast, it would not be possible to avoid take or pay. The possibilities will be examined in the Gordian Associates' studies. During discussion of the studies the Bank will pay particular attention to the supply/demand match for the later 1980's The forecasts take no account of the potential for substituting cooking and heating fuels for small scale users with natural gas. There is already a gas distribution system in Tunis supplying 20,000 households. The quantities involved in domestic supplies are small. As part of the project, the Bank will finance a feasibility study of supplying natural gas to households and small scale industry, to be completed by mid Agreement was reached on this at negotiations Following a study by the Foster Wheeler Energy Corporation, the Government has decided to proceed with the expansion of its Bizerte refinery to an annual capacity of 4 million tons. The expanded refinery will initially use Tunisian crude, both El Borma (Zarzaitine) and Ashtart blends in roughly equal proportions, production of which will be sufficient for maximum refinery output through 1985 only. Design based on domestic crudes will improve the security of supply, and will result in low sulphur products. The refinery has been planned so as to maximize the production of middle distillates and minimize the quantity of fuel oil. Nevertheless, some imbalances are anticipated including significant exports of fuel oil and naphtha. The precise mix of products will depend on the crudes used in practice and, in turn, depend on further discoveries in Tunisia. Refinery product mixes are shown in Annex Sector Organization and Structure 1.21 Initially the petroleum sector was in the hands of overseas oil companies with the state controlling refining, power and gas distribution. The Government has substantially increased its role through the establishment

11 - 7 - of a state oil company, joint operating companies, and the agreed acquisition of the largest distribution company. Exploration and Production 1.22 In exploration and production the primary state company is ETAP (Entreprise Tunisienne d'activites Petrolieres), which is 100% Government owned. ETAP has wide coordinating powers for the whole sector. The other state companies in this sector are SITEP, SEREPT 1/ and CFTP 2/, each 50% Government owned. SITEP operates the El Borma field and SEREPT the Ashtart field. Apart from its earnings through royalties and taxes the Government takes approximately 50% participation in Tunisia's oil and gas production. In addition to the state companies there are fifteen external groups engaged in exploration (including two major international oil companies, the remainder being North American independents and European companies) and there are three producers. Refining 1.23 The provision of all refined products is controlled through two state industries, STIR (Societe Tunisienne des Industries de Raffinage) and ETAP. The Government through STIR owns and operates the country's only refinery. Product imports are controlled by ETAP. The new refinery will also be wholly-owned by STIR. Transmission, Distribution and Marketing 1.24 STEG (Societe Tunisienne de l'electricite et du Gaz) is responsible for hydroelectricity and for the generation and distribution of electricity. In relation to gas, STEG has the responsibility for the transmission and distribution of El Borma gas and Cap Bon gas, and the manufacture and distribution of town gas in Tunis. STEG's activities will be expanded to include the transmission and distribution of Algerian gas from the intercontinental pipeline The construction, ownership and operation of the Algeria-Italy gas pipeline will not involve STEG and will result in the establishment of three companies in Tunisia, whose roles are described in the next chapter Distribution of oil products from the refinery and the terminal of the Bizerte/Tunis products pipeline is the responsibility of the oil companies. The Government company, SNDP (Societe Nationale de Distribution de Petrole) has 40% of the market. Together Esso, Shell and Mobil have 35% and eight other companies share the balance. Government Organization 1.27 The energy sector operates under the Energy Department of the Ministry of Industry, Mines and Energy 3/. The main functions of 1/ Societe de Recherche et d'exploitation des Petroles de Tunisie. 2/ Compagnie Franco-Tunisienne des Petroles. 3/ Recently merged with the Ministry of Commerce.

12 - 8 - the Energy Department have been to negotiate exploration and development agreements, to set standards for the operation of the sector and to set fuel prices and power tariffs. There was no obvious need during the late 1960's and 1970's for Tunisia to undertake more than rudimentary energy planning and coordination. The need for more formalized plan4ng was recognized in 1977 and the Government has reorganized accordingly to meet the challenge The Energy Department has recently been remodelled to handle long term energy planning and the study and review of the economic, financial and legal aspects of alternative energy development plans. The Department's first priority is to complete the Gordian Associates study on energy pricing and planning as required under the second power loan (IBRD 1355-TUN) Apart from its longer term planning and its study of non-conventional energy resources, the reorganized Energy Department operates through four divisions: (1) exploration and production; (2) refining transmission and distribution; (3) gas; and (4) power, to correspond with the sector structure. Control 1.30 The Government controls the oil and gas industry in many ways. For the state companies the Government appoints the president and the board, it controls the provision of long-term finance and it controls prices. The long-term development plans of the state companies are an integral part of Tunisia's national plan. Exploration is controlled through the issue of exploration licenses, which carry with them minimum work obligations. Permits are valid for three years and can be extended three times with a reduction each time of 20% in permit area, together with commitment to further work obligations. If a field is developed a production license concession is granted for 50 years, a substantially longer period than is common in other countries. The import of petroleum products is channelled through ETAP. The Government controls the retail prices of all petroleum products and transport charges, but within these limits distribution is handled by the various distribution companies. Sector Investments and Financial Sources 1.31 At the time of adoption of the current national plan, the energy sector was expected to absorb 17% of Tunisia's total capital investments over the five years , which is high compared with other countries at a similar stage of development. The Fifth Plan provided for $1,330 million of investment in primary energy and $500 million for secondary energy. Because of the deferral of the Miskar project, actual expenditure will be $500 million less. Further information is in Annex Sector Policies Resource Development 1.32 The main energy source so far found in Tunisia is oil and gas. Other resources play a minimal role. The Government's policy in energy development is to increase Tunisia's production of crude oil and oil products,

13 and to maximize the export of oil products through substituting gas for fuel oil in the domestic market. While taxation, licensing and participation policies are broadly comparable to those in other countries, there exists in Tunisia a particularly favorable attitude to foreign participation which encourages a satisfactory level of exploration. Further detail is in Annex Pricing 1.33 Retail prices of petroleum products are broadly characterized by two distinct pricing tiers: retail prices of lighter products, such as motor fuels, are relatively high, and generally higher than is common in the oil exporting countries; retail prices of middle distillates and fuel oil, on the other hand, have been kept low for many years through subsidies, both in order to keep down the general price level and to assist Tunisian industry. Overall, the "reconstituted barrel" for Tunisia realises $32 which is approximately world prices. A comparison of retail prices of principal petroleum products in Tunisia with those in other countries is shown in the following table: Regular gasoline Gas oil Fuel oil $/gallon $/gallon $/tonne Tunisia Brazil Egypt Syria Thailand United Kingdom United States Revenue needed to finance refinery operations and the cost of imports comes from three sources. Firstly, Tunisia receives oil as royalties on production; secondly, part of the production of each field has to be offered to the local market at a discount, and thirdly, revenue is generated on the sale of LPG, gasolines (part of the profit on gasolines is in the form of taxes earmarked for other needs) and aviation kerosene and the export of naphtha. The first two of these are heavily dependent on future production levels. The rising proportion of imports has made it impossible for Tunisia to maintain the subsidies and prices of products have increased in recent years. Nevertheless, domestic prices for the heavier products were somewhat below world prices prior to the 1979 price explosion; price adjustments in December 1979 were also relatively small. (Annex 1.06 lists the current retail prices in Tunisia and bulk prices in Italy) The Bank has undertaken a preliminary study of the effect of energy prices on Tunisian industrial energy demand, both of power and of oil and gas. Energy was found to form only a small proportion (6%) of the end costs of products, such that adjustment to economic prices would have little effect

14 on product prices, and hence demand. In any case, most of the products exported by Tunisia have little energy input. It was noticed that there had been no discernible impact on demand as a result of major price increases in previous years As discussed in Chapter IV, on project grounds, it is essential to increase fuel oil prices in the short and medium term, so as to ensure that gas prices do not exceed fuel oil prices. An increase in fuel oil prices will be achieved in steps over the next few years, and discussed more fully in Chapter IV. In respect of the other energy prices, parity with international prices (or above) is the most appropriate long-term solution, but may take a decade to achieve for low volume socially sensitive products such as kerosene and gas oil (to the extent it is used for fishing and agriculture). The Gordian Associates study, which will pay particular attention to pricing, will be available during The Bank will discuss the whole report with the Government as part of its supervision of the second power loan and will seek agreement on pricing strategy at that time In the short and medium term, it is important to ensure a suitable relationship between the prices of industrial fuel substitutes, and to maintain the financial viability of the institutions concerned, both suppliers of primary energy (such as STEG gas) and consumers of primary energy, principally STEG power. The principal aim for energy pricing within the present project is to focus on the domestic price of fuel oil and natural gas. Role of the Bank 1.38 The Bank has had a long standing involvement with STEG both in the power sector and in the financing of the El Borma to Gabes gas pipeline, and has made three loans totalling $34 million. All three projects have been succiessful, although the most recent currently has problems in respect of spare parts for gas turbines. In that time STEG has developed into one of the most important companies in Tunisia, setting an example in efficiency and management The need for a study on tariffs was identified as a result of the second power loan. As a result of further discussion with the Bank the study has been widened and is now an energy master plan study including pricing policy and is being undertaken by Gordian Associates. The Bank will review the findings with the Government. To the extent necessary to ensure the financial viability of the gas entity within STEG, fuel and gas prices will be increased in association with this project The Bank has been actively involved in the Tunisian gas sector for the last four years, initially with the Miskar project (see Chapter II) and the general strategy in relation to the provision of gas for Tunisian industry. The strategy led to the present project. In relation to the project, the Bank has assisted in the choice of pipeline routes, their sizing and timing. The Bank will assist with a number of related studies which will concentrate on supplies to households and small scale users.

15 II. THE PROJECT Background: Developments in Algeria and Italy 2.01 The possibility of importing gas from Algeria has been an issue since the signature of the Algeria/Italy gas supply contract in 1973 and the corresponding transit agreement for a pipeline from Algeria across Tunisia to Italy. The steep increase in oil prices in late 1973 and the trend towards national control of resources led to renegotiation of the contract to an LNG-based operation. In 1977 the terms of a transit agreement were agreed between Tunisia and ENI, the Italian state oil company, and the gas supply was switched back to the original pipeline proposal In 1974 the Miskar structure was discovered, and was delineated steadily between then and During the appraisal of the Miskar project in 1977 the Bank suggested investigation of purchasing gas from Algeria as an alternative to investing $600 million in a single gas field. Negotiations for Algerian gas and delineation of Miskar proceeded simultaneously, providing Tunisia with two real alternatives. Provisional agreement on purchase terms at the same time as determination of the overall Miskar reserves (at a lower level than that hoped for), when taken together with risk and strategic considerations, led to a Government decision to proceed with the gas purchase A Bank appraisal mission in October 1979 found that, although planning for the onshore gas pipeline project was well advanced, it was suitable for Bank financing and was a project into which the Bank could make a worthwhile input. During and since that mission the project changed substantially, the capital expenditure planned for the 1980's has been reduced, and the gas purchase contract was clarified. Construction of the project is scheduled from the summer of 1980, and contracts for most of the materials and equipment had to be let between the dates of appraisal and Board presentation. Institutional Framework 2.04 The institutional framework for the intercontinental pipeline is complex, the arrangements differing in Algeria, Tunisia, the Sicily Channel and Italy. The Algerian state company Sonatrach will construct, own and operate the pipeline from Hassi R'Mel (Algeria) up to its frontier. In relation to Tunisia, there will be three companies established in Tunisia, whose roles in relation to the pipeline in Tunisian territory will be: (1) to construct the intercontinental pipeline; (2) to own the pipeline from commissioning; and (3) to operate the pipeline. A fourth company will own the offshore portion including that part in Tunisian waters and a fifth will own the onshore pipeline prior to commissioning. The first of these will be a subsidiary of ENI, the second Tunisian, and the third joint Italo-Tunisian with Tunisia having the majority share after five years. The fourth and fifth companies are not Tunisian. Tunisia will pay 1% of the pipeline cost to take possession, but Italy will retain ownership of the carrying capacity. In respect of the operations, responsibility will transfer to Tunisia after five

16 years. Algerian interest in the overall venture takes the form of ownership of the pipeline within Algeria, and of a share in the cost of the Sicily Channel crossing. As already noted, distribution within Tunisia is the responsibility of STEG. Gas Availability 2.05 The Hassi R'Mel gas field in Algeria (discovered in 1956), which is one of the largest gas fields in the world, is the source of gas for a number of on-going major gas supply contracts and will supply Italy through the intercontinental pipeline with at least 12 billion cubic meters of gas a year for 25 years, plus about 2 billion cubic meters for Tunisia. There is a possibility of increasing the pipeline throughput to a total of 20 billion cubic meters. Supplies to Italy are expected to commence in October Discussion has already begun on the possibility of a second gas pipeline for supplying France, Switzerland and Germany. Algeria has vast gas reserves and is actively seeking to promote sales by pipeline The Tunisian Government is entitled to royalties on gas transitting to Italy, either in cash or in kind at the discretion of the Tunisian government. The arrangement allows maximum flexibility in Tunisia's gas supplies. In addition to the royalties, STEG will purchase from SONATRACH 700 million cubic meters a year of gas from 1982 rising to 1,200 million cubic meters on a 20 year contract. STEG has requested a further 800 million cubic meters a year (starting with 400 million in 1986) in association with Algerian plans to increase overall capacity of the pipeline to 20 billion cubic meters but has so far had no response. Purchased gas is subject to take or pay. Total gas available to Tunisia from the pipeline is below, expressed in tons of oil equivalent (one thousand cubic meters of Algerian gas are equivalent to a ton of oil). Thousands Tons oil equivalent Royalty gas Gas contract Purchase Request - - _ These figures exclude royalty gas on a second gas pipeline, tentatively planned for the mid-1980s The gas is purchased at the Algerian frontier. Its cost (because of lags in price adjustments) fluctuates in the range 60-70% of the present international price for fuel oil. It has to be taken at approximately an equal hourly rate throughout the year, which optimizes the intercontinental pipeline system but causes some extra distribution costs in Tunisia and, in the absence of gas storage, limits the extent to which the gas can substitute for oil. STEG will use its power plants, particularly that at Sousse, to equalize the hourly take.

17 The Intercontinental Pipeline 2.08 The gas pipeline from Algeria to Italy (Hassi R'Mel to Bologna) will be 2500 km in length, of which 920 km are in North Africa, 160 km in the Sicily Che-'nel and 1420 km in Italy. The pipeline will be 48" in diameter in Algeria, Tunisia, Sicily and the greater part of its route through Italy, while decreasing gradually on the last section connecting it to the Northern Italian Network. The Sicily Channel has three 20" lines plus a 20" spare, the Messina Straits have three 20" lines and a 10" spare. Over the whole length of the pipeline there will be 11 compressor stations totalling 500,000 horsepower Tunisia has the right to use the intercontinental pipeline to transmit gas from the Algerian border through to various places in Tunisia, for which it will pay a charge of $1 to $4 per toe based on estimated total throughput and distance. It also has the right to add additional offtakes. Construction of the intercontinental pipeline is ahead of schedule and no difficulty is expected in achieving the October 1981 commissioning date. Tunisia will endeavor to take royalty gas from this date. The area of greatest risk--the Sicily Channel crossing--is progressing satisfactorily. Regardless of the progress offshore, the Algerian and Tunisian portions of the pipeline can operate independently. Project Description - Tunisia's Pipeline 2.10 Tunisia's own pipeline system will be built in stages, the first two being within the next four years. The final stage, which is essentially for security and flexibility and/or to transmit Miskar gas onshore, is not expected before The project financed by the proposed loan, namely Stage I, constitutes the initial phase in distributing gas from the Algeria- Italy pipeline to consumers in Tunisia. This stage is for pipelines to Tunis, Sousse, Gafsa and Tadjerouine (Map No ). Stage II for which the Bank will finance the optimization studies, will extend the system from Gafsa to Gabes and from Tunis to Bizerte. Pipe diameters have been determined on the basis of potential 1990 demand, on the avoidance of the need for installing compressors in the first two stages, and on the basis of an eventual loop connecting Sousse southwards to Gabes. Operating pressure will be about 70 atmospheres. Should the additional gas purchase (paragraph 2.06) not be obtained, it will be necessary to reassess the need and timing for the extension to Bizerte The first stage of the project includes the items listed below: (a) a 20" buried pipeline running from the intercontinental pipeline in the coastal region 70 km north to Tunis and 70 km south to Sousse. There will be provision for compressors to be added at a later stage. (b) an 18" buried pipeline running from a point near the Algerian border 60 km south to Gafsa.

18 (c) a 90 km 8" buried pipeline from the intercontinental pipeline to Kasserine and Tadjerouine. (d) 170 km of laterals connecting the transmission lines to customers. 80% of the laterals are for the Gafsa area. (e) a cathodic protection system to prevent chemical or electro-chemical corrosion. (f) three injection terminals, including filtration and metering, at the connections with the intercontinental pipeline; block valves approximately every 20 km and at the branching point for each consumer's delivery pipe; scraper trap assemblies at both ends of each section of the network; and about 18 (stage 1) delivery terminals for pressure reduction, straining and metering. (g) Conversion of customers oil-using plant and equipment to dual firing (oil and gas). (h) consultancy services for right of way, engineering, procurement, project management, construction supervision, start-up and commissioning. (i) other consultancy services for studies on supplies to households and small-scale industrial users and optimization of the stage II system. I(j) training of STEG employees both in Tunisia and abroad STEG has recommended to the Government that Stage I should also include an extension from Sousse to Djemmal. The extension would not be economic and has been omitted from the project description and cost estimates and from the proposed Bank loan. At $5 million, its construction by STEG would make little difference to the aggregate economic and financial forecasts. It is expected that the two stage II pipelines will be built in Final decisions have not yet been taken on the routing of the Gabes pipeline or on the sizing of the Bizerte pipeline. Present plans are for an 18" pipeline connecting Gafsa to Gabes, and for an 18" pipeline from Tunis to Bizerte. Status of Project Preparation 2.13 The major part of the project preparation activities has been completed. SOFREGAZ (engineering consultants, France) have undertaken route surveys, market studies and optimization studies. In association with a Tunisian company, TESA, they have completed most of the detailed design. The results of the SOFREGAZ studies are contained in a series of 14 reports issued between 1974 and Contracts have been signed with SOFREGAZ/TESA and OTC for the consultancy services. Copies of all SOFREGAZ reports will be forwarded to the Bank. STEG has agreed to forward quarterly progress reports on the pipeline construction.

19 ETAP will arrange the rights of way. As a national project land can be acquired compulsorily to meet requirements, subject to compensation in accordance with a national formula. All land should be acquired by September 30, Project Implementation 2.15 STEG has overall responsibility and control of the project and will carry out the physical works and studies through the gas directorate. SOFREGAZ/TESA have been engaged to supervise the project and to assist STEG staff in training and in all project aspects. SOFREGAZ is an experienced consulting organization with a proven track record in managing gas pipeline construction. In conjunction with STEG, SOFREGAZ has prepared a detailed PERT analysis of the project, which is summarized in Annex The start-up date for supplies to Tunisia has not been finalized but is expected to be 1st November 1981 for the main part of the system. It is expected that there will be a six month period before take or pay applies. There is sufficient time to achieve completion on the scheduled date. The cost of gas, which is subject to take or pay, will be equivalent to about $200,000 per day. Project Costs 2.17 The Project is estimated to cost $88 million, of which $55 million or 63Z represents the foreign exchange component. A physical contingency of 6% was applied to all costs and reflects the thoroughness of the preparatory work. The basic project cost estimate is in 1980 prices. Price escalation has been allowed at loz for 1980 and 9% for 1981, except for linepipe already contracted for at a fixed price. Project engineering, management and construction supervision are expected to require 420 man months, and are expected to cost $12,000 per month for expatriates and $6,000 per man month for Tunisians, Including all costs. Interest during construction is estimated at $4 million. The following table gives a breakdown of the cost. STAGE I Local Foreign Total --In Millions D.T.- Local Foreign Total ---In Millions US$-- Studies Linepipe Pipelaying/cathodic protection Valves and fittings Land and right of way Conversion Metering (main offtakes) Physical contingencies Price contingencies TOTAL

20 A firm estimate cannot be made for the next stage of development until decisions are made on the outstanding items, i.e. the routing of the Gabes pipeline and the sizing of the Bizerte pipeline. (The Bank will finance the studies on these options, which will be completed in 1982.) For the present, it is estimated that the cost will be approximately US$61 million at current prices based on the assumptions outlined in paragraph The cost of compressors, storage and a central dispatch system will form part of a subsiequent stage and are scheduled for the later 1980's. Project Financing Plan 2.19 The total financing required is $92 million, including $4 million of interest during construction. Financing proposed is: IBRD Export credits Equity Other borrowings $37 million $12 million $25 million $18 million Details of the allocation of the proposed Bank loan are in paragraph 2.23 below. The proposed Bank loan of US$37 million would be made to STEG with the Government guarantee at the current lending rate for 17 years including 4 years of grace. Including payments to the Government, the effective interest rate on the Bank loan will be 10%. The loan would be equal to 40% of the total cost of stage 1 and to 63% of its foreign exchange component. Export credits have been arranged for $5 million and no difficulty is expected in arranging a further $7 million for the second contract for linepipe by October 31, The initial $5 million is a condition of effectiveness. The terms expected are 5 years including grace and an interest rate of 8.5 to 10% The balance of the financing is to be $25 million in equity from the Government, provided as $10 million in 1980 and $15 million in 1981, and $18 million in commercial loans, to be drawn in amounts of $10 million and $8 million in 1981 and 1982 respectively. Loan terms available in Tunisia are currently 8% interest and a minimum repayment period of 7 years, which are compatible with the needs of the project. No funds are to be provided by STEG. Procurement and Disbursement 2.21 The borrower has decided that all goods and services will be procured through international competitive bidding. This practice has been followed in all procurement activities so far. To avoid delay in completion of the project, orders will be placed during the first five months of 1980 for purchases of linepipe, valves and fittings. Including the Stage I engineering, orders placed total US$24 million (27% of project costs) Potential bidders for the pipelaying are subject to prequalification and the selection will be agreed by the Bank. The bid documents will permit the work to be let as four contracts or in combination. Bidders could win

21 part or all of the work. Bids will be obtained from contractors in accordance with Bank guidelines. It is expected that some bidders will seek local firms to participate in undertaking the work. Contract award for pipelaying (US$39 million including contingencies) is expected in June, shortly after Board presentation. Retroactive financing will be required only for valves and fittings ($600,000) The proposed Bank loan would meet the foreign exchange cost of pipelaying, cathodic protection and the acquisition and installation of valves and pipe fittings, supervision of conversion, power plant conversion, metering, studies and the optimization for Stage II, as below, including the foreign cost element of local contracts. Amount Allocated US$ million (1) Pipelaying and cathodic protection 17.3 (2) Valves and fittings 3.8 (3) Conversion (supervision and for power) 2.2 (4) Metering 8.1 (5) Studies (urban supplies) 0.5 (6) Optimization for Stage II 0.1 (7) Unallocated The loan should be fully disbursed by the second quarter of The closing date would be December 31, Annex 2.02 gives the estimated disbursement schedule. Ecology and Safety 2.24 The proposed gas project does not pose serious ecological problems. The route survey took care to avoid, where possible, damage to the countryside, and once the pipelines are constructed the ecological disturbance will be virtually nil. The project will improve the air quality in Tunisia's major cities by making available a clean burning sulphur free fuel. The expanded refinery is planned to produce low sulphur fuel oil. The gas project will lead to elimination of the sulphur content and the sooting effects associated with fuel oil. It will also lead to reduction in the transportation of oil products by road Gas pipelines have a good safety record, and STEG's experience in more than 20 years of operating a high pressure system has been good. The Tunisian pipelines will be buried to a depth of about three feet to minimize accidental damage, and they will be located for the most part away from centers of population. STEG is arranging for a satisfactory maintenance system and proper operator training both to ensure efficiency and safety.

22 Full efficiency and control will be achieved through a central dispatch and communtications system, scheduled for the late 1980's, and will be necessary once a compressor is installed. Project Risks 2.26 The Tunisian pipeline project faces no special project risks. There is suifficient lead time to construct the pipeline, an experienced consultant has been engaged, and the pipeline should be ready in good time The physical risk associated with the project is downstream on the intercontinental pipeline, for which the Sicily Channel crossing requires new technology. However, delays offshore should have no effect on supplies to Tunisia. There is also the risk resulting from 50% of Tunisia's energy supply coming through a single pipeline. This is not a significant factor as the major energy consumers will have dual-fired installations and will retain present oil storage tanks. Fuel oil is usually easy to obtain even when other oil products are in short supply There is a financial risk in that part of the gas to be delivered through the system is subject to take or pay provisions. No difficulty is expected in being ready before take or pay applies. The excess of demand over supply in the later eighties is adequate but is not large and a major downturn in the economy could present some difficulty in absorbing the minimum quantities of gas. The plans of the Government to ensure its ability to use additional gas will require careful review in the light of the growth in demand and actual progress with energy-using projects There is an economic risk in that the whole economic advantage of the project relies on the differential between the cost of gas and the price realizable by Tunisia when selling large quantities of fuel oil. The best advice available is that, on the basis of the present contract, the margin should be adequate at all times and there should be no prolonged difficulty in sellinlg the fuel oil The final risk is political in that a major portion of Tunisia's energy would be supplied by a single foreign country. It is worth noting that Tunisian territory and ports are used for transporting Algerian oil, and that in respect of this project, Tunisia is a minority partner in what is essentially a major gas supply to Italy.