Document of The World Bank Report No: 16432 UA STAFF APPRAISAL REPORT UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT APRIL 24, 1998 Energy Department Europe and Central Asia Region CLURRENCY EQUIVTALENTS Currency unit hrivaya, abbr. UAH (from September 2, 1996) US$1 = 1.76 hrivnyas (as of September 1996) (Prior to September 2, 1996, the currency unit was k.arbovanet (Krb); US$I = 176,000 (at August 1996) US$1 = 2.15 hrivnyas (as of 1998) WEIGHTS AND MEAStURES atm atmosphere MJ Megajoule (100J) bcm billion cub.c meter mt million metric tons Gcal Gigacalorie (i09 cal) MW Megawatt (106W) GW Gigawatt MVA Megavolt Ampere kg kilogram PJ Petajoule (101'J) kin square kilometer psi pounds per square inch koe kilograms of oil equivalent t metric ton kV kilovolt tce tons of coal equivalent kW kilowatt toe tons of oil equivalent kWh kilowatt hour TWh Terawatt hour (1012Wh) rn3 cubic rmeter CALORIFIC VALUES 1 Unit of Fuel Gcal Wood (ton) 2.0 Coal (ton) 5.0 Standard fuel (ton) 7.0 Natural gas (000 m3) 8.5 Mazut (ton) 9.7 Crude Oil (ton) 10.0 Diesel (ton) 10.2 Gasoline (ton) 10.5 Liquified Petroleum Gas (ton) 10.8 CONVERSION FACTORS 1 Gcal = 4.187 GJ = 3.968 million Btu = 1,163 kWh 1 tce = 7 Gcal and 1 toe = 10 Gcal 1 kWh of hydro and nuclear energy output converted to primary thermal equivalent at 250 grams of oil equivalent. ABBREVIATIONS CAS Country Assistance Strategy CHP Combined-Heat-and-Power DH District Heating EBRD European Bank for Reconstruction and Developmnent ESMAP Energy Sector Management Assistance Program FSU Former Soviet Union GDP Gross Domestic Product GNP Gross National Product GPN General Procurement Notice G-7 Group of Seven HMSAP Housing and Municipal Service Allowance Prograrm HOB Heat-Only-Boiler ICB International Competitive Bidding ICR Implementation Completion Report IMF International Monetary Fund KMDHC Kiev Municipal District Heating Comapany LPG Liquified Petroleum Gas NCB National Competitive Bidding NERC National Electricity Regulatory Commission PIU Project Inmplementation Unit SOE Statement of Expenditure FISCAL YEAR January 1 - December 31 Vice President: Johannes Linn, ECAVP Country Director: Paul Siegelbaum, ECCIt Energy Director: Hossein Razavi, ECSEG Task Team Leader: Carolyn Gochenour, ECSEG UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT TABLE OF CONTENTS Page No. Loan and Project Summary ................................................. i I. SECTOR BACKGROUND ................................................. 1 A. Country Context ......................................... 1 B. Overview of the Energy Sector ......................................... 2 C. Energy Sector Policy and Strategy ......................................... 5 D. Kiev District Heating (DH) Conditions and Priority Needs ................................ 6 E. Bank Strategy, Past Experience and Project Rationale ...................................... 7 II. THE PROJECT .. 9 A. Project Origin ......................... 9 B. Project Objectives ............................. 10 C. Project Components and Description ......................... 10 D. Cost Estimates ......................... 12 E. Project Financing Arrangements ......................... 14 F. Implementation Arrangements ......................... 15 G. Procurement Arrangements ......................... 16 H. Disbursement ......................... 18 I. Accounts and Audits ......................... 19 J. Environmental Aspects ......................... 20 K. Supervision and Monitoring ......................... 21 III. IMPLEMENTING AGENCIES ......... ............ ........................ 22 A. Kievenergo .............................................. 22 B. Kiev Municipal District Heating Company (KMDHC) ........................... .......... 23 IV. FINANCIAL ASPECTS ............................................. 24 A. Past Financial Performance of Project Agencies ....................................... 24 B. Heat Tariffs ....................................... 25 C. Electricity Tariffs ....................................... 26 D. Billing and Collection Performance of Project Agencies ................................... 28 E. Future Financial Performance of Project Agencies ....................................... 30 V. PROJECT JUSTIFICATION, RISKS AND SOCIAL IMPACTS ........... ................... 33 A. Project Justification ................................................. 33 B. Risk Analysis and Project Risks ................................................. 40 C. Social Impacts ................................................. 42 VI. AGREEMENTS REACHED AND RECOMMENDATION ...................................... 45 ANNEXES 1 - Kiev Heat Demand Analysis 2 - Kiev District Heating Improvement Component 3 - Detailed Cost Estimates 4 - Project Implementation Schedule and List of Procurement Packages 5 - Estimated Schedule of Disbursements 6 - Supervision Plan 7 - Performance Monitoring Indicators 8 - Kievenergo Financial Analysis 9 - Kiev Municipal District Heating Company Financial Analysis 10 - Economic Analysis 11 - Social Assessment CHARTS 1 - Organization of Kievenergo 2 - Organization of Kiev Municipal D1H Company MAP IBRD 28701 - Kiev' District Heating System in the Year 2000 Shown as "Kyiv" on the map, in accordance with official Ukrainian usage. -i- UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Loan and Project Summary Borrower: Ukraine Beneficiary: Kievenergo Poverty: Not applicable Loan Amount: US$ 200 million Loan Terms: LIBOR-based interest rate for US dollar single currency loans with a maturity of 20 years including 5 years grace Commitment Fee: 0.75% on undisbursed loan balances, beginning 60 days after signing, less any waiver On-Lending Terms: As a loan to Kievenergo at the World Bank interest rate plus a mark-up of up to 1 % for loan administration to be repaid over 20 years including 5 years grace Financing Plan: See para 2.14 Net Present Value: US$ 160.4 million discounted at the opportunity cost of capital of 10% (20% economic rate of return) Map: IBRD Map No. 28701 Project ID: UA-PA-44832 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT I. SECTOR BACKGROUND A. Country Context 1.1 Ukraine, the second largest country in Europe with a population of over 50 million people, is still struggling to transform its flagging post-Soviet economy into one based on market principles, despite more than six years of efforts to that end. Sluggish economic reforms and rampant hyperinflation during the first three years after Ukraine gained independence from the Soviet Union in August 1991, combined with the external shocks of sharply higher energy prices and reduced sales to traditional markets, significantly compounded the economic situation. Despite a considerable degree of price and exchange rate stability achieved in the last three years, the decline in production has only slowed but not stopped. According to official statistics, the Ukrainian economy has slumped by nearly 60% from 1991 to 1997. Living standards have also fallen sharply and poverty became more widespread. Annual per capita GDP has declined from US$ 1,250 in 1995 to US$ 1,020 in 1997. The Government has accumulated over US$ 2.5 billion of wage arrears and debts to the public sector by the end of 1997. 1.2 Nevertheless, there have been indisputable accomplishments in the past three years. The annual level of inflation has been brought down from 8000% at its peak in the Fall of 1993 to 16% in 1997. A new currency, the hrivnya, was introduced in September 1996 and fluctuated by no more than 5% until late 1997 when a wider currency corridor was introduced allowing a modest depreciation of the currency. A significant degree of current account convertibility has been established. The trade regime has also been liberalized. Domestic prices have largely been decontrolled, consumer subsidies reduced and energy prices increased to world levels for non-household users and substantially increased for household users. Further reduction in consumer subsidies is expected after the elections in March 1998. In addition, tax and accounting reforms have been initiated with the introduction of a modern profit tax and adoption of international accounting standards by commercial banks. A radical restructuring of the energy sector is underway, and a mass privatization program is to be completed by the end of 1998. Large-scale privatization has been launched with shares in a number of flagship Ukrainian industrial enterprises and energy and telecommunications companies to be sold at auctions this year. 1.3 However, officially recorded production is still declining, albeit at a much slower pace. In 1997, real GNP fell by 3.2% as compared to 10% in 1996, 12% in 1995 and 23% in 1994. These figures excessively dramatize the production declines since they do not fully account for goods and services produced in the shadow economy, which is estimated at 40-60% of the overall economy. The problem of financing an excessively large budget deficit through borrowing came to a head in the Fall of 1997 when the cost of borrowing in the domestic capital markets shot up due to crowding out and the contagion effects of the East Asian crisis. Faced with repayments due on maturing T-bills and pressures to pay the backlog of wages, the Government of Ukraine has continued to borrow extensively in hrivnyas in the domestic T-bill market and in the international markets at extremely high risk premiums. Nevertheless, the Ukrainian leadership realizes that the only way forward now is to maintain macroeconomic stability while pressing ahead with structural reforms to raise much needed revenues for the state budget, attract investments into the economy and dispose of inefficient state enterprises constantly lobbying Government for subsidies and favors. This will ultimately lead to economic recovery and improved standards of living for the population. The World Bank and the 2 International Monetary Fund (IMF) support Ukraine in its efforts to implement reform policies. The IMF is working with the Government to develop an Extended Funding Facility. Currently the World Bank is supporting eleven projects totaling more than US$ 2 billion in Ukraine. 1.4 The Bank's overall strategy in Ukraine calls for a graduated expansion of the lending program in line with the intensity of the reform effort. This approach will allow the Bank to respond promptly in support of broader and deeper reforms while avoiding burdening Ukraine with debt that would not contribute to economic recovery and improved creditworthiness. The Bank intends to continue to provide Ukraine with a high level of non-lending services and engage the Government and civil society in an intensive policy dialogue under all scenarios. The energy sector is a very high priority area, given the dramatic price increases which have occurred since independence, the significant dependence on energy imports and the resulting need for energy conservation and improvements in efficiency of energy facilities. A central part of the Bank's strategy will be to continue to support energy sector reforms aimed at creating a market environment conducive for private participation. B. Overview of the Energy Sector 1.5 Energy Demand. Energy demand in Ukraine is characterized by high energy intensity of industrial output and the high share of industry in final energy consumption, due to the low thermal efficiency of energy consumption technologies and high share (about 40% in 1995) of industry (iron and steel, basic chemicals) in GDP. Energy consumption per capita was about 3,000 kilogram oil equivalent (koe) in 1996, which is high compared to Western European standards. Following a modest decline of 11% between 1985 and 1990, the energy intensity of official GDP increased 60% in the 1991-95 period reaching 5.2 koe/US$, a ratio that is several times higher than in developed countries. The true energy intensity of GDP, however, is likely to be substantially lower due to the large size of the shadow economy. 1.6 Primary Energy Resources. Ukraine has vast coal resources, important oil and gas resources and significant hydro, wood, peat and uranium resources. Donbass, the main coal mining basin, contains metallurgical coal, anthracite and high grade thermal coals, as well as coalbed methane gas. The unusually difficult geological conditions in central Donbass make the mining of coal costly and labor intensive. Crude oil and natural gas resources are declining, but are still significant. Remaining proven and probable reserves are 190 million tons of oil and 1,400 bcm of natural gas. The shallower and larger, oil and gas pools in the Dnieper-Donetsk and Carpathian regions are rapidly being depleted. These deposits are being replaced by reserves in smaller, deeper and less productive reservoirs, which are more expensive to find, drill-up and produce, to the point that a large part of the reserves appear to be uneconomic. Hydro resources are significant but are almost fully developed, while wood and peat resources appear to have greater potential. Ukraine also has significant uranium reserves and receives nuclear fuel, in exchange for its uranium mined domestically and extracted from warheads of dismantled missiles, for its sizable nuclear electricity generating capacity. 1.7 Energy Supply. Domestic energy production, consisting of fossil fuels and primary electricity (hydro and nuclear power), represented 45-50% of consumption in the 1990-97 period (see Table 1.1 below). Domestic energy production steadily declined during the period; most of the decline was due to decreased coal and natural gas output. The main energy import items include crude oil and oil products mostly from Russia, natural gas from Russia and Turkmenistan, and coal from Russia and Poland. The cost of fossil fuel imports reached about US$ 6.2 billion in 1993 and increased to US$ 7.5 billion in 1995 and to US$ 8.7 billion in 1996, creating a demand for foreign exchange that the economy was unable to meet. The difference was financed by payment arrears to Russia and Turkmenistan (the arrears were subsequently converted to debt) and balance-of-payment support from 3 the IMF and the World Bank. In 1997, the cost of fossil fuel imports decreased to about US$ 7.6 billion, mainly as a result of the decrease in gas imports. Table 1.1: Primary Energy Supply and Consumption Year 1990 1991 1992 1993 1994 1995 1996 1997 PRODUCTION washed coal (mt) 130.7 108.7 105.4 91.0 75.9 65.6 54.3 58.6 crude oil & condensate (mt) 5.3 4.9 4.5 4.2 4.2 4.0 4.1 4.1 natural gas (bcm) 27.8 24.0 22.0 19.2 18.3 18.1 18.4 18.1 peat & wood (mt) 4.3 4.0 3.7 4.1 4.0 3.9 4.0 3.7 nuclear (TWh) 76.2 75.1 73.7 75.2 68.9 70.5 79.6 79.4 hydro (TWh) 10.3 11.5 7.8 11.2 12.3 10.1 8.8 10.0 Total Production (mtoe) 116.77 102.10 97.02 88.44 78.81 73.11 69.8 71.9 IMPORT coal (mt) 21.1 12.7 11.7 8.7 7.5 16.0 11.0 11.9 crude oil (mt) 54.3 49.6 35.3 19.7 15.8 13.3 9.2 8.9 natural gas, net (bcm) 87.3 89.5 89.1 79.8 69.1 66.3 71.0 62.4 petroleum products (Imt) 11.5 13.1 5.0 6.2 6.5 9.5 6.0 6.5 Total Import (mtoe) 150.56 145.13 121.88 98.06 84.79 87.16 81.1 74.4 EXPORT . . . - . . - .. coal (mt) 20.0 13.7 7.8 3.5 4.6 2.4 2.0 2.4 petroleum products (mt) 11.3 8.4 6.4 1.1 1.7 1.4 1.4 0.8 electricity, net (TWh) 28.0 14.3 4.6 1.2 1.1 4.1 4.4 4.3 Total Export (mtoe) 28.30 18.83 11.45 3.15 4.28 3.63 3.5 3.1 Primary Energy Consumption (mtoe) 239.02 228.40 207.45 183.35 159.32 156.64 147.3 143.2 Annual Percentage Change -4.4% -9.2% -11.6% -13.1% -1.7% -5.9% -2.8% Notes: *A ton of oil equivalent is defined as 10 million kcal. The applied conversion factors are: coal - 0.5, crude oil - 1.0, peat & wood - 0.2, hydro & electricity - 0.25, natural gas - 0.85, petroleum products - 1.0. Source: World Bank estimates (March 1998). 1.8 Energy Prices. Since 1991, energy fuel prices have skyrocketed and now approximate world market levels. Most notable are the prices of natural gas and crude oil, utilized primnarily in heat and electricity production, which increased from about $ 0.25/1,000 m3 and $ 1.35/ton to about $80/1,000 m and $106/ton, respectively, during 1996 as shown in Figure 1.1 below and remained about the same in 1997. The price increases of energy inputs were translated into higher prices for essential services, especially electricity and heat. Electricity, gas and coal prices are set by the central government, while district heating (DH), LPG, heating oil, peat and wood prices are set by local governments. Household energy prices cover 50-80% of costs, with household DH prices, outside of Kiev, currently covering 80% of costs but are expected to cover 100% of costs in the near future. The difference between costs and prices is covered by subsidies from the central and local governments 4 and/or by cross-subsidies from industrial to household consumers (particularly for DH). In Kiev, DH prices currently cover costs without cross-subsidies. Figure 1.1: Prices of Inported Oil and Gas (1990-96) 120 E 100 = = OiL 190 191t92u99r99a19l19 60 4 0 ~~~ 40~~~~ :~20 z~ 0 1990 1991 1992 1993 1994 1995 1996 1.9 Non-payment by customers became a major problem for electricity, gas and heat suppliers in 1994-95, weakening the financial position of the utilities. In September 1995, the Government issued a resolution on the non-payment of energy bills requiring that all non-payers be disconnected and also providing indemnity to energy suppliers in the case of damages to consumers. The implementation of the resolution was unsatisfactory during the unusually cold winter of 1995/96, but it improved rapidly in mid-1996. A new government resolution was issued on August 1, 1996, calling for businesses which fail to pay their electricity bills to have their power supply cut off. Earlier in February 1995, the Government introduced the Housing and Municipal Service Allowance Program (HMSAP), which allows families whose monthly payments for housing, water and sewerage, hot water, heating and other municipal services that exceed 15% of monthly income to apply for an allowance equal to the difference. The Bank approved a loan m August 1996 to assist the Govermnent to cope with the growing demand from applicants for these allowances; the loan is supporting the computerization requirements to improve the administration of HMSAP. Despite HMSAP, payment discipline in the household sector remains poor as also is the case for the agriculture and budgetary sectors. As household energy and other service prices are further raised to cost recovery levels, the requirements for targeted assistance to households is expected to continue over the near term, until household incomes grow commensurably with the rise in service prices, after which targeted assistance would be needed for only the poorest income groups. 1.10 Sector Institutions. The main government agencies in the sector are the Ministry of Coal Industry, the Ministry of Power and Electrification (Minenergo), the State Committee for the Oil and Gas Industry and the State Committee for Energy Conservation. The State Committee for Housing and Communal Services also plays a role in overseeing municipal-owned DH enterprises. In 1994-95, the Government implemented a corporatization program in the oil, gas and power subsectors, with the long-term objective of privatizing most of the assets and activities except those that are considered of strategic importance (e.g., oil, gas and electricity transmission lines, nuclear plants, dispatch centers). The Cabinet of Ministers also has approved a privatization plan of state-owned, joint-stock energy generating and distribution companies, including Kievenergo, whereby investment competitions could be conducted after passage of a law regulating investors' activities. The corporatization program of the coal industry was started in 1996, parallel with a program to close uneconomic mines. 5 C. Energy Sector Policy and Strategy 1.11 In 1992-93, the Government's reaction to the increase in the price of energy imports and cost of energy supply was to rely on methods of central planning such as price controls, cross- subsidization among consumer classes, and the rationing of energy, rather than allowing market mechanisms to regulate and balance supply and demand. A key reason concerned the political risk of increased unemployment inherent in market-based solutions. Another prominent concern was dependency on one supplier, Russia, for half of Ukraine's primary energy needs. 1.12 In late 1993, the Government prepared a "Concept for the Development of the Energy Sector of Ukraine for the Period up to 2010." The "Concept" was subsequently approved by the Parliament. It spelled out the following main directions for Ukraine's long-term energy strategy: (a) the development and implementation of a policy that promotes energy savings; (b) economically and environmentally justified utilization of domestic energy sources; (c) restructuring of the economy to reduce the energy intensity of production; and (d) increasing reliance on alternative (renewable) energy sources. The investment program outlined in the "Concept" recognized the priority of rehabilitating capacities in the power, heating, coal, gas and oil subsectors, and it also included a number of ambitious expansion schemes in coal mining, oil and gas production, and nuclear power generation. 1.13 In early 1994, the Parliament passed a Law on Energy Conservation. The Law provides economic incentives for investments in energy conservation. Specifically, it calls for the establishment of national and local extra-budgetary funds, based on special taxes on coal and on penalties for inefficient energy use by industrial enterprises, to support energy savings initiatives. In order to prepare the necessary regulations and to coordinate the implementation of the Law, a State Committee for Energy Conservation was established in July 1995. The Government approved the regulations for the operation of the national extra-budgetary Energy Efficiency Fund in February 1996. To-date, however, revenues of the Energy Efficiency Fund have been relatively insignificant. 1.14 A long-term Comprehensive State Energy Conservation Program was announced in August 1996 which aims at achieving an annual savings by the year 2010 of about 109 million tons of coal equivalent, more than the total output of coal, gas and oil in Ukraine in 1996 or about one third of total energy consumption of Ukraine in 1996. While the energy conservation potential for any year depends on the general structure of the economy (e.g., surviving industries), GDP, fuel consumption rates, capacity utilization, among other things, the structure of energy conservation potential has been estimated at 42-48% of 1990 consumption or about 145-170 million tons of coal equivalent to be achievable in relative terms from the following sectors over the period: manufacturing - 57%, power industry - 21%, public services and utilities - 12%, transport - 7% and agriculture - 3%. Within the public services and utilities sector, a number of measures have been identified to improve energy efficiency in heating systems, water supply and sewerage systems, housing development and urban transport. The main measures targeted in the heating sector include the replacement of obsolete boilers with ones of higher efficiency, introduction of anti-corrosion protection of heating systems and insulated pipelines, introduction of automation and control systems at consumers and production plant, and utilization of alternative fuel and energy sources. These measures are to be complemented with energy efficiency measures inside buildings, including heat meters. As highlighted in the Conservation Program, the main impediment to implementation of the energy efficiency measures is the lack of investment funds. 1.15 In mid-1995, the Government prepared and submitted to the Parliament the "National Energy Program of Ukraine up to 2010." The "Program" was approved by the Parliament in early 1996. It follows the main policy directions established in the "Concept." For the DH sector, the Program calls for the continued development of centralized DH systems as well as for the development of combined-heat-and-power (CHP) plants. The Program acknowledges the need to reconstruct and 6 rehabilitate existing DH equipment, install new capacities and construct new high efficiency heat-only- boilers (HOBs) with capacities up to 180 Gcal/h, and promotes the use of waste gases in heat production. Total Ukraine heat demand has been projected to increase from 166,000 Gcal/h in 1995 to about 203,000 Gcal/h by 2010, to be covered by increasing heat production by about 6.7% from CHP plants and by about 11.3% from HOBs. D. Kiev District Heating (DH) Conditions and Priority Needs 1.16 The Kiev DH system, with a capacity of about 15,000 Gcal/h and networks totaling 2,300 km, is the third largest in the countries of the FSU, after the Moscow and St. Petersburg systems, and is thought to be the third largest in the world. In Kiev, the DH system provides most of the heat and hot water for urban dwellers as well as steam for industry, produced in CHP or in HOB plant and transported through pipeline networks to substations to buildings. 1.17 The Kiev system consists of several DH operators, including Kievenergo which supplies heat to the main system and owns and operates the main heat sources, consisting of two CHP plants (TETS 5 and TETS 6) and about 9 large boiler houses (2,400 Gcal/h from turbines and 3,900 Gcal/h from HOBs) and the main transmission network (768 km). Kievenergo transfers heat from its own plants as well as heat purchased from one CHP plant (TETS 4) operated by a cooperative, which leases the facility from the state, to the distribution system (460 km), owned and operated by the Kiev Municipal District Heating Company (KMDHC) which is responsible for supplying heat to end-users. KMDHC also operates several isolated networks in the city (200 km) and associated boiler houses (800 Gcal/h). In addition, several other entities are responsible for heat supply in other isolated networks (7,900 Gcal/h), including industrial enterprises (5,000 Gcal/h). 1.18 The main Kiev DH system is technically well-designed, with a share of heat from CHP plant in the main system at about 50% of total heat production, bringing it near the economic optimum theoretically achievable under constant flow conditions and contributing to low costs of heat production. The Kiev system also includes some highly economical, advanced technology solutions at its 300 MW CHP plants (TETS 5 and TETS 6) which have supercritical steam conditions achieving a higher electricity yield per produced heat unit than conventional CHP plants. 1.19 Despite the overall contraction of Ukraine's economy, particularly the industrial sector, since independence, the City of Kiev presents a net growth both in terms of population (2.7 million growing at about 1 % per year) and local economy, a trend which is expected to continue (see Annex 1). The lack of adequate heat in the growing city center and suburban residential areas represents a severe bottleneck to growth. At the city center, the capacities of the main boiler plants (CT-1, CT-2) have been reduced due to the lack of rehabilitation and replacement investments to pumping capacity and boilers, which are nearly 50 years old. Furthermore, contrary to normal practice, the Kiev system does not have any standing reserve capacity. As an illustration, in October 1996 when the outdoor temperature was only +2°C, the operable parts of the plants were working at two-thirds of their available capacity, which clearly indicates that capacity will be insufficient when the outside temperature is at the design level of -22°C. As a result, heat supply to households is being rationed and the development of new and renovated office space, hotels and other buildings is severely constrained. 1.20 The weight point of new residential housing development in Kiev is at Pozniaki subdivision, located in the southeastern section of the city. The population occupying existing buildings and apartments at present is approximately 260,000. This area is under continuous construction, and in the year 2002, the population is estimated to grow to 370,000. Due to the lack of investment funds, not even the first unit of the boiler plant to supply Pozniaki subdivision with heat has been able to be completed. As an emergency solution, a pipeline has been constructed from the already-overloaded 7 TETS 5 CHP plant to the area. Through this pipeline, the existing occupied apartments are served with some heat, facilitating an indoor temperature of barely + 100C currently during the winter season. As a result, residents at Pozniaki subdivision are facing a crisis situation with regard to heating and hot water services. 1.21 Since independence, maintenance of the Kiev DH system has also been underfunded, resulting in serious corrosion of present assets, especially pipelines, due to the deteriorating water quality. Heat and water losses are high as compared to Western systems, with heat losses in the transmission and distribution systems estimated at about 20% overall, whereas ultimately, these losses could be reduced to 6-8% through the sealing of leaks that occur at corroded network sections and equipment. The volume of make-up water that needs to be added to the system annually varies from 5- 45 times depending on the network and compares poorly with make-up water quantities of 1-2 times annually in Western systems. The replacement value of the presently corroding assets has been estimated at more than $ 3 billion, and therefore investments aimed at reducing corrosion and extending the lifetimes of these assets would have high economic and financial benefits. 1.22 The lack of automation and heat metering at consumer connections in substations and, to some extent, at boiler plants results in additional wastage of heat energy in the Kiev DH system. The system operates on constant flow and variable temperature conditions, rendering the dispatch of the heat load to plants having the lowest generation cost cumbersome. Introduction of a variable flow regime through automated substations with consumption metered and controlled by consumers could reduce heat energy consumption by as much as 25 % for the same service levels. E. Bank Strategy, Past Experience and Project Rationale 1.23 The Bank's overall strategy is to support Ukraine's efforts to accelerate structural reforms and to promote efficient investments in high priority sectors in order to complete the transition of the country to a market economy, accelerate the rate of economic growth and increase efficiency. This will require strengthening key financial institutions, accelerating privatization, extending the openness of the policy environment, rehabilitating and re-orienting its physical infrastructure, and extending the social safety net and the efficient delivery of social services. 1.24 The Bank approved the first loan of US$ 27 million equivalent to Ukraine in June 1993 to finance an Institution Building Project (Ln. 3614-UA) aimed at supporting enterprise and financial sector reform and public economic and financial management; this project is still ongoing. The second Bank operation was a Rehabilitation Loan (Ln. 3831-UA) of US$ 500 million equivalent approved in December 1994, and implementation of the Loan was satisfactory. This Loan provided financing for critical imports needed to stem the decline in production and to cushion the deterioration of living standards of the population. The third Bank operation was the Hydropower Rehabilitation and System Control Project (Ln. 3865-UA) of US$ 114 million equivalent approved by the Bank's Board in April 1995, signed in September 1995, and declared effective in May 1996. Despite the lack of substantive issues, the Government's approval process preceding submission of the loan documents to Parliament for ratification took many months. Learning from this experience, the Bank provided assistance to the Government to simplify its loan approval procedures. The following operations, the Coal Pilot Project (Ln. 4016-UA), the Enterprise Development Adjustment Loan (Ln. 4057-UA), Agriculture Sector Adjustment Loan (Ln. 4103-UA), Social Protection Support Project (Ln. 4097-UA) and Export Development Loan (Ln. 4107-UA) have reached effectiveness considerably faster. Further Bank energy operations, including the Coal Sector Adjustment Loan (Ln. 4118-UA) and the Electricity Market Development Project (Ln. 4098-UA), became effective during December 1996 and January 1997, respectively. A Treasury Systems Project (Ln. 4285-UA) was approved during February 1998. 8 1.25 The Bank has been involved in the Ukrainian energy sector since early 1992. An Energy Sector Review (Report No. 11646-UA) was issued in 1993, leading to an Energy Strategy Conference held in Kiev in June 1993. During the Conference, an understanding was reached that the Bank's lending operations should aim primarily at the rehabilitation of existing assets rather than construction of new facilities where existing capacity is sufficient, while supporting initiatives that increase the financial and operational autonomy of enterprises and foster competition. After the Conference, the Government, assisted by the Bank and other multi- and bilateral agencies, started the preparation of a number of projects to rehabilitate hydropower plants, thermal power plants, and gas transmission, distribution and metering facilities. The completion of a pump storage plant, restructuring of the coal industry, and energy efficiency investments in DH were added to the agenda in 1995. Utilizing donor funds, the Bank provided technical services in the areas of industrial energy audits; rehabilitation of thermal, hydropower and DH plants; gas distribution and metering; legislation for oil and gas production; and power industry institutional, regulatory and legal reforms. The Bank has also been actively supporting the dialogue between the G-7 and the Government of Ukraine in the area of nuclear safety. 1.26 The proposed Loan represents the first Bank investment loan to Ukraine in the DH sector. Past experience in implementation of other Bank-supported DH projects is available from projects in Poland, China, Estonia and Latvia, all on-going. Some lessons learned to-date include: (a) strong project ownership and advanced preparation of project components is necessary for timely implementation, (b) decentralized project management arrangements work far better than centralized arrangements, (c) the relationship between prices and incomes changes rapidly in countries in transition and the heating service which appears largely unaffordable will become easier to afford in a relatively short period of time, (d) end-user efficiency improvements, which initially appear difficult to support due to building ownership and affordability reasons, may be possible to support on a pilot level, (e) there is the possibility to redress the financial difficulties of DH companies during project preparation through tariff increases and settlernent of arrears by major debtors, including households, and (f) strong support from municipalities is needed to resolve collections and payment issues. These lessons have been considered during the preparation period of the proposed project. The project represents an important case study for an ongoing ESMAP-sponsored study on DH systems which is examining industry structure, alternatives to DH and the conditions under which building efficiency improvements can best be supported. 1.27 The proposed project is consistent with the Bank's overall Country Assistance Strategy (CAS) in Ukraine, discussed by the Bank's Board in June 1996, as well as the interim strategy in the CAS Progress Report, and which assigns emphasis to the energy sector and seeks to support Ukraine's efforts to improve energy efficiency by replacing or rehabilitation old production facilities, networks and substation equipment. The strategy also calls for greater efforts in energy conservation, pricing and ownership. The project is also fully consistent with the Government's energy strategy, would support energy conservation, improvement of the efficiency of energy facilities and environmental conditions, and rehabilitation of existing plants. The efficiency gains would lead to lower costs of heat production and operation thereby resulting in more affordable heat tariffs and lower requirements for social assistance. Most importantly, the quality and reliability of heating services would be improved for the current and growing demand. At the same time, institutional development programs for concerned energy agencies would help strengthen their management and operations. 9 II. THE PROJECT A. Project Origin 2.1 Based on an official request from Kievenergo, the key enterprise providing heat in Kiev, a Bank mission visited Ukraine during June 1995 to explore the possibility of Bank support for a project to improve the DH system and service in the capital city of Kiev. Kievenergo emphasized the urgent need to rehabilitate and expand the DH system in Kiev in order to improve the currently poor service and provide for the growing population in the city. At that time, agreement was reached with Kievenergo and also with Kiev Municipal DH Company (KMDHC), owning part of the DH system, on a possible project focused on DH improvements in Kiev as well as for the need for consultancy studies to carefully review the priority requirements and establish the feasibility of an affordable investment program. 2.2 In July 1995, the Government, through the Ministry of Economy, formally approved the Kiev DH project concept for further study. With World Bank support, terms of reference for the required feasibility, engineering and institutional studies were prepared. Since the Kiev system is large and the support required for the background studies was too great for one donor, funding was sought from two sources, the United States Trade and Development Agency and the Finnish Government. Consultants (Joseph Technology and Ekono Energy) were selected under competitive procedures. Both firms are utilizing Ukrainian institutes (Ukrenergoprom and Kievproyekt) on their teams to ensure the full use of information available in Ukraine and to promote the transfer of knowledge in the preparation of the investment studies. 2.3 During September 1995, the Bank received official requests from Sevastopol Municipality and its DH company for a heat supply improvement project in Sevastopol as well as from the newly-established State Committee for Energy Conservation for an energy efficiency project addressing the needs of schools and hospitals in Kiev. Initially, it was planned that these additional requests would be combined with the Kiev DH request into one Heat Supply and Energy Efficiency Project. However, due to the different timetables for identifying grant funding for feasibility studies and selecting consultants, it was subsequently agreed that these new requests would become separate projects. The proposed Kiev Energy Efficiency Project in Public Buildings, when implemented (expected to commence in 1999), would complement the proposed Kiev District Heating Improvement Project by reducing the high energy losses in the larger public users of DH in the Kiev system. 2.4 In accordance with the agreed timetable, appraisal of this project took place in March 1997. Technical specifications and draft bidding documents have been prepared for the first year's goods and works contracts so that bidding would be able to commence shortly after Loan negotiations. It is expected that a number of contracts could be ready for award around the time of Loan effectiveness. 10 B. Project Objectives 2.5 The project, which would be the first DH investment project in Ukraine designed to address the most critical needs in Kiev, would have the following main objectives: (a) to replace and increase heat production capacity to better meet existing and expected future demand and to improve the reliability and service levels in the Kiev DH system; (b) to extend the life of, increase the efficiency of and enhance conservation of the Kiev DH system, through rehabilitation and introduction of modern technologies and materials; and (c) to promote sound cost recovery policies and practices and the commercialization and institutional strengthening of project DH companies, to identify the most efficient corporate and institutional structure for provision of DH in Kiev and ways to facilitate the eventual privatization of the service, and to support project implementation. C. Project Components and Description 2.6 The project would consist of the following components listed below and described in more detail in Annex 2: (a) heat production capacitv improvement component, including replacement (560 Gcal/h) and construction of new boilers (1,580 Gcal/h) along with rehabilitation of other boilers in the main DH system, to alleviate the current deficit of heat production capacity and to better meet the existing and growing demand; (b) DH rehabilitation component, including a substantial program of transmission (80 km) and distribution (15 km) pipeline and network improvements in the main DH system, water treatment and substation (1,500) improvements, including heat meters (1,500) and construction of a stack in the city center, to address the deteriorating technical conditions and outmoded technology, and rehabilitation of an electric substation (2 x 40 MVA) and power cables in the city center to provide adequate electric supply for boiler houses and DH pumping equipment; and (c) institutional support component for project agencies, including consultancy and advisory services, training, equipment and software for project management and implementation, for audits and for review of appropriate institutional and corporate structures for DH enterprises, including support for implementation of recommendations. 2.7 Kiev DH System. The main part of the Kiev DH system, owned and operated by Kievenergo and KMDHC, consists of 10 major networks served by 2 CHP (TETS 5 and TETS 6) and 9 large HOB plants (including CT-1 and CT-2 in the city center) and a number of small isolated networks served by 112 small HOB plants. The main fuel for all boilers and CHP units is gas, although the larger boilers and CHP units can use mazut as well, and a few of the smaller boilers use coal. Nearly all of the major networks in the main system are interconnected but operated during the 11 heating season as separate networks. The main system includes 21 booster pumping stations which are needed to transfer heat to various elevations over long distances. For the main networks, there are also dispatch centers to monitor and control operation of the system. In the main system, about 2,200 consumer substations are operated and maintained, of which about 800 are large substations serving groups of about 10-15 buildings. Only about 150 of the large substations are metered. A map of the Kiev DH system is included. The DH systems owned and operated by industrial and other enterprises are not included in the project. 2.8 The investments in heat production plant would include replacement of old, worn-out boilers at CT-1 and CT-2 plants with new boilers, including two 100 Gcal/h and two 180 Gcal/h hot water boilers, and expansion of boiler capacity, including construction of three 100 Gcal/h and one 180 Gcal/h hot water boilers, as well as rehabilitation of other boilers and construction of a new 100 m high stack at CT-1 plant to improve the environmental conditions in the dense city center. In addition, a program of expansion of boiler capacity at TETS 5 and TETS 6 CHP plants, including construction of three new 180 Gcal/h hot water boilers, would be undertaken along with a program of reconstruction of the water treatment system at TETS 5 in order to reduce effluent pollution and increase water treatment system capacity. The partially-constructed boiler house at Pozniaki subdivision would be completed and equipped with two 100 Gcal/h and two 180 Gcal/h hot water boilers. The additional boiler capacity would be sufficient to cover today's heat production capacity deficit in the main DH system and allow for a small portion of the estimated future capacity requirements, as explained in Annex 1. 2.9 The DH rehabilitation investments would include a substantial program of replacement of old transmission and distribution pipelines and valves and installation of 1,500 substations including heat meters. According to experience in other Bank-supported DH projects (e.g., Jelgava, Latvia), installation of heat meters without automation equipment does not contribute to any significant energy savings. Therefore, heat meters are being installed under the project only where automation equipment is being installed. The utility would be expected to use the meters to improve their measurement of heat and water losses. Further, in order to ensure adequate electricity supply to the city center and for DH pumping stations and boiler plant, the Center electric substation (2 x 40 MVA) and power cables will be replaced. 2.10 Institutional Support Component. A package of support which is necessary to better ensure the successful implementation of the project and the development of DH companies to facilitate an appropriate institutional structure and their commercial operations would be included in the project. Terms of reference for the consultancy and advisory services were discussed and agreed during negotiations. The component consists of the following items summarized below: (a) Restructuring Study of the Kiev DH Companies: to review options for the most efficient institutional and corporate structure for DH in Kiev, to identify the requirements for effective management, corporate and operations systems and to provide support for implementing the study recommendations; (b) Implementation Support and Audits: including consultancy services for detailed design, construction supervision, procurement and disbursement, and auditing services for the incremental auditing costs of the project; and (c) Training and Equipment: for training of the management and staff of the DH companies in the areas of procurement and disbursement, introduction of international accounting standards, computerized billing, and environmental issues, among other things, and provision of office equipment, computers and software. 12 D. Cost Estimates 2.11 The total project cost is estimated at US$ 308.9 million equivalent (UAH 814.0 million) of which US$ 240.7 million (UAH 634.2 mnillion) or about 78% is the foreign exchange component. Import duties are estimated at about US$ 3.8 million equivalent and are included in the cost estimates. The duties represent about 1.2% of the total project cost. Base cost estimates are expressed in February 1998 prices. Summary project costs are shown in Table 2.1 and detailed cost estimates are given in Annex 3. 2.12 Project costs were estimated by project agencies and their consultants, based on similar works recently implemented in Ukraine and recent quotations for equipment. Cost estimates for technical assistance are based on recent actual costs for similar activities. The remaining detailed designs and supervision costs are estimated at 3-6% of base costs. 2.13 Physical contingencies are estimated at 10% of base costs for goods, works and designs. Price contingencies for local costs are based on expected price increases of 15% in 1998, 15% in 1999, 12.5% in 2000, 10% in 2001, 9% in 2002 and 8% in 2003. Price contingencies for foreign costs are based on an expected price increase of 2.3% per year during the project period. In total, physical contingencies are estimated at 10% of base cost, and price contingencies are estimated at about 7 % of base cost plus physical contingencies. To convert local prices to US dollar equivalents, it is assumed that the divergence between local and foreign price escalation will be corrected by exchange rate adjustments over the life of the project. 13 Table 2.1: Summary of Project Costs Hr. US$ million million % % of Local Foreign Total Local Foreign Total Foreign Base Cost KIEVENERGO 1. Pozniaki Boiler Plant 27.6 62.8 90.4 10.1 23.0 33.1 69% 16% 2. CT-I Rehabilitation 10.5 62.2 72.7 3.8 22.8 26.6 86% 13% 3. CT-2 Rehabilitation 9.0 119.0 128.0 3.3 43.6 46.9 93% 22% 4. TETS-5 Rehabilitation and Expansion 16.9 32.1 49.0 6.2 11.8 17.9 66% 8% 5. TETS-6 Rehabilitation and Expansion 20.0 29.1 49.1 7.3 10.7 18.0 59% 8% 6. Center Electric Substation 7.9 18.8 26.7 2.9 6.9 9.8 71% 5% 7. Pipe Replacement 26.2 112.5 138.7 9.6 41.2 50.8 81% 24% 8. Replacement of Valves 2.0 8.7 10.8 0.8 3.2 4.0 81% 2% 9. Design and Supervision 13.7 0.0 13.7 5.0 0.0 5.0 0% 2% 10. Subtotal Base Cost, Kievenergo 133.7 445.4 579.1 49.0 163.1 212.1 77% 100% 11. Physical Contingencies, 10% 13.4 44.5 57.9 4.9 16.3 21.2 77% 10% 12. Price Contingencies 8.2 39.4 47.6 3.0 14.4 17.4 83% 8% 13. Technical Assistance 0.0 1.4 1.4 0.0 0.5 0.5 100% 0% 14. Total Project Cost before Duties 155.3 530.8 686.0 56.9 194.4 251.2 77% 118% 15. Import Duties, 2% 8.3 0.0 8.3 3.0 0.0 3.0 0% 1% 16. Total Project Cost, Kievenergo 163.6 530.8 694.3 59.9 194.4 254.3 76% 120% KIEV MUNICIPAL DH COMPANY 1. Secondary Pipe Replacement 1.2 4.8 6.0 0.4 1.8 2.2 80% 5% 2. Rehabilitation of Substations 7.1 95.6 102.7 2.6 35.0 37.6 93% 83% 3. Design 9.6 4.9 14.5 3.5 1.8 5.3 34% 12% 6. Subtotal Base Cost, KMDHC 17.9 105.3 123.2 6.5 38.6 45.1 85% 100% 4. Physical Contingencies, 10% 1.8 10.5 12.3 0.7 3.9 4.5 85% 10% 5. Price Contingencies 1.1 8.4 9.5 0.4 3.1 3.5 89% 8% 6. Technical Assistance 0.0 2.2 2.2 0.0 0.8 0.8 100% 2% 7. Total Project Cost before Duties 20.7 126.4 147.2 7.6 46.3 53.9 86% 119% 8. Import Duties, 2% 2.1 0.0 2.1 0.8 0.8 0% 2% 9. Total Project Cost, KMDHC 22.8 126.4 149.3 8.4 46.3 54.7 85% 121% Total Project Cost 186.4 657.2 843.6 68.3 240.7 308.9 78% 14 E. Project Financing Arrangements Financing Plan 2.14 The proposed Bank Loan of US$ 200.0 million (UAH 527.1 million) would finance about 65 % of total project costs (or 66% of total project costs net of duties). It is expected that the EBRD would co-finance the project by providing a loan of US$ 40.0 million (UAH 105.4 million) amounting to about 13% of total project costs (or 13% of total project costs net of duties). As the activities to be funded by the EBRD loan are an integral part of the project, it was agreed during negotiations that the EBRD loan should become effective by September 1, 2000, or such date as the Bank may agree, unless the Borrower establishes that adequate funds for the activities to be funded by the EBRD loan are available ftom other sources. The remaining 23% of total project cost (UAH 181.5 million) would be provided by project agencies from their own funds or local borrowings. As a condition for negotiations, Kievenergo demonstrated that its local counterpart contribution would be provided out of internally generated funds. The financing plan is summarized below in Table 2.2. Table 2.2: Project Financing Plan UAH million US$ million % Total Cost Total Project Cost a! 814.0 308.9 100 of which: World Bank 527.1 200.0 65 EBRD 105.4 40.0 13 Project Agencies: Kievenergo 142.9 54.2 18 Kiev Municipal DH Company 38.6 14.7 5 a/ Excluding interest during construction estimated at about US$ 45 million to be fmanced by Kievenergo and about US$ 14 million to be financed by KMDHC. Flow of Funds and Lending/On-Lending Terms 2.15 The World Bank Loan would be made to Ukraine (represented by the Ministry of Finance) and on-lent to Kievenergo. The Loan would be made with a maturity of twenty years including a five year grace period at the LIBOR-based interest rate for US dollar single currency loans. The Loan would be passed on to Kievenergo as a sub-loan at the same interest rate plus a mark-up of up to 1 % to be repaid over twenty years, including five years grace on repayment of principal. The maturity of twenty years allows for a five year grace period, corresponding to the implementation period of the project, and a repayment period of fifteen years. The foreign exchange risk of the Loan would be borne by Kievenergo which would also be responsible for the commitment fee. Execution of a subsidiary loan agreement between Ukraine and Kievenergo would be a condition of effectiveness of the Loan. 2.16 It is expected that the EBRD loan would be made to Ukraine and on-lent to Kiev Municipality and its DH company. The EBRD loan would be made to Ukraine at a variable interest rate of LIBOR + 1 % (about 7.5% currently) with a front-end fee of 1 % for a period of fifteen years, including five years grace. The EBRD loan would be passed on to Kiev Municipality as a sub-loan at the EBRD interest rate plus a mark-up of up to 1 % to be repaid over fifteen years, including five years grace on repayment of principal. The maturity of fifteen years allows for a five year grace period 15 corresponding to the implementation period of the project and a repayment period of ten years. The EBRD loan would be further on-lent to Kiev Municipal DH Company at the same terms and conditions. The foreign exchange risk of the EBRD loan would be borne by Kiev Municipality and its DH company. The processing of the EBRD loan is behind the schedule of the World Bank loan. Retroactive Financing 2.17 A provision for retroactive financing up to about US$ 7 million has been made for expenditures incurred after March 1, 1998, primarily for completion of the first phase of the Pozniaki HOB plant which is urgently needed. This activity is necessary to facilitate heating services in the Pozniaki area and needs to be undertaken prior to the next heating season. Inflation and Interest Rates 2.18 Inflation rates in Ukraine, as measured by changes in the Consumer Price Index, were 4,734% in 1993, 891% in 1994, 376% in 1995, 40% in 1996 and 16% in 1997 and are estimated to be about 15% in 1998, 15% in 1999, 12.5% in 2000, 10% in 2001, 9% in 2002 and 8% per year thereafter through 2005, reflecting gradual stabilization of the economy. Short-term credit is now available through the commercial banking system; interest rates on commercial bank loans are administered by the National Bank of Ukraine and have generally kept ahead of inflation in recent months. Long-term investment loans, however, are not available in Ukraine today through the commercial banking system. The interest rates on long-term investment loans to be provided for the project by the Bank and EBRD are therefore the only available proxies for appropriate interest rates to be charged to project agencies. The proposed Bank and EBRD lending rates plus a margin of up to 1 % are considered reasonable. These lending rates are also in line with on-lending interest rates under other ongoing World Bank and EBRD loans in Ukraine. F. Implementation Arrangements 2.19 Kievenergo, Kiev Municipality and Kiev Municipal DH Company would be responsible for implementation of their respective DH components. Kievenergo has appointed its Project Manager and all the remaining technical and accounting personnel, with satisfactory qualifications, for carrying out its part of the project, as a condition for negotiations. Kievenergo would be assisted by international and local consultants for the tendering process, bid evaluation, contract awards, supervision of equipment installation and follow-up. 2.20 Kiev Municipal DH Company has also appointed its Project Manager. It is expected that Kiev Municipality and Kiev Municipal DH Company would nominate the remaining technical and accounting personnel, with satisfactory qualifications, for carrying out their part of the project prior to the negotiations of the EBRD loan. Kiev Municipality and Kiev Municipal DH Company would be assisted by international and local consultants for the tendering process, bid evaluation, contract awards, supervision of equipment installation and follow-up. 2.21 Project implementation would be expected to begin in late 1998 and would be carried out over a five and a half year period. The project implementation schedule is included in Annex 4. 16 G. Procurement Arrangements 2.22 A summary of procurement arrangements is given in Table 2.3 following. Table 2.3: Project Procurement Arrangements a! (US$ million) Procurement Method Procurement Category ICB NCB Other b/ N.B.F. TOTAL COST 1. Works. Kievenergo 1.0 45.3 46.3 Installation works and civil (1.0) (1.0) works 2. Goods. Kievenergo 189.5 10.0 199.5 Boilers, equipment (188.5) (10.0) (198.5) 3. Services. Kievenergo Design and supervision 5.0 5.0 Technical assistance and training 0.3 0.3 (0.3) (0.3) Incremental audit costs 0.2 0.2 (0.2) (0.2) 4. Works. Goods and Services, 53.9 53.9 KMDHC 5. Import Duties 3.8 3.8 TOTAL 189.5 11.5 107.9 308.9 (188.5) (11.5) (0) (200.0) Note: Figures in parentheses are the amounts financed by the Bank Loan. N.B.F. (Not Bank-financed) are the amounts financed by the Kiev DH companies and EBRD. a/ Co-financed in parallel with the EBRD; procured in conformity with World Bank Guidelines for Procurement under IBRD Loans and IDA Credits (January 1995 revised January and August 1996 and September 1997) for the World Bank-financed part of the project and in conformity with EBRD Guidelines for Procurement for the EBRD-fmanced part of the project. bk Includes intemational shopping (US$ 10.0 million), minor works (US$ 1.0 million), and consultancy contracts (US$ 0.5 million) procured in conformity with World Bank Guidelines for Selection and Employment of Consultants by World Bank Borrowers (January 1997 revised September 1997). 2.23 Procurement of goods and works, totaling about 34 packages ranging in value from US$ 0.3-13.8 million, would follow ICi3 procedures using standard bidding documents according to the Bank's "Guidelines for Procurement under IBRD Loans and IDA Credits" published in January 1995 (revised January and August 1996 and September 1997) except that: (a) international shopping procedures would be used for small goods purchases ranging in value from US$ 50,000-300,000 for a total of about US$ 10.0 million (about 3.2% of total procurement); and (b) minor works procurement procedures would be used for the remaining small works contracts under US $50,000 for a total of about US$ 1.0 million (about 0.3% of total procurement). The list of Kievenergo's procurement packages is included in Annex 4. In addition to the procurement workshop held during the appraisal 17 mission, a further procurement workshop would be held during project launch which would explain thoroughly the procurement process for selected packages in goods, works and consulting services. 2.24 The part of the project being financed by EBRD would follow EBRD procurement procedures. The EBRD would finance separate contracts on a parallel basis. 2.25 Supply and installation contractors bidding under ICB procedures for contracts above US$ 10.0 million would be prequalified. Prequalification would be based entirely upon the capability and resources of prospective bidders to perform the particular contract satisfactorily, taking into account their (a) experience and past performance on similar contracts, (b) capabilities with respect to personnel, equipment, and construction or manufacturing facilities, and (c) financial position. For the prequalification of goods and works, the Bank's standard documentation would be used. 2.26 When ICB procedures are used for goods, qualified domestic manufacturers may be allowed a preferential margin of 15%, or the existing rate of import duties, whichever is lower, in accordance with the Bank's Procurement Guidelines. 2.27 Implementation support including consultancy services for detailed designs, construction supervision, procurement and disbursement, and training in the amount of about US$ 0.3 million as well as financial auditing services in the amount of about US$ 0.2 million would be carried out by consultants whose qualifications, experience and terms and conditions of employment shall be satisfactory to the Bank. Such consultants shall be selected in accordance with the principles and procedures satisfactory to the Bank on the basis of the "Guidelines for the Selection and Employment of Consultants by World Bank Borrowers" published in January 1997 (revised in September 1997). The engineering consultants (Joseph Technology and Ekono Energy) who carried out the feasibility studies, technical specifications and initial bid packages would be retained on a sole source basis for engineering and implementation support in the amount of US$ 0.3 million. Because of the existence of a large number of local consultants and the necessity of the consultants being familiar with local conditions and language, the short list of consultants for design and supervision services costing less than US$ 200,000 shall comprise only local consultants. 2.28 Prior review by the Bank of draft tender documents, including review of bid evaluation reports and recommendations for contract awards, would be carried out for all ICB procurement. The list of goods and technical specifications to be procured using international shopping procedures would be submitted for prior review by the Bank. For international shopping, quotations from a minimum of three suppliers from at least two World Bank member countries would be required. Some minor goods and works would be procured using national shopping procedures for which quotations from at least three firms would be required. All terms of reference for technical assistance contracts would be subject to prior review. Technical assistance contracts with individuals over US$ 50,000 and with firms over US$ 100,000 would be subject to prior review. Contracts with individuals and firms under these amounts would be subject to post review on a selective basis. Overall, the above procurement plan would result in the Bank's prior review of over 95% of total Bank-financed procurement. To better ensure that the project will be implemented in a timely manner, as a condition of negotiations, Kievenergo prepared the draft bidding documents for ICB contracts for the first year of the project and submitted them to the Bank for review. 2.29 A General Procurement Notice (GPN) was published on April 30, 1997, and an update has recently been prepared and submitted for publication. 18 H. Disbursement 2.30 The proceeds of the Bank Loan would be disbursed against: (a) 100% of foreign expenditures of imported goods, 100% of local expenditures (ex- factory cost) and 80% of expenditures of other goods obtained locally; (b) 100% of foreign and 80% of local expenditures for works contracts; and (c) 100% of foreign and local expenditures for technical assistance and incremental audits. 2.31 The EBRD loan would be disbursed against the KMDHC component of the project in accordance with EBRD disbursement procedures. 2.32 In the case that grant ftnds can be identified to cover any of the costs of technical assistance, the Bank Loan allocated to this purpose may be reallocated to other parts of the project, if needed. 2.33 Disbursement Schedule. The estimated schedule of disbursements is given in Annex 5. It is expected that disbursements would be completed in six years by December 31, 2004, about 6 months after completion of equipment supply and installation. A comparison cannot be made to disbursement profiles for district heating projects, as the few Bank loans made to-date for projects of this nature are still under implementation. The disbursement schedule is considered realistic, given that preparation of technical specifications and bidding documents for the first year's procurement activities were available prior to Loan negotiations. 2.34 Disbursement Documentation. Disbursements for individual consulting contracts of up to US$ 50,000 equivalent, firm consulting contracts of up to US$ 100,000 equivalent, goods contracts of up to US$ 300,000 equivalent and works contracts of up to US$ 1 million equivalent would be made against statements of expenditure (SOE). The supporting documents for these contracts would not be sent to the Bank but would be retained by Kievenergo for inspection by supervision missions and by external auditors. Disbursements for all other contracts would be made against standard Bank documentation. 2.35 Special Account. In order to ensure the timely provision of funds available to finance small costs of the project, a Special Account in US dollars would be established in a foreign commercial bank by the Ministry of Finance for Kievenergo in the amount of up to US$ 800,000. Funds in the Special Account would be available to finance only eligible expenditures under the project. During the early stage of the project, the initial allocation to the Special Account would be limited to US$ 400,000. However, when the aggregate disbursements under the Loan have reached the level of US$ 5 million, the initial allocation may be increased up to the authorized allocation of US$800,000. Replenishment applications should be submitted at least every three months and must include reconciled bank statements as well as other appropriate supporting documents. The minimum size of a disbursement application for direct payment would be 20% of the current deposit to the Special Account (US$ 80,000 or US$160,000). During negotiations, agreement was obtained regarding the arrangements for establishing and operating the Special Account. 19 1. Accounts and Audits Accounting Policies and Revaluation of Assets 2.36 Both Kiev DH companies follow standard, cash-based Soviet accounting requirements for income tax reporting purposes, based on a unified chart of accounts in effect since 1993. The financial statements are supplemented by financial indicators based on accrual accounting standards for management reporting purposes. A draft accounting law is currently under consideration by the Government and, when approved by the Parliament, would require introduction of international accounting standards (LAS). For project financial reporting purposes, both Kiev DH companies would be required to follow IAS. 2.37 Fixed assets are revalued periodically in accordance with Government regulations, which called for a major increase in values in 1996. Fixed assets are still thought to be undervalued, but the current assessment is that it would be inappropriate to proceed with a full asset revaluation, since the actual value that can be given to them, in view of their poor operational efficiency and outdated technology, are uncertain. Furthermore, raising tariffs to reflect revaluation of assets would require additional social assistance. Once project investments, which are large relative to current asset levels, are commissioned, however, the value of assets would be greatly increased and the cost of heat services would reflect a larger depreciation charge and return on investment as the operational efficiency of assets is improved. Project Accounting and Auditing Requirements 2.38 In order to properly record project expenditures, Kievenergo, Kiev Municipality and Kiev Municipal DH Company would prepare project accounts for their respective parts of the project. The Kievenergo project account would identify all sources and uses of funds in carrying out its part of the project, including a detailed accounting of the use of the proceeds of the World Bank Loan. The Kievenergo project account would be prepared in accordance with IAS and audited by an independent auditor acceptable to the Bank, and the audit report would be submitted to the Bank within six months of the end of the fiscal year. This project account audit report would also contain a separate opinion on the statement of expenditure (SOE) procedure, when utilized, and on the operation of the Kievenergo Special Account. The Kiev Municipality and Kiev Municipal DH Company project accounts would similarly be prepared in accordance with IAS and audited by an independent auditor acceptable to EBRD. 2.39 In order to properly monitor the financial performance of Kievenergo, its financial statements (income statements and balance sheets), in addition to its project account, would be prepared in accordance with IAS and audited by an independent auditor acceptable to the Bank, and the audit report would be submitted to the Bank within six months of the end of the fiscal year. The first audit report would cover Kievenergo's activities for its 1998 fiscal year. The audit report would contain a separate opinion on compliance by Kievenergo with all financial covenants under the Bank Loan. The financial statements of Kiev Municipal DH Company, in addition to its project account, would similarly be prepared in accordance with LAS and audited by an independent auditor acceptable to EBRD. It is expected that a local branch of a private, international commercial auditor, in association with a local auditing firm if available, would carry out the audits, and this arrangement is considered acceptable. During negotiations, agreement was obtained regarding the accounting and auditing requirements of the project. 20 J. Environmental Aspects Environmental Review Process 2.40 Preparation of the proposed project has included environmental studies consistent with the requirements of the Ukrainian Ministry of Protection of Natural Environment, 1992 Law of Ukraine for the Protection of the Environment, and the provision of World Bank Operational Directive 4.00 "Environmental Policies." In accordance with these procedures, an environmental review, consistent with the requirements for a category "B" project for the boiler houses, CHP plant, DH piping, Center electric substation and rehabilitation components has been performed. The institutional support program was placed in category "C" and did not require an environmental analysis. The findings of the environmental studies and proposed mitigation and monitoring activities are presented below. Potential Environmental Impacts and Mitigation Measures 2.41 Implementation of the proposed project is anticipated to have positive environmental benefits through improved efficiency in the use of fuels, by contributing to a reduced level of air pollution in Kiev and by reducing the wastage of water used in the DH system. The specific potential impacts and mitigation measures for each proposed component are as follows: 2.42 Heat Production Capacity Improvement Componen. During the rehabilitation and replacement of the boilers, it is likely that insulation materials containing asbestos would be found. Therefore, a survey is necessary to identify where asbestos is located at the plants. The removal of asbestos materials should be performed by personnel trained in the appropriate practices. Contractors or others responsible for boiler works would be required to comply with the regulations of the European Union. New materials to be used for insulation would not contain asbestos or ozone- depleting substances. 2.43 All boiler components would increase fuel utilization efficiency. Air pollution in Kiev is caused almost entirely by industry and automotive exhaust gases and to a very small extent by emissions from Kievenergo's heat production plant which are fueled mainly by gas. Despite the net increase in production capacity of the boilers, the emissions of NOR, SO2 and particulates released to the atmosphere would be substantially reduced from the present levels, since the new plants would utilize modern technology such as low-NO, burners, flue gas recirculation and a higher stack at the CT-1 plant in the city center. The decrease in flue gas emissions would reduce the present environmental emission fines amounting to about $ 7,000 per month which are paid by Kievenergo to the Ukrainian Ministry of Protection of Natural Environment. It is recommended that Kievenergo continues its systematic flue gas monitoring system, employing in-situ stack monitoring technology. 2.44 DH Rehabilitation Component. The DH distribution network and group substation rehabilitation activities are also expected to involve asbestos removal from the old insulation materials, requiring similar mitigation measures as for the boilers. The replacement of pipelines and network components would result in reduced wastage of water, thereby reducing the requirements for water treatment chemicals and effluents discharge. It is probable that during rehabilitation of the Center electric substation, traces of polychlorinated biphenyls (PCBs) would be revealed. In this case, the dielectric oils of the old transformers and circuit breakers would have to be analyzed for PCBs in order to identify appropriate handling procedures according to the regulations of the European Union. Any contaminated soils would be disposed of in accordance with local regulations. 21 2.45 Training. Training in environmental issues would be arranged under the project, and would include the subjects of asbestos and PCB handling, worker health and safety, among other things. K. Supervision and Monitoring 2.46 As this is the first Bank-supported DH investment project in Ukraine, a significant supervision effort would be required particularly during the first two years when a large portion of the procurement actions would be undertaken. Therefore, it is planned that about 20 staff-weeks of effort each year for the first two years and about 15 staff-weeks each year thereafter would required for supervision. A detailed supervision plan will be discussed during negotiations and is attached as Annex 6. 2.47 Kievenergo would prepare semi-annual progress reports which would be submitted to the Bank within one month after the end of each semester. The progress reports will include, among other things, information regarding: (a) overall progress of the project, (b) costs for each contract and for the total project, (c) procurement actions, (d) financial performance, (e) compliance with covenants under the Loan, (f) issues affecting project implementation and (g) performance monitoring indicators. The first progress report covering the period ending December 31, 1998 would be sent to the Bank by end-January 1999. An outline of the proposed format, including the performance indicators, was discussed during negotiations. The proposed performance monitoring indicators are shown in Annex 7. 2.48 The Bank would carry out a mid-term review of the project not later than September 30, 2001. In addition to the topics covered under the semi-annual progress reports, the mid-term review would include an in-depth review of the economic viability of the project components, based on actual costs and benefits achieved to-date, and of the overall institutional and financial viability of Kievenergo. Based on the outcome of the mid-term review, measures would be taken to ensure the efficient completion of the project. The timing of the mid-term review was agreed during negotiations. 2.49 An Implementation Completion Report (ICR) would be prepared by the Bank with inputs from Kievenergo not later than six months after completion of the project. The ICR would evaluate how well the objectives of the project have been met, the overall performance of the project, the performance of Kievenergo and lessons learned. During negotiations, agreement was obtained regarding the reporting and monitoring requirements of the project. 22 III. IMPLEMENTING AGENCIES A. Kievenergo Background 3.1 Kievenergo was established as a state-owned, joint-stock company on August 31, 1995, by transfer of the rights, assets and liabilities of the subdivisions and administration located in Kiev of the former Kievenergo Energy Production Association. Kievenergo is primarily responsible for the generation, transportation, distribution and sale of electrical and thermal energy in the City of Kiev. About 80% of DH supply in Kiev is provided by Kievenergo, which owns and operates the large heat production plants and transmission networks and sells heat to consumers through substations and distribution networks owned by Kiev Municipal District Heating Company (KMDHC) to which it pays a distribution fee. Kievenergo's founder is Minenergo which oversees the Company's activities and decides on issues related to the major trends of the Company's activities, organizational structure, legal matters, and appointment of key Company and supervisory personnel, among other things. Organization and StafFing 3.2 Kievenergo's organizational structure is shown in Chart 1. Minenergo appoints the General Director, who is in charge of the overall day-to-day management of the Company and acts as Chairman of the Board. A Supervisory Council, comprised of representatives from Minenergo, Kievenergo, Kiev Municipality, the State Property Fund and a bank, exercise control over its activities. The privatization plan for Kievenergo is under implementation and allows for 40.5% of shares to be owned by company employees and pensioners, employees of state power industry enterprises and other organizations, 26% of shares to be owned by the state and administered by Minenergo, 30% of shares to be sold at auction and 3.5% of shares sold at the stock exchange. Kievenergo supervises CHP plants which provide heat and electricity for Kiev and also take part in the national electricity market. CHP plants and heating networks of Kievenergo are not subject to privatization and are not included in the authorized fund of the company. The rights to use these assets are transferred by an agreement to Kievenergo by Minenergo. 3.3 The Company is comprised of a number of subsidiaries including 2 CHP plants (TETS 5, TETS 6), the Kiev District Heating Facilities Enterprise, Cable Facilities Enterprise, and a number of maintenance, auto transport, construction and other technical, research and training enterprises. As of February 1998, Kievenergo employed about 8,400 people in all stages of production, distribution and utilization of electrical and thermal energy. Kievenergo's management and staff are judged to be well-qualified, both in the technical and financial areas. 3.4 Personnel training is carried out at a training center, by vocational programs, at a two- year technical college and Kiev Polytechnic University. Management and marketing training in the energy field is provided at seminars offered by the Ukrainian-Bavarian Entrepreneurial Center, International Business Center, and Pennsylvania Power and Light Company, as well as by internships at industries located in Bavaria, Austria and the United States and recently by study tours to Finland. During the project period, Kievenergo's management and staff would receive training support in the areas of procurement and disbursement, introduction of international accounting standards, computerized billing and environmental issues, among other things. 23 B. Kiev Municipal District Heating Company (KMDHC) Background 3.5 KMDHC was re-established on July 1, 1992 as a state-municipal enterprise wholly owned by the City of Kiev. KMDHC is responsible for the production, transportation and distribution of space heating and domestic hot water to public sector consumers. KMDHC owns and operates 112 heat-only-boiler plant, 2,225 DH substations and about 950 km of underground piping networks in six heating districts of Kiev City. Most of the heat is supplied by Kievenergo to substations from which KMDHC distributes the heat to all consumers for a fee. KMDHC generates about 20% of the total city heat supply at its 112 boiler plants serving small, isolated networks. KMDHC is responsible for billing only those consumers supplied with heat from its boiler plants. Organization and Staffing 3.6 KMDHC's organization structure is shown in Chart 2. Kiev City carries out its rights to manage the enterprise through a board of directors which is the executive body of the enterprise. Kiev City also appoints the Director, who is in charge of the overall day-to-day management of the Company. 3.7 The Company is comprised of a number of subsidiaries concerned with district boiler operations, heating districts operations, automation and control, dispatch and a number of maintenance, transport, construction and other technical and administrative activities. As of October 1996, KMDHC employed about 3,945 people. KMDHC's management and staff are judged to be well-qualified, both in the technical and financial areas. KMDHC's training needs are judged to be similar to Kievenergo's and a program of support would be developed under the project to be supported by EBRD. Institutional Structure for DH in Kiev 3.8 The main Kiev DH system is owned and operated by two companies, but it is unclear as to whether this is the best arrangement for operation of the system in an efficient manner. To assist in identifying the most efficient institutional and corporate structure for DH, technical assistance is recommended to be carried out under the project. Draft terms of reference have been developed and were agreed during Loan negotiations. The technical assistance is expected to review the options of: (a) existing structure, (b) merger of the two companies, and (c) merger of the distribution networks but not the isolated networks of KMDHC with Kievenergo. In addition, the technical assistance is expected to review the opportunities for privatization in heat supply activities and provide recommendations on ways to encourage private sector participation. Once agreement is reached on the most appropriate structure, the key steps necessary to legally create the new DH structure and the minimum conditions to make it operational, including effective management systems, corporate and operations systems, would be proposed. During negotiations, agreement was obtained with the Borrower that technical assistance for the review of the institutional and corporate structure for DH in Kiev would be carried out under the management of Kiev Municipality by consultants in accordance with terms of reference satisfactory to the Bank. The study would commence within two years after Loan effectiveness. 24 IV. FINANCIAL ASPECTS A. Past Financial Performance of Project Agencies 4.1 The past financial performance of Kiev DH companies are typically the same since the onset of the energy price shocks in the early 1990s, although the severity of the problems vary according to the different structure of activities and consumers of the companies. In general, since the import prices of fuels (gas and mazut) utilized in DH production increased to world market levels, DH tariffs have increased dramatically and frequently (e.g., 6 times in 1995) while the growth of incomes has not kept pace. Due to these large increases in heat charges, consumers have had difficulty in paying their heat bills on time. A social assistance program targeted to poorer households was introduced during 1995, but up-to-now has not been fully effective in reducing arrears from these consumers, partly because of the limited ability of the social assistance offices to cope with the large increase in applications for social assistance and partly due to insufficient funding at the local level to support the program. As a result, DH companies have been experiencing serious cash flow problems and consequently have been unable to pay their suppliers (mainly fuel suppliers) on time. While DH companies have made heroic efforts to raise DH tariffs to cost recovery levels, tariff levels have, up-to- now, been insufficient to allow for adequate maintenance and necessary repairs, let alone new investments. This performance demonstrates the need to reduce heat production and operating costs through efficient investments and for more effective social assistance schemes for households to permit them to better pay for heat services. 4.2 The past and present financial performance of Kievenergo (since its establishment in end-August 1995) and KMDHC, restated on an accrual basis, for 1995-97 are shown in detail in Annexes 8 and 9, respectively, and the financial highlights of Kievenergo and KMDHC are shown in Table 4.1 below. The financial statements show that the two Kiev DH enterprises had gross sales in 1997 of about $ 505 million, about 94% of which is attributable to Kievenergo's heat and electricity activities, demonstrating Kievenergo's dominance in the provision of DH in the main system in Kiev. Both DH enterprises showed profits on operations during 1995-97. Despite the cash flow difficulties, neither DH company has any significant long-term debt; Kievenergo has only one small outstanding loan associated with the Pozniaki project in the amount of about $ 1.2 million which will be repaid during 1998-99. The lack of any significant long-term borrowings would allow for adequate debt servicing capacity for the project loans, with the lowest debt service coverage ratio projected to be 4.5 in 2003, well above the minimum advisable ratio of 1.5. The proposed investment project of about $ 300 million, while large in absolute terms, represents less than one year of sales and only a small fraction of the roughly estimated current replacement value of more than $ 3.3 billion of the main DH assets. The proposed investments are urgently needed to protect and prevent further corrosion of these sizable assets. 25 Table 4.1: Financial Highlights of Kievenergo and KMDHC, 1995-97 (US$ million) Kievenergo KMDHC 1995* 1996 1997 1995 1996 1997 Est. Total Revenue 173.5 429.5 472.8 25.1 29.5 32.5 Total Operating Expenses 145.0 373.7 391.9 18.8 26.1 28.3 Net Income 18.3 34.6 48.1 4.7 2.1 1.5 Current Assets 168.8 274.2 336.8 15.6 33.6 30.5 Net Fixed Assets 132.1 345.6 368.9 16.6 109.4 107.3 Total Assets 352.9 678.0 756.9 32.2 143.0 137.8 Current Liabilities 161.5 253.8 326.2 14.6 32.3 26.3 Long-Term Debt 1.6 4.8 1.2 0 0 0 Total Equity 189.9 419.3 429.4 17.6 110.8 111.5 Total Liabilities and Equity 352.9 678.0 756.9 32.2 143.0 137.8 * Since Kievenergo's establishment on August 31, 1995. B. Heat Tariffs 4.3 Since the onset of the energy fuel price increases after independence, the Government has made substantial efforts to raise the overall levels of heat tariffs in Kiev to keep pace with the rapid rise in heat production and operating costs, as shown for the period 1994-98 in Table 4.2 below. As mentioned above, heat in the main DH system in Kiev is primarily provided by Kievenergo which produces and supplies heat through substations and distribution network-s of KMDHC. Average DH tariffs for customers served by these two DH companies are established according to a methodology recommended by the Ukrainian Cabinet of Ministers and approved by Kiev City Government and which takes into account both companies' costs associated with the main DH system, including production costs, transmission and distribution costs, operations and maintenance costs, depreciation, interest and a profit margin. KMDHC also produces and supplies heat in small isolated networks for which DH tariff levels follow the same methodology. Today, the average DH tariff for the customers of the main system is about $17.7/Gcal. During negotiations, agreement was obtained that Kiev Municipality would adjust heat tariffs on a regular basis to allow Kievenergo to cover the costs of production, transmission and distribution, operations and maintenance, depreciation, interest, and make an adequate contribution to reserves. During negotiations, agreement was also obtained that Kievenergo would continue to request Kiev Municipality to adjust its heat tariffs to cover the costs of production, transmission and distribution, operations and maintenance, depreciation, interest, and make an adequate contribution to reserves. The analysis of heat tariff increases would be carried out at the beginning of each heating season to determine the rate of the next increase. Table 4.2: Heat Tariffs in the Main DH System in Kiev (US$/Gcal) Consumer 1994 1995 1996 1997 1998 Industrial 4.58-4.88 28.26-33.24 34.23-35.77 27.78 26.14-33.15 Residential 0.23 4.61 14.29-14.34 15.66 14.73 Other 0.27-1.36 4.29-13.37 14.84-25.60 15.66-35.17 15.85-23.09 Average 1.86 11.99 19.69 19.10 17.77 26 4.4 Although the average levels of heat tariffs for the two Kiev DH companies were sufficient to cover costs (except depreciation based on replacement values) in recent years, the tariff structures were facing a number of problems. First, the tariff structures for both DH companies included cross-subsidies from industrial consumers to residential consumers. Second, the cost of heat produced from CHP plants was higher than in HOB plants, based on the principles of cost allocation, while it would be expected that heat produced from CHP plants would be lower in cost. Third, the tariff structure contained only an energy charge rather than a two-tier structure with fixed and variable components that would allow for more transparent information about the marginal cost of heat supply from the DH system. Fourth, existing consumers covered the cost of connecting new consumers to the DH service. In addition, the tariff levels with depreciation based on fixed asset values, which are thought to be below replacement values, and on very long economic lives (about 75 years on average) was making it difficult for DH enterprises to renew DH assets on a self-financing basis. 4.5 In order to address the problems mentioned above with the heat tariff structure and levels, technical assistance was requested by Kievenergo for a heat tariff study which commenced in March 1997 under terms of reference agreed with the Bank and under funding from Kievenergo and a grant secured from the Finnish Government. Kievenergo and Kiev Municipality have already started implementing the findings of the study. In particular, cross-subsidies have been eliminated with tariffs for all consumer groups now established at levels covering costs (only profit margins vary). During negotiations, agreement was obtained that Kiev Municipality would maintain the heat tariff structure of Kievenergo without cross-subsidies between the different categories of consumers. Furthermore, depreciation is now based on an average life of DH assets about 35 years, and the cost allocation formula for pricing heat and electricity from CHP plants has been changed to allow for some of the co- generation benefits to be shared with the heat consumers. As a result, the average heat tariff in the main DH system has decreased from its highest level during early 1997 of about US$22/Gcal to today's level of about US$17.77/Gcal. Actions are also underway to start the process for introduction of a two-tier tariff with fixed and variable charges beginning with the 1998/99 heating season. These significant steps undertaken by Kievenergo and Kiev Municipality during the project preparation period underscore the importance being given to improving the affordability and viability of the DH service in the capital city of Kiev. C. Electricity Tariffs 4.6 As for heat tariffs, the Government has recently made substantial efforts to raise electricity tariffs to cover the operating costs of the power industry, including Kievenergo. Increases during 1995-96 have brought the average electricity price (US cent 3.8/kWh equivalent in November 1996) close to the economic cost of electricity (US cent 4.1/kWh) 2 Kievenergo's prices are in line with the industry's prices, although its average tariff (US cent 2.4/kWh in 1995) is somewhat below the average for the industry as a whole (US cent 2.9/kWh in 1995) due to its particular composition of customers and the lower costs of producing electricity from its CHP plants. Table 4.3 below shows Kievenergo's electricity tariffs during the period 1994-98. Z/ The low economic cost (in international comparison) is explained by decreasing electricity demand resulting in surplus generation, transmission and distribution capacity. 27 Table 4.3: Kievenergo Retail Electricity Tariffs (US cents/kWh) Consumer 1994 1995 1996 1997 1998 Large Industrial 0.57 3.23 2.70 3.14 3.10 Small Industrial 0.62 3.08 4.10 4.18 4.20 City Electric 0.56 2.95 3.80 4.13 4.20 Transportation Non-Industrial 0.55 2.93 4.10 4.31 4.30 Agro-Industrial 0.38 2.06 3.30 3.37 3.50 Residential* 0.06 1.04 2.30 2.87 3.00 Other 0.34 2.50 3.40 3.86 3.30 Average 0.42 2.38 3.40 3.60 3.75 * including discounts given to privileged consumers (e.g., veterans, Chernobyl victims, etc.) 4.7 Electricity tariffs previously included substantial cross-subsidies from industrial to residential consumers. From January 1998, the nationwide electricity tariff for non-privileged urban household consumers was increased to about US cents 4.7/kWh, which is above the level of the electricity tariffs for industrial consumers, substantially reducing the cross-subsidy. However, the tariff for Kievenergo's other category of household consumer (i.e., households with electric stoves and heaters for which the tariff is US cents 2.9/kWh) is still below economic cost. In order to ensure the rational use of electricity and to reduce the cross-subsidy, electricity distribution companies, including Kievenergo, are to set the average household electricity price (before discounts) at least 20% higher than the average industrial price by end-1997 and maintain the average household electricity price above the average industrial price by this percentage over the project period. Assuming 1996 consumption levels for the different household and industrial consumer categories, Kievenergo's average household electricity price (before discounts) is already 24% higher than the average industrial electricity price. Adjustments to the average household electricity tariff would therefore be needed only when industrial tariffs are adjusted. 4.8 Part of the difference between the average electricity price and the economic cost is due to discounts given to some privileged residential consumers, including veterans, Chernobyl victims and military personnel, representing about one-third of residential consumers. These discounts impose a large financial burden on the distribution companies and create incentives for uneconomic use of electricity. Taking into account that the discounts cannot be eliminated abruptly, the Government has decided to introduce a norm (i.e., a lifeline consumption level) above which consumption would be billed at the regular price, thereby reducing the cost of the discounts. In accordance with Cabinet of Ministers Resolution No. 879, dated August 1, 1996, electricity distribution companies, including Kievenergo, are to limit the discounts applicable to residential consumers to the consumption norms specified. 4.9 Historically, regulation of retail electricity prices was carried out by the Ministry of Economy, but this task has been taken over in 1996 by the National Electricity Regulatory Commission (NERC). A new methodology for the calculation of retail electricity tariffs is incorporated in the licenses that have been recently issued by NERC to regulated suppliers, including Kievenergo. The 28 methodology allows for the full pass-through of the wholesale tariff and full recovery of the costs of distribution and supply in the retail tariffs. During negotiations, agreement was obtained that the Borrower would cause NERC to regulate electricity tariffs for Kievenergo in a manner that would enable Kievenergo to maintain satisfactory financial performance (e.g., adequate debt service coverage and current ratio). During negotiations, agreement was also obtained that Kievenergo continue to request NERC to regulate electricity tariffs at such levels that would enable Kievenergo to maintain satisfactory financial performance. D. Billing and Collection Performance of Project Agencies 4.10 Billing. Kievenergo and KMDHC contract with municipal house maintenance companies, known as zheks, to prepare bills and collect payments for heat and hot water services from residential consumers. Due to the limited metering of heat production plants and consumption, the costs of heat production and operation are attributed to each building according to estimated consumption in the building, and in the case of apartment buildings, divided among households based on square meters for heat services and on the number of persons for hot water services. Zheks also adjust the bills of residential consumers for any discounts that may be applicable under the social assistance program. Bills for heating and hot water are added to household charges for rent and other utilities for the residential consumers for payment on a monthly basis. While this system of billing provides an incentive for consumers to install heat meters since heat losses are paid by the non-metered consumers, few residential consumers have the ability to pay for the installation of meters. Metering of production plant and consumer substations would be improved under the project. 4.11 Budgetary and industrial consumers, on the other hand, are typically metered, and billing is made directly (except for small budgetary organizations which are sometimes billed through zheks) and based on actual consumption of heat, hot water and steam, carried out monthly for budgetary organizations and every 10 days for industrial consumers. Kievenergo's electricity service for all consumer groups is metered, but since meters are not read for residential consumers on a monthly basis, each household reports the quantity of electricity consumed and pays its bill to commercial banks which charge Kievenergo a 7% commission for handling the utility payments. Since early 1998, Kievenergo has been working on improving electricity consumption and payment records, with the introduction of an automated data processing system under an agreement with the firm UNION FENOSA (Spain). 4.12 Collection Performance. Collection performance of heat bills by Kievenergo and KMDHC and electricity bills by Kievenergo deteriorated during the past years. Due to the large rise in heat and electricity tariffs relative to the growth of incomes, especially during 1994/95, many consumers were not able to pay their bills on time, causing a large build-up of accounts receivables by Kievenergo of about 1 1/2 years at June 1995. During 1996, Kievenergo substantially improved the collection of heat and electricity bills from its consumers, but the overall level of accounts receivables was still high at January 1, 1997 at about 195 days of billings or about $ 229 million. During 1997, arrears, particularly of budgetary organizations, increased. In accordance with a Cabinet of Ministers Decree, arrears of budgetary organizations prior to January 1, 1998, are being restructured to be repaid over five years. In order to improve future payment performance of budgetary organizations, the Government and municipalities have now started implementing line-item budgeting for utility bills. After restructuring of arrears of budgetary organizations, overall accounts receivables at January 1, 1998, were at about 175 days. About 90% of Kievenergo's accounts receivables are from its heat and hot water customers. 4.13 After the restructuring of the debts of budgetary organizations, municipal zheks are currently responsible for the bulk (82%) of the receivables to Kievenergo. Taxes owed by Kievenergo 29 during th.e year are estimated to be sufficient to allow for the cancellation of a significant share of accounts receivables of budgetary organizations, and offsets are typically used to settle accounts with budgetary organizations. Industrial consumers are subject to penalties (0.75%/day) and disconnections, and rescheduling of payments has been agreed for many industrial consumers in arrears. The greatest difficulty therefore concerns collections of bills from residential consumers through zheks. 4.14 The high level of Kievenergo's accounts receivables for heat and hot water consumers is partly due to the billing practice of zheks, which allows residential consumers to pay for their heat and hot water services equally each month throughout the year despite the higher consumption levels in the winter months. In addition, Kiev Municipality's failure to transfer all the financial resources to Kievenergo to cover the approved discounts for heating and hot water services applied by zheks under the social assistance program adds to the high level of accounts receivables. In 1996, for example, the service providers in Kiev received only 35% of the funds required to cover discounts to consumers, although this improved somewhat during 1997 to about 50%. Since Kievenergo does not maintain the individual payment records of residential consumers which are maintained by the zheks and does not know the level of discounts granted by the local authority, it is not in a position to identify the portion of its accounts receivables attributable to Kiev Municipality for its overdue social assistance payments. 4.15 In order to address this problem, Kievenergo initiated, during 1997, a pilot scheme in three districts of Kiev whereby households are required to pay directly to Kievenergo, and the early results are encouraging. After a trial period, Kievenergo may introduce the direct payment approach in the other districts, and this would be expected to improve the collection of heat bills from households. Kievenergo is also taking other steps to improve collections, including the establishment since January 1997 of a special unit to fo!io!w-up on collections. It has further introduced a consumer services department and is undertaking public relations campaigns. Support for computerization of consumer accounts would also be provided under the project. Kievenergo's accounts receivables position by consumer group as of January 1, 1998 is shown in Table 4.4 below. Table 4.4: Kievenergo Accounts Receivables as a Proportion of Sales in Due Days (US$ million) Accounts Receivables Due Days as of as of January 1, 1998 1997 Sales January 1, 1998 elec heat total elec heat total elec heat total Industry 5.6 3.0 8.6 69.3 89.2 158.5 29 12 20 Residential Housing 11.9 184.6 196.5 56.5 152.5 209.0 77 442 343 Budget Organizations 0 0 0 1.8 55.1 57.0 0 0 0 Other 4.4 15.7 20.1 45.9 2.4 48.3 35 2388 152 Total 21.9 203.3 225.2 173.6 299.2 472.8 46 248 175 4.16 KMDHC is also experiencing an unusually high level of accounts receivables. As of January 1, 1997, its overall level of receivables was at about 330 days of billings or about $ 27 million. Again, budgetary organizations and zheks are responsible for the bulk (85%) of the receivables. KMDHC has also restructured the debts of budgetary organizations. KMDHC is working on improving collections from residential consumers and initiated a similar pilot scheme during 1997 to collect directly from residential consumers. 30 4.17 Payments from consumers for heating and electricity services are made in cash only. Payments in the form of barter, promissory notes, bonds and other forms of securities are not accepted in Kiev despite the widespread barter practices and pledges that have prevailed elsewhere in Ukraine's energy sector. 4.18 The overall levels of accounts receivables should be reduced further before project agencies would be in a position to demonstrate their ability to adequately collect from consumers in order to repay their respective loans. Therefore, as a condition for negotiations, Kievenergo reduced its overall accounts receivables by about 20 days to 175 days. Collection performance in 1998 and thereafter is expected to improve as a result of further efforts being taken by the project agencies to collect from consumers, especially residential consumers, as well as further support being provided to the social assistance program. During negotiations, agreement was obtained that Kievenergo would maintain and further reduce its overall accounts receivables, excluding accounts receivables for budgetary organizations prior to January 1, 1998 which have been restructured, to 175 days by end- 1998, 150 days by end-1999, 130 days by end-2000, 110 days by end-2001, 90 days by end-2002 and 70 days each year thereafter. Targets are also expected to be established for KMDHC under the EBRD loan. E. Future Financial Performance of Project Agencies 4.19 Kievenergo. Projections of financial performance of Kievenergo over the period 1998- 2003 are shown in Annex 8. The financial projections include a forecast of Kievenergo's income statements, sources and applications of funds statements and balance sheets along with financial performance indicators. The projections have been prepared on a conservative basis assuming that: (a) heat demand in the main DH system would increase over the project period in accordance with a conservative scenario of residential, industrial and public growth and would consider increases in production capacity and improvements in service levels and likely energy conservation measures (see Annex 1); (b) electricity demand in Kiev would remain flat during the period 1998-2003; (c) the same mix of fuels (mainly gas) would be used over the near term and fuel prices, which are at world market levels, would increase with international inflation; (d) collection performance would gradually improve in accordance with covenanted targets (see para 4.18) allowing for a similar gradual improvement in payment performance to suppliers; and (e) the World Bank loan would be at an interest rate of 8%, with a maturity of 20 years, including a 5-year grace period. 4.20 The forecast for Kievenergo considers its investment costs and also the distribution fee it would pay to KMDHC to cover the costs of distribution in the main DH system, including the costs associated with the new investments being undertaken by KMDHC. The forecast shows that the project investments, which would bring about efficiency improvements and increased sales, would have a positive impact on heat tariffs, since the average heat tariff would need to increase at rates below expected domestic inflation over the project period. With the current and proposed increases in tariffs during the project period, Kievenergo would be able to generate the counterpart contribution to the project investment costs and maintain satisfactory financial performance, with a satisfactory operating ratio (averaging about 87% over the project period) and adequate working capital (current ratio above 31 1.2 after 1998) and debt service coverage (well above the minimum advisable of_ 1.5). Kievenergo would also begin to build up cash reserves for future investments during the latter years of the project period. In order to protect its financial position, during negotiations, agreement was obtained that Kievenergo maintain a debt service coverage ratio of at least 1.5 during the project period. In order to ensure adequate liquidity, agreement was obtained during negotiations that Kievenergo maintain a current ratio of at least 1.2 during the project period. To properly monitor financial performance, during negotiations, agreement was obtained that Kievenergo prepares a report annually on or about March 31, beginning in FY99, for each year during project implementation containing financial projections for the upcoming year to be reviewed by the Bank. 4.21 Kiev Municipal District Heating Company. Projections of financial performance of KMDHC over the period 1997-2002 are shown in Annex 9. The financial projections include a forecast of KMDHC's income statements, sources and applications of funds statements and balance sheets along with financial performance indicators for its operations in isolated networks. Since KMDHC's financial statements include its performance related to the isolated networks but only report on its net profit on operations in the main DH system, a fuller forecast of KMDHC's sources and application of funds statements associated with its operations in the main DH system has also been prepared. The projections have been prepared on a conservative basis assuming that: (a) heat sales in KMDHC's isolated networks would remain at the same level as in 1996; (b) the same mix of fuels (mainly gas) would be used over the near term and fuel prices, which are at world market levels, would increase with international inflation; (c) collection performance would gradually improve in accordance with targets to be agreed with EBRD allowing for a similar gradual improvement in payment performance to suppliers; and (d) the EBRD loan would be at an interest rate of 10%, with a maturity of 15 years, including a 5-year grace period. 4.22 The forecast for KMDHC's operations in isolated networks, which have higher unit costs, lower efficiency and lower heat load densities than the main system, shows that the average heat tariff would need to increase by about 20% in 1998 and by about 5% each year during 2000-2003. These rates of tariff increases are below the overall rates of domestic inflation over the project period. With the proposed tariff increases, KMDHC would be able to maintain satisfactory financial performance, with an operating ratio averaging about 78% over the project period and adequate working capital (current ratio above 1.3). KMDHC would also begin to build up cash reserves for future investments during the latter years of the project period. It is expected that during negotiations of the EBRD loan, agreement would be sought that KMDHC maintain an adequate debt service coverage ratio and an adequate current ratio during the project period. To properly monitor financial performance, during negotiations of the EBRD loan, it is also expected that agreement would be sought that KMDHC prepares a report annually containing financial projections for the upcoming year beginning in end-FY99 to be reviewed by the EBRD on an annual basis. 4.23 The forecast of KMDHC's sources and applications of funds statements for its operations in the main system shows that, with a share of loan financing of about 75% and with the distribution fee covering its costs including an adequate profit margin of about 14%, KMDHC would be able to generate the counterpart contribution for this part of the project investment costs and maintain satisfactory financial performance. In order to better ensure satisfactory financial performance, as a condition of negotiations, Kievenergo settled the outstanding amount (about UAH 7 million) as of January 1, 1997, of its distribution fee to KMDHC. In addition, during negotiations, 32 agreement was obtained that Kievenergo would continue to pay a distribution fee to KMDHC in a timely manner to cover KMDHC's costs of distribution. Further agreement was reached during negotiations that, at the time of signature of the EBRD loan, any outstanding amounts of the distribution fee would be restructured according to an agreement with KMDHC to be repaid within one year. Agreement is also expected to be sought during negotiations of the EBRD loan that Kiev Municipality would continue to approve regular increases of KMDHC's distribution fee sufficient to allow KMDHC to cover its costs of distribution, including operations and maintenance costs, interest, depreciation, and an adequate profit margin. 33 V. PROJECT JUSTIFICATION, RISKS AND SOCIAL IMPACTS A. Project Justification Summary 5.1 The proposed project would have significant economic benefits for Ukraine related to savings from the improved efficiency of the DH system, the avoidance of a demand deficit and the improvement of space heating and hot water service levels and reliability in the capital city of Kiev. The project would also have substantial financial benefits for the heat utilities related to fuel and operational cost savings and increases in sales revenue. 5.2 For the purposes of the economic analysis, the project has been grouped into 9 economically independent components.3 Each component has been subjected to a least cost analysis, particularly those including expansion of DH capacity, verifying in all cases that the proposed investments are the least cost options. The economic analysis shows that all the proposed components are justified. The overall economic rate of return (ERR) of the project is about 20%, with an economic net present value (NPV) of $ 160.4 million discounted at the opportunity cost of capital of 10% and a weighted average benefit to cost (B/C) ratio of 1.3. Sensitivity and risk analyses were also undertaken, and the results indicate that the ERRs are quite robust and have a high overall likelihood of about 50% of being achieved. The results of the economic analysis are summarized in Table 5.1 below, presented in descending order of B/C ratios. Table 5.1: Economic Indicators of the Projects Components Subproject NPV ERR Probability B/C Ratio US$ 000 % % Kievenergo 1 CT-1 Boiler Plant Rehabilitation & Expansion 38,783 30.3 62 1.7 2 TETS 5 Rehabilitation & Expansion 16,341 27.5 48 1.3 3 Pipe Replacement and Valves 20,902 16.0 43 1.3 4 CT-2 Boiler Plant Rehabilitation & Expansion 17,980 16.3 54 1.2 5 Center Electric Substation 9,648 25.8 47 1.2 6 TETS 6 Rehabilitation & Expansion 16,227 22.6 32 1.2 7 Pozniaki Boiler Plant 24,027 15.5 55 1.2 KMDHC 8 Rehabilitation of Substations 15,356 27.1 28 1.5 9 Pipe Replacement and Valves 1,135 15.3 43 1.2 Investment Program 160,400 19.6 49 1.3 Note: Discounted at 10% to the start of 1998. 5.3 Each component was also subjected to a financial analysis, showing that the financial rates of return (FRRs) were in all cases above the cost of capital for Ukraine, with the overall FRR of the project slightly lower than the ERR at about 16%. A distributional analysis was also undertaken which indicates that a significant share of about 32% of the project net benefits would help lower income households, while about 36% of the net benefits would help the Government in the form of 3 An independent project is defined as that component, if excluded from the investment program, which leaves the NPV of the remaining projects unchanged. This is distinguished from mutually exclusive projects (or project design options) for which accepting one necessarily excludes accepting another. 34 added fiscal revenue. The assumptions for calculating the economic and financial indicators for the various components are described following and elaborated in Annex 10. Least-Cost Analysis 5.4 The proposed expansion of DH heat production capacities at the various boiler plants has been compared to the option of decentralizing heat supply to buildings by installing individual gas boilers and has been clearly demonstrated to be the least-cost option in each case. This result is largely explained by the high heat load densities in project areas in the main interconnected DH system (5.9 Gcal/h per km of network as compared to 2.7 Gcal/h per km of network in Helsinki) and the higher efficiencies of the large DH boilers relative to the smaller decentralized boilers (90% versus 75% respectively). 5.5 In addition, a simplified model for Kiev has been developed for evaluating the costs of the two green field options based on Western technology of centralized heating as compared with a decentralized heating option. The model compares the costs of two centralized heating options (a) where heat is produced from gas-fired HOBs and (b) where heat is produced at zero cost where no sunk costs for any equipment or pipeline exist with the costs of (c) individual gas boilers where it is assumed that existing gas networks reach every building. The model compares the long-run costs at the user level of (a) a gas-fired centralized HOB plant with hot water DH network, automated substations and metering, (b) a centralized HOB plant with hot water DH network, automated substations and metering, where the heat cost at the generation plant is zero, and (c) independent gas-fired boilers located in buildings. The model assumes a capital cost of 10%, technical life of 20 years for all options, centralized boiler cost of $ 60,000/Gcal/h, DH network and substation cost of $ 487,000 per km per Gcal/h, gas network cost of $ 12,000/Gcal/h (including reinforcing of the present gas network for building-level boilers, typical (300 m) connection lines to buildings, pressure regulators and gas meters), individual boiler cost of $ 116,000/Gcal/h (including installation and construction work required for two boiler units to achieve the required reliability and to be consistent with the building code), DH network losses of 8%, operating and maintenance costs of 1.5% and 3% of capital costs for centralized and decentralized heating systems respectively, a gas price of about $ 82.4/1,000 m3 or $10.20/Gcal, and a peak load duration of 2,200 hours. The model results are summarized in Figure 5.1 below. Used for comparison purposes for providing the absolute lower limnit below which no centralized heat source (whether based on inexpensive or waste fuel, co-generation, free heat from waste incineration or CHP, etc.) can be less expensive than heat from individual boilers in buildings. 35 Figure 5.1: Centralized Versus Decentralized Heating Options 50* -4-- Centralized option ($/Gcal) 40 --tUCID Decentralized option ($/Gcal) _ -Centralized option with zero fuel cost ($/Gcal) 30 * 30- 0 Ls - - - 10 _ _ 0.9 1.7 2.6 3.4 4.3 5.2 6.0 6.9 7.7 8.6 Heat Load Density (GcalIh per km of network) 5.6 The results show that, for high head load densities of more than 4 Gcal/h per km of network, centralized DH production at HOB and/or CHP plants is the preferred option. Where heat load densities are between 1 Gcal/h per km and 4 Gcal/h per km, a detailed analysis would be needed using actual fuel and heat production costs at the plant to determine the preferred option. Where heat load densities are below 1 Gcal/h per km, decentralized individual boilers are the preferred option. As mentioned above, Kiev has a high concentration of heat demand per km of primary network at about 5.9 Gcal/h per km. With a population close to 3 million, it requires heat to serve the demand for hot water, space and ventilation heating for about 50 million rn2 of residential buildings and about 25 million m2 of public and commercial buildings. Almost all households live in apartment buildings, more than 90% of which have at least five floors. Industry demands heat for the same purposes and for industrial processes, and there are more than 1,000 industrial, construction, transportation and storage facilities in the city. For the proposed boiler components located in the dense built-up areas of the city where a large share of DH investments in plant and networks are already in place, the case for preservation and expansion of DH is even stronger and is estimated to be closer to the centralized option with zero fuel cost. 5.7 The option of constructing new CHP capacity as an alternative to HOB capacity was also considered. However, in the present power situation in Ukraine whereby electricity capacity is currently underutilized and this situation is expected to last until at least 2007, constructing new power production capacity at this time would be premature. When electricity demand grows and new CHP capacity is built in the distant future, the present HOB investments could be utilized as peak load and reserve sources. 5.8 Other components of the project have also been subjected to a least-cost analysis. Table 5.2 below summarizes the results of the least-cost analysis for three key components which have been compared with the option of decentralized gas boilers. The analysis considered the capital and operating costs of the components and the decentralized alternatives and discounted the costs using the opportunity cost of capital for Ukraine. Given the existing sunk costs and the high heat load densities in Kiev, the components constitute in all cases the least-cost options. The detailed analysis used in the comparison of alternatives is presented in Annex 10. 36 Table 5.2: Least Cost Analysis Subproject Cost Independent Gas Boilers Excess cost (US$ 000) Cost (US$ 000) (%) TETS 6 Rehabilitation & Expansion 89,653 107,586 20.0 Pozniaki Boiler Plant 154,953 178,870 15.4 TETS 5 Rehabilitation & Expansion 55,978 58,382 4.3 Note: Discounted at 10% to the beginning of 1998. Economic Analysis 5.9 The economic analysis compares the economic costs of each project component with its economic benefits. All costs and benefits are valued at early 1998 border prices and are incremental in nature. The economic analysis considers the difference between the cost and benefits for each project component "with the project" and "without the project," over the minimum life of the investments of 20 years for each component. Shadow prices for foreign exchange and labor costs are not required for the economic analysis. An exchange rate conversion factor to compensate for price distortions related to trade or other barriers is not needed, since the current exchange rate is judged to be a market- clearing rate. Similarly, since real wage rates have proved to be fairly flexible and have declined in line with declining national product, no conversion factor for labor costs is required. 5.10 The investment costs for each of the project components include equipment and installation costs, including design and supervision costs and physical contingencies. The costs of technical assistance have been included proportionally as part of the investment costs for each component, since technical assistance includes support to strengthen the procurement, construction supervision and institutional capacity of project agencies and is considered necessary for the overall success of the project. The variable costs include fuel costs, operation, repair and maintenance costs as well as losses. For the boiler components, fuel costs were estimated based on the international price of natural gas as forecasted by the World Bank for Europe and adjusted for Ukrainian transport costs to the boiler houses ($82.4/1,000 m3). All costs have been adjusted to exclude taxes, duties and estimated inflation costs. 5.11 The five major boiler plant components at CT-1, CT-2, TETS 5, TETS 6 and Pozniaki, which include replacement of old worn out boilers and/or expansion of the capacity of the boiler houses, would all increase the available capacity of heat, thereby avoiding a deficit in demand and increasing the DH service levels in these areas. Similarly, the Center electric substation would increase the available capacity of electricity in the city center thereby ensuring an adequate supply of electricity for DH pumping stations and boiler plant. The economic benefits of these increased capacity investments have been based on estimates of what consumers would be willing to pay to avoid the deficit, using the proxy of the incremental sales revenues and the estimated consumer surplus. In the calculations, a price elasticity of demand of -0.5 was assumed. A more detailed explanation of the calculation of willingness to pay is presented in Annex 10. 5.12 The boiler plant components at CT-1, CT-2, TETS 5 and TETS 6 also include rehabilitation of other boilers and introduction of variable speed pumps. These components would result in higher efficiency in heat production with lower fuel, operating (including electricity costs related to pumping) and maintenance costs. After rehabilitation, boiler efficiencies at CT-1 and CT-2 would increase from 75% to 95% and at TETS 5 and TETS 6, from 89% to 95%. At TETS 5, the water treatment plant would also be reconstructed, resulting in less corrosion and hence extended life of pipeline networks and boilers and reduced maintenance costs and repairs. Further unquantifiable 37 benefits would result from reduced emissions of SO2, NO, and particulates resulting from the introduction of modem technology including low-NO, burners, flue gas recirculation and the higher stack at CT-1. 5.13 The main economic benefits of the substantial program of replacement of transmission and distribution pipelines and valves were derived from reduced heat and water losses in the networks, reduced repair and maintenance costs and improved reliability of the heating service, which is subject to frequent breakdowns, as evidenced during the past several winters. The pipeline sections to be replaced currently cause outages at a rate twice as high as the average for the whole network of about 220 hours per year. Replacement of these pipelines would be expected therefore to save 220 hours of interrupted service, which has been valued at $65/Gcal considering the cost of alternative electric heaters. 5.14 The main benefits of the substation investments have been derived from estimates of reductions in heat requirements for the same service levels resulting from efficiency improvements in the substations and better controls, reduced heat and water losses, and reduced repair and maintenance costs. 5.15 A summary of the present values of the benefits of each component by type of benefit is presented in Table 5.3. The table shows that the component with the highest present value of benefits is the Pozniaki boiler component, followed by the TETS 6 rehabilitation and expansion component. Further unquantifiable benefits would result from the generation of professional and technical employment required for the design, fabrication and installation of equipment. Table 5.3: Present Values of Benefits by Subproject (US$ 000) Resource Savings Investments in: Avoiding Efficiency Loss R&M Reliability Total Deficit in Savings Reduction Savings Improvement Benefits Demand Kievenergo 1 Pozniaki Boiler Plant 182,056 182,056 2 TETS 6 Rehab & Expansion 116,336 116,336 3 Pipe Replacement & Valves 53,257 44,559 5,130 102,945 4 CT-2 Rehab & Expansion 73,780 20,595 94,375 5 CT-1 Rehab & Expansion 71,429 21,772 93,202 6 TETS 5 Rehab & Expansion 63,453 13,812 77,266 7 Center Electric Substation 65,415 65,415 KMDHC 8 Rehabilitation of Substations 12,594 11,585 19,471 43,650 9 Pipe Replacement & Valves 3,983 2,058 245 6,286 Total _ __ 572,469 26,407 68,82 108,456 5,374 781,531 Note: Discounted at 10% to 1998. Project Financial Analysis 5.16 The financial analysis includes a discounted cash flow analysis for each project component from the point of view of the DH companies, the key project beneficiaries. The cost streams include all the costs the DH companies would incur, which are the costs used in the economic 38 analysis, plus taxes and duties. Among the taxes are a 25% social overhead on labor applicable to construction and operating and maintenance (O&M) costs for each component, a 20% VAT on fuel transport costs, water treatment chemicals and local supplies, and a 2% import duty on foreign materials. The benefit streams include the additional sales revenue and the cost savings from the reduction in losses, fuel used and O&M requirements. The results of the financial analysis are presented in Table 5.4 below. The component with the highest financial net present value (FNPV) is CT-1 boiler plant rehabilitation and expansion at $ 39 million and the lowest is Center electric substation with a FNPV of $ 3 million. The project has an overall FNPV of $ 110 million and a FRR of about 16%. Table 5.4: Financial Indicators of the Components Subproject FNPV FRR Kievenergo (US$ 000) % 1 CT-1 Boiler Plant Rehabilitation & Expansion 39,016 29.4 2 CT-2 Boiler Plant Rehabilitation & Expansion 16,988 15.7 3 Pipe Replacement and Valves 13,285 13.4 4 TETS 5 Rehabilitation & Expansion 11,302 21.4 5 TETS 6 Rehabilitation & Expansion 6,244 14.9 6 Pozniaki Boiler Plant 2,986 10.7 7 Center Electric Substation 2,936 14.0 KMDHC 8 Rehabilitation of Substations 16,314 27.3 9 Pipe Replacement and Valves 758 13.3 Investment Program 109,828 16.3 Sensitivity Analysis 5.17 A sensitivity analysis was undertaken to test the robustness of the ERRs of each project component to changes in key variables in the cost and benefit streams, such as investment costs, repair and maintenance costs and willingness to pay, which are subject to risk and uncertainty. The results indicate that the proposed investments have attractive and robust economic indicators, as only with very large increases in investment costs or substantial decreases in benefits would the ERRs fall to levels below the opportunity cost of capital of about 10%. A summary of the changes in the cost and benefit streams of each component that would be required for the ERRs to fall below 10% is presented in Table 5.5 below. 39 Table 5.5: Percentage Increases in Costs or Reduction in Benefits for a 10% ERR _____ _________(%) Costs Benefits Component Investment Running Willingness Efficiency Loss R&M Reliability Costs to pay Savings Reduction Savings Improvement Kievenergo CT-I Rehab & Expansion 184 111 -58 -176 TETS 5 Rehab & Expansion 104 35 -25 Center Electric Substation 101 20 -14 TETS 6 Rehab & Expansion 88 23 -14 CT-2 Rehab & Expansion 46 41 -23 -82 Pozniaki Boiler Plant 44 21 -12 Pipe Replacement & Valves 27 300 -50 -46 -520 KMDHC Rehabilitation of Substations 64 355 -122 -133 -79 Pipe Replacement & Valves 24 265 -32 -55 -464 5.18 As Pozniaki DH boiler plant component is the largest component of the project, the results of its sensitivity analysis are displayed separately in Figure 5.2. The graph shows that investment costs would need to increase by more than 40%, running costs, including fuel and operational costs, would need to increase by more than 20%, or the heat tariff would need to decline by more than 12% before the ERR drops below the opportunity cost of capital of 10%. The point where the curves intersect corresponds to the ERR of Pozniaki of 15.5%. Figure 5.2: Sensitivity Analysis of Pozniaki 100% T. ... ..................... 75% , ,.. - Investment ..... 50% .--- Fuel, O&M, and other costs - - Increase in WTP 25% ..... . . . .................. ................ 0I I_I_I_ ____I -25% 1 -- --- --------------f------- ......... -50% . .... . . .. -75% .S .. . . . . . . . . . . . . . .. . . . . . . . . . . . . . . .. . . -100% . ................................................................................ 2% 6% 10% 14% 18% 22% 26% 30% Distributional Analysis 5.19 A distributional analysis of how cost and benefits are allocated among the different project stakeholders, specifically the poor and the Government, was also undertaken. The poor households, those in the lowest income quartile, would be expected to benefit from employment opportunities for unskilled labor during the construction period of the project and receive a net increase in incomes. Poor users are also expected to benefit from the reduction in supply shortages and improvement in supply reliability. Low income households cannot compensate for the lack of heat as better-off households can. They therefore experience significant personal costs related to health and 40 consequent loss of income due to inadequate heating and hot water service levels. The project is expected to reduce these disadvantages, resulting in an increase in the consumers surplus of low income users. The Government is expected to benefit from the additional tax revenues generated by the project from import duties, VAT on project expenditures and social taxes on labor. DH utilities are also expected to gain from the net increase in sales revenue, the reduction of fuel costs and system losses, and the savings in operations and maintenance expenses. Table 5.6. presents the results of the distributional analysis. The table shows that about 32% of the net benefits would help the poor, with a 58% certainty, and about 36% of the benefits would help the Government, with a 62% certainty. Based on a risk analysis, it was estimated with a 75 % certainty that about 29 % of the net benefits of the project would help the poor, while another 26% would help the Government. Table 5.6: Distributional Analysis of the Project Discounted Cost and Benefit Flows (US$ 000) Private Sector Public Sector Net Benefita Unskilled Users Labor Non-poor Poor Taxes Utilities Costs Investment costs 15,116 20,003 (270,269) (235,150) Fuel costs 1,835 (255,609) (253,774) O&M cost 1,855 10,019 (54,546) (42,672) Other costs 3,023 4,287 (76,851) (69,540) Benefits Reduced losses (1,329) 83,967 82,637 Fuel and O&M savings (20,264) 141,314 121,040 Increased willingness to pay (167,882) 90,164 108,365 541,823 572,469 Improved reliability 4,528 846 - 5,374 Net Benefit 19,995 (163,354) 91,019 122,915 109,828 180,385 Distribution Analysis Coefficients Probability Coefficients of with a 75% occurrence certainty Poor 32.3% 58.0% 29.2% Fiscal 35.8%. 62.0% 25.5% Note: These values are discounted over the expected life of the components (i.e., 20 years). a The total net benefit is equivalent to the project's economic NPV of $160,400 plus the net benefit to unskilled labor of $19,995, with all the financial transfers canceled out. B. Risk Analysis and Project Risks Risk Analysis 5.20 Projects in Ukraine face a considerable degree of risk. Part of the risk is associated with the macroeconomic and political uncertainties facing all transition economies. Another part is specific to the project, and for this part a risk analysis was carried out to estimate the likelihood that certain risks, such as project delays, cost increases, lower avoided demand deficits and lower boiler efficiencies, for example, would materialize and have an adverse impact on the economic indicators of the project. More specifically, risk analysis enables the assignment of probability distributions to the different input variables, key parameters and assumptions of the spreadsheet cost benefit model so that a weighted expected NPV and ERR can be estimated. Based on the risk distributions for each variable, 41 the cost benefit model was subjected to a random Monte Carlo simulation with 1,000 trials, estimating the probability of occurrence for each component's NPV and ERR. Based on this analysis, the ERRs that could be achieved for each project component with a 75% certainty were estimated. These results are summarized in Table 5.7 below, while Annex 10 presents the detailed assumptions utilized in the risk analysis. For the project as a whole, an ERR of about 17 % with a 75 % certainty can be expected. Table 5.7: Economic Rates of Return with a 75% Probability Subproject _ JERR Kievenergo (%) 1 CT-1 Rehabilitation and Expansion 28.7 2 TETS 5 Rehabilitation and Expansion 20.0 3 Pipe Replacement and Valves 12.6 4 CT-2 Rehabilitation and Expansion 14.7 5 Center Electric Substation 20.5 6 TETS 6 Rehabilitation and Expansion 13.5 7 Pozniaki Boiler Plant 13.2 KMDHC 8 Rehabilitation of Substations 23.3 9 Pipe Replacement and Valves 11.8 Investment Program 17.4 Project Risks 5.21 Being the first DH investment project in Ukraine, the project faces a number of risks, which need to be properly mitigated to reduce the probability of uneconomic outcomes. These risks are presented along with proposed mitigation measures in Table 5.8 below: 42 Table 5.8: Project Risks and Mitigation Measures Risks Proposed Mitigation Measures 1. The implementation capacity of project agencies in To reduce this risk, the detailed implementation carrying out an investment program of this order of arrangements have been fully identified and agreed magnitude to-date is untested and may result in a with the project agencies prior to project start-up and longer implementation period than expected. adequate staffing arrangements have been put in place. In addition, bidding documents for the first year's procurement activities have been prepared by Loan negotiations, and international and local engineering consultants would assist project agencies with the technical implementation of the project. 2. There is the risk of heat tariff increases not being Given the commitment by the Government, Kiev implemented for political or other reasons in a timely Municipality and DH companies to adjust heat tariffs manner. frequently during the recent period of energy price increases, the risk of the heat tariff increases not being implemented is expected to be relatively small. Monitoring performance in these areas would be a major focus of attention during Bank supervision. 3. Further uncertainty exists about how effective the A package of measures to improve means testing and social assistance program for households will be, and other aspects of the social assistance program is this has the potential to negatively impact the financial currently under discussion with Kiev Municipality for position of DH companies. If the social assistance consideration for inclusion in the complementary Kiev program is not working properly, arrears of Public Buildings Energy Efficiency Project. consumers' heat bills will increase. Monitoring performance in this area would also be a key focus of attention during supervision of the project. C. Social Impacts 5.22 A social assessment, to appraise the impacts of the lack of adequate heat and hot water on residential DH consumers in Kiev, was carried out during the appraisal of the project. The social assessment was based on (a) structured in-depth interviews and focus group discussions with residential DH consumers and (b) a survey administered to 365 households in Kiev. The key issues addressed from the point of view of residential consumers in apartment buildings included: (a) quality and reliability of the provision of heat and hot water, (b) level of satisfaction and hardships due to insufficient provision of heat and hot water, (c) patterns of supplementary heating and other coping strategies, (d) expenditures for district heat and hot water by different income groups, (e) metering, (f) collections, (g) cost recovery, (h) affordability and willingness to pay, (i) willingness to insulate and reduce heat losses, (j) willingness to save hot water, and (k) effectiveness of the means-tested housing and communal services social assistance program targeted to low-income households. The key findings of the social assessment are summarized below and elaborated in Annex 11. 43 5.23 Quality of DH and Hot Water Services and Coping Strategies. Special emphasis in the Kiev survey was placed on evaluating the low levels of DH and hot water services and how the low service levels affect the poorer (defined as the 25% of households with the lowest per capita expenditures) and vulnerable segments of the population as compared to the better off groups. The survey confirmed that more than three-fourths of households considered the room temperature in their apartments to be too cold during winter, one-third of households experienced problems with hot water pressure and delays in obtaining hot water after the tap is opened, and all households experienced interruptions in hot water supply. 5.24 To cope with the insufficient room temperatures in winter, (a) about one-fourth of households supplement DH with heat from individual space heaters, primarily electric heaters; (b) about one-third of households replaced or plan to replace wall radiators, (c) two-thirds of households close the curtains in their apartments, (d) a number of households weather-strip windows and doors, (e) some households replace windows, and (f) only a few households supplement DH with gas heating, since only very few households are connected to the gas network for space heating. While poorer households have some ability to utilize the inexpensive procedure of weather-stripping, typically they do not have the financial means of the better-off households to undertake the other measures, with the poorest 25% of households on DH having practically no financial margin for coping with the insufficient provision of DH and hot water. As a result, poor and vulnerable people are exposed to hardships, increased health risks and other disadvantages due to deficient supplies of DH. 5.25 Social Assistance Program for Low-Income Households. Considering Ukraine's policy of full cost recovery for DH and other communal services, particular emphasis in the social assessment was placed on the effectiveness of the current social assistance system to provide targeted assistance to low-income households for the provision of housing and communal services. Evidence from the Kiev survey shows that this assistance system has serious flaws, with insufficient coverage, not reaching about 54% of mainly poor people who have to pay more than 15% of their total monthly expenditures on housing and communal services, and substantial leakage, with 24% of non-poor households benefiting from social assistance when their expenditures on housing and communal services are less than 15% of total monthly expenditures. The insufficient coverage and substantial leakage of the social assistance program reveals that the means-testing carried out by the local government to target social assistance to poor households is not working satisfactorily. 5.26 The social assistance program does not work effectively either for the providers of communal services, such as Kievenergo, since the local government makes available only a small part of the financial resources to be transferred to the service providers through the zheks for approved social assistance. Based on information provided by the Ministry of Social Protection, the providers of communal services in Kiev received only 35% of the funds to be transferred to them for approved social assistance in 1996 which increased to about 50% in 1997. The local government's failure to transfer the necessary financial resources puts the country's policy of full cost recovery for communal services at risk. 5.27 Conclusions and Recommendations. To protect poor and vulnerable households against hardships in cold winters, a more reliable provision of DH and hot water at satisfactory levels of service and quality is needed. The proposed project would make a substantial improvement in this direction by supporting the investments necessary to address the current demand deficit and improve service levels and reliability of DH and hot water for the city. 5.28 To improve coverage and reduce leakage of the social assistance program for low- income households, the local government authority should redesign the methods applied for means- testing. It is recommended that the current ineffective methodology be replaced by a suitable proxy means test. This methodology, first implemented in Chile in the late 1970s and 1980s, then applied in 44 many other countries, has recently also been experimentally used in Volgograd, Russia, with technical assistance of the World Bank. The methodology uses a formula of weighted variables of household characteristics, which are easy to collect and verify, and allows to satisfactorily predict income. Such household characteristics include, for example, number of children in the family, number of elderly, location in rural or urban areas, number of unemployed household members, whether the household owns a refrigerator or a car, etc. The formula used in proxy means testing has to be developed based on suitable data on household expenditure and characteristics. The household surveys undertaken in Ukraine during 1995 and 1996, supported by the survey in Kiev undertaken as part of the preparation of this project, have generated a database suitable for developing a scoring formula for means testing in Ukraine. 5.29 Further, the fact that 36% of the households unduly not receiving social assistance believe that they are not eligible may suggest that these households are not appropriately informed about the social assistance program, although they know about the existence of the program. To enable households to better assess their eligibility for social assistance, the local government authority could enhance its public information and communication strategy. In addition, the local government authority could facilitate a suitable service for consultations with its residents about the program, which could be used, at the same time, as a means of systematically obtaining feedback from households on issues of program implementation. Establishing a telephone line in each city district for questions and answers of citizens could be a suitable option. 5.30 In addition, the fact that 43% of the households unduly not receiving social assistance observe unfriendly attitudes of the personnel processing social assistance applications may suggest that these attitudes, to some extent, restrain households from applying for social assistance. To overcome this obstacle, the local government could provide training and guidance to its personnel in charge of processing social assistance applications. 5.31 To improve cost recovery of the DH and hot water services from residential consumers, the service providers, such as Kievenergo, could address the local government's failure to transfer funds for approved social assistance in the frame of reference of a suitable strategy of beneficiary participation, whereby customers and the public in general are periodically informed about the progress in obtaining funds for approved social assistance and the implications of the lack of these funds for satisfactorily providing heating and hot water to households. In addition, the service providers could inform customers about the zheks' performance in passing on funds collected from households. At the same time, the service providers could inform their customers and the public about achievements and issues regarding the provision of heat and hot water and obtain feedback on the quality and reliability of service provision. 5.32 Furthermore, efforts, such as those recently initiated by Kievenergo, to send bills directly to consumers should be supported and expanded, as this provides a more transparent method of billing. In this case, discounts provided for under the social assistance scheme could be applied by Kievenergo which would then be in a position to clearly determine the level of social assistance required from the local government authority. These recommendations to improve the social assistance program and cost recovery will be pursued during the implementation phase of the project through discussions with Kiev Municipality, through the Bank's ongoing dialogue on the Poverty Assessment and through the Bank-supported Social Protection Support Project. In addition, a package of measures to improve means testing and other aspects of the social assistance program is currently under discussion with Kiev Municipality for consideration for inclusion in the complementary Kiev Public Buildings Energy Efficiency Project. 45 VI. AGREEMENTS REACHED AND RECOMMENDATION Conditions for Negotiations 6.1 Prior to negotiations, the following conditions were met: (a) Kievenergo identified how its local counterpart contribution would be provided (para 2.14); (b) Kievenergo nominated the remaining technical and accounting personnel, with satisfactory qualifications, for carrying out its part of the project (para 2.19); (c) Kievenergo prepared the draft bidding documents for ICB contracts during the first year of the project and submitted them to the Bank for review (para 2.28); (d) Kievenergo reduced its overall accounts receivables by about 20 days to 175 days (para 4.18); and (e) Kievenergo settled the outstanding amount (UAH 7 million) as of January 1, 1997 of its distribution fee to KMDHC (para 4.23). Agreements Reached during Negotiations 6.2 During negotiations, agreements were obtained regarding: (a) the EBRD loan to become effective by September 1, 2000, or such date as the Bank may agree, unless the Borrower establishes that adequate funds for the activities to be funded by the EBRD loan are available from other sources (para 2.14); (b) on-lending arrangements for the Loan (para 2.15); (c) arrangements for establishing and operating the Kievenergo Special Account (para 2.35); (d) accounting and auditing requirements of the project (paras 2.38-2.39); (e) the timing of the mid-term review and the reporting and monitoring requirements of the project (paras 2.47-2.49); (f) the Borrower to cause technical assistance for the review of the institutional and corporate structure for DH in Kiev to be carried out under the management of Kiev Municipality by consultants in accordance with terms of reference and timetable satisfactory to the Bank (para 3.8); (g) the Borrower to cause Kiev Municipality to adjust heat tariffs for Kievenergo on a regular basis to cover the costs of production, transmission and distribution, operations and maintenance, depreciation, interest and make an adequate contribution to reserves (para 4.3); 46 (h) Kievenergo to continue to request Kiev Municipality to adjust its heat tariffs to cover the costs of production, transmission and distribution, operations and maintenance, depreciation, interest and make an adequate contribution to reserves (para 4.3); (i) the Borrower to cause Kiev Municipality to maintain the heat tariff structure of Kievenergo without cross-subsidies between the different categories of consumers (para 4.5); (j) the Borrower to cause NERC to regulate electricity tariffs for Kievenergo in a manner that would enable Kievenergo to maintain satisfactory financial performance (e.g., debt service coverage, current ratio) (para 4.9); (k) Kievenergo to continue to request NERC to regulate electricity tariffs at such levels that would enable Kievenergo to maintain satisfactory financial performance (para 4.9); (1) Kievenergo to reduce its overall accounts receivables, except for accounts receivables of budgetary organizations prior to January 1, 1998, to 175 days by end-1998, 150 days by end-1999, 130 days by end-2000, 110 days by end-2001, 90 days by end-2002 and 70 days each year thereafter (para 4.18); (m) Kievenergo to maintain a debt service coverage ratio of at least 1.5 during the project period (para 4.20); (n) Kievenergo to maintain a current ratio of at least 1.2 during the project period (para 4.20); (o) Kievenergo to prepare a report annually on or about March 31, beginning in FY99, for each year during project implementation containing financial projections for the upcoming year to be reviewed by the Bank (para 4.20); and (p) Kievenergo to continue to pay a distribution fee to KMDHC in a timely manner to cover KMDHC's costs of distribution and, at the time of signature of the EBRD loan, any outstanding amounts of the distribution fee would be restructured according to an agreement with KMDHC to be repaid within one year (para 4.23). Condition of Effectiveness 6.3 A condition of effectiveness would be that a subsidiary loan agreement has been executed between Ukraine and Kievenergo (para 2.15). Recommendation 6.4 Subject to the above, the Project is suitable for a Bank Loan of US$ 200 million at the LIBOR-based interest rate for US dollar single currency loans with a maturity of 20 years including 5 years grace. The Borrower would be Ukraine. ANNEX I Page 1 of 8 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Kiev Heat Demand Analysis A. Kiev Heat Demand 1. Kiev, with a population of about 2.7 million, requires heat to serve the demand for hot water, space and ventilation heating of about 50 million m of residential buildings plus approximately 25 million m of public and commercial buildings. Almost all households live in apartment buildings, 92% of which have at least five floors, leading to a high concentration of demand for heat per km2 of land, a factor favorable for DH. Industry demands heat for the same purposes and for industrial processes. There are more than a thousand industrial, construction, transportation and storage facilities in the city. 2. The heating season starts when temperature during five consecutive days has fallen below 8°C and ends when temperature during five consecutive days has been above 80C. During normal conditions, the heating season starts in October and ends in April. The capacity of the heating systems in Kiev is designed to cover the heat demand of buildings during the coldest days of the heating season when temperatures drop to -220C, a situation which normally occurs more than 10 days during a heating season. The average outside temperature during the heating seasons between 1990 and 1995 was 2. 1°C. 3. As Figure 1.1 above shows, the average total annual heat demand in Kiev during the first half of the 1990s was about 30 million Gcal, with households consuming 47%, followed by commercial and public demand with 23%, and industries with the remaining 30%. Average peak heat demand in the same period was about 11,000 Gcal/h, of which the residential share was 46%, industrial 32% and commercial/public 22%. The target indoor temperature is 180C (as compared to 200C in Finland), but due to severe fuel shortages since 1992 and capacity shortages, temperatures typically have reached no more than 150C during the period and have been as low as 10-130C in some areas. Annual Heat Demand Peak Heat Demand 30 million Gcal 11 thousand Gcal per hour Figure 1.1: Kiev Heat Energy and Peak Heat Demand ANNEX 1 Page 2 of 8 4. Kiev is divided into eight DH regions, two of which are for future development. About 80% of the public-residential demand and 40% of industrial demand are currently covered by the interconnected system operated by Kievenergo (production, transmission and supply) and by KMDHC (distribution). The system cuts across the areas of the six heating regions with the highest demand densities. It is divided into a number of "mini- sections," each closed off by valves and served by a particular CHP or HOB plant. 5. About 6% of the public-residential demand for heat is covered by 112 isolated DH systems operated by KMDHC, including individual boilers in the buildings. These isolated systems are far from of the interconnected system (about 10 kmn away) to make an interconnection economically feasible. The remaining 14% of public-residential heat demand is covered by 29 isolated DH systems connected to industrial boilers, to small "apartment sized" boilers installed in individual houses, and to Akademiteploenergo, the DH company of the Academy of Science, which supplies heat from its two HOB plants to several academic institutes and industrial customers. The remaining 60% of industrial demand is covered by industrial boilers. 6. The economic crisis and the deep structural changes experienced by Ukraine since independence from the former Soviet Union (FSU) have had a severe impact on heat demand and supply. On the demand side, residential demand for peak capacity in Kiev continued to rise by 6-7% between 1990 and 1995 with the increase in residential construction, whereas public demand fell by an estimated 5-7% per year during the same period. The share of industrial demand in the interconnected system fell by 16% in 1991 to 5% in 1996 because of production cutbacks, closure of industrial concerns and the increase in heat tariffs. On the supply side, Kievenergo was forced by its weak financial position to postpone needed investments to expand capacity in the interconnected system where a capacity deficit emerged despite the slower growth in public and industrial demand. The available capacity in the interconnected system in 1996 was 6,300 Gcal/h serving a demand of about 7,200 Gcal/h, estimated by considering the current building volume and target indoor temperature. The demand deficit is distributed unevenly in the interconnected system, with the more severe deficit in the city center and in the growth areas such as Pozniaki. B. Heat Demand Forecasts 7. The forecasts in the 1995 Master Plan ("Draft Plan of the Kiev DH System Development in the Period until 2005 and Potentially Until 2010" prepared by Ukrenergoprom in close cooperation with Kievenergo, Energoproject and Kievproyekt) provided the basis for Kievenergo's investment program in heat production capacity in the interconnected DH system. The forecasts of residential and public heat demand were based on expected population growth, planned development of the city, on estimates of improved housing area per inhabitant and on the expected decommissioning of houses. The corresponding figures for peak load and annual heating energy for residential and public buildings are calculated on the basis of Ukrainian building design standards. The forecast of industrial heat demand was based on a detailed analysis of known industrial enterprises that have survived the recent economic downturn and that are likely to exist in the future, considering their new construction and expansion plans and expected changes in production technology. ANNEX 1 Page 3 of 8 8. According to the Master Plan, total peak heat demand in Kiev (excluding self- produced industrial heat) is forecasted to increase from 10,700 Gcal/h in 1996 to 13,300 Gcal/h in 2011. Within this, the peak demand in the interconnected system is expected to increase from 7,200 Gcal/h to 10,260 Gcal1h. In the short term, the largest expansion in demand comes from heat district 6 (which provides the justification for the construction of the Pozniaki plant), and from district 1 (where the ongoing residential construction will conclude about 2001). TETS 5 supplies districts 1, 5 and 6. Once the Pozniaki plant becomes operational, TETS 5 will supply districts 1 and 5 only. TETS 6 supplies districts 3 and 4. Around 40% of the growth in construction during the period will occur in the virgin districts 7 and 8, which are outside the focus of the project. The heat demand in these two regions will be covered by new boilers within those isolated DH systems. 9. The Master Plan estimates have been adjusted downwards considering: (a) the decline in industrial demand (excluding the demand for steam) that occurred in 1996, (b) the limited availability of capital in Ukraine to fund new residential buildings, (c) the energy conservation response to economic pricing of heat, and (d) efficiency improvements in the operation of the DH system. The forecast of peak heat demand in the interconnected system, taking into account the adjustments in (a), (b) and (c) above, is shown in Table 1.1 following. ANNEX 1 Page 4 of 8 Table 1.1: Forecast of Heat Demand for District Heat in the Interconnected DH System Heat Demand 1996 2001 2006 2011 Industrial (Gcal/h) - existing 1,434 1,434 1,434 1,434 - new I/ 108 288 431 - efficiency improvement 15 3 56 - Total Industrial 1,434 1,527 1,688 1,809 - Average annual growth rate (%) 1.3% 2.0% 1.4% Residential (Gcal/h) - existing 3,955 3,942 3,919 3,869 - new 21 202 599 654 - efficiency improvement (from 4 go Table 1.2) - Total Residential 3,955 4,103 4,428 4,387 - Average annual growth rate (%) 0.7% 1.5% -0.2% Public & Commercial (Gcal/h) - existing 1,854 1,854 1,854 1,854 - new 21 167 560 958 - efficiency improvement 20 48 84 - Total Public & Commercial 1,854 2,001 2,366 2,728 - Average annual growth rate (%) 1.5% 3.4% 2.9% Total Demand (Gcal/h) - existing 7,243 7,230 7,207 7,157 - new 477 1,447 2,043 - efficiency improvement -77 173 276 - Total Demand 7,243 7,630 8,481 8,924 - Average annual growth rate (%) 1.0% 2.1% 1.0% 2001: 15% of estimated growth in Master Plan 2006: 35 % of estimated growth in Master Plan 2011: 50% of estimated growth in Master Plan 2/ 70% of estimated growth in Master Plan ANNEX I Page 5 of 8 10. As mentioned before, the forecasts above have been adjusted to take into account expected investments in energy saving measures. The forecasts assume that energy efficiency of buildings constructed between 2001 and 2005 will be 3% higher than the 1986 norms and of buildings built between 2006 and 2010, 5% higher. 11. Table 1.2 below shows separately the impacts of energy efficiency improvements on energy and peak demand for heat in buildings built before 1997. Improvements in temperature control, insulation and other measures reduce the annual consumption of heat energy. These improvements, however, have only a limited impact on peak demand. Table 1.2: Impact of Energy Saving Improvements on Public and Residential Heat Energy and Peak Heat Demand (%) Pre 1997 Buildings 1996 2001 2006 2011 Heat Energy Demand - Staircase and window seals 0.0 -1.0 -3.0 -5.0 refurbishment - Temperature control 0.0 -4.0 -7.0 -10.0 Cumulative impact on energy demand 0.0 -5.0 -10.0 -15.0 Peak Heat Demand - Staircase and window seals 0.0 -0.5 -1.0 -2.0 refurbishment - Temperature control 0.0 -0.5 -1.0 -1.0 Cumulative impact on peak demand 0.0 -1.0 -2.0 -3.0 12. Further adjustments to the heat demand forecasts have been made considering the expected efficiency improvements in the operation of the DH system. It has been assumed that the improvements of the thermal insulation of pipes and reduction in water leakages will gradually decrease the average level of transmission and distribution losses from the present 20% to 12% by 2011, equivalent to the average level of losses in German DH systems in 1994, reducing the need for new heat production capacity. 13. Furthermore, the Master Plan assumes a 100% correlation of the coincidence of different consumers' peak heat demand under the current constant flow system. The introduction of variable flow through individual controls at consumers will decrease the coincidence factor. The forecast assumes that the present coincidence factor will decline to 95% by 2011, after converting a major part of the DH system to variable flow. Table 1.3 summarizes the assumptions concerning efficiency changes in the operation of the DH system used in the forecasts of heat production capacity. ANNEX I Page 6 of 8 Table 1.3: Assumptions Concerning DH Losses and Coincidence Factor of Peak Demand in the Interconnected DH System 1996 2001 2006 2011 Coincidence factor of peak demand 1.00 0.99 0.97 0.95 Average energy losses in transmission and distribution 20% 17% 14% 12% Energy losses at peak 8% 7% 6% 5% C. Supply and Demand Balance: 1996 - 2011 14. Based on the previous assumptions and considerations, a peak heat demand forecast, which is the basis for establishing heat production capacity requirements, has been developed as presented in Table 1.4 below. In the final calculation of the heat production capacity requirements, the impacts of the coincidence at peak, system losses and a 15 % reserve capacity requirement have been considered. ANNEX I Page 7 of 8 Table 1.4: Peak Heat Demand and Capacity Forecast in Kiev (1996-2011) Units: Gcal/h 1996 2001 2006 2011 KIEV TOTAL: - Residential 4,915 5,233 5,550 5,902 - Public 2,361 2,551 2,963 3,483 - Industrial 3,465 3,574 3,780 3,935 Total 10,741 11,358 12,292 13,321 INTERCONNECTED SYSTEM: - Residential 3,955 4,103 4,428 4,387 - Public 1,854 2,001 2,366 2,728 - Industrial 1,434 1,527 1,688 1,809 Total 7,243 7,630 8,481 8,924 Impact of reduced coincidence at peak at consumers on peak 7,243 7,554 8,226 8,478 heat demand Impact of reduction of system losses on peak heat demand at 7,822 8,083 8,720 8,902 production plant Impact of reserve requirements on heat production capacity 8,996 9,295 10,027 10,237 requirements 15. Table 1.5 below shows the actual installed capacity in 1996 as compared to the development of installed capacity resulting from the proposed project investments at CT-1, CT- 2, TETS 5, TETS 6 and Pozniaki. (The real available capacity in 1996 was about 250 Gcal/h less than shown in the table, because of operational problems in the Voskresenka and Beliche boiler plants.) ANNEX 1 Page 8 of 8 Table 1.5: Development in Installed Capacity in the Interconnected DH System Operated by Kievenergo (1997-2003) Units: Gcal/h 1997 1998 1999 2000 2001 2002 2003 Increase WB-project: - CT-1 570 570 570 670 670 770 870 300 - CT-2 610 610 610 610 780 780 780 170 - Pozniaki 0 0 0 100 200 380 560 560 - TETS 5 1,700 1,700 1,700 1,700 1,880 1,880 1,880 180 - TETS 6 1,400 1,400 1,400 1,580 1,760 1,760 1,760 360 Subtotal: 4,280 4,280 4,280 4,660 5,290 5,570 5,850 1,570 Outside WB-project - Molod 105 - Voskresenka 300 - Otradny 200 - Vinogradar 200 - Nivki 150 - Belichy 330 - Nikolskaya Borch. 400 -TETS4 621 Subtotal: 2,306 2,306 2,306 2,306 2,306 2,306 2,306 Total 6,586 6,586 6,586 6,966 7,596 7,876 8,156 1,570 6,300 16. The project will increase the heat production capacity of the interconnected system operated by Kievenergo by 2003 to about 8,156 Gcal/h, representing a net increase in production capacity of 1,570 Gcal/h. At the same time, the heat production capacity requirements are estimated to increase by 2001 to about 9,295 Gcal/h, as compared to current available production capacity of about 6,300 Gcal/h, representing a need for about 2,995 Gcal/h of additional capacity. For the interconnected DH system operated by Kievenergo, the project is expected to be able to meet today's shortfall of about 1,520 Gcal/h in production capacity (excluding reserve requirements) and about 50 Gcal/h of the additional 1,475 Gcal/h needed to meet the conservative estimates of future growth in 2001. UKRAINE ANNEX 2 KIEV DISTRICT HEATING IMPROVEMENT PROJECT Detailed Project Description Detailed Pioe Decuiripon _________________ ________ Conworfiot LoCdon _ _ ___ ___. Deptbn ____- __Ca i funictbon Kievenserg _ _ _ __ _ _ _ _ New hot waer boilers nd uxiiary Kiev, Ponyaki region, a new high density A phased construction of hot water boilers to a site where the Completion ofthe frst00 o hunit.lnstall a second 100 Heat and hot watr production for the Poznyak area, with a etipmentto Poznyaki heat.nlysoiler plant residential am for abot 370,000 people. firstunit and whole infratructre is under constuction The Gcal/h hot water boiler and two hot water boilers 180 al/h, population of260,000 at present and 370,000 estimated in 2001. construction works have been delayed due to lack of financing. each Rehabilitafion of het-only-hoiler stations, CT Kiev, CT-I is located in District Heating CT-I: replacement of two 100 GraUh boilers and two 180 CT-I. the existing capacity is 570 G(al/h and after the project Heat production to the city center of Kiev, to heating regions # I I and CT - 2. Region I ad CT 2 is located in region # 3. Gadih boilers each; installation of three new 10OGc Uh boilers 870 Gcal/h, CT-2, the existing capacity is 610 Gcal/h and after and #2, where at present, there is deficit of heat production each; and rehabilitation of other boilers. CT- 2: one new hot the project 780 Gcal/h, capacity. water boiler I 0 Gcal/h; replacement of three boilers 100 t-Uh each; Hot water boilersto the existing CHP plants 5 Kiev, CHP 5 is located at the heating region# CHP 5: one new hot water boiler 180 Gca/; CHP 6: two new CHP 5: existing thermal capacityl700 Gca after project CIP S, heat producton to the city cett ofKiev, to heating and 6. I, CHP 6is located in the heating region #4. hot water boilers 180 GcalUh each 1880 Gca/h. CHP 6: existing thermal capacity 1400 Gzal/h, regions # 1, where at present, there is deficit ofheat production after project 1760 Gral/h. capacity. CHP 6, heat production to the heaing region # 4 in the north eastem part of Kiev to serve growing population Center Electric Substation . . Kiev, city center I- . _ t10/1IOkV substation, 2x40 MVA traforiners, 3.15 km 110 I 0/10kV, 2x40 MVA Electricity supply to the city center ofKiev, including DH kV twin cable line pumping stations and the hot water boiler plantt CT-I which will together utilize approximately 50%, of the capaeity. Replacement of worn-out primary pipelines All heating regions in Kiev. Replacement ofold, leaking pipelines by new preinsulated About 80 km of netwok lngth. To reduce heat and water losses and to seoure the continuous pipes up to pipe diameter DN 500 end by concrete duct operation of the DH system in Kiev. pipelines above DN 600 Replacement of valves All heating regions in Kiev. Replacment of shut-off valves in the DH network. Number of vaves in about 1460. Tight valves will reduce the water losses rem aly in the OH systerm. Kiev Municipal DM Company, Main Secondary pipe replacement All heating regions in Kiev. Replacement of warn-out secondary pipelines. About IS km of netwok length To reduce heat and water losses and to secure the continuous operation of the DH system in Kiev. Rehabilitaton of wom-out substations All heating regions in Kiev. Rehabilitation of old substations with modem heat exchanger Number of modernized substations will be 1500. To reduce beat and water losses and to secure the continuous substations, including control equipment and heat meters. operation of the DH system in Kiev. UKRAINE Annex 3 KIEV DISTRICT HEATING IMPROVEMENT PROJECT Project Cost Estimate (US$ million) 19 19m 200 2001 2mi 2003 2004 T. Lold Fz T Loo Fol Totl L.M F- 8D Tld Lolv1 Fo.oLo Told L 11 FondIAF toll LIA Forlg Totl ILoAo F.Im Tbl Lo Foluo Told Eqlpt-0Wy 2.100 k.Mqq-t 0.000 7.781 7.781 4.335 4.335 4.942 4.942 5.942 S.942 0.000 23.000 23.000 taootioo 2. IaOGoboqopo 0.38D 0.3a0 1.900 1.900 0.300 0.3a0 9.00 1.000 1.900 9.000 6.400 0.oo0 6.40 coil W.I.o 0.000 0.300 0.300 0.300 0.600 0.00 100 .200 0.55 0.55 3.655 0.000 3.653 TolI 10150 23.000 33.11 qoipboo0 ly Rhb. 3.1000t1b 1.640 5.280 6.920 7.700 7.700 4.920 4.920 2.240 2.240 1.122 1.122 1.640 21270 22.910 Ecfio Ropl oo o 2o000Vh 0.370 .370 0.556 0.536 0,363 0.363 0112 0. 12 0.110 0.110 0.ooo 1.311 1.511 CivlWookW Ropkooo2.oSOlG. 0.529 0.520 0.765 0765 0.529 0.529 0.226 0.226 01S0 6.150 2.10 0.000 2.199 Told La"9 2711 2.620 CT -2BoIooPL, O. 000 00 0.000 Eqopo fly NowboiloO 1 U00.Ab 13.062 13.862 11.682 11.682 12.110 12.110 4442 4.442 0.ooo 42.096 42.096 f o Rob3.IOO00G 0.401 0.401 0.401 0,401 0.537 0.537 0.160 0.160 o.o0o 1.499 1.40 Coo Wl h Rool t 3I00OG bb 1.029 1.029 1.084 1,004 0.636 0.640 0.480 0.400 3.279 0.000 3.279 Twl 3.279 43-05 4Ks74 TErrS RbbWbi-0o 0.000 0.000 0.0 EFqop bly N- boiloollOGcoIf 0500 3.500 1.704 1.704 0.o00 5.204 s.2a4 o-to 2100D2.100 1.174 1.174 3.274 0.000 3.274 CivH W . 1 1.900 1.900 LO0 1.010 2.910 0.000 2.910 W.W Too019B"Potkbot&IU 0.000 3.200 3.200 3.276 3.276 0.000 6.476 6.476 Tld Wo0 To0oln 0.000 184 11.70 17.44 TCI 6 FRobltdO 0.00 0.000 0.0O0 EOipoT fIy 2 -oc 100 .Ao boo 0.000 6.500 6.000 4.164 4.164 o.o0o 10.664 10.664 Eonfi 2.200 2.200 2.790 2.790 4.990 0.o00 4.900 Civ Wo.* 0.000 1.500 1.500 0.836 0.036 2.336 0.000 2.336 Told 0O00 7.226 10.444 17300 0.000 0.000 0. Col. S0W00d0 0.000 0.000 0000 PewerCobk. .dAo IlOkV -bIo & o..ooo..io 0.000 6.900 6.900 0.000 6.900 6 Iooll 0 0.400 0.90 e 0.930 1.350 0.000 1.350 Cioc Woo. 0.700 0.700 0.830 0.830 .S30 o0.000 1.530 Tol 2.ao 40 9.710 laoo _ 0.000 0.000 0.000 Pi" SoPIY ROpoo f78koof-twk 0.000 8.200 0.200 0.300 8.300 8.300 8.300 8.216 8.216 8.194 0.194 0.000 41.210 41.210 Wooc o.oo0 1.920 1.920 1.920 1.920 1.920 1.920 1.920 1.920 1.920 1.920 9.600 9.600 Told 0.000 9400 41.210 00.60 T.0O OO 0000 0000 0.000 Koo- 6p_tdoe v 0000 0000 0.000 Volvo &ff1 Rop%oo of 1400 vo- 0.000 0.650 03650 0.650 0.650 0.650 0.650 0.650 0.630 0600 0.600 0.000 3.200 3.200 Wbo 0.000 0.150 0.13 0.150 010 0.150 0.136 0.150 0.150 0.150 O.10 07.00 0.000 0.736 Told 0.700 .20 31000 D-lp 0.000 0.000 0.000 DNipo .o looldis. 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 0.000 5.000 0.ooo 3.000 _tolOol, Bo Cd 2000 0.60 2.500 14.950 333I 4.4801 &3ON 39.146 02.204 .019 37.439 40458 7.0 3X414 43.04 2.776 15.748 10024 O.ISO 1.232 I.32 48.73 14. 10 212.003 0 C.y.kd Cooihoo 0% 0.29s 0.000 0.298 1.495 3.353 4.u4s 1,306 3.915 5.220 0.802 3.744 4,546 0.704 33601 4.305 0.278 1.575 1.052 0.015 0.123 0.130 40.7 16.311 21.208 PdblCooil.. 0.000 0.000 0.0oo 0,345 3.512 3.058 0.747 2.004 2.750 0.697 2.907 3.604 0.013 3.772 4.505 0.321 2.006 2.407 0.065 0.163 0.228 2.980 14.444 17.432 T.. Abb TA fo K-.o 0.100 0.100 0.200 0.200 . 0.200 0-200 0000 o.oo 0000 0.500 T"oldP.,oJod Co .odoo 3.270 00 3.7l 16.79 4049 0727 10.1 40204 0375 414.290 03.00 119 197 4307 319 337 09.400 22.7 0.230 1.51S 1740 1sf4 21.223 b O,I ,% o.0oo oooo 0.905 0sos 0.036 0.036 0.860 00 03ss 0300 0030 0030 3.047 3.047 Told P..jooo C.d.o0oIVAT 3.270 0.000 3.273 14.790 4.490 07.207 14.010 43.204 01.200 00.374 44.290 54.I64 9420 43.307 02.145 3.72 40040.200I2 19.4n 1.11 :260 .58 1.77" 50.00 Mm 24.279 UKRAINE Annex 4 KIEV DISTRICT HEATING IMPROVEMENT PROJECT Page 1 of 2 Project Implementation Schedule 97 1 998 '19992 1 2001 2002 2003 ID Task Name Otr3Qtr4QtrlQtr2Qtr3Qtr4Qtr Qtr2Qtr3Qtr 4trl ltr2Qtr3Qtr4QtrlQtr2Qtr3Qtr4Qtr 1 Qtr2Qtr3Qtr4 Qtr 2Qtr 3Qtr 4|Qtr 1 I Pozniaki Boiler Plant__ _ _ _ _ _ _ __ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 12 CT-i Boiler Plant . l 26 CT-2 BoilerrPlant I . 38 TETS S Rehabilitation _ l 45 TETS 6 Rehabilitation _u 54 Center Substation . - 59 Kievenergo pipelines 71 Kievenergo replacement of valves UKRAINE Annex 4 Paze 2 of 2 KIEV DISTRICT HEATING IMPROVEMENT PROJECT Major Procurement Packages KIEVENERGO Description Type Estimated Procure- Docum. Invitation Contract Contract Major Procurement Packages 1) Cost ment Prepara- to Signing Completion (US$ mill. Method tion, since Bid Pozniaki Boiler Plant Equipment and Accessories 2 x 100 Gcal/h, equipment G 8.78 ICB 9/1/97 8/1/98 1/1/99 12/1/99 Boiler Equipment 1 x 180 Gcal/h, equipment G 6.27 ICB 7/1/99 1/l/00 7/1/00 1/1/02 Boiler Equipment 1 x 180 Gcal/h, equipment G 10.03 ICB 7/1/00 1/1/01 7/1/01 1/1/03 CT-I Boiler Plant Boiler& Equipment Supply Boiler Replacem. 2 x 100 GcalUh G 6.03 ICB 1/1/99 7/1/99 1/1/00 1/1/02 Boiler Supply New Boiler 180 GcaU/h G 8.79 ICB I/l/00 7/1/00 1/1/01 1/1/02 Boiler Supply New Boiler 180 GcaU/h G 6.24 ICB 1/1/01 7/1/01 1/1/02 1/1/03 Auxiliary Boiler Equipment Supply Boiler Rehabilit. 3 x 100 GcaUh G 3.83 ICB 1/1/02 7/1/02 1/1/03 2/1/04 CT-2 Boiler Plant Boiler Supply New Boiler 2 x 100 GcaUh G 10.90 ICB 7/1/99 1/1/00 7/1/00 1/1/02 Boiler & Auxiliary Equipment Supply New Boiler 100 GcaUh G 16.19 ICB 7/1/00 1/1/01 7/1/01 10/1/02 Boiler Supply New Boiler 180 Gcal/h G 13.16 ICB 1/1/01 7/1/01 1/1/02 1/1/03 Auxiliary Boiler Equipment Boiler Rehabilit. 3 x 100 Gcal/h G 4.06 ICB 1/1/02 7/1/02 1/1/03 1/1/04 TETS S Rehabilitation Boiler Equipment Supply New Boiler 180 Gcal/h G 3.99 ICB 9/1/97 8/1/98 1/1/99 7/1/00 Auxiliary Equipment and Boiler Pipelin Boiler Equipment G 2.03 ICB 6/1/98 8/1/98 1/1/99 7/1/00 Water Treatment Equipment Water Treatment G 7.38 ICB 1/1/00 7/1/00 1/1/01 1/1/03 TETS 6 Rehabilitation Boiler Equipment Supply New Boiler 180 Gcal/h G 7.41 ICB 9/1/97 8/1/98 1/1/99 4/1/00 Boiler Equipment Supply New Boiler 180 Gcal/h G 3.42 ICB 1/1/99 7/1/99 1/l/00 1/1/01 Auxiliary Equipment and Boiler Pipelin Boiler Equipment G 1.33 ICB 1/1/99 7/1/99 1/1/00 1/1/01 Center Substation Power Cables and Accessories 110 kV cable & accessories G 7.87 ICB 9/1/97 8/1/98 1/1/99 12/1/99 Kievenergo pipelines Pipe Supply/package 1 Pipes G 9.35 ICB 9/1/97 8/1/98 2/1/99 11/1/99 Pipe Supply/package 2 Pipes G 9.46 ICB 1/1/99 7/1/99 1/1/00 11/1/00 Pipe Supply/package 3 Pipes G 10.00 ICB 1/1/00 7/1/00 1/1/01 11/1/0l Pipe Supply/package 4 Pipes G 10.23 ICB 1/1/01 7/1/01 1/1/02 11/1/02 Pipe Supply/package 5 Pipes G 10.23 ICB 1/1/02 7/1/02 1/1/03 11/1/03 Kievenergo replacement of valves Valve Supply/package I Valves G 0.74 ICB 9/1/97 8/1/98 2/1/99 11/1/9 Valve Supply/package 2 Valves G 0.74 ICB 1/1/99 7/1/99 1/1/00 11/1/0 Valve Supply/package 3 Valves G 0.74 ICB 1/1/00 7/1/00 1/1/01 I1/1/01 Valve Supply/package 4 Valves G 0.74 ICB 1/1/01 7/1/01 1/1/02 11/1/0 Valve Supply/package 5 Valves G 0.68 ICB 1/1/02 7/1/02 1/1/03 11/1/03 Auxiliary equipment Equipment G 10.00 IS Auxiliary equipment Works W 1.00 MW Audits C 0.20 LC Consultancy & Design & Supervision C 0.30 DC 61/98 6/1/00 Bank Financed Procurement 200.00 of which ICB 192.13 91% 1) G for Goods, W for Works, C for Consultancy 2) ICB for Intemational Competitive Bidding, LC for Least Cost Selection, DC for Direct Contracting, MW for Minor Works ANNEX 5 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Estimated Schedule of Disbursements Kievenergo Project Bank FY and Disbursed Cumulative Disbursements Semester Ending in Semester Amount as of % of Total (US$ million) 1999 31 -Dec-98 0 0.00 0.0% 30-Jun-99 2.20 2.20 1.1% 2.20 2000 31 -Dec-99 2.40 4.60 2.3% 30-Jun-00 11.00 15.60 7.8% 13.40 2001 31-Dec-00 44.00 59.60 29.8% 30-Jun-01 27.80 87.40 43.7% 71.80 2002 31-Dec-01 27.60 115.00 57.5% 30-Jun-02 25.80 140.80 70.4% 53.40 2003 31-Dec-02 26.00 166.80 83.4% 30-Jun-03 15.00 181.80 90.9% 41.00 2004 31 -Dec-03 8.40 190.20 95.1% 30-Jun-04 8.70 198.90 99.5% 17.10 2005 31-Dec-04 1.10 200.00 100.0% Loa n Closing Date 31-Dec-04 ANNEX 6 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Supervision Plan The supervision of the project is expected to require about 20 staff-weeks per year in the first two years and 15 staff-weeks per year thereafter. The schedule below is in addition to the regular review requirements for procurement actions, consultancy and advisory services and general administration, estimated to be about 9.5 staff-weeks per year for the first two years and about 9 staff-weeks per year thereafter. Approximate Activity Expected Skill Staff- Dates Requirements Weeks 9/98 Supervision Engineer, Financial Analyst, 4.5 (Project Launch) Procurement Specialist 2/99 Supervision Engineer, Financial Analyst 3.0 6/99 Supervision Engineer, Financial Analyst 3.0 9/99 Supervision Engineer, Financial Analyst 4.5 2/00 Supervision Engineer, Financial Analyst 3.0 6/00 Supervision Engineer, Financial Analyst 3.0 9/00 Supervision Engineer, Financial Analyst 3.0 6/01 Supervision Engineer, Financial Analyst 3.0 (Mid-Term Review) 10/01 Supervision Engineer, Financial Analyst 3.0 3/02 Supervision Engineer, Financial Analyst 3.0 9/02 Supervision Engineer, Financial Analyst 3.0 3/03 Supervision Engineer, Financial Analyst 3.0 9/03 Supervision Engineer, Financial Analyst 3.0 3/04 Supervision Engineer, Financial Analyst 3.0 12/04 Supervision Engineer, Financial Analyst 3.0 (Project Completion) ANNEX 7 Page 1 of 3 UKRAINE KIEV DISTRICT HEATING IMROVEMENT PROJECT Performance Monitoring Indicators Kievenergo Technical Indicators To monitor the performance of the operation of the heat production plants and the whole DH system in Kiev, the below indicators will be regularly followed: For CT-1, CT-2, and Pozniaki, the following data will be collected: 1. Fuel consumption, heat production and plant efficiency Plant For each month Fuel consumption Gas (mi ), mazut (t) Gcal Gas consumption (million m3), gas into plant Mazut consumption (tons), mazut into plant Total ----- Heat out of the plant _---- Monthly overall efficiency % 2. Fuel consumption, heat production, electricity production and plant efficiency For TETS-5 and TETS-6 following data will be collected: Plant For each month Fuel consumption Gas (mi ), mazut (t) Gcal Gas consumption (million m3), gas into plant Mazut consumption (tonnes), mazut into plant Total ----- Heat out of the plant ._ GWh Total fuel consumption, (gas and mazut) Heat out of the plant ----- Electricity out from the plant Monthly overall efficiency % ANNEX 7 Page 2 of 3 3. District heating circulation pumps' electricity consumption For TETS-5, TETS-6, CT-1, CT-2 and Pozniaki, the following data will be collected: Plant For each month MWh | kWh/Gcal Circulation pumps' electricity consumtion X) x) specific pumping energy consumption = pumping energy/heat production 4. Make-up water to DH systems Plant For each month m3 % of flow X) Added make-up water x) monthly make-up water amount (m3 ) divided by supplied DH-circulation (m3 ) flow during the month 5. Water quality Make-up water and DH circulation water quality will be monitored as follows at each main heat source. In a graphical form (excel-graph) daily figures of following parameters: * pH, * hardness, * oxygen, * added make-up water (cubic meters) In a graphical form (excel-graph) weekly average values about following parameters: * chloride, * iron, * particles, * conductivity. The graph should indicate when the plant or water treatment plant has been out of operation. 6. Follow-up of heat supply deficit Kievenergo will provide following data from each main heat source, CT-1, CT-2, Pozniaki, TETS-5, TETS-6: Plant For each month _ _ _ __ ~~~~~~~Gcal/h Contracted heat load Capacity available ANNEX 7 Page 3 of 3 Monitroring heat losses and reduction of capacity deficit, following hourly temperature measurements are proposed for the main heat sources CT-1, CT-2, Pozniaky, TETS-5 and TETS-6: * from the plant, * supply temperature, * return temperature, * at a long distant substation or DH chamber, * supply temperature * return temperature, * outdoor temperature, The results will be presented in an excel-graph. The places where the temperatures are measured will be agreed with the Bank. The pipe route to the measurement points will be described, including pipe route (map), pipe dimensions/lengths, insulation materials, other important information. 7. Monitoring of breakdowns in the main DHI systems Plant /Region For each month Number Hours Major breakdowns x) Minor breakdowns x) Major breakdown = extent: more than 2000flats or duration more than 10 hours Financial Indicators Target Values Indicator end-1998 end-1999 end-2000 end-2001 end-2002 end-2003 Accounts Receivable (days) 175 150 130 110 90 70 Debt Service Coverage Ratio 1.5 1.5 1.5 1.5 1.5 1.5 (min) Current Ratio (min) 1.2 1.2 1.2 1.2 1.2 1.2 Average Heat Tariff ($/Gcal) 17.77 18.50 18.50 20.00 20.50 21.00 Residential Heat Tariff as % 100 100 100 100 100 100 of Average Heat Tariff (excluding profit margin) Average Retail Electricity 3.75 4.05 4.29 4.55 4.82 5.11 Tariff (US cents/KWh) Average Household 120 120 120 120 120 120 Electricity Tariff as % of Average Electricity Tariff ANNEX 8 Page 1 of 8 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Kievenergo Financial Analysis Key Assumptions for the Financial Projections Kievenergo Combined Operations Key Assumptions 1. Heat Production - HOB - Estimated to increase as new HOB plant under the project are commissioned. Each new boiler is assumed to operate for 2,200 hours/year. 2. (Heat and Water) Losses - Includes transmission losses, which are assumed to decrease as project investments in transmission pipelines are implemented. 3. Total Heat Sales - The quantity of heat to be sold, including self-production from cogeneration and HOBs as well as heat purchases from TETS 4, which is phased out after 1998. 4. Total Electricity Sales - The quantity of electricity to be sold, assumed at the same level as 1996. 5. Fuel Quantities 5.1 in Standard Fuel (SF) - A hypothetical fuel with a heating value of 7 Gcallton, used to estimate fuel requirements of both heat and power plants. Assumes the following conversion factors: HOBs: 154.3 kg SF per 1 Gcal of heat output, 92.5% average overall efficiency Cogen: 160.6 kg SF per 1 Gcal of heat output 214.3 kg SF per 1 MWh of electricity output, 70% fuel utilization rate of cogeneration cycle 5.2 Quantity of Gas - Calculated as: Standard Fuel (tons) x Percentage of Gas*l/8,000 kcal/m3 of gas x 7,000 Gcal 5.3 Quantity of Mazut - Calculated as: Standard Fuel (tons) x Percentage of Mazut* 1/9,500 kcal/kg of mazut x 7,000 Gcal ANNEX 8 Page 2 of 8 6. Gas Price, Mazut Price - Assumed to increase each year by the rate of international inflation. 7. Purchased Electricity Tariff - Assumed to increase each year by 3%. Income Statements 1. Operating Revenues: 1.1 Heat Revenues - Annual heat sales x heat tariff, calculated net of VAT. 1.2 Electricity Revenues - Annual electricity sales x electricity tariff, calculated net of VAT. 2. Operating Expenses: 2.1 Salaries and Benefits, Goods & Materials, Maintenance, Other and Other Income - Assumed to increase each year by the rate of domestic inflation. 2.2 KMDHC Distribution Fee - The fee Kievenergo pays to KMDHC for transporting heat energy to consumers through KMDHC's distribution networks, calculated as shown in the KMDHC Sources and Applications of Funds Statements - Main System. 3 Depreciation - 3% of the average value of gross fixed assets in 1997 and thereafter, based on more realistic depreciation rates which have been introduced as a result of the heat tariff study and other efforts. 4. Transportation Tax, Land Tax, Tax Rebate on Social Development - Assumed to increase each year by the rate of domestic inflation. 5. Income Tax - Estimated at 30% of net income before tax minus transportation tax land tax. Sources and Applications of Funds Statements 1. Borrowings - World Bank - Assumed at 79.6% of total project costs before duties. 2. Results-Related Remuneration - Assumed at 35% of net income in each year. ANNEX 8 Page 3 of 8 3. Debt Service: 3.1 World Bank - Estimated at an interest rate of 8%, with a maturity of 20 years including 5 years of grace on repayment of principal. Balance Sheets 1. Gross Fixed Assets - 1996 amount reflects major revaluation. In 1997 and each year thereafter, the amounts reflect project assets as they are commissioned. 2. Work-in-Progress - Beginning in 1997, amounts reflect project costs, including design and supervision costs and duties. 3. Accounts Receivables - Estimate in line with covenanted annual targets. 4. Inventories - Estimated at 4 months of goods and materials and 1.5 months of fuel. 5. Capital - The statutory fund of Kievenergo was restructured in 1997 as part of the privatization process to exclude the value of assets which are not subject to privatization. The amount excluded was transferred to the Reserve Fund. 6. Retained Earnings - Prior year balance increased by annual net income less results-related remuneration. 7. Accounts Payables - Assumed to decline in line with reduction of accounts receivables. Table 8.1 Kievenergo Combined Operations Key Assumptions For Years Ending December 31 Unit Actual Estimated 1995 1996 1997 1998 1999 2000 2001 2002 2003 Inflation Foreign 2.5% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% Domestic 376.0% 40.0% 16.0% 15.0% 15.0% 12.5% 10.0% 9.0% 8.0% Heat Production '000 Gcal 13,320 13,582 13,582 13,582 13,582 15,446 16,218 17,029 17,881 Cogen 8,003 8,057 8,057 8,057 8,057 8,057 8,057 8,057 8,057 HOB 5,317 5,525 5,525 5,525 5,525 6,365 7,750 8,366 8,982 Purchases from TETS 4 '000 Gcal 2,508 2,176 2,176 564 - - - - Heat Produced and Purchased 15,828 15,758 15,758 14,146 13,582 15,446 16,218 17,029 17,881 Losses '000 Gcal 2,374 1,776 2,206 1,980 1,766 2,008 2,108 2,214 2,325 Losses 15% 11% 14% 14% 13% 13% 13% 13% 13% Total Sales '000 Gcal 13,454 13,982 13,552 12,166 11,816 13,438 14,110 14,815 15,556 Electricity Production 10' kWh 3,240 4,951 4,951 4,951 4,951 4,951 4,951 4,951 4,951 Auxiliary Use 106 kWh 365 558 558 558 558 558 558 558 558 Transmission Losses 108 kWh 289 441 441 441 441 441 441 441 441 DH Pumps 106 kWh 111 170 170 170 170 170 170 170 170 Sales from own Plants 106 kWh 2,475 3,782 3,782 3,782 3,782 3,782 3,782 3,782 3,782 Purchases 106 kWh 2,401 1,066 1,066 1,066 1,066 1,066 1,066 1,066 1,066 Total Sales 106 kWh 4,876 4,848 4,848 4,848 4,848 4,848 4,848 4,848 4,848 Fuel Quantities & Prices In Standard Fuel '000 tons at 2,800 3,207 3,207 3,207 3,207 3,337 3,551 3,646 3,741 Percentage of Gas 85% 79% 85% 82% 78% 80% 80% 80% 80% Percentage as Mazut 15% 21% 15% 18% 22% 20% 20% 20% 20% Quantity of Gas 106 m3 2,083 2,076 2,386 2,360 2,181 2,336 2,486 2,552 2,619 Quantity of Mazut '000 tons 309 470 355 425 527 492 523 537 551 Gas Price US$O000 m3 80 83 85 83 80 82 84 86 88 Mazut Price US$/ton 75 97 99 98 99 101 104 106 108 Cost of Gas '000 US$ 166,602 173,097 203,531 195,880 174,454 191,174 208,096 218,580 229,437 Cost of Mazut '000 US$ 23,211 45,590 35,178 41,650 52,177 49,806 54,214 56,946 59,774 Total Fuel Cost '000 US$ 189,812 218,687 238,709 237,530 226,630 240,980 262,310 275,526 289,212 Purchased Heat Tariff US$/Gcal 14.32 15.00 15.45 13.90 - - - - - Purchased Electric Tariff US$/IOOkWh 2.99 2.50 2.58 2.65 2.73 2.81 2.90 2.99 3.08 Cost of Purchased Heat '000 US$ 35,910 32,639 33,618 7,840 - - - - - Cost of Purchased Eiectridty '000 US$ 7,172 26,650 2,745 2,825 2,910 2,995 3,091 3,187 3,283 Total Purchased Energy '000 US$ 43,082 59,289 36,363 10,665 2,910 2,995 3,091 3,187 3,283 a/ 1 ton of standard fuel has a calorific value of 7 Gcal ._00_Z 0I Table 8.2 Kievenergo Combined Operations Income Statements For Years Ending December 31 ('000 US$) Unit Actual Estimated 1995 1996 1997 1998 1999 2000 2001 2002 2003 Annual Heat Sales '000 Gcal 5,788 13,982 13,552 12,166 11,816 13,438 14,110 14,815 15,556 Annual Electric Sales 106 kWhr 2,362 4,848 4,848 4,848 4,848 4,848 4,848 4,848 4,848 Heat Tariff US$/Gcal 16.43 19.69 22.08 17.77 18.50 18.50 20.00 20.50 21.00 Electricity Tariff US$P100 kWhr 3.32 3.18 3.58 3.75 4.05 4.29 4.55 4.82 5.11 Foreign Inflation 2.5% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% Domestic Inflation 376% 40% 16% 15% 15% 12.5% 10% 9% 8% Exchange Rate UAH/US$ 1.82 1.85 2.15 2.42 2.64 2.83 3.01 3.16 Operating Revenues '000 US$ Heat Revenues 95,104 275,306 299,224 216,182 218,602 248,603 282,193 303,712 326,686 Electricity Revenues 78,393 154,198 173,558 181,800 196,344 207,979 220,584 233,674 247,733 Total Operating Revenues 173,497 429,504 472,782 397,982 414,946 456,583 502,777 537,386 574,419 Operating Expenses '000 US$ Fuel 101,071 218,687 238,709 237,530 226,630 240,980 262,310 275,526 289,212 Energy Purchased 23,407 59,289 36,363 10,665 2,910 2,995 3,091 3,187 3,283 Salaries and Benefits 5,583 32,161 39,237 45,122 51,891 58,377 64,215 69,994 75,594 Goods and Materials 2,405 9,946 12,134 13,954 16,047 18,053 19,859 21,646 23,378 Maintenance 5,745 9,657 11,782 13,549 15,581 17,529 19,282 21,017 22,698 KMDHC Distribution Fee 4,581 10,000 11,000 12,650 16,420 22,712 28,170 30,629 33,371 Other 2,257 33,953 41,423 25,872 29,753 33,472 36,819 40,133 43,343 Total Operating Expenses 145,049 373,693 390,647 359,342 359,232 394,119 433,746 462,133 490,879 Net Operating Income '000 US$ 28,448 55,810 82,135 38,640 55,714 62,464 69,032 75,253 83,540 Other Income 7,298 3,324 4,055 4,664 5,363 6,033 6,637 7,234 7,813 Income Before Depreciation 35,746 59,134 86,190 43,304 61,078 68,497 75,669 82,487 91,353 and Interest Depreciation 2,417 8,203 18,627 20,580 21,366 22,274 24,066 25,805 27,417 Income Before Interest 33,329 50,931 67,563 22,724 39,712 46,223 51,603 56,682 63,936 Interest on Borrowings 6,346 3,824 585 351 2,125 5,780 9,416 12,783 14,898 Net Income Before Tax 26,983 47,107 66,978 22,372 37,587 40,443 42,187 43,899 49,037 Taxes '000 US$ Transportation Tax 4 4 4 5 6 6 7 8 8 Land Tax 909 1,379 1,682 1,935 2,225 2,503 2,753 3,001 3,241 Income Tax 7,821 13,717 19,587 6,130 10,607 11,380 11,828 12,267 13,736 Total Taxes 8,730 15,100 21,274 8,069 12,838 13,890 14,588 15,276 16,986 Tax Rebate on Social - 2,638 3,219 3,701 4,257 4,789 5,268 5,742 6,201 Development Net Income 18,253 34,646 48,923 18,004 29,006 31,342 32,866 34,365 38,252 Table 6.3 Klevenergo Comnbined Operatlons Sources and Applications of Funds Statenents for Yr"s Ending Decembr 31 (000 US$) Estmatod 1998 1999 2000 2001 2002 2003 SOURCES Interal Sources Income Before Interest 22,724 39,712 46,223 51.603 56.682 63,936 Tax Reoate on Social Development 3,701 4,257 4,789 5,268 5.742 6,201 Depreciation 20,580 21,368 22,274 24,066 25,805 27.417 Tota lnternal Soures 47,005 65,334 73,2U6 80,936 88,229 97,554 BorrowIngs World Bank 2,610 45,606 48,064 42,837 41,353 18,138 Other - - - - Tobl BorrowIngs 2,610 45,600 48,064 42,637 41,353 18,138 TOTAL SOURCES 49,615 110,940 121,350 123,773 129,S82 115,691 APPUCATIONS Construction Projects Pozniakd Construcfion 880 10,181 5,315 8,042 8,697 CT-1 RehabiibaSion 7,819 9,029 5,812 2,578 CT-2 RehabilitatIon 15,292 13,167 13,333 5,082 TETS 5 Rehabilitafion 7,500 3.968 3,200 3,276 TETS 6 Rehabilitation 10,200 7,790 Center Electic Substafion 1,100 8,680 Pipeline Replacements 10,120 10,220 10,220 10,136 10,114 Replacement of Valves 800 800 800 800 750 Design and Supervison 1,000 1,000 1,000 1,000 1.000 - Contingencies 298 8,706 7,970 8,150 8.890 4,259 Total Construction Projects 3,278 57,187 60,174 53,608 51,944 22,783 Technical Assistance - 100 200 200 Total ProjectoCst Before Dutes 3,278 57,287 60,374 53,808 51,944 22,783 Dufies on the Project 905 856 868 388 TOTAL PROJECT COST 3,278 57,287 61,279 54,664 52,812 23,171 Taxes 8.069 12,838 13,890 14.588 15,276 16,986 Resutts-Relted Remuneration 6,301 10.152 10,970 11,503 12,028 13,388 Debt Service World Bank Interest 104 2,033 5,780 9,416 12,783 14,898 Balance 2,610 48,216 96,280 139,116 180.469 191,986 Principal - - - - 6,620 Totl World Bank Debt Service 104 2,033 5,780 9,416 12,783 21,518 880 Other Borrowings Interest 247 92 Principal 1,237 - Increase (Decrease) in Worring 29,957 28,048 27,565 32,183 33.240 (10,048) Capital TOTAL APPLICATIONS 49,194 110,449 119,483 122,354 126,139 65,016 Surplus/Deficit 420 491 1.867 1,419 3,443 50,675 Opening Cash Balance 6,980 1 7,400 7,891 9,758 11,177 14,619 Closing Cash Balance 7,400 7,891 9,758 11,177 14,619 65,295 00 Table 8.4 Kievenergo Combined Operations Balanco Sheets for Years Ending December 31 ('000 US$) Actual 1995 1996 1997 1998 1999 2000 2001 2002 2003 ASSETS Fixed Assets Gross Fixed Assets 184,026 620,915 661,005 710,995 713,393 771,560 832,839 887,503 940,315 Less: Accumulated Depreciation 51,931 275,312 292,106 312,686 334,052 356,326 380,392 406,197 433,615 Net Fixed Assets 132,095 345,603 368,899 398,309 379,341 415,234 452,447 481,306 506,701 Work-in-Progress 51,835 57,972 49,990 3,278 58,167 61,279 54,664 52,812 23,171 Total Fixed Assets 183,930 403,575 418,889 401,587 437,508 476,513 507,111 534,118 529,872 Long-Term Investments 147 153 1,237 1,237 1,237 1,237 1,237 1,237 1,237 Current Assets Cash and Bank Notes 9,829 2,524 6,980 7,400 7,891 9,758 11,177 14,619 65,295 Account Receivable 117,040 229,141 225,230 190,813 170,526 162,618 151,522 132,506 110,162 Advances - 105 110 101 101 111 122 130 138 Inventories 18,688 32,063 25,390 34,343 33,678 36,140 39,408 41,656 43,944 Other 23,256 10,408 79,061 79,061 79,061 79,061 79,061 79,061 79,061 Total Current Assets 168,812 274,241 336,771 311,718 291,257 287,689 281,290 267,973 298,600 TOTAL ASSETS 352,889 677,969 756,897 714,542 730,002 765,438 789,638 803,327 829,709 EQUITY AND LIABILITIES Equity Capital 168,138 138,105 14,565 14,565 14,565 14,565 14,565 14,565 14,565 Reserve - 237,008 391,619 391,619 391,619 391,619 391,619 391,619 391,619 Retained Eamings 21,715 44,235 23,239 34,942 53,795 74,168 95,531 117,868 142,732 Total Equity 189,853 419,348 429,423 441,126 459,979 480,352 501,715 524,052 548,916 Long-Term Debt World Bank - - - 2,610 48,216 96,280 139,116 180,469 191,986 Other 1,555 4,804 1,237 - - - - - - Total Long-Tern Debt 1,555 4,804 1,237 2,610 48,216 96,280 139,116 180,469 191,986 Current Liabilities Accounts Payable to Suppliers 137,834 239,234 312,430 257,000 208,000 175,000 135,000 85,000 75,000 Short-Term Loans 23,626 2,408 - - - - - - - Other 21 12,176 13,807 13,807 13,807 13,807 13,807 13,807 13,807 Total Current Liabilities 161,481 253,818 326,237 270,807 221,807 188,807 148,807 98,807 88,807 TOTAL EQUITY & LIABILITIES 352,889 677,969 756,897 714,542 730,002 765,438 789,638 803,327 829,709 00 00 Table 8.5 Kievenergo Combined Operations Ratios of Financial Performance 1995 1996 1997 1998 1999 2000 2001 2002 2003 OVERALL GROWTH Growth in Quantity of Heat Supplied -3% -10% -3% 14% 5% 5% 5% LIQUIDITY Current Assets/Current Liabilities 1.05 1.08 1.03 1.15 1.31 1.52 1.89 2.71 3.36 Quick Assets/Current Liabilities 0.79 0.91 0.71 0.73 0.80 0.91 1.09 1.49 1.98 OPERATING PERFORMANCE Operating Expenses/Revenues 84% 87% 83% 90% 87% 86% 86% 86% 85% PROFITABILITY Return on Gross Fixed Assets 10% 6% 7% 3% 4% 4% 4% 4% 4% Return on Net Fixed Assets 14% 10% 13% 5% 8% 8% 7% 7% 8% Return on Equity 10% 8% 11% 4% 6% 7% 7% 7% 7% Return on Equity + Long-Term Debt 10% 8% 11% 4% 6% 5% 5% 5% 5% DEBT, FINANCIAL LEVERAGE Debt Service Coverage 29.59 30.75 12.68 8.60 6.90 4.53 Interest Coverage 133.77 30.75 12.68 8.60 6.90 6.55 Long Term Debt/Equity 0.01 0.01 0.00 0.01 0.10 0.20 0.28 0.34 0.35 RECEIVABLES Receivables/Annual Amounts Due (Days) 246 195 174 175 150 130 110 90 70 rm coX ANNEX9 Page 1 of 7 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Kiev Municipal DH Company Financial Analysis Key Assumptions for the Financial Projections Income Statements - Isolated Networks 1. Annual Heat Sales - The quantitiy of heat to be sold, assumed at the same level as 1996. 2. Operating Revenues: 2.1 Heat Revenues - Annual heat sales x heat tariff, calculated net of VAT. 3. Operating Expenses: 3.1 Fuel - Assumed to increase each year by the rate of international inflation. 3.2 Electricity - Assumed to increase each year by the rate of domestic inflation. 3.3 Salaries and Benefits, Goods and Materials, Maintenance and Other - Assumed to increase each year by the rate of domestic inflation. 3.4 Depreciation - Assumed at 1.3% of the average value of gross fixed assets in 1997, in line with the current average depreciation rate, and at 3% of the average value of gross fixed assets in 1998 and thereafter, when more realistic depreciation rates were introduced as a result of the heat tariff study and other efforts. 4. Income Tax - Estimated at 30% of net income before tax minus land tax. Sources and Applications of Funds Statements - Isolated Networks 1. Results-Related Remuneration - Assumed at 35% of net income in 1996 and constant thereafter. Sources and Applications of Funds Statements - Main System 1. Kievenergo Distribution Fee - Current Operations - Assumed to increase each year by the rate of domestic inflation. ANNEX 9 Page 2 of 7 2. Kievenergo Distribution Fee - Project Operations - Assumed to cover the estimated operating and maintenance costs of project assets plus interest and includes a 14% profit margin. 3. Operating and Maintenance Cost - Current Operations - Assumed to increase each year by the rate of domestic inflation. 4. Operating and Maintenance Cost - Project Operations - Assumed at 6% of project investment costs. 5. Depreciation - Current Operations - Assumed at 10% of Kievenergo distribution fee on current operations. 6. Depreciation - Project Operations - From 1998 and each year thereafter, assumed at 3% of the value of project fixed assets. 7. Borrowings - EBRD - Assumed at 74% of total project cost in the main system before duties. 8. Debt Service - EBRD - Assumed at an interest rate of 10%, with a maturity of 15 years including 5 years of grace on repayment of principal. Balance Sheets - Isolated Networks 1. Gross Fixed Assets - 1996 amount reflects major revaluation. In 1997 and each year thereafter, the amounts reflect future assets as they are commissioned. 2. Work-in-Progress - Beginning in 1997, amounts reflect future construction costs. 3. Accounts Receivables - Estimated at 240 days in 1998, 210 days in 1999, 180 days in 2000, 120 days in 2001, 90 days in 2002 and thereafter. 4. Inventories - Estimated at 6 months of goods and materials and 1 month of fuel. 5. Retained Earnings - Prior year balance increased by annual net income less results- related remuneration. 6. Accounts Payables - Assumed to decline in line with reduction of accounts receivables. Table 9.1 KMDHC Operations in Isolated Networks Income Statements For Years Ending December 31 ('000 US$) Unit Actual Estimated 1995 1996 1997 1998 1999 2000 2001 2002 2003 Annual Heat Sales '000 Gcal 1,236 1,363 1,363 1,363 1,363 1,363 1,363 1,363 1,363 HeatTariff US$/GcaI 20.28 21.68 23.85 28.62 28.62 30.05 31.56 33.13 34.79 Foreign Inflation 2.5% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% 2.3% Domestic Inflation 376% 40% 16% 15% 15% 12.5% 10% 9% 8% Exchange Rate UAH/$ 1.82 1.85 2.15 2.42 2.64 2.83 3.01 3.16 Operating Revenues '000 US$ Heat Revenues 25,070 29,546 32,500 39,000 39,000 40,950 42,998 45,148 47,405 Total Operating Revenues 25,070 29,546 32,500 39,000 39,000 40,950 42,998 45,148 47,405 Operating Expenses '000 US$ Fuel 13,511 17,980 18,393 18,817 19,249 19,692 20,145 20,608 21,082 Electricity 987 1,081 1,319 1,516 1,744 1,962 2,158 2,352 2,540 Salaries and Benefits 2,462 5,055 6,168 7,093 8,157 9,176 10,094 11,002 11,883 Goods and Materials 337 432 527 606 697 784 863 940 1,016 Maintenance 164 112 137 157 181 203 224 244 263 Other 1,349 1,435 1,750 2,013 2,315 2,604 2,864 3,122 3,372 Total Operating Expenses 18,808 26,095 28,294 30,202 32,342 34,422 36,348 38,269 40,156 Net Operating Income 000 US$ 6,262 3,451 4,206 8,798 6,658 6,528 6,650 6,878 7,249 Other Income 563 - - - - - - - - Income Before Depreciation and Interest 6,824 3,451 4,206 8,798 6,658 6,528 6,650 6,878 7,249 Depreciation 179 472 2,096 4,836 4,836 4,836 4,836 4,956 5,196 Income Before Interest 6,645 2,978 2,111 3,962 1,821 1,692 1,814 1,922 2,052 Interest on Borrowings Net Income Before Tax 6,645 2,978 2,111 3,962 1,821 1,692 1,814 1,922 2,052 Taxes and Non-Taxable Income '000 US$ Land Tax 22 22 22 22 22 22 22 22 Income Tax 1,994 887 627 1,182 540 501 537 570 609 Total Taxes 1,994 909 649 1,204 562 523 559 592 631 Non-Taxable Income Net Income 4,652 2,070 1,462 2,758 1,259 1,169 1,254 1,330 1,421 II Table 9.2 KMDHC Operations in Isolated Networks Sources and Applications of Funds Statements for Years Ending December 31 ('000 USS) Actual Estimated 1995 1996 1997 1998 1999 2000 2001 2002 2003 SOURCES Internal Sources Net Operating Income Before Interest 6,645 2,978 2,111 3,962 1,821 1,692 1,814 1,922 2,052 Non Taxable Income - - - - - - - - Depreciation 179 472 2,096 4,836 4,836 4,836 4,836 4,956 5,196 Total Internal Sources 6,824 3,451 4,206 8,798 6,658 6,528 6,650 6,878 7,249 Borrowings EBRD Other - - Total Borrowings - - TOTAL SOURCES 6,824 3,451 4,206 8,798 6,658 6,528 6,650 6,878 7,249 APPLICATIONS Construction Projects Total Construction Projects - - - - - - - Technical Assistance Total Project Cost Before Duties - Duties on the Project Total Construction Projects 1,447 - - - - 8,000 8,000 4,000 Taxes 1,994 909 649 1,204 562 523 559 592 631 Results-Related Remuneration - 724 724 724 724 724 724 724 724 Debt Service EBRD Interest - - - Balance - - - Principal - - - Total EBRD Debt Service - - - Other Borrowings Interest - - - Principle - - - - - - Increase (Decrease) in Working Capit - 2,407 1,612 5,462 2,713 5,972 (2,353) (2,987) 573 TOTAL APPLICATIONS 1,994 5,486 2,985 7,390 3,999 7,219 6,931 6,329 5,929 Surplus/Deficit 4,831 (2,036) 1,222 1,408 2,658 (691) (281) 549 1,320 Opening Cash Balance 2,145 109 1,331 2,739 5,397 4,707 4,425 4,974 Closing Cash Balance 2,145 109 1,331 2,739 5,397 4,707 4,425 4,974 6,294 e eD -4 Table 9.3 KMDKC Operations in the Main System Sources and Applications of Funds Statements for Years Ending December 31 (.aDO USS) Actual Estimated 1995 1996 1997 1998 1999 2000 2001 2002 2003 Domestic Inflation 376% 40% 16% 15% 15% 12.5% 10% 9% 8% SOURCES Internal Sources Kievenergo Distribution Fee: Current Operations 4.681 10.000 11.600 13,340 16,675 20,427 22,470 24,492 26.451 Project Operations - - 607 3,342 6,863 7,404 8,288 Total Klevenergo Distribution Fee 4,581 10.000 11.600 13,340 17,282 23.769 29,332 31,896 34.739 Less; Operating & Maintenance Cost of Distribution Net-Current Operations 4,018 8.772 10,176 11.702 13,457 15,139 16,653 18,152 19.604 -Project Operations - - 874 2.502 2,502 3,270 Depreciation - Current Operations 1.000 1,160 1,334 1,668 2,043 2.247 2,449 2,645 Depreciation - Project Operations 437 1,251 1,635 1.641 Total Internal Sources 563 2,228 2,584 2.972 5,493 10,235 13,675 15,326 16,151 Borrowings EBRD - - 10.652 19,846 9.354 148 Other - - Total Borrowings - - - 10,652 19,846 9.354 148 TOTAL SOURCES 563 2,228 2.584 2.972 16,144 30.081 23.029 15.474 16.151 APPUCATIONS Construction Projects Secondary Pipe Replacement 1,100 1.100 Rehabilitation of Group Substations 9,400 18,800 9.400 Design and Supervision 1,398 2,650 1,252 Contingencies 2.255 3.992 1.753 Total Construction ProJects 14.153 26.542 12,404 Technical Assistance 200 200 200 200 Total Project Cost Before Duties - 14,353 26,742 12,604 200 Dulies - 213 397 187 3 Total Project Cost - 14.567 27,139 12.792 203 Debt Service EBRD Interest - 533 2,057 3.517 3,993 4,000 Balance - - 10.652 30,498 39,852 40.000 36,000 Principal - 0 0 0 0 4,000 Total EBRD Debt Service - 533 2,057 3,517 3.993 8,000 Other Borrowings Interest - Principle Total Other Borrowings - TOTALAPPUCATIONS - - 15,099 29197 16,309 4,196 8,000 Surplus/Deflict 563 2,228 2.584 2,972 1,045 884 6.720 11,279 8,151 Table 9.4 KMDHC Operations in Isolated Networks Balance Sheets for Years Ending December 31 ('000 US$) Actual Estimated 1995 1996 1997 1998 1999 2000 2001 2002 2003 ASSETS Fixed Assets Gross Fixed Assets 25,875 161,215 161,215 161,215 161,215 161,215 161,215 169,215 177,215 Less: Accumulated Depreciation 9,287 51,824 53,920 58,756 63,593 68,429 73,266 78,222 83,419 Net Fixed Assets 16,588 109,391 107,295 102,459 97,622 92,786 87,949 90,993 93,796 Work-in-Progress - - - - - - 8,000 8,000 4,000 Total Fixed Assets 16,588 109,391 107,295 102,459 97,622 92,786 95,949 98,993 97,796 Long-Term Investments - - - - - - - - - Current Assets Cash and Bank Notes 2,145 109 1,331 2,739 5,397 4,707 4,425 4,974 6,294 Account Receivable 11,477 28,621 24,041 25,644 22,438 20,195 14,136 11,132 11,689 Advances - - - - - - - - Inventories 1,339 1,611 1,796 1,871 1,953 2,033 2,110 2,188 2,265 Other 672 3,296 3,296 3,296 3,296 3,296 3,296 3,296 3,296 Total Current Assets 15,633 33,638 30,464 33,550 33,085 30,230 23,968 21,590 23,544 TOTAL ASSETS 32,221 143,029 137,759 136,009 130,707 123,016 119,917 120,583 121,340 EQUITY AND LIABILITIES Equity Capital 17,299 108,554 108,554 108,554 108,554 108,554 108,554 108,554 108,554 Reserve - 575 575 575 575 575 575 575 575 Retained Earnings 293 1,638 2,376 4,409 4,944 5,389 5,919 6,524 7,221 Total Equity 17,592 110,767 111,505 113,538 114,073 114,518 115,047 115,653 116,350 Long-Term Debt EBRD - - - - - - - - - Other Total Long Term Loans - - - - - - - - Current Liabilities Accounts Payable to Suppliers 13,950 28,905 23,289 19,505 13,668 5,533 1,904 1,964 2,025 Short-Term Loans 678 390 - - - - - - - Other - 2,966 2,966 2,966 2,966 2,966 2,966 2,966 2,966 Total Current Liabilities 14,628 32,261 26,255 22,471 16,634 8,498 4,870 4,930 4,991 TOTAL EQUITY AND LIABILITIES 32,220 143,028 137,759 136,009 130,707 123,016 119,917 120,583 121,340 w Ct Table 9.5 KMDHC Operations in Isolated Networks Ratios of Financial Performance Actual Estimated 1995 1996 1997 1998 1999 2000 2001 2002 2003 OVERALL GROWTH Growth in Heat Production 10% 0% 0% 0% 0% 0% 0% 0% LIQUIDITY CurrentAssets/Current Liabilities 1.07 1.04 1.16 1.49 1.99 3.56 4.92 4.38 4.72 Quick Assets/Current Liabilities 0.93 0.89 0.97 1.26 1.67 2.93 3.81 3.27 3.60 OPERATING PERFORMANCE Operating Expenses/Revenues 75% 88% 87% 77% 83% 84% 85% 85% 85% PROFITABILITY Retum on Gross Fixed Assets 18% 1% 1% 2% 1% 1% 1% 1% 1% Return on Net Fixed Assets 28% 2% 1% 3% 1% 1% 1% 1% 2% Return on Capital 27% 2% 1% 3% 1% 1% 1% 1% 1% Return on Equity 26% 2% 1% 2% 1% 1% 1% 1% 1% DEBT, FINANCIAL LEVERAGE Debt Service Coverage, Main System - - 9.84 4.79 3.77 3.72 1.96 Interest Coverage, Main System - - 9.84 4.79 3.77 3.72 3.91 Long Term Debt/Equity 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 RECEIVABLES Receivables/Annual Amounts Due (Days) 167 354 270 240 210 180 120 90 90 me t ANNEX 10 Page 1 of 15 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Economic Analysis 1. Least-cost, economic, financial, sensitivity, risk and distributional analyses were conducted on the 9 economically independent components. The economic and financial internal rates of return are based on the incremental costs and benefits derived from the "with and without" project approach. All costs and benefits flows are expressed in 1998 constant economic prices. The 10% discount rate used in the analysis corresponds to the opportunity cost of capital in Ukraine. The key assumptions and results of these analyses, with a component-by-component breakdown of the main features, are presented below. A. Least Cost Analysis 2. Three subprojects were identified that could be supplied alternatively with independent gas boilers in individual buildings, including Pozniaki boiler plant and TETS 5 and TETS 6 rehabilitation and expansion components. All of these subprojects are less expensive than the alternative of independent gas boilers installed in individual buildings. 3. The basic idea in the comparison of alternatives is that the costs of the base option of rehabilitating and/or expanding district heating (DH) would be evaluated against the costs of the option of decentralizing the heating system to buildings which would be furnished with two individual gas boilers. For reliability of supply, two boilers (2 x 70%) would be installed in each building. It was first considered that the boilers could be located on the roofs of buildings, whereby neither separate boiler houses nor chimneys would be required. However, since most buildings were constructed in the 1950's ("Kruchevka buildings") and are in an advanced state of disrepair, in practice it might not be technically or economically feasible to reinforce the building structures for roof-top boilers. Also it would be difficult to obtain the necessary permits, given current building standards. Therefore, given that the concerned areas are not too congested, ground level gas boilers were considered. In addition to the heating system investments, an allowance has been made for inproving and increasing the capacity of the existing gas distribution network, which is basically designed for the supply of cooking gas only. The basic parameters of the alternative of independent gas boilers are presented in Table 1. Table 1: Decentralized Gas Heating Key Assumptions Item Unit Price US$ Gas boilers (inc. 2 boilers, enclosure, pumps, installation) 39,900 Building reinforcement 15,000 Gas network improvement 4,400 Pressurization system 1,000 Piping 3,000 Line balancing valves 200 Pipe etc. installation 2,000 SCADA Variable 4. The total investment required to decentralize the heat supply and to implement individual gas heating for each building is estimated to be between US$ 60,000-70,000. The required capital and ANNEX 10 Page 2 of 15 operating costs for this alternative for the considered subprojects were, in each case, considerably higher than rehabilitation of the existing systems and expansion; consequently, the proposed DH subprojects were recommended for further economic analysis. 5. It should also be noted that several of the areas are linked together with other networks and the boiler plants complement each other during summer maintenance periods and in case of boiler unavailability during the heating season. The conversion to decentralized gas heating would have an adverse effect on the adjacent systems. 6. Individual gas heating is a competitive option in smaller areas with lower heat load densities. This is the case especially in new areas where both options are "green field" investments but also in cases where rehabilitation of the DH system requires (almost) complete rebuilding. B. Cost Benefit Analysis 7. The economic rates of return (ERRs) are evaluated from the comparison of the economic costs with the economic benefits. The costs and benefits are incremental and derived from the comparison of "with project" versus "without project" situation. The without project scenario represents the continued operation of the system "as is", subject only to routine maintenance, and with the continued degradation of the existing DH assets, the deterioration of efficiency, losses and reliability. The ERR is the discount rate that produces a zero net present value for the difference between costs and benefits. 8. The investment costs are net of fiscal and financial transfers and represent the annual costs (foreign and domestic) for the execution of each component. The technical assistance is considered necessary for the overall success of each subproject and thus allocated proportionally to their investment costs. An allowance of 10% for physical contingencies has been made. The economic life of the components has been estimated at 20 years. The projects cost estimates are based on early 1998 price levels. 9. Running costs include fuel, operation, repair and maintenance expenditures, as well as losses. Fuel costs are applicable only to the boiler plant investments. Fuel costs were estimated based on the international prices of natural gas and heavy fuel oil as forecast by the World Bank for Europe adjusted for Ukrainian transport costs to the boiler house. Table 2 presents the adopted annual gas price forecasts. Table 2: Gas and Petroleum Price Forecasts Real Price Forecasts (base = 1998) 1995 1996 1997 1998 1999 2000 2005 2010 Kiev Price of Gas (US$ per 1,000 m3) a/ 80.00 82.40 87.30 82.40 81.80 79.40 74.60 73.90 Mazut price ($/ton) 75.00 97.00 97.66 84.60 84.49 82.08 78.13 75.93 Petroleum Reference Price (US$ per barrel) 15.89 19.75 19.62 17.00 16.98 16.49 15.70 15.26 a / Prices in Ukraine are assumed to change in tandem with gas prices in Western Europe. Source: World Bank, Commodity Markets and the Developing Countries, February 1998. 10. A summary of the benefits brought about by the individual investment components is shown in Table 3 below. A short description of the arguments behind each asserted benefit is also included in the table. ANNEX 10 Page 3 of 15 Table 3: Source Of Benefits By Subproject Investment Avoided Savings in Thermal Water losses Repair & Undelivered Other demand defid heat transmission (direct + maintenance energy production losses thermal) and pumping _ Preinsulated DH educe losses of reduce leakage reduce annual reduce pipes & shut-off wet pipes to that repair and interruptions, valves, of polyurethane maintenance sections to be Kievenergo & foam insulated costs renewed cause KMDHC pipelines 20%-> outages 2 7% in 78 km of imes more 768 km network than the (Kievenergo) in network 4.3 of 159 km average network (KMDHC) Substations and improve reduce leakage reduce annual reduce annual secondary insulation on repair and nergy by network pipes and maintenance 10% through equipment, costs etter control eliminate secondary piping Pozniaki Boiler increase in Plant willingness to pay for the net increase in supply of 1,636 = MGcal CT-1 & CT-2 increase in as savings reduce O&M improved 0% reduction Boiler Plant willingness to from increase costs from boiler in electric Rehabilitation & pay for the net in boiler $1.6/Gcal to reliability consumption Expansion increase in efficiency from $0.5/Gcal, due reduces due to new supply of 669 89% to 95% to reduced system outage variable speed MGcal for CT- labor needs, from 220 umps I and 691 for maintenance hours to 218, CT-2 requirements, n average and longer I______________ ______________ asset life TETS-5 and increase in TETS-6 willingness to Rehabilitation & pay for the net Expansion increase in supply of 765 MGcal for rETS 5 and 1,148 for TrETS 6 Center Electric increase in Substation willingness to pay for the net increase in supply of 238 MGcal Network increase in Rehabilitation willingness to pay for the net increase in supply of 319 MGcal _ ANNEX 10 Page 4 of 15 C. Consumer Surplus 11. An important benefit in some investment components is the willingness to pay (WTP) for the additional supply. As mentioned earlier, WTP is the area under the demand curve. It consists of sales revenue and consumer surplus. When a project prevents a demand deficit, it actually prevents the price to rise under competition to that level of demand that would reach an equilibrium with the constrained supply. When a project prevents a price hike, more consumers have access to the same product and existing consumers pay a lower price for the same amount of consumption. Valuing the benefits of additional supply at the ongoing price understates the project's contribution to society's welfare, because it ignores consumer surplus: the difference between what consumers are prepared to pay for a product and what they actually pay. In principle, this increase in consumer surplus should be treated as part of the benefits of the project. 12. Measuring consumer surplus is straightforward under certain simplifying assumptions. Consider a project that lowers the price of a product from P1 to P2. As a result of the lower price, the quantity demanded rises from Ql to Q2 as Figure 1 shows. Consumer surplus is the sum of areas A and B. Area A is what consumers save from the price drop and is equal to the difference in price times the quantity sold at the old price. 13. There may also be a gain Figure 1: Consumer Surplus in consumer surplus without any decline in price. If supply is rationed at a price below what consumers would be willing to pay, an increase in supply at the same controlled price involves a gain in P1 consumer surplus over and above what consumers actually pay for the increase. P2 This is particularly significant for public utility projects. 14. In this project, a linear demand curve and a price elasticity of - - demand of -0.5 have been assumed. With Q Q these assumptions and with the information on consumption with the project (Q2), the existing price (P2) and the avoided deficit (Q2 - Ql), the price without the project (P1) has been estimated. With the help of a spreadsheet model, the incremental sales revenue and consumer surplus associated with the avoided deficit due to each boiler plant component and the Center electric substation were estimated for each year. D. Economic Value Of Unserved Heat 15. In the present situation in Kiev, the consumers' demand for heat cannot be fully satisfied for several reasons, including (a) unavailability of transmission or distribution equipment due to unscheduled outages, (b) rationing due to scarcity of fuel (budget constraint), and (c) capacity deficit. 16. Outages in distribution are typically caused by pipe breakdowns. Depending on the network layout, substituting heat delivery can sometimes be arranged to some extent by changing the sectioning of the network and by alternative water flow routing. Usually, however, the heat delivery is cut-off completely from consumers who depend on the damaged transmission or distribution segment. The actual damage caused by a total cut in heat delivery can become substantial, depending on the duration of the outage. ANNEX 10 Page 5 of 15 17. As an example, in December 1996 a breakage occurred in a DN 500 pipeline in Kievenergo's system. The ambient temperature was about -20°C and the repair and resumption of supply took about 10 days. Meanwhile, the consumers either suffered from cold or used alternative heating methods, typically electric heaters. In some houses, where the heating and domestic hot water risers were not drained, the freezing caused the pipes to burst causing significant damage. 18. Heat supply is currently being rationed for several months during the heating period. Room temperatures remain below the design values, but continuous heat delivery is secured. Fortunately, the present constant flow heat distribution method is well suited to allocate the scarcity relatively evenly among consumers. From the consumer's point of view, low room temperature causes inconveniences, health risks and moisture problems in buildings. 19. During peak demand periods, the existing heat production capacity is insufficient to meet demand (even if sufficient fuel were available). This causes further rationing in heat supply. Currently, the room temperature can remain as low as 10-14°C in some districts during cold winter periods. 20. The value of unserved heat can be estimated based on: (a) the substitution costs of alternative heating methods, and (b) the economic value of damages caused by undelivered heat. The first method provides a very conservative estimate because not every household can afford to purchase an electric heater. Consumers that can not afford an electric heater bear all the costs associated with the increased sickness rate, work absences and loss of income due to a prolonged heat supply outage. The second method would provide a better estimate, since there are other economic damages caused by underheating and cut-off periods, not only to households, but also to industrial users, such as the direct and indirect production losses where heat is one of the main inputs, mechanical damages in buildings' heating systems, and in building structures (insulation, painting, etc.) due to moisture. Consequently, the cost of unserved heat varies considerably depending on the time of year, consumer type, duration of interruption, etc. 21. In the analysis for this Table 4: Estimation of Value of Unserved Heat project, a conservative estimate of the outage value has been derived from the first method Concept Value Unit utilizing the economic cost of heat from Electric heater (I - 1.5 kW) 25 $ per unit electric heaters, the most commonly used Life 5 years form of substitution of heat during the coldest Thermal output 0.00135 Gcal/h periods and periods of total outages. The Average usage 220 hrs/yr economic cost of unserved heat has been Discount rate 10% estimated at $65/Gcal, based on a unit cost of Capital recovery factor 26.4% an electric heater of $25 per 1 - 1.5 kW, with Cost of electricity 43.031 $/Gcal an expected 5 year average service life and Annual output 0.297 Gcal an electricity economic cost of $37/Mwh or Annual capital cost 6.59 $/yr $43/Gcal. Table 4 presents a summary of the Capital cost per unit 22.21 $/Gcal assumptions used in the calculation. Value of Unserved Heat 65.2 $/Gcal ANNEX 10 Page 6 of 15 E. Risk Analysis 22. The project components are subject to several risks which are largely beyond the scope of the project design, such as macroeconomic, policy and institutional risks, as well as those related to the existing system. The purpose of risk analysis is to assign probability distributions to the different input variables, key parameters and assumptions so that a weighted expected outcome can be obtained. Risk analysis allows the examination of the risks which are more relevant for the profitability of the project, enabling the design of a more targeted risk mitigation strategy. The software "Crystal Ball" was used to carry out the analysis. The software allowed the extension of the forecasting capability of the spreadsheet cost benefit model developed in Excel for each project component. Each input variable, parameter and assumption was expressed as a range of possible values within a probability distribution curve. Then, by using a Monte Carlo simulation, the software enabled the outcomes of the cost benefit model in a forecast chart showing the entire range of possible results and the likelihood of achieving each of them. 23. The main input variables, key parameters and assumptions of the analysis along with their risk distribution curves, are presented in Table 5 below. Table 5: Summary of Risk Distributions Variables Expected Value Risk Distribution Standard Deviations/ Extreme Values Investment / Physical Contingency 10 % Normal % Current DH Boiler Efficiency 89 % Normal 1% Attainable DH Boiler Efficiency 95 % Normal 1% Current Transmission Losses 15 % Extreme Values 10 To 25% Attainable Transmission Losses 7 % Uniform 6 To 8% Current Distribution Losses 22 % Extreme Values 15 To 25% Attainable Distribution Losses 15 % Extreme Values 10 To 17% Losses Of Bad Sectors Compared To Twice The Network Normal 20% Network Average Average Gas Price Variable Normal 10% Water Losses Of Bad Sectors Thrice The Network Normal 30% Average Maintenance And Repair Time Savings 5% Reduction Weibull Due To Shut-Off Valves Outage Value $65.2/Gcal Extreme values 34 to 340% Reliability Improvements 220 Hours Per Annum Normal 20% On Average Of Unplanned Interruptions 24. As Pozniaki is the largest component of the project, the summary graph os its risk analysis is presented below. The frequency chart shows the ERRs on the X axis and the probabilities of occurrence on the Y axis. After 1,000 trials, the range of the ERRs extended from 5.2% (the most uneconomic return) to 28.8 % (the best possible outcome). It was estimated, with a 75% certainty, that a minimum ERR of 13.2% could be expected for Pozniaki, well above the 10% discount rate. ANNEX 10 Page 7 of 15 Forecast: Pozniaki ERR 1 1,000 Trials Frequency Chart 3 Outliers .033 -- 33 .025 -ow7 111 11 |24.75 J2 .0017 1 -lli -l 1 -16.5 . & .008 - 8.25 .000 1 1 5.0% 10.6% 16.3% 21.9% 27.5%/ UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Economic Analysis (Constant 1998 US$000) Economic Cost and Benefit Flows of the Proposed Components 1998 1999 2000 2001 2002 2003 2004 2005 2010 2018 PVs Pipe Replacement and Valves Kievenergo Investment costs -21,747 -21,967 -21,967 -21,781 -21,624 -75,211 Operational & Maintenance (1% of Tot Inv) -217 -437 -657 -875 -1,091 -1,091 -1,100 -1,100 -1,100 -6,832 Reduced thermal losses 1,469 2,953 4,437 5,908 7,369 7,037 6,720 5,564 4,254 39,201 Reduced water losses 514 1,034 1,553 2,068 2,579 2,494 2,412 2,039 1,559 14,056 R&M without the project 1,667 3,351 5,036 6,705 8,363 8,187 8,025 7,227 1,100 44,559 Reliability improvement 188 377 567 755 941 910 880 744 569 5,130 Net benefit -18,126 -14,689 -11,032 -7,220 -3,462 17,538 16,937 14,476 6,382 20,902 NPV (1000 US$) $20,902 ERR 16.0% Pipe Replacement and Valves KMDHC Investment costs -1,843 -4,887 -4,722 Operational & Maintenance (1% of Tot Inv) -18 -67 -67 -67 -67 -67 -67 -67 -429 Reduced thermal losses 268 689 658 629 600 573 475 363 3,560 Reduced water losses 30 79 76 74 71 69 58 44 423 R&M without the project 141 393 382 372 362 352 308 67 2,058 Reliabfiity improvement 17 46 44 43 41 40 34 26 245 Net benefit -1,405 -3,748 1,093 1,049 1,007 967 807 433 1,135 NPV (1000 US$) $1,135 ERR 15.3% Rehabilitation of Substations Investment costs -10,492 -14,012 -10,492 -23,968 Operational & Maintenance (2% of Tot Inv) -210 -490 -700 -700 -700 -700 -700 -700 -4,327 Savings in delivered energy 887 2,010 2,835 2,615 2,412 2,225 1,548 897 12,594 Reduced thermal losses 725 1,644 2,319 2,139 1,973 1,820 1,267 734 10,305 Reduced water losses 84 196 281 262 245 229 162 94 1,280 R&M without the project 1,259 2,940 4,199 3,969 3,753 3,551 2,727 700 19,471 Net benefit -7,746 -7,711 -1,557 8,285 7,683 7,125 5,005 1,725 15,356 NPV (1000 US$) $15,356 ERR 27.1% ceO UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Economic Analysis (Constant 1998 US$000) Economic Cost and Benefit Flows of the Proposed Components 1998 1999 2000 2001 2002 2003 2004 2005 2010 2018 PVs Pozniaki Boiler Plant Investment costs -5,589 -15,092 -15,852 -18,931 -9,821 -48,491 Operation & Maintenance costs -303 -460 -460 -1,540 -1,540 -1,540 -1,540 -7,364 Fuel Costs -3,906 -5,857 -5,784 -19,124 -18,887 -18,727 -18,727 -90,253 auxiliary electric cost -490 -745 -745 -2,493 -2,493 -2,493 -2,493 -11,921 Increase Sales Revenue 6,848 10,399 10,355 34,667 34,667 34,667 34,667 165,822 Consumer Surplus 151 329 327 3,667 3,667 3,667 3,667 16,234 Net benefit -5,589 -15,092 -15,852 -16,632 -6,155 3,693 15,177 15,414 15,574 15,574 24,027 NPV (1000 US$) $24,027 ERR 15.5% CT-1 Boiler Plant Rehabilitation & Expansion Investment costs -8,829 -10,196 -6,563 -2,911 -1,561 -20,117 Fuel Costs -6,800 -6,648 -6,499 -6,117 -6,513 -30,652 Auxiliary electricity cost -121 -121 -121 -121 -121 -590 O&M cost -630 -630 -630 -630 -630 -3,060 Increase Sales Revenue 14,182 14,182 14,182 14,182 14,182 68,896 Consumer Surplus 522 522 522 522 522 2,534 Reduced O&M Costs 3,850 3,955 4,063 4,635 5,540 21,772 Net benefit -8,829 -10,196 -6,563 8,091 9,699 11,516 12,470 12,979 38,783 NPV (1000 US$) $38,783 ERR 30.3% CT-2 Boiler Plant Rehabilitation & Expansion Investment costs -17,268 -14,868 -15,056 -5,739 -35,717 Fuel Costs -8,161 -7,980 -7,802 -7,351 -6,819 -36,537 Auxiliary electricity cost -202 -202 -202 -202 -202 -983 O&M cost -650 -650 -650 -650 -650 -3,158 Increase Sales Revenue 14,632 14,632 14,632 14,632 14,632 71,083 Consumer Surplus 555 555 555 555 555 2,697 Reduced O&M Costs 3,642 3,741 3,843 4,384 5,241 20,595 Net benefit -17,268 -14,868 -15,056 4,077 10,097 10,376 11,368 12,758 17,980 NPV (1000 US$) $17,980 ERR 16.3% IIX UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Economic Analysis (Constant 1998 US$000) Economic Cost and Benefit Flows of the Proposed Components 1998 1999 2000 2001 2002 2003 2004 2005 2010 2018 PVs TETS 5 Rehabilitation & Expansion Investment costs -8,469 -4,481 -3,613 -3,699 -15,131 Fuel Costs -5,222 -5,157 -5,093 -5,030 -4,967 -4,906 -4,864 -4,864 -34,404 Auxiliary electricity cost -648 -648 -648 -648 -648 -648 -648 -648 -4,476 O&M cost -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -1,000 -6,913 Increase Sales Revenue 8,582 9,041 9,043 9,005 9,005 9,005 9,005 9,005 61,981 Consumer Surplus 223 223 211 210 210 210 210 210 1,472 Water treatment savings 1,998 1,998 1,998 1,998 1,998 1,998 1,998 1,998 13,812 Net benefit -8,469 -548 844 812 4,535 4,598 4,660 4,701 4,701 16,341 NPV (1000 US$) $16,341 ERR 27.5% TETS 6 Rehabilitation & Expansion Investment costs -13,396 -8,797 -17,680 Fuel Costs -9,400 -9,283 -9,168 -9,054 -8,941 -8,830 -8,756 -8,756 -61,928 Auxiliary electricity cost -1,166 -1,166 -1,166 -1,166 -1,166 -1,166 -1,166 -1,166 -8,057 O&M cost -1,800 -1,800 -1,800 -1,800 -1,800 -1,800 -1,800 -1,800 -12,444 Increase Sales Revenue 15,447 16,274 16,277 16,208 16,208 16,208 16,208 16,208 111,565 Consumer Surplus 721 724 684 681 681 681 681 681 4,771 Net benefit -13,396 -4,993 4,749 4,828 4,870 4,983 5,094 5,168 5,168 16,227 NPV (1000 US$) $16,227 ERR 22.6% Center Electric Substation Component Investment costs -1,242 -9,802 -9,230 Production Costs -5,413 -5,547 -5,680 -5,813 -5,947 -6,080 -6,213 -6,347 -6,347 -46,537 Increase Sales Revenue 7,267 7,446 7,625 7,804 7,983 8,162 8,341 8,520 8,520 62,476 Consumer Surplus 334 334 333 349 365 382 399 416 416 2,939 Net benefit -1,242 -7,614 2,234 2,279 2,340 2,402 2,464 2,527 2,590 2,590 9,648 NPV (1000 US$) $9,648 ERR 25.8% I-A 0 o0 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Economic Analysis (Constant 1998 US$000) Economic Cost and Benefit Flows of the Proposed Components 1998 1999 2000 2001 2002 2003 2004 2005 2010 2018 PVs Total Investment Program Investment costs -6,831 -68,505 -89,528 -88,475 -67,412 -30,274 -1,561 -250,266 Fuel costs -14,622 -18,347 -20,118 -34,829 -47,661 -46,924 -45,815 -45,679 -253,774 O&M cost -217 -3,465 -4,317 -4,902 -6,398 -7,478 -7,487 -7,487 -7,487 -44,527 Other costs -5,413 -7,360 -7,983 -8,371 -8,828 -10,710 -10,843 -10,976 -10,976 -72,564 Reduced losses 1,983 7,092 10,597 13,308 15,050 14,419 13,821 11,564 9,047 82,637 Fuel and O&M savings 1,667 5,638 10,379 14,122 22,810 22,411 22,059 20,829 13,545 121,050 Increase willigness to pay 7,601 32,753 41,220 45,096 75,027 102,874 103,070 103,266 103,266 572,469 Improved reliability 188 394 612 799 984 951 920 778 595 5,374 Net benefit -6,831 -62,696 -69,098 -56,314 -27,477 33,542 73,245 74,615 72,159 62,310 160,400 NPV (1000 US$) $160,400 ERR 19.6% I. UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Financial Analysis (Current US$000) Financial Cost and Benefit Flows of the Proposed Components 1998 1999 2000 2001 2002 2003 2004 2005 2010 2018 PVs Pipe Replacement and Valves Kievenergo Investment costs -24,422 -24,669 -24,669 -24,460 -24,283 -84,462 Operational & Maintenance (1% of Tot Inv) -266 -535 -805 -1,071 -1,336 -1,336 -1,347 -1,347 -1,347 -8,370 Reduced thermal losses 1,480 2,974 4,469 5,951 7,422 7,088 6,769 5,605 4,285 39,485 Reduced water losses 545 1,096 1,646 2,192 2,734 2,644 2,556 2,162 1,653 14,899 R&M without the project 1,936 3,891 5,846 7,785 9,710 9,506 9,317 8,391 1,277 51,732 Reliability improvement Net benefit -20,728 -17,244 -13,512 -9,604 -5,754 17,901 17,295 14,810 5,867 13,285 FNPV $13,285 FRR 13.4% Pipe Replacement and Valves KMDHC Investment costs -2,006 -5,320 -5,141 Operational & Maintenance (1% of Tot Inv) -23 -82 -82 -82 -82 -82 -82 -82 -525 Reduced thermal losses 270 694 663 633 605 577 478 365 3,586 Reduced water losses 31 83 81 78 75 73 62 47 449 R&M without the project 164 456 444 432 420 409 358 78 2,390 Reliability improvement Net benefit -1,564 -4,168 1,105 1,060 1,018 977 815 408 758 FNPV $758 FRR 13.3% Rehabilitation of Substations Investment costs -11,125 -14,857 -11,125 -25,413 Operational & Maintenance (2% of Tot Inv) -257 -600 -857 -857 -857 -857 -857 -857 -5,301 Savings in delivered energy 893 2,024 2,855 2,634 2,429 2,241 1,560 903 12,686 Reduced thermal losses 731 1,656 2,336 2,155 1,988 1,833 1,276 739 10,379 Reduced water losses 89 208 297 278 259 242 172 100 1,357 R&M without the project 1,462 3,414 4,876 4,607 4,357 4,123 3,166 813 22,606 Net benefit -8,207 -8,155 -1,618 8,816 8,176 7,582 5,316 1,697 16,314 FNPV $16,314 FRR 27.3% S o Xn UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Financial Analysis (Current US$000) Financial Cost and Benefit Flows of the Proposed Components 1998 1999 2000 2001 2002 2003 2004 2005 2010 2018 PVs Pozniaki Boiler Plant Component Investment costs -5,877 -15,869 -16,668 -19,906 -10,327 -50,989 Operation & Maintenance costs -371 -564 -564 -1,887 -1,887 -1,887 -1,887 -9,021 Fuel Costs -3,935 -5,899 -5,826 -19,263 -19,023 -18,863 -18,863 -90,906 auxiliary electric cost -490 -745 -745 -2,493 -2,493 -2,493 -2,493 -11,921 Increase Sales Revenue 6,848 10,399 10,355 34,667 34,667 34,667 34,667 165,822 Net benefit -5,877 -15,869 -16,668 -17,854 -7,135 3,221 11,025 11,265 11,425 11,425 2,986 FNPV $2,986 FRR 10.7% CT-1 Boiler Plant Rehabilitation & Expansion Investment costs -9,314 -10,755 -6,923 -3,071 -1,646 -21,221 Fuel Costs -6,849 -6,696 -6,546 -6,161 -6,560 -30,873 Auxiliary electricity cost -146 -146 -146 -146 -146 -708 O&M cost -772 -772 -772 -772 -772 -4,124 Increase Sales Revenue 14,182 14,182 14,182 14,182 14,182 68,896 Reduced O&M Costs 4,716 4,845 4,977 5,677 6,787 26,671 Net benefit -9,314 -10,755 -6,923 8,061 9,767 11,695 12,781 13,491 39,016 FNPV (1000 US$) $39,016 FRR 29.4% CT-2 Boiler Plant Rehabilitation & Expansion Investment costs -18,118 -15,600 -15,797 -6,021 -37,475 Fuel Costs -8,220 -8,038 -7,859 -7,404 -6,868 -36,801 Auxiliary electricity cost -243 -243 -243 -243 -243 -1,180 O&M cost -796 -796 -796 -796 -796 -3,868 Increase Sales Revenue 14,632 14,632 14,632 14,632 14,632 71,083 Reduced O&M Costs 4,461 4,583 4,708 5,370 6,420 25,229 Net benefit -18,118 -15,600 -15,797 3,813 10,139 10,442 11,560 13,146 16,988 FNPV (1000 US$) $16,988 pa FRR 15.7% a - ----- o X~~~~~~~~~~~~ UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Financial Analysis (Current US$000) Financial Cost and Benefit Flows of the Proposed Components 1998 1999 2000 2001 2002 2003 2004 2005 2010 2018 PVs TETS 5 Rehabilitation & Expansion Investment costs -8,954 -4,737 -3,821 -3,911 -15,998 Fuel Costs -5,260 -5,195 -5,130 -5,066 -5,003 -4,941 -4,899 -4,899 -34,653 Auxiliary electicity cost -777 -777 -777 -777 -777 -777 -777 -5,372 O&M cost -1,225 -1,225 -1,225 -1,225 -1,225 -1,225 -1,225 -1,225 -8,469 Increase Sales Revenue 8,582 9,041 9,043 9,005 9,005 9,005 9,005 9,005 61,981 Water treatment savings 1,998 1,998 1,998 1,998 1,998 1,998 1,998 1,998 13,812 Net benefit -8,954 -1,420 22 -3 3,934 3,997 4,059 4,101 4,101 11,302 FNPV (1000US$) $11,302 FRR 21.4% TETS 6 Rehabilitation & Expansion Investment costs -13,664 -8,973 -18,034 Fuel Costs -9,468 -9,350 -9,234 -9,119 -9,006 -8,894 -8,819 -8,819 -62,375 Auxiliary electricity cost -1,399 -1,399 -1,399 -1,399 -1,399 -1,399 -1,399 -1,399 -9,669 O&M cost -2,205 -2,205 -2,205 -2,205 -2,205 -2,205 -2,205 -2,205 -15,244 Increase Sales Revenue 15,447 16,274 16,277 16,208 16,208 16,208 16,208 16,208 111,565 Net benefit -13,664 -6,597 3,320 3,439 3,485 3,599 3,711 3,786 3,786 6,244 FNPV (1000 US$) $6,244 FRR 14.9% Center Electric Substation Component Investment costs -1,553 -12,252 -11,537 Production Costs -5,584 -5,721 -5,859 -5,996 -6,134 -6,272 -6,409 -6,547 -6,547 -48,003 Increase Sales Revenue 7267.4 7446.4 7625.4 7804.4 7983.4 8162.4 8341.4 8520.4 8520.4 62476 Net benefit -1,553 -10,568 1,725 1,766 1,808 1,849 1,891 1,932 1,974 1,974 2,936 FNPV (1000 US$) $2,936 t FRR 14.0% to Q- UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Financial Analysis (Current US$000) Financial Cost and Benefit Flows of the Proposed Components 1998 1999 2000 2001 2002 2003 2004 2005 2010 2018 PVs Total Investment Program Investment costs -7,429 -75,161 -95,610 -94,929 -72,543 -33,376 -1,646 -270,269 Fuel costs -14,728 -18,479 -20,263 -35,081 -48,006 -47,263 -46,146 -46,010 -255,609 O&M cost -266 -4,245 -5,289 -6,005 -7,838 -9,161 -9,171 -9,171 -9,171 -54,546 Other costs -5,584 -7,897 -8,525 -8,917 -9,443 -11,329 -11,466 -11,604 -11,604 -76,851 Reduced losses 2,025 7,189 10,755 13,518 15,298 14,657 14,049 11,752 9,187 83,967 Fuel and O&M savings 1,936 6,410 11,741 15,960 26,560 26,140 25,774 24,522 16,278 141,314 Increase sales revenue 7,267 31,475 39,789 43,523 72,366 96,857 97,036 97,215 97,215 541,823 Improved reliability Net benefit -7,429 -69,783 -77,406 -64,937 -34,727 28,487 67,513 68,959 66,568 55,896 109,828 NPV (1000 US$) $109,828 ERR 16.3% ANNEX 11 Page 1 of 7 UKRAINE KIEV DISTRICT HEATING IMPROVEMENT PROJECT Social Assessment I. INTRODUCTION 1. During the appraisal of the project, a social assessment was carried out to appraise the impacts of the lack of adequate heat on residential district heat customers in Kiev. The assessment was based on: (i) structured in-depth interviews and focus group discussions with residential district heat customers and (ii) a survey administered to 365 households in Kiev. The Kiev International Institute of Sociology (KIIS) carried out the survey and provided consultants for assisting in conducting in-depth interviews and focus group discussion. The findings of the assessment are presented below. II. FINDINGS A. GENERAL INDICATORS 2. POPULATION AND TYPE OF RESIDENCE. The vast majority of Kiev's households live in flats in apartment buildings and have district heating. Thus the population on district heating in Kiev is practically identical with the city's population, in general. Only 33% of the households are connected to district heating networks countrywide. 3. DISTRICT HEAT AND HOT WATER SUPPLY. In Kiev, 96% of residential district heat customers receive hot water supply in conjunction with the provision of district heat. Nationwide, only 70% of the households with district heating have hot water in conjunction with district heating. 4. DISTRICT HEATING AND GAS FOR SPACE HEATING. Some of Kiev's households on district heat (6%) have gas connections for space heating in addition to district heating. 5. ELECTRICITY, COLD WATER, CENTRAL SEWERAGE, TELEPHONE. In Kiev, all househoids on district heat have electricity, cold water supply and central sewerage. 77% of these households have telephones. Nationwide, only 61 % of households are connected to the cold water network, 36% have central sewerage and 37% have telephones. 6. HOUSEHOLD SIZE, CHILDREN, LIVING SPACE. In Kiev, households on district heat have, on average, 3.05 members, 1.24 children under 15 years of age and 36 m2 of living space. These indicators are similar to those of Ukraine's population as a whole. 7. OWNERSHIP. In Kiev, 38% of the households on district heat own their flats, 55 % of the flats belong to the state and 5 % to a state agency. By contrast, nationwide, 72% of households own their homes, while 24% of the dwellings belong to the state or a state agency. Of those households in Kiev who own their flats, 26% received it under arrangements with a housing construction cooperative, 56% privatized it and 10% bought it. Of those households ANNEX 1 Page 2 of 7 whose flats belong to the state, 36% plan to privatize their flats. On average, households have been living for about 13 years in their current flats. 69% of the families interviewed were on a waiting list before getting their flats. The families were on the waiting lists for about 10 years, on average. B. DISTRICT HEATING 8. COLD ROOM TEMPERATURE. In general, households considered the temperature in their flats during winter too cold. In 20% of the flats, the temperature was too low, always; in 18% of the flats, frequently; and in 39% of the flats, sometimes. Only in 23% of the flats was it never too cold. Apartments located in building corners tend to be colder than apartments not situated in corners. 9. HEATING INTERRUPTIONS. Heating interruptions, once or several times, were reported by 34% of the households. Most of the interruptions lasted from a few hours to a whole day. In some cases, the interruptions lasted from two days to one week, in other cases they lasted more than a week. 10. DIFFERENCES IN EFFECTIVENESS OF HEATING. 35 % of the households indicate that heating is better in the upper floors of the buildings. 38% of the households indicate that heating is better in some of the rooms in their flat than in others. 11. SUPPLEMENTING DISTRICT HEATING. To improve the room temperature in winter, about 26% of the households supplement district heat by using individual space heaters. In almost all of the cases, households use electric heating equipment. The few households with connections to the gas network for space heating (see No. 3 above) are able to supplement district heating with gas heating when the provision of district heating is unsatisfactory. 12. INSULATION. To make their flats less drafty, a number of households insulate or weather-strip windows (44%) and doors (26%) in their apartments. Poor' and non-poor2 households report this inexpensive procedure of home insulation at similar rates of frequency. Some households also replace windows to make their apartments tighter; however, primarily better-off households can afford this measure. 13. REPLACING RADIATORS. To improve the temperature in their apartments, 22% of the households replaced one or more of their wall radiators. An additional 9% still plan to replace radiators. However, primarily better-off and hardly the poor households can afford this investment. 14. OPENING WINDOWS. In 20% of the cases, it was sometimes too hot in the apartments of the respondents. However, high room temperature was practically never the motive for opening windows in winter. The overwhelming majority of households opens windows in the apartments to get fresh air. Most of the respondents open windows several times per day. On average, they open the windows more than five minutes each time. ' Poor households are defined as the 25% of households with the lowest per capita expenditures. Currently, there is no suitable poverty line available. 2Non-poor households are all households not included in the group of the 25% of households with the lowest per capita expenditures. ANNEX I I Page 3 of 7 15. METERING AND CONSERVING HEAT. 42% of households think it would be better to have a heat meter in each apartment and pay for the heat actually received. However, only 22 % of the households would consume less heat than they are currently consuming, if they paid only for the heat actually received. Two thirds of households would not consider it an improvement if heat meters were installed only at the building level. Furthermore, in about 44% of the cases, households regularly close the curtains in winter to keep their apartment warmer. An additional 19% of the household close curtains when it is very cold. If curtains cover the wall radiators, almost 42% of the households lift the curtains when they are closed to get as much heat as possible. C. HOT WATER 16. QUALITY OF SERVICE. Only in 35% of the apartments hot water comes out immediately when the tap is opened. In 27% of the cases, it comes out after a minute, in 21 % of the cases, after one to five minutes, and in 16% of the cases, it takes more than five minutes. Hot water interruptions are reported by almost all households. 59% of the households indicate that such interruptions occur several times in recent months, 25% indicate, regularly, and 8% say, at least, once. 46% of the households indicate that interruptions are more likely to occur in summer, whereas 53% report interruptions to occur at any time of the year. 34% of the households have problems with hot water pressure. Due to low pressure, many households sometimes have little or no hot water; some households, often; and a few households, always. 17. METERING AND CONSERVING HOT WATER. 39% of the households would like to have a hot water meter in their apartment. However, the vast majority of the households are not willing to pay for the installation of a meter. If they had to make an effort, 40% of the households would be able to save a little of the hot water they consume while 47% indicated they would not be able to conserve anything. If paying only for the hot water really consumed, 35 % of the households indicated that they would consume less than they are actually consuming. D. EXPENDITURE 18. Households on district heat spend most of their total expenditures for food, on average, 63%. For district heating, they spend 6% and for hot water, 4%. For housing and communal services altogether, including the charges for electricity, water, sewerage, gas, telephone (except long distance calls) as well as some other minor services, households spend, on average, 19% of their total expenditures. Together, the charges for district heating and hot water amount to one half of all the charges housing and communal services. E. POVERTY AND EXPENDITURE 19. DIFFERENT STRUCTURE OF EXPENDITURE OF POOR AND NON-POOR HOUSEHOLDS. The structure of expenditure of poor and better-off households is different. Poor households spend considerably more of their total expenditure for food than non-poor households. Also, poor households spend much more of their total expenditure than non-poor households for district heating, hot water, as well as housing and all other communal services. ANNEX 11 Page 4 of 7 20. COMPARISON ACROSS EXPENDITURE GROUPS. Household expenditure shares for housing and communal services as well as food can be compared across expenditure groups obtained by ranking households according to per capita expenditure and dividing them in 4 equally sized segments, or quartiles, as shown in Table 1 below. This comparison shows that the shares of expenditure for district heating, hot water, gas, water and sewerage, housing, electricity and food decrease as the household per capita income increases. In addition, the comparison shows that the households of the bottom quartile spend between 2 and 6 times the share of their total expenditures for different municipal services as the households of the top quartile spend for the same purpose. Table 1: Household Expenditure for Municipal Services and Food as a Percentage of Total Expenditure by Expenditure Qartiles Li Expenditure Categories Quartile 1 Quartile 2 Quartile 3 Quartile 4 1. District Heating 12 8.1 7.0 4.1 3.4 2. Hot Water L2 7.2 4.3 2.9 1.8 3. Housing L2 7.1 3.7 2.3 1.3 4. Electricity 12 4.1 2.3 2 1.6 5. Water and Sewerage 12 3.0 1.8 1.1 0.8 6. Gas L2 1.3 0.7 0.4 0.3 7. Food 71.2 67.0 61.0 54.8 /1 Expenditure quartiles have been established based on ranking household per capita expenditure in ascending order. /2 Discounts and subsidies are deducted. 21. LIMITED MARGIN OF POOR HOUSEHOLDS FOR COPING WITH INSUFFICIENT PROVISION OF DISTRICT HEATING AND HOT WATER. In-depth interviews and focus group discussions with local consultants and households in Kiev showed that the poor have practically no margin for coping with insufficient provision of district heating and hot water. Data on household expenditure obtained from the survey carried out during the appraisal mission helps to explain this finding, as shown in Table 2 below. In this table, shares of non-food expenditures and expenditure shares for housing and communal services altogether can be compared across expenditure groups. The subtraction of the expenditure shares for housing and communal services from shares of non-food expenditures in line 3 of the table produces a negative value for quartile 1. Considering that total household expenditure is composed of food and non-food expenditure, this value means that the poorest 25 % of the households on district heat would have to reduce their expenditure for food if they fully and timely paid all the charges for housing and communal services. Table 2: Household Expenditure for Non-Food Items and Municipal Services altogether as a Percentage of Total Expenditure by Expenditure Qartiles Expenditure Categories Quartile 1 Quartile 2 Quartile 3 Quartile 4 1. Non-Food Items 28.8 33.0 39.0 45.2 2. All Municipal Services Ll 31.1 20.6 14.0 10.7 3. (1) - (2) -2.3 12.4 24.9 34.5 LI Includes: district heating, hot water, electricity, water and sewerage, gas, telephone (except long distance calls) as well as some other minor services. ANNEX I I Page 5 of 7 22. PAYMENT OF RESIDENTIAL CONSUMERS FOR HOUSING AND COMMUNAL SERVICES. In Kiev, 44% of the households owe for housing and communal services, and on average, they owe 4.45 monthly payments. When they pay, they pay for 1.37 months, on average. More poor households than non-poor households owe for housing and communal services, and, in addition, they owe larger amounts. Only very few households with debts for housing and communal services have entered into a formal arrangement with their zheks for paying these debts in installments over a mutually agreed period of time. The vast majority of households would not pay on time for housing and comnmunal services, even if they were fined or cut off from service. Similarly, almost all households are not willing to pay 20% more for district heating and hot water if the service would improve. (A 20% tariff increase for heat and hot water is expected to be implemented in Kiev around mid-1997 to allow for full cost recovery from residential consumers.) The vast majority (90%) of the respondents with debts for housing and communal services indicate they don't pay on time because they don't have enough money. F. DISCOUNTS 23. In Kiev, nearly 32% of the households receive discounts for housing and communal services, including electricity. In almost 90% of the cases, the discounts amount to 50% of the regular tariff. 13% of the households get 25% discounts, while some households get 75% or 100% discounts. In 75% of the cases, these discounts apply for all household members, otherwise, only for single members of the household. G. SUBSIDIES FOR LOW-INCOME HOUSEHOLDS 24. The subsidy program is practically known to all households in Kiev, and all households surveyed know where and how to apply. About 28 % of the households receive the subsidy, whereas 3 % of the applications have been rejected. 29% of the households surveyed believe that they are not eligible; some indicate that their debts for housing and communal services prevented them from applying (3 %); others did not apply because they did not want to get registered as unemployed (6%); 13% of the households still plan to apply; and 12% do not plan to apply for different reasons. On average, the subsidy per beneficiary household amounts to 34 Hryvnias. 25. BENEFICIARY SATISFACTION. Largely, households did not complain about the administrative procedures for applying to the subsidy, and the performance of the officials processing the applications. The majority of the respondents qualified the attitude of the civil servants processing the applications as "normal." 10% of the respondents thought the personnel processing applications were polite and considerate whereas 26% rated their attitude rather negatively. Minor complaints were that lines in the subsidy offices were long and that the applicants had to come several times. 26. LEAKAGE AND LACK OF COVERAGE. The effectiveness of the program is constrained by serious flaws. First, the system has a substantial leakage: 24% of the households receiving the subsidy do not deserve it because their expenditure for housing and communal services, including electricity, would not exceed 15% of their total expenditure per month if they would not receive the subsidy. Second, the subsidy program has insufficient coverage: 54% of the households not receiving the subsidy, would deserve it, because they ANNEX I I Page 6 of 7 have to pay more than 15% of their total expenditure for housing and communal services. Most of these households are poor. 36% of the households unduly not receiving the subsidy, think they are not eligible. 43% of the same segment of households observe unfriendly attitudes of the personnel processing subsidy applications. 27. DEFICIENT MEANS-TESTING. The insufficient coverage and the substantial leakage of the subsidy program reveal that the means-testing carried out by the local government to target the subsidy to poor households is not working satisfactorily. 28. LACK OF FINANCIAL TRANSFERS TO MUNICIPAL SERVICE PROVIDERS. In spite of the above constraints to its effectiveness, the subsidy program works for the residential population in so far as beneficiary households in fact pay less for housing and communal services. However, the program hardly works for the providers of communal services, like Kievenergo, because the city makes available only a small part of the financial resources to be transferred to the latter for approved subsidies. Furthermore, Kievenergo does not know what share of the funds to be transferred by the zheks are charges paid by households for heat and hot water, and what proportion of the funds to be transferred are financial resources for approved subsidies because, currently, subsidies are approved globally for housing and communal services including electricity and are not prorated to the different services provided and deducted from the respective charges at the level of each residential customer. In Kiev, the providers of communal services received in 1996 only 35% of the funds to be transferred to them for approved subsidies. The city's failure of transferring financial resources to local utilities for approved subsidies puts at risk the Government's policy of fully recovering costs for the provision of communal services. III. CONCLUSIONS AND RECOMMENDATIONS 29. To protect poor and vulnerable households against hardships in cold winters, a reliable provision of district heating and hot water at satisfactory levels of quality is needed. Poor households suffer more than better-off households from insufficient heating levels because their financial margin for coping with this deficiency is limited. 30. The fact that 36% of the households unduly not receiving the subsidy believe that they are not eligible (see No 26 above) may suggest that these households are not appropriately informed about the subsidy program although they very well know that the program exists (see No 24 above). To enable households to better assess their eligibility for the subsidy, the local government in Kiev should enhance its public information and communication strategy regarding the subsidy program. In addition, the city should facilitate for its residents a suitable service for consultations on the program. This service could be used, at the same time, as a means of systematically obtaining feedback from households on issues of program implementation. Establishing a telephone line in each city district for questions and answers of citizens regarding the subsidy could be a suitable option to better inform the public and get feedback from residents. 31. The fact that 43% of the households unduly not receiving the subsidy observe unfriendly attitudes of the personnel processing subsidy applications (see No 26 above) may suggest that these attitudes, to some extent, restrain households from applying for the subsidy. ANNEX I I Page 7 of 7 To overcome this obstacle, the local government in Kiev should provide training and guidance in dealing with customers to its personnel in charge of processing subsidy applications. 32. To improve coverage and reduce leakage of the subsidy program for low- income households, the local government in Kiev should redesign the methods applied for means-testing. The current ineffective methodology used should be replaced by a suitable proxy means test. This methodolgy, first implemented in Chile in the late 1970s and 1980s, then applied in many other countries, and recently also experimentally used in Volgograd, Russia, with technical assistance of the World Bank, uses a formula of weighted variables consisting of information on household characteristics which is easy to collect and verify and allows to satisfactorily predict income. Such characteristics are frequently variables such as number of children in the family, number of elderly, location in rural or urban areas, number of unemployed household members, whether the household owns a refrigerator or a car etc. The formula used in proxy means testing has to be developed based on suitable data on household expenditure and characteristics. The household surveys carried out in Ukraine in 1995 and 1996 (and further refined for surveying Kiev households) have generated a database suitable for developing a scoring formula for means testing in Ukraine. 33. The transfer of funds for approved subsidies from the city should be addressed by Kievenergo in the frame of reference of a suitable strategy for beneficiary participation. The objective of this strategy would be to: (i) regularly inform customers and the public in general on achievements and issues regarding the provision of heat and hot water and (ii) obtain feed-back from customers on quality and reliability of service provision. In the context of this strategy, residential customers and the public should be periodically informed regarding Kievenergo's efforts of obtaining funds due for approved subsidies. In particular, the information provided to beneficiaries and the public should include details on the implications of the lack of these funds for satisfactorily providing heating and hot water to households. Also in the context of this strategy, residential customers and the public should be informed regarding the zheks' regular failure of passing on to Kievenergo all funds collected from households for communal services. Simultaneously, Kievenergo should inform on the implications of the lack of these funds for satisfactorily providing heating and hot water to residential customers. JOINT STOCK COMPANY KIEVENERGO ORGANIZATIONAL CHART , Company, Founder "Minenergo" of UkraineZ Supervisory Auditng Council I Committee Chairman of the Board First VP for Economics Technical and Supervisory and SupervisoryIndepender t Subsidiar es | Cc hief |LEconomic; VP of Capita VP of TETS VP of TETS 6 VP of KTS VP of KKS VP of District VP of Department General Construction Heating Electrical Account.ant Head Problems Problems Director of Labor Director of Director of Reviewer L Safety Dept. Personnel Dept. Property Dept. Technical Adverbsing Production Serc -conoi Gneral Cptl Labor Pesne et fDept. Office Head of he Ac inDervce Constpruction Safety D epar Valuable Department su b iSol Dept. Service Corporation of Foreign Civil and Papeps Efeecnmconmctve Financian he ll Fue and producffon ndeaFinancialstFueland FiTeecDicstrictuElingsrandl robemic |SDept. Transportation Protection Heating System -[Jt and l Service Special Security Service Service NOTE: The operating management ComrclFte of independent subsidiaries is Dept. performed In thie following manner: in D Development the economic activies by 1 st VP in the Dept. production area by the 1 st VP of Electic Buildings and Technical Problems. Supervsion Structures and Service Marketing Independent Subsidiaries Total Number of Economic andt EtEr [Director TS E Manager VDrco Diretr of Director K Director of D retro Dicorf DirEcTorj IDfrectorTSEI MPE | I(KERE | | KDHCE CE TETS_ | CE TETS6 TE KEAE Total Number of Economic and Social Services - 84 People at JV: 165 Technical and Production Services - 71 Other - 10 KIEV COMMUNAL DISTRICT HEATING COMPANY, KDHC (KIEVZHILTEPLOKOMMUNENERGO) | Director General Deputy I Directors Chief Engineer General conc Producton Deputy Crief Problems Engineer u Maintenance Producton and Heating Districts Personnel Dept. n Supply Dept. Accounng l Dept. - ~Tprchnical Dept. 1D S quipmEm Cotn Repair I AdjustmenW or |ATranisportation |e5odci n - forCnstrtio Seviept Heain ReDisrit | SascDept. { |Dprmn 1,2,3,4, 5 Enamel Coating| MAP SECTION IBRD 28701 S~~ S&6 ~tkYUA A >' }U, Sea~ RUSSIAN UKRAINE Z BELARUS r FEDERATION E POLAND KYIV DISTRICT HEATING IMPROVEMENT PROJECT ''CZECH- KYIV DISTRICT HEATING SYSTEM IN THE YEAR 2000 >RE -'SL Y -' '? '''4 -USTRIA NR MOLDOVA PS6 KILOMETERS KE APRIL 1 997