ECUADOR NATIONAL TRANSMISSION SYSTEM STRENGTHENING PROGRAM LOAN PROPOSAL PUBLIC SIMULTANEOUS DISCLOSURE

Transcription

1 PUBLIC SIMULTANEOUS DISCLOSURE DOCUMENT OF THE INTER-AMERICAN DEVELOPMENT BANK ECUADOR NATIONAL TRANSMISSION SYSTEM STRENGTHENING PROGRAM (EC-L1117) LOAN PROPOSAL This document was prepared by the project team consisting of Jesús Tejeda (ENE/CEC), Project Team Leader; Arnaldo Vieira de Carvalho (INE/ENE), Project Team Co-leader; Carlos Hinestrosa (INE/ENE); Carlos J. Echevarría (ENE/CPE); Paola Méndez (INE/ENE); Juan Carlos Páez (INE/ESG); Rafael Poveda (CAN/CEC); Gumersindo Velázquez (FMP/CEC); Patricio Crausaz (FMP/CEC); Mónica Lugo (LEG/SGO); under the supervision of Alejandro Melandri, Interim Chief of the Energy Division (INE/ENE) and Morgan Doyle, Representative in Ecuador (CAN/CEC). This document is being released to the public and distributed to the Bank s Board of Executive Directors simultaneously. This document has not been approved by the Board. Should the board approve the document with amendments, a revised version will be made available to the public, thus superseding and replacing the original version.

2 CONTENTS PROJECT SUMMARY I. DESCRIPTION AND RESULTS MONITORING... 1 A. Background, current situation, and proposal... 1 B. Objectives, components, and costs... 9 C. Results Matrix II. FINANCING STRUCTURE AND MAIN RISKS A. Financing instruments B. Environmental and social safeguard risks and associated mitigation measures C. Fiduciary risk D. Execution risks E. Other special considerations and risks III. SUMMARY OF IMPLEMENTATION MEASURES A. Execution arrangements and period B. Summary of arrangements for results monitoring and evaluation... 15

3 - ii - ANNEXES Annex I Annex II Annex III Summary Development Effectiveness Matrix (DEM) Results Matrix Fiduciary Agreements and Requirements ELECTRONIC LINKS REQUIRED 1. Annual work plan (AWP) 2. Monitoring and Evaluation Plan (M&E) 3. Complete Procurement Plan 4. Environmental and Social Management Report OPTIONAL 5. Technical and environmental studies and specifications for electric works Technical, economic, and financial evaluation 7. Projected cash flow for the program 8. Midterm evaluation of loan 2457/OC-EC 9. Program rationale under the Public Utilities Policy (document GN ) Piura Peru-Ecuador Extra High Voltage International Interconnection Agreement Terms of reference for the final evaluation of the program Paul L. Joskow, Patterns of Transmission Investment Master Plan for Electrification of Ecuador CONELEC Plan Nacional del Buen Vivir

4 - iii - ABBREVIATIONS AWP Annual work plan CEA Andean Electric Corridor CELEC EP Corporación Eléctrica del Ecuador [Ecuador Power Corporation] CENACE National Energy Control Center CONELEC National Electricity Board EIA Environmental impact assessment EIRR Economic internal rate of return ESMP Environmental and Social Management Plan GDP Gross domestic product IIS Integrated information system km Kilometers kv Kilovolts LOEP Ley Orgánica de Empresas Públicas [Organic Law on Public Enterprises] LPG Liquefied petroleum gas LRSE Law on the Power Sector Regime MC-09 Mandato Constituyente [Constituent Assembly Legislative Decree] 09 MC-15 Mandato Constituyente [Constituent Assembly Legislative Decree] 15 of 2008 MEER Ministry of Electricity and Renewable Energy MEM Wholesale Electricity Market MF Ministry of Finance MVA Megavolt-ampere MVAR Megavolt-ampere reactive MW Megawatts MWh Megawatt hour NPV Net present value PDU Power distribution utilities PET Transmission Expansion Plan PME Master Plan for Electrification of Ecuador PMU Program Management Unit PNBV Programa Nacional del Buen Vivir [ Good Life National Program] SINEA Andean Electric Interconnection System SNI National Interconnected System SNT National Electric Transmission System System kv Transmission System

5 PROJECT SUMMARY ECUADOR NATIONAL TRANSMISSION SYSTEM STRENGTHENING PROGRAM (EC-L1117) Financial Terms and Conditions Borrower: Republic of Ecuador Flexible Financing Facility* Amortization period: 25 years Executing agency: Corporación Eléctrica del Ecuador (CELEC EP) Weighted Average Life: years** Disbursement period: 5 years Source Amount (US$) Grace period: 13 years** IDB - Ordinary Capital 150,000,000 Inspection and supervision fee: *** Local contribution 19,500,000 Interest rate: LIBOR-based Total 169,500,000 Credit fee: *** Currency: U.S. dollars charged to the Ordinary Capital Program at a Glance Program objective and description: To help improve the operating conditions of the National Transmission System (SNT) and ensure the supply of high-quality energy to consumption centers, nationally and regionally. The specific objectives are: (i) to strengthen the 230 kv and 138 kv systems of the SNT; (ii) to increase the reliability of the SNT; and (iii) to contribute to regional Extra High Voltage energy integration, as part of the Andean Electric Corridor Special contractual conditions precedent to the first disbursement: (i) signing and entry into effect of a subsidiary agreement between the Ministry of Finance and the executing agency establishing the obligation to use the funds in accordance with the terms and purposes agreed in the loan contract (paragraph 3.1); (ii) the executing agency s establishment of the Program Management Unit (PMU), comprising a general coordinator, a procurement specialist, a financial specialist, an environmental specialist, an electrical engineer, and a computer engineer, as agreed with the IDB (paragraph 3.1); (iii) establishment by the executing agency of a short list for hiring an external firm to audit the program s financial statements and preparation of the corresponding terms of reference, approved by the IDB (paragraph 3.1); and (iv) presentation of an updated version of the program operating manual, duly approved by CELEC EP, and its entry into effect with the IDB s no objection (paragraph 3.5). Special contractual conditions for execution: Before starting the works covered in component I, the executing agency will present, to the Bank s satisfaction, evidence of: (i) the permits and licenses required under Ecuadorian law for constructing the projects under the program (paragraph 3.6); (ii) the Environmental Impact Assessment (EIA) and the Environmental and Social Management Plan (ESMP), together with the budget for their execution (paragraph 2.4); (iii) the corresponding environmental license (paragraph 2.4); (iv) the resolution reserving rights-of-way for the new transmission lines (paragraph 2.4); (v) legal ownership of the land where the substations will be located (paragraph 2.4); (vi) inclusion of the required environmental technical specifications and the ESMP in the contracts for construction and supervision of the planned works (paragraph 2.4); and (vii) evidence that at least one public consultation has been held for each project, including: (a) project description; (b) description of probable impacts; (c) description of measures for mitigating the impacts identified (ESMP); (d) description of the system for receiving and processing complaints and claims; and (e) arrangements for receiving suggestions concerning the proposed project or its ESMP (paragraph 2.4). Retroactive financing and recognition of expenditures: The Bank may provide retroactive financing, charged to the loan proceeds, and recognize expenditures, charged to the local contribution, up to an amount equivalent to 20% of the loan or the local contribution, respectively, for eligible expenditures incurred prior to the loan approval date related to preinvestment studies for the program, provided that such expenditures meet requirements substantially similar to those established in the loan contract (paragraph 3.2). Exceptions to Bank policies: None Project qualifies as: SEQ [ ] PTI [ ] Sector [ ] Geographic [ ] Headcount [ ] * ** ** Under the Flexible Financing Facility (FN-655-1), the borrower has the option of requesting changes to the amortization schedule and currency and interest rate conversions. When considering such requests, the Bank will take operational and risk management considerations into account. The original weighted average life of the loan and the grace period may be shorter, depending on the effective signature date of the loan contract. The credit fee and inspection and supervision fee will be established periodically by the Board of Executive Directors as part of its review of the Bank s lending charges, in accordance with the applicable policies.

6 I. DESCRIPTION AND RESULTS MONITORING A. Background, current situation, and proposal 1.1 Background. Ecuador is pursuing a development model, the guidelines of which were set forth in the 2008 Constitution and reflected in the Plan Nacional del Buen Vivir [ Good Life National Plan ] (PNBV). That model calls for strengthening the role of the State as a driver of the economy and as a provider of public goods and services, in particular infrastructure, health, and education. 1.2 With the reforms introduced by the government, the Republic of Ecuador recorded average annual growth rates of 4.6% between 2008 and 2012, and the nonoil economy 1 averaged rates of 4.8%. This growth reduced the poverty level from 29.5% in 2011 to 23.7% in Over that same time the Gini index, which measures degrees of inequality, declined from to During the first quarter of 2013, the Central Bank reported GDP growth of close to 3.5%. In this context, investments in the energy sector are defined in accordance with the guidelines in the PNBV and the Master Plan for Electrification (PME), aimed at achieving efficient, sustainable, and sovereign development. 1.3 Planning for the sector as laid out in the PME is based on the projection of demand for electric power. That planning considers not only population and consumption growth trends but also the projected new power demands resulting from mining projects, the Pacific Refinery, the National Efficient Cooking Program, the Petroamazonas Project for Optimizing Power Generation and Energy Efficiency, the national program for changing the country s energy matrix, electrically powered public transit (the Quito Metro and the Cuenca Tranvía), and the initiative for regional energy integration. The PME calls for developing the system to ensure that sufficient energy reserves are available to satisfy national demand, to optimize operating costs through international connections, and to guarantee Ecuador s capacity to contribute to the regional power market. To achieve these goals, the PME cites as critical elements reliability, quality, and security in the generation, transmission, and distribution of electric power. 1.4 The PME projects the demand for electricity using a base scenario that correlates macroeconomic, 2 demographic as well as energy and customer variables to determine the expected trend of demand to the year As a result, it estimates average annual growth of 5% between 2012 and 2022, reaching 26,542 gigawatthours at the end of that period. This corresponds to a maximum generating capacity of 4,723 megawatts (MW) for meeting demand in A more optimistic scenario, which assumes full development of the strategic projects planned for 1 2 Nonoil GDP represents approximately 87% of total GDP. The PME makes reference to a decline in the growth rate of the national economy, which affects the industrial, residential, and commercial demand projections in which GDP was used as an explanatory variable. As a result, average growth is estimated at 3.7% ( ), below the historic average growth rate of 4.7% ( ).

7 - 2 - coming years (paragraph 1.3), implies growth exceeding 8%, equivalent to 6,864 MW at the end of that same period. 1.5 Electric power infrastructure. In 2013, Ecuador s power system had an installed generating capacity of 4,543 MW, of which hydroelectric generation accounted for 2,255 MW and thermal generation for 2,287 MW. There are new hydropower projects now under construction, for an additional capacity of 4,165 MW. Eight of those projects, equivalent to 2,362 MW, are regarded by the government as flagship projects. The flagship hydropower projects located in the Amazon basin and on the Pacific coast are expected to come on stream beginning in At the present time, the National Electric Transmission System (SNT) has 1,841 km of 230 kv 4 transmission lines and 1,718 km of 138 kv lines. 5 The transmission lines are arranged in a 230 kv trunk ring with double circuit lines interconnecting 10 substations and linking the Paute hydroelectric plant, the country s largest generating plant, with the two most important consumption centers of Guayaquil and Quito, as well as the rest of the country. The SNT also has 138 kv radial transmission lines fed from the trunk ring to link power generation centers with consumption centers. To meet the additional energy requirements of the power distribution utilities (PDU), there are approximately 115 km of circuits operating at 69 kv. 6 As part of the existing transmission infrastructure, the country has international connection lines, and these helped to alleviate the country s power crisis during In 2003, 212 km of 230 kv transmission lines came on-stream with Colombia, and in 2008 construction of a second line of the same caliber enabled the transfer of up to 500 MW. In 2004 the interconnection with Peru came online, with construction of 107 km of 230 kv transmission lines. This circuit allows the noncontinuous transfer of up to 100 MW between the two countries. 1.7 Legal framework for the power sector. Legislation governing the power sector in Ecuador is based on the 2008 Constitution, the Constituent Mandate 15 (MC-15), the Law on the Power Sector Regime (LRSE 7 ) as amended (Law ), the Organic Law on Public Enterprises (LOEP) of 2009, 8 and Executive Decree 220 of 2010, creating the Empresa Pública Estratégica Corporación Eléctrica del Ecuador [Ecuador Power Corporation] (CELEC EP). The LRSE establishes the regulatory framework for the power sector and creates the Electric Transmission Company, The amounts of public and private investment needed to carry out the generation expansion plan are US$6,011,662 and US$1,071,837, respectively. Master Plan for Electrification ,285 km of double circuit and 556 km of single circuit. 625 km of double circuit and 1,093 km of single circuit. The Galapagos Islands are operated as an isolated system of the National Interconnected System. The LRSE and MC-15 set the rules for the sector. Other related provisions include Resolution 173, in which the Ministry of Environment grants CONELEC accreditation as the responsible environmental authority; and CONELEC regulation 003/06, specifying those power transmission lines that require environmental impact assessments. The LRSE sets objectives for power generation, transmission and distribution. The LOEP regulates aspects concerning the establishment and management of public enterprises, including the strategic sectors.

8 - 3 - Transelectric S.A. Transelectric S.A. began operations in 1999 with the disappearance of the Ecuadorian Electrification Institute (INECEL). In 2009, the generating companies of Ecuador and Transelectric were merged, and in 2010 CELEC EP was officially created. Transelectric became a business unit of CELEC EP, called CELEC EP-Transelectric (hereinafter Transelectric). 1.8 Institutional framework of the power sector. The agency responsible for power sector policy is the Ministry of Electricity and Renewable Energy (MEER). The National Electricity Board (CONELEC) is responsible for regulation and control of the power supply and planning for the sector, subject to the National Development Plan and the policies of the MEER. The transmission function is concentrated in Transelectric, with the basic objective of transporting electric power and ensuring free access to the transmission networks for agents in the Wholesale Electricity Market (MEM). 9 Distribution and marketing of electric power is handled through 10 majority publicly-owned PDUs. 10,11 Technical and financial transactions on the MEM are administered by the National Energy Control Center (CENACE). 1.9 MC-15 requires CONELEC to establish a single rate 12 which the PDUs must apply for each type of consumer. The transmission rate approved in takes into account the costs of operation and maintenance, service quality and social and environmental management as approved by CONELEC, recognizing that the planned investment amounts are covered as established in MC This rate 15 is applied to distributors and large-scale consumers in recognition of the use of the transmission lines, transformer substations, and other elements that comprise the SNT. All the PDUs are covered by trust funds administered by specialized institutions in the local banking system: Banco de Guayaquil and Banco del Pichincha, privately owned, and the publicly owned Banco del Pacífico. The revenues of each of the PDUs, including the offset for the reduced power rate ( tarifa dignidad ) from the government, go into the respective trust funds to guarantee the payments associated with the provision of service, in the order of The MEM consists of generators, distributors, and large-scale consumers. Responsibility for providing generation, transmission, and distribution services as well as the marketing, import, and export of electric power lies with the CELEC EP and other firms authorized by law to perform such functions. The Corporación Nacional de Electricidad (CNEL) has 10 business units and distributes power to 1.3 million customers (36% of the customer market in Ecuador). Other utility firms, serving 1.7 million customers (46% of the customer market), are Empresa Eléctrica de Quito S.A., Unidad Eléctrica de Guayaquil, Empresa Eléctrica Regional Centro Sur C.A., Empresa Eléctrica Azogues S.A., and Empresa Eléctrica Riobamba S.A. According MC-15, the single rate that the PDUs must apply reflects operating and maintenance costs. Pursuant to CONELEC Resolution 0107/08 of 12 August As of 2008, under MC-15 the government reserves the right to administer, regulate, control, and manage the sector and provides that investments in generation, transmission, and distribution are to be financed from the general government budget, eliminating the investment component from the power rate. The transmission rate applicable in 2013 is US$1.77 per kw month of maximum demand (CONELEC, Resolution 008/2013).

9 - 4 - priority established by the MEER: (i) international interconnections; (ii) generators using renewable energies under CONELEC regulation 004/11; (iii) generation exceeding 50 MW; (iv) payment to the PDUs for operation and maintenance; and (v) transmission service, etc Knowledge of the sector. As part of the strategy for addressing the challenges facing the SNT (paragraph 1.3), the government is financing the Transmission Expansion Plan (PET). The Support for the Transmission Program (loan 2457/OC-EC), financed by the IDB in the amount of US$64.7 million, is part of the PET investment plan being executed by CELEC EP through Transelectric. Loan 2457/OC-EC began execution in 2011, and its objectives include improving electricity service conditions, minimizing the risks of interruptions in electricity supply in the different areas of the National Interconnected System (SNI), and improving the capacity for managing the transmission service of CELEC EP and Transelectric. As of the first quarter of 2014, loan 2457/OC-EC had been 91% disbursed, with 100% of the resources committed, and a level of execution of close to 65% 16 for the agreed activities. The last disbursement is planned for February The results achieved with the PET investments in recent years include: (i) construction of 146 km of 230 kv transmission lines and 143 km of 138 kv transmission lines; (ii) the rehabilitation, expansion, and construction of nine substations; and (iii) the increase in the reserve capacity by 1,104 MVA to satisfy new demand of 60,105 MWh per month. These works have helped reduce loadability in the Loja substation and the Cuenca-Loja Cumbaratza transmission line, bringing them within the parameters established by CONELEC regulation 004/ On this basis, the SNT has an additional reserve capacity to meet demand in the provinces of Loja and Zamora Chinchipe. The works at the Esmeraldas and Quinindé substations will boost their reserve capacity, ensuring that demand can be met in accordance with current regulations. 18 The investments made under loan 2457/OC-EC in the country s northern zone will improve efficiency in the transport of high energy flows as a result of the requirements of the zone itself and of the 138 kv corridor under conditions of maximum power transfer from Colombia, when the Agoyán and Pucará power plants are offline. This will increase the levels of reliability of the northern zone of the national grid, the Quito PDU, and the power exchanges with the Colombian system. The Inga substation will provide a new feed point from the SNT to the Quito PDU, allowing it to meet the needs of the new Quito airport and the northeastern zone of the province of Pichincha, as well as to connect the Coca Codo Sinclair 19 and Quijos power plants to the SNI Component I, for expansion of the transmission network, has a level of execution of 65.7%. Reactive Power Transactions in the MEM, which establishes the permitted SNT bus voltage variation limits in the 138 kv lines at 0.93 p.u. and 1.05 p.u. Idem.

10 Loan 2457/OC-EC is financing training for members of the 13 business units of CELEC EP in project management, the procurement of an integrated information system (IIS), 20 and implementation of the Enterprise Resource Planning (ERP) system. The Ecuadorian government has also used fiscal resources to promote the adoption of better organizational practices in CELEC EP. During 2013, with the agreement of the Strategic Sectors Coordinating Ministry (MICSE) and the MEER, the international consulting firm of Pricewaterhouse Coopers AG Ltda. (PWC) was hired to conduct a study on a comprehensive upgrade of the management and operations model and improvement of the efficiency of power sector firms in Ecuador. As a result of phase 1 of that study, completed in October 2013, a number of organizational and technological projects have been undertaken with a view to improving corporate management and enhancing the efficiency of the power sector. The report on the financial audits of loan 2457/OC-EC, conducted by Deloitte & Touche S.A., indicates satisfactory financial execution by CELEC EP Current situation. The growth in demand for electric power in Ecuador has outstripped supply, leading to an annual deficit that is estimated at more than 100 MW. In 2012, annual energy demand was 6.1% greater than in Current reserve margins are high, but they are not available on a permanent basis because of the great variation in hydrology between the rainy and dry seasons, fuel storage capacity, and the periodic maintenance requirements of the power plants. The PME s high-growth scenario for power demand estimates that additional generating capacity of approximately 232 MW will be needed on average each year in order to meet demand to the year 2022, together with a robust, reliable transmission system, with expanded capacity to take up the energy from the generating projects now under construction. The main weaknesses that the SNT faces are closely linked to the country s energy security and the system s operating security 22 : (i) flexibility for operating efficiently at times of minimum demand in the binational interconnections; (ii) boosting capacity in substations that have been operating for more than 30 years, thus making it possible to meet demand from the PDUs; (iii) the need to expand the 138 kv sub-transmission system to alleviate saturation at high consumption points; (iv) low capacity of 230 kv transmission for serving distribution points; (v) saturation of feeders through rising demand, which entails building new power delivery points from the SNT in order to improve the quality of service and offer sufficient capacity; (vi) increasing the 500 kv transformer capacity so that energy from the new generating projects can be transferred with lower electricity losses The IIS has been used to acquire 770 additional light IFS licenses for use of Corporate Phase II, Maintenance Modules and Projects; 330 full IFS licenses for use of the IFS phase II system. Loan 2457/OC-EC Report, DOCNUM= The regulations Dispatch and Operation Procedures (006/00), Reactive Power Transactions in the MEM (004/02), and Quality of Power Transport and Connection Service in the SNI (003/08) establish the quality, security, and reliability parameters that must be observed by the transmitter and all other MEM agents.

11 In response to these requirements, the government has several hydroelectric projects under construction (paragraph 1.5), of which around 2,362 MW will come on stream gradually beginning in Under loan 2457/OC-EC, CELEC EP is undertaking additional works in the SNT, including 230 kv, 138 kv, and 69 kv transmission lines as well as modernization and renovation of substations and subtransmission lines more than 30 years old (paragraph 1.10). Currently, construction is under way on approximately 600 km of Ecuador s first 500 kv extra high voltage (EHV) transmission system (System 500) needed to bring the energy from the Coca Codo Sinclair hydroelectric plant into the SNT, which will connect the Inga substation in Quito with the Chorrillo substation in Guayaquil System 500 is a key part of the government strategy for meeting the increased demand for electric power, and will make it possible to proceed with development of the Andean Electric Corridor (CEA) as part of the Andean Electric Interconnection System (SINEA 24 ), which is planned as an EHV system. The SINEA initiative had its origins in the Galapagos Declaration signed by the governments of Bolivia, Chile, Colombia, Ecuador, and Peru on 2 April 2011 at a meeting in Galapagos, Ecuador. During that meeting, ministers and senior officials of the power sector agreed on the importance of the benefits that would flow from electrical interconnection in the region, as a fundamental step for the economic integration and development of participating countries Proposal. According to the PME, construction of the PET will require approximately US$95 million a year, without considering the budget for the projects in execution since In order to comply with the provisions of Constituent Mandate 09 (MC-09) and MC-15, and taking into account the experience and outcomes achieved through loan 2457/OC-EC, the government considers it appropriate to continue with the same financing scheme, through the National Transmission System Strengthening Program (the program), with a view to meeting the financing needs described in the PME and the specifications of the SNT. 25 This will make it possible to connect the planned new loads (paragraph 1.3) and to structure a robust system for incorporating System 500, which is seen as the backbone of the CEA. In this way, the program will ensure an adequate supply of electricity to meet the demand that will be generated by the initiative to migrate from liquefied petroleum gas (LPG) to electricity for residential customers, and it will facilitate progress with the binational project to build the first EHV segment between Ecuador and Peru, pursuant to recent progress made in the negotiations included under the Piura Agreement System 500 will cut across a large portion of the country and will come online in two stages, in 2015 and The IDB is supporting the SINEA initiative through regional technical-cooperation project RG-T2056. The reliability of the transmission system plays a key role in the investment decision, above and beyond the standard economic criteria.. Paul L. Jaskow, Patterns of Transmission Investment. MIT. IDBDOCS- # Joskow Transmission Investment. Piura Agreement construction of the 500 kv Peru-Ecuador EHV line.

12 The country s strategy. Ecuador has a power sector strategy defined by the guiding documents, the PNBV and the PME. In line with the Bank s Public Utilities Policy (document GN ), the sector is consistent 27 with the core principles of supporting basic needs, transparency, financial sustainability, and adequate institutional organization, in that it has clearly defined the following: (i) separation of the roles of the MEER, as the policy body, the CONELEC, as the regulatory body, and the transmission and distribution companies; (ii) the structure of the sector, which allows private sector participation in generation 28 and distribution; and (iii) reform of the state-owned companies to improve their management and sustainability based on rates that cover operation and maintenance, and on government contributions that will guarantee expansion of the sector. The program to expand and improve the SNT is also aligned with the objectives of the Bank s Public Utilities Policy for promoting universal and sustainable access for electricity service through power rates, and improving the public utility companies ability to provide efficient service Alignment with the IDB strategy with Ecuador. The Country Strategy Update with Ecuador (document GN ) considers that Bank engagement in the sector will support the country in its effort to create a sustainable energy strategy, one that will facilitate an adequate supply of energy, help to diversify the country s generating capacity, improve the system s reliability, promote energy efficiency, and expand coverage of electricity service. More specifically, the program will support achievement of the objectives in the country strategy by promoting: (i) energy diversification through greater delivery of energy from renewable sources; (ii) energy efficiency in the transmission stage, contributing to improving the reliability of service; and (iii) reduction of electricity losses. 29 The program is also aligned with the priority areas of the Bank s Infrastructure Strategy: Sustainable Infrastructure for Competitiveness and Inclusive Growth (document GN ), in that it will: (i) promote access to infrastructure services through the financing of works in the SNT that will ensure the interconnection of power from strategic projects (paragraph 1.3); and (ii) improve quality of life by providing a robust power system that, over the medium term, will see LPG replaced by electricity for residential customers The IDB is currently supporting the Ecuadorian power sector through the following operations: Support for the Transmission Program (loan 2457/OC-EC), Modernization of Pumping Stations on the Emerald-Quito Multiproduct Pipeline (loan 2472/OC-EC), and the Electrification Program for Rural and Marginal Urban Rationale for the program under the Public Utilities Policy, document GN , DOCNUM= Private participation is allowed when public enterprises do not have the capacity to meet demand or when necessary and appropriate for serving the public, community, or general interest. In this case, CONELEC Regulation 002/11 requires power generation with nonconventional renewable energies. Electricity losses are currently running at 12.7%. They are expected to fall to 7.5% by 2022 (PME ).

13 - 8 - Areas (loan 2608/OC-EC), which now have disbursement levels 30 of 91%, 98%, and 98%, respectively. In addition, at the end of 2013, the second stage of the Electrification Program for Rural and Marginal Urban Areas (loan 3087/OC-EC) was approved. Overall, these operations, pursued in the context of the strategic programs for the sector Electrification Plan for Rural and Marginal Urban Areas (FERUM), Plan for Reducing Electricity Losses (PlanRep) and Plan for Improving the Distribution Network (PMD) have contributed to: (i) expanding the distribution network to provide greater electricity coverage (95.4%); (ii) reducing total electricity losses by approximately 25% on average nationwide, to 12.74% over the last five years; and (iii) improving the system s technical service quality indices (AIFI from to and AIDI from to ) over the last two years. The sound execution performance of IDB-supported operations in the sector has provided some lessons that could be considered good practices, such as: (i) preparing projects and their execution instruments in close collaboration with the executing agencies, from the design stage onward; (ii) selecting projects for financing that are prioritized in sector policy documents; (iii) continuous technical and management strengthening of executing agencies as part of government objectives; and (iv) continuous interaction between the IDB team and the project management units, to facilitate understanding of the IDB s procurement and monitoring procedures The Bank is also supporting the sector in initiatives relating to energy diversification, through the use of nonconventional renewable energies, energy efficiency, regional power integration, reduction of electricity losses in distribution, operation of smart networks, and sustainable electrification in isolated rural areas, through a number of technical cooperation projects: ATN/MC EC, GRT/FM-1384-EC, ATN/OC EC, ATN/ME EC, ATN/OC RG, 32 and ATN/KK EC Consistency with the Ninth General Capital Increase (GCI-9). This operation is aligned with the priorities for the lending program established in the GCI-9 (document AB-2764): (i) lending to small and vulnerable countries; (ii) lending to support climate change initiatives, renewable energy and environmental sustainability; and (iii) lending to support regional cooperation and integration by strengthening the transmission system with Colombia, improving the reliability of the transmission system as a transition to System 500, and supporting the design of the EHV power interconnection with Peru. The expected outcomes of the program will contribute to the following outputs in the GCI-9 results framework: (i) kilometers of new transmission lines installed or upgraded; (ii) number of cross Disbursement status as of December AIFI: Average Interruption Frequency Index (per nominal installed kva); AIDI: Average Interruption Duration Index (per nominal installed kva). Support for Andean Electrical Interconnection Studies. Analysis and recommendations for the successful implementation of the Smart Grid Program in Ecuador. Pending IDB approval.

14 - 9 - border or transnational projects supported; and (iii) contribution to regional development goals relating to stabilization of CO 2 emissions through adequate transfer and dispatch of energy from renewable sources. B. Objectives, components, and costs 1.22 The general objective of the program is to help improve the operating conditions of the SNT and ensure the supply of high-quality energy to consumption centers, nationally and regionally. The specific objectives are: (i) to strengthen the 230 kv and 138 kv systems of the SNT; (ii) to increase the reliability ratings of the SNT; and (iii) to contribute to regional EHV energy integration, as part of the CEA. The program includes two components: 1.23 Component I. Expansion and strengthening to improve transmission capacity and quality of the SNT (US$162 million). This component accounts for 96.6% of program resources, and includes preinvestment studies and the construction of four new transmission systems, as well as the expansion of two existing systems: (i) Santo Domingo-Esmeraldas transmission system, with 163 km of transmission lines (230-kV), and substations of 230/138 kv; (ii) Tabacundo transmission system with 25 km of transmission lines (230-kV and 138-kV) and 230/138-kV and 230/69-kV substations; (iii) Durán transmission system with 10 km of transmission lines (230-kV) and a 230/69-kV substation; (iv) Concordia-Pedernales transmission system with 95 km of transmission lines (230-kV) and two substations of 138/69 kv; (v) transmission system for the expansion of substations: 138/69 kv and the increase of capacitive power by 30-MVAR; and (vi) transmission system for improving the Esclusas substations with capacitors of 2x60 MVAR. These works are part of the PET in the Northern, Tabacundo, and Riombamba; the Southern zone, Yanacocha; the Southwestern zone, Durán, as well as the interconnection of the Santo Domingo-Esmeraldas and Pedernales-La Concordia segment. These works will boost hydroelectric generation in the provinces of Santo Domingo, Esmeraldas, and Guayas while reducing generation needs at the Esmeraldas and Trinitaria thermal power plants, meeting the growing needs of the southern and northern regional PDUs, strengthening the interconnection with Colombia through the Tabacundo substation, relieving congestion on the Milagro- Dos Cerritos-Pascuales 230-kV power corridor, and improving the voltage profiles and power supply capacity of the SNT bus bars in the province of Manabí Component II. Final design for development of the EHV Electrical Interconnection Infrastructure with Peru (US$5.6 million). With reference to the electrical integration infrastructure planning study 34 financed under the SINEA, entry into service of a 500 kv transmission line between Ecuador and Peru will produce a significant coupling of marginal costs in the two countries. The study shows that the benefits derived from the time this line enters into service will average US$94.0 million annually over the period , US$165.0 million 34 Study financed through technical cooperation project RG-T2056. Planning Report. AF-Mercados, SIGLA, August 2013.

15 annually between 2021, and 2025, and up to US$172.0 million annually from 2026 to The total approximate cost of this interconnection would be US$210 million, and with a rate of return of 12% and 30 years of useful life, its annual cost would be around US$26 million. Comparing this value with the total savings to be obtained, the interconnection clearly makes economic sense. On the basis of these results, 3.3% of program resources will be used in this component to finance final designs and development of environmental specifications for the EHV system, including: 35 geographic location of the project, topography, soil mechanics, layout of roads and existing infrastructure, design criteria, configuration of the proposed system, costs, climate, access areas, applicable standards and regulations, equipment specifications, works, time schedule, and telecommunication and control systems Cost and financing. The estimated cost of the program is US$169.5 million, of which US$150 million will be financed by the IDB and US$19.5 million recognized as the local counterpart contribution (see Table 1). COMPONENTS Table 1. Program costs (US$ thousands) FINANCING IDB COUNTERPART * TOTAL Component I. Expansion and strengthening to improve transmission capacity and quality of the SNT 145,000 17, ,400 Santo Domingo-Esmeraldas transmission system 58,035 6,964 64,999 Tabacundo transmission system 29,286 3,514 32,800 Durán transmission system 12,388 1,486 13,874 Concordia-Pedernales 138/69 kv, 66 MVA transmission system 25,782 3,094 28,876 Expansion projects 19,509 2,342 21,851 Component II. Final design for development of the EHV electrical interconnection infrastructure with Peru 5, ,600 Program administration 0.0 1,500 1,500 Program monitoring and supervision Program management unit (PMU) Midterm and final program evaluations External audits Contingencies TOTAL 150,000 19, ,500 * Amount to be contributed by CELEC EP C. Results Matrix 1.26 The program has a results matrix showing outcome indicators and targets associated with its objectives and components. The indicators selected for the 35 The specific scope will be defined in the terms of reference for the final designs to be prepared.

16 overall outcomes are: (i) reserve transmission capacity (MVA) for meeting demand in the SNI; (ii) average maximum loadability in transmission lines and substations; and (iii) incremental demand met from new installations associated with the program (MWh per month). In addition, the thermal generation displaced will be measured as will the reduction in electricity losses. The results and targets have been formulated and projected for five years ( ) (see Annex II, Results Matrix). 36 A. Financing instruments II. FINANCING STRUCTURE AND MAIN RISKS 2.1 The program will be financed as a specific investment loan. The funds will be disbursed over a period of five years, starting on the loan contract s effective date: Table 2. Disbursement schedule (US$ millions) Source Year 1 Year 2 Year3 Year 4 Year 5 Total IDB Counterpart Cumulative Economic and financial analysis. The economic evaluation of component I identified the type of impact on electricity service of the various works included in the component, grouping them into 10 projects. The economic rate of return was calculated for each of the proposed projects. Starting with a technical analysis of demand, load flow, and simulations of load dispatch in the national grid, projections were obtained as needed to estimate the annual costs and benefits associated with each project over the period The results for recent years were extrapolated over the remaining useful life of the assets, estimated at 40 years. The economic return was evaluated at market prices and at efficiency prices, using shadow price relationships. The economic evaluation of the program at efficiency prices indicates an economic internal rate of return (EIRR) of 28.1% and a net present value (NPV) of net benefits to the country, discounted at 12%, of US$194.1 million. The sensitivity analysis shows that, under adverse changes on the order of 15% in the main parameters used in the evaluation, the program s EIRR is still above 12%. The evaluation of the program s financial impact took into account additional revenues from transporting greater amounts of electricity and replacing thermal generation, resulting in an IRR of 15.3% and an NPV of US$29.9 million. The analysis for component II yields an NPV of US$428 million, a cost recovery period of three years, and an IRR of 34%. 36 The indicators, their baselines, and target values have been analyzed and agreed with CELEC EP. These indicators will be used for monitoring and evaluation of the program, with the support of Transelectric.

17 B. Environmental and social safeguard risks and associated mitigation measures 2.3 The program will have positive impacts by improving the reliability and quality of the country s electricity supply, reducing losses, and transferring the greater volume of energy generated. Any potential adverse social and environmental impact would arise primarily during the construction phase 37 for the new substations and transmission lines, and to a lesser extent during operation. 38 There is not expected to be any involuntary resettlement or economic displacement of people. The impacts will be moderate and easy to handle through standard procedures. 39 Consistent with the Bank s Environment and Safeguards Compliance Policy (Operational Policy OP-703), the program was classified as a category B operation. Because of its characteristics, the program is also subject to Operational Policies OP-704 scenario I and OP-765, 40 and these have been considered in the Environmental and Social Management Plan (ESMP). 2.4 With respect to the social and environmental risks, in addition to observing the operating conditions established for this purpose, the executing agency will present to the Bank s satisfaction, before beginning construction on any of the works: (i) the Environmental Impact Assessment and the ESMP, together with the budget for their execution; (ii) the corresponding environmental license; (iii) the resolution reserving rights-of-way for the new transmission lines; (iv) evidence of legal ownership of the land where the substations are to be located; (v) inclusion of the required environmental technical specifications and the ESMP in the contracts for construction and supervision of the planned works; and (vi) evidence that at least one public consultation has been held for each project, including: (a) project description; (b) description of probable impacts; (c) description of measures for mitigating the identified impacts (ESMP); (d) description of the system for receiving and processing complaints and claims; and (e) arrangements for receiving suggestions concerning the proposed project or its ESMP. The Bank will supervise the environmental and social aspects of the works financed on a semiannual basis, including visits at the beginning of the works and upon their acceptance These include: (i) the impact on air quality through the uncontrolled emission of particulate matter into the atmosphere as a result of construction work on the transmission lines and substations; (ii) noise generated in the vicinity of works through the operation of construction machinery and equipment and the installation of towers, in particular; (iii) generation of liquid, solid, and gaseous wastes; and (iv) increased risk of accidents due to the presence of machinery, faulty disposal of debris or materials, or lack of work signage. These include: (i) changes in land use along the route of the transmission lines and at substation sites; (ii) depreciated economic value of adjacent properties due to restricted use for other activities; (iii) nonionizing radiation emissions in the direct zones of influence of the power transmission networks; and (iv) generation of common and hazardous wastes through maintenance work, especially on the transformers. The Environmental and Social Management Report (IDBDOCS ) presents an analysis of the main potential impacts, as well as the measures for mitigating them. Operational Policy OP-704, Disaster Risk Management Policy; Operational Policy OP-765, Indigenous Peoples Policy.

18 C. Fiduciary risk 2.5 The evaluation of the fiduciary capacity of CELEC EP and its Transelectric business unit showed that the executing agency has sufficient capacity to carry out the planning, financial management, and procurement activities for the program. No significant fiduciary risks were identified. D. Execution risks 2.6 Program management risks. Risks identified relate to events that could cause delays during execution: (i) timely transfer of program funds from the Ministry of Finance (MF) to the executing agency; (ii) changes in the PMU and its full-time dedication to the program; and (iii) the capacity to prepare bidding processes for complex works. To mitigate these risks, as a condition precedent to the first disbursement, a suitable mechanism will be agreed for transferring program funds from the MF to the executing agency s consolidated account and for ensuring that those funds are used in accordance with the terms and purposes established in the loan contract. Furthermore, in setting up the PMU, the executing agency will confirm full-time dedication of the team assigned to program execution and the profile of the team will be agreed upon in order to mitigate risks in the preparation of complex bidding processes. 2.7 Procurement risks. The potential risks lie in the capacity of executing agency personnel to follow IDB procurement policies properly. Although good procurement practices were evident during implementation of loan 2457/OC-EC, potential personnel turnover within the organization may pose the need for further training. To mitigate this risk, every effort will be made to retain the PMU personnel who have been successfully executing loan 2457/OC-EC, or to select new personnel in accordance with the profile of each position, as well as to provide ongoing training to the PMU on Bank procurement policies. 2.8 Political risk. This risk relates to the possibility of changes in the decision to pursue regional electrical integration. The integration initiative is spelled out in the PME, which places special emphasis on the electrical interconnection with Peru. This risk is not expected to affect component II of the program. Moreover, the inclusion of support for designing the EHV interconnection infrastructure with Peru will facilitate monitoring of the bilateral negotiations and the final agreements for the future construction of the EHV line with Peru. E. Other special considerations and risks 2.9 Technical and economic viability. 41 The technical viability of these projects is ensured by the preparation of designs and the construction approval process. The designs of program projects are prepared in accordance with current technical, regulatory, social, and environmental specifications in the sector. This process will help to mitigate risks associated with social objections in the areas of influence of 41 Technical, economic, and financial evaluation, DOCNUM=