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1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No: MD Public Disclosure Authorized Public Disclosure Authorized PROJECT PAPER ON A PROPOSED ADDITIONAL FINANCING CREDIT IN THE AMOUNT OF SDR 6.7 MILLION (US$ 10 MILLION EQUIVALENT) TO THE THE REPUBLIC OF MOLDOVA FOR THE ENERGY I1 PROJECT December 23,2008 Public Disclosure Authorized Sustainable Development Department Ukraine, Belarus and Moldova Country Unit Europe and Central Asia Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS (Exchange Rate Effective November 30,, 2008) Currency Unit = Moldova Leu MDL10.39 = US$1 US$1.49 = SDR 1 FISCAL YEAR January 1 - December 31 CDCF CFU EMP EO1 GPN IDA IP MEPIU PDO PREM SDN SDR SIDA SPN UNDB ABBREVIATIONS AND ACRONYMS Community Development Carbon Fund Carbon Finance Unit Environmental Management Plan Expressions of Interest General Procurement Notice International Development Association Implementation Progress Moldova Energy Projects Implementation Unit Project Development Objective Poverty Reduction and Economic Management Network Sustainable Development Network Special Drawing Rights Swedish International Development Cooperation Agency Specific Procurement Notice United Nations Development Business Vice President: Country Director: Country Manager Sector Director: Task Team Leader: Shigeo Katsu Martin Raiser Melanie Marlett Peter Thomson Doina Visa

3 MOLDOVA ENERGY. ADDITIONAL FINANCING CONTENTS Page. Introduction... 1 I I1. Background and Rationale for Additional Financing in the amount of $10 million equivalent... 1 I11. Proposed Changes... 2 IV Consistency with CAS or CPS... 3 V Appraisal of Restructured or Scaled-up Project Activities... 4 General... 4 Technical... 4 Fiduciary... 5 Procurement... 5 Financial Management and Disbursement... 6 Environmental... 7 VI. Expected Outcomes... 7 VI1 Benefits and Risks... 7 Critical risks during project implementation... 8 VI11. Financial Terms And Conditions For The Additional Financing. 8

4 Project Paper Data Sheet Date: December 23,2008 Country: Republic of Moldova Project Name: Energy I1 Additional Financing Project ID: P Team Leader:Doina Visa Sector DirectodManager: Peter Thompson Country Director: Martin Raiser Environmental Category: B FY Annual Cumulative 23.O o Does the scaled-up or restructured project trigger any new safeguard policies? No For Additional Financing [ ] Loan [ XI Credit [ ] Grant For Loans/Credits/Grants: Total Bank financing (US$m.): SDR 6.7 million (US$lO.O million equivalent) Proposed terms: Standard IDA terms (40 years maturity, including 10 years grace period) Financing Plan (US$m.) Source 1 Local I Foreign I Total Borrower IBRD/IDA SIDA Total o o 11.0

5 I. Introduction 1. This Project Paper seeks the approval of the Executive Directors to provide an additional credit in an amount of SDR 6.7 million (US$lO.O million equivalent) to the Republic of Moldova for the scale-up of the heating component of the Energy I1 Project (P040558, IDA Credit MD). 2. The project development objective will not change. The proposed additional credit would help finance the costs associated with scaled-up activities to enhance the impact of the heating component of this well-performing project. Performance monitoring indicators have been revised to reflect the scale-up of the original project. 18 additional public institutions in 10 rayons/administrative units, including hospitals and educational buildings (schools and kindergartens) and social assistance centers have been proposed to be financed through Additional Financing. The Closing Date of the proposed Additional Financing is December 3 1, The Swedish International Development Cooperation Agency (SIDA) has expressed interest to provide Additional Financing, as they did during the implementation of the heating component of the original Project. It is expected that SIDA will finance technical assistance for preparation of technical specifications and technical supervision. SIDA has indicated that it could provide a grant of US$l.O million. SIDA is also assessing the request of the Government of Republic of Moldova to finance the improvement of the heating systems for two additional hospitals. SIDA intends to channel the investment funds through the Bank if this request is approved by SIDA. 11. Background and Rationale for Additional Financing in the amount of US$10 million equivalent 4. The original credit for the Moldova Energy I1 Project in the amount of SDR 25.7 million (US$35.0 million equivalent) was approved by the Board of Executive Directors on November 25, 2003, and became effective on March 2,2004. The project s original objectives were to: (a) improve the security and reliability of the electricity transmission system and wholesale electricity supply and facilitate unimpeded commercial operation of the power system and (b) improve the availability, quality and efficiency of heating in selected buildings. The original project comprises four components: (i) electricity system upgrade (Part A); (ii) heating supply and efficiency improvement (Part B); (iii) technical assistance for project implementation and energy sector reforms (Part C); and (iv) project management and administration (Part D). The project objectives and design have not changed, but the scale-up will be focused on the heating component (Part B) and development objective (b). 5. The original heating component was completed in September It has been highly visible and effective, not only due to its energy efficiency effect, which helps mitigate the impact of rising energy prices, but it has also had positive social welfare benefits. Before the project, most of the buildings were not heated, or were underheated, or partially heated only during the coldest period of the year by temporary electric space heaters. Now the entire buildings are heated to comfortable temperatures. As a result of the project 35 institutions (including schools, hospitals, kindergartens, orphanages) and 3 7 residential buildings now have heat availability 1

6 during the entire winter heating season (more than 120 days a year, compared to the baseline of 0-30 days per year). It is estimated that improved heating has benefitted 8,399 students, approximately 1 million patients/staff/visitors, and 2,132 families whose apartment buildings were connected to new boilers. Buildings with heating improvements financed by the Energy I1 Project were heated to 21 C throughout the 2006/2007 and 2007/2008 heating seasons. 6. Implementation progress (IP) and Project Development Objective (PDO) ratings for the project have been satisfactory for over two years. The audit reports for the project accounts have always been unqualified (clean). The audits for Moldelectrica (the electricity transmission company) have been qualified, but an action plan for improvement has been agreed and procurement of a consultant to do a re-valuation of Moldelectrica s assets is underway with SIDA financing. According to the audit for the year ending December 3 1,2007, Moldelectrica is meeting all of the financial covenants under the project; all other legal covenants are also being met. The project has not had any environmental, social or other safeguard problems. An environmental supervision of the original project was completed in September 2008 and found that the EMP was being complied with and that there was no need to revise the EMP for the additional financing. 7. Rationale. Based on the positive experience of the heating component of the original project, the Government requested additional financing to scale up the impact and development effectiveness of the project. Moldova tops the list prepared jointly by the Bank s PREM and SDN of the most vulnerable countries to food and energy price increases. Financing additional improvements in supply and distribution of heat and demand side measures for heat and hot water consumption in selected public buildings would mitigate the adverse impact of energy price increases on vulnerable groups. 8. The project team has considered several possible approaches for financing the project, including a new operation or a repeater operation. Processing this as a new operation is not proposed in the interest of maximizing cost effectiveness and timeliness in processing, so that the additional financing can complement the ongoing activities. A credit provided under an Additional Financing arrangement in accordance with OP would leverage use of the Borrower s existing implementation capacity and utilize existing implementation arrangements for the original project. Moldova is currently receiving carbon benefits from the Carbon Finance Unit (CFU) agreement with Community Development Carbon Fund (CDCF) established under the Moldova Energy Conservation and Emission Reduction Project, and the new investments under the Additional Financing could qualify for a similar arrangement Proposed Changes 9. Supported activities. The additional financing would scale up the second component of the Project (Part B) by improving the heating supply for around 18 additional public institutions located throughout the country (in 10 rayons /administrative units), including hospitals, educational buildings (schools and kindergartens) and social assistance centers. The Ministry of Economy and Trade through the Steering Committee established to follow the Energy I1 project implementation has prepared an indicative list of additional buildings based on requests received during the original project (204 proposals received from District Councils and Rayons). The list approved on October 17, 2008 includes investments in public buildings 2

7 estimated at around EUR 7.2 million. The selection of the institutions has been done using the selection criteria agreed with the Bank during the preparation of the Energy 11 Project, and prioritized based on the communities needs. The final list of investments will be established during project implementation based on the actual cost determined during the procurement process. 10. PDO. The project development objective will not change. The Additional Financing will scale up the component B of the Energy I1 project, and the Results Framework has been revised to reflect the new targets. The Key Performance Indicators have been revisited to reflect also the social impact of the project, and to be easy to be measured. New indicators have been introduced to measure the social impact: number of students and teachers benefiting from heated educational facilities and number of hospital staff and visitors (including patients) benefiting from heated medical spaces during the winter. 11. Project Management component. An additional US$0.45 million equivalent will be allocated for the additional Project Management cost incurred by MEPIU. This funding will cover expenses such as additional audit, technical assistance, salaries, office equipment, communications and banking charges. 12. Implementation period. The implementation of the proposed activities will last beyond the Closing Date of the original Energy I1 project (December 3 1,2009). The Closing Date of the proposed Additional Financing is December 3 1, The procurement and disbursement plans were agreed at Negotiations and placed in the Project Files. 13. Implementation entity. The current institutional arrangements will continue to be used for the implementation of the activities under the Additional Financing. 14. Financing plan. The proceeds of the additional financing will cover the costs related to the investments in the rehabilitation of the heating systems of the agreed public buildings, consultancy services (including audit services), and the incremental operating costs incurred by the PIU. SIDA will cover the expenses for the engineering and supervision of the investments in the selected heating systems. IV. Consistency with CAS or CPS 15. The Country Assistance Strategy (CAS) approved by the Board on December 14, 2004, was designed in alignment with the priorities of the Government of Moldova s Economic Growth and Poverty Reduction Strategy Paper. The CAS emphasizes the need for sustainable economic growth and poverty reduction by (a) promoting conditions for sustaining growth and employment creation; (b) improving access to social capital and services, and community infrastructure; and (c) improving public sector governance and combating corruption. Interventions at the local community level are recommended due to the high concentration of poverty in the rural areas and small cities. The additional activities will contribute to the CAS objectives and proposed approaches. 3

8 16. The Country Partnership Strategy (CPS) for is scheduled to be discussed at the Board on January 29,2009. The aim of this CPS will be to deepen and sustain the gains made during the last four years while applying greater selectivity and working more intensely in those areas critical for achieving key development results. The additional activities will also contribute to meeting the new CPS objectives. 17. The Energy I1 Additional Financing will improve the education and health conditions as well as the quality of social services by ensuring heat and hot water to selected public buildings for at least 120 days during the winter time. More efficient heating systems will contribute to energy savings by modernizing the obsolete existing heating system, and will lead to better results of the educational and medical services (increase in student attendance at the schools, and acceptable conditions in the hospitals). V. Appraisal of Restructured or Scaled-up Project Activities General 18. The proposed scaling up of the heating component of the Energy I1 project will increase the number of schools, kindergartens, hospitals, and social centers with adequate heating in small cities. Selected local public authorities as mentioned in the project s Procurement Plan will be the beneficiaries and executing agencies of the project. Investments in the heating systems of the local public authorities would be owned and operated by the local administration through their heating organizations or through other municipal balance sheets. Heating organizations are typically established as Municipal Enterprises owned by the local administration, and based on assets transferred to the municipalities from the former state owned centralized Termocomenergo enterprise. Allocation of Financing Proceeds Category (1) Goods, consultants services, incremental operating costs for the Project TOTAL AMOUNT Amount of the Financing Allocated (expressed in SDR) 6,700,000 6,700,000 Percentage of Expenditures to be Financed (inclusive of Taxes) 100% Technical and Economical 19. The heating component of the Energy I1 Project has been designed to support the transition of the heating sector to a more economic, local heating supply and more efficient use of energy. The physical deterioration of the central district heating caused by increasing and 4

9 unaffordable operating costs and by poor management has led to a very poor quality of heating services. Many apartments have been disconnected from the central district heating, worsening the situation and leading to a further increase of the heat bill for those who remain connected. Hospitals, schools, kindergartens and other public buildings have suffered from this situation, and heat and hot water availability have become scarce. The Consultancy company hired to assist the MEPIU in the implementation of the original heating component of the Energy I1 project has evaluated from technical and economical aspects the requests for the inclusion of public buildings in the project issued by the local communities, and recommended to the project Steering Committee a list of buildings for their final selection. Most of the heating systems of the selected public buildings, including the boiler plants are over 40 years old and are in an extremely poor condition, leading to frequent breakdowns and increased operation and maintenance costs. The success of the implementation of the heating component of the Energy I1 project has motivated the GOM to request on June 16, 2008, an additional US$lO million to scale up this component. The technical solutions will take into account the specific situation of each investment and will improve the efficiency of heat generation, distribution network and supply equipment. Boiler efficiency will be over 92 % (depending on boiler model and load), the heat distribution pipes will be pre-insulated, and leak detectors and automatic control of the heating system based on the outside temperatures will be installed. Inside the public buildings the radiators will have thermostats to adjust the heat supply. Some nearby residential buildings may also be connected to the new boiler plants for the public buildings. All boiler plants to be installed will use gas for heat generation, The more efficient and clean energy production will also reduce the NOx and C02 emissions. The owners of the public buildings included in the project will earn money for reducing the C02 emissions by participating in the Carbon Fund market. Fiduciary Procurement 20. The MEPIU project team has obtained sufficient experience in implementing the ongoing Energy I1 Project. The procurement specialist who has implemented the earlier credit will continue to work on this additional credit. Procurement for the proposed additional credit will be carried out in accordance with the World Bank "Guidelines: Procurement under IBRD Loans and IDA Credits" dated May 2004 and revised in October 2006, and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" dated May 2004, and revised in October 2006 in addition to the provisions stipulated in the Development Credit Agreement 21 The General Procurement Notice (GPN) was published by MEPIU in the United Nations Development Business (UNDB) and in the Bank's dgmarket in December The GPN described in general terms the list of potential goods, works and consulting services contracts to be procured under the project and invited all potential suppliers, contractors and consultants to express interest and request additional information from the MEPIU. Invitations to pre-qualify or to bid, shall be advertised as Specific Procurement Notices (SPNs) for International Competitive Bidding (ICB) procurement packages and Expressions of Interest (EOI) for consulting assignments estimated to cost more than US$200,000 equivalent per contract will be published in UNDB (on-line), in dgmarket and a national newspaper of broad circulation as the 5

10 corresponding bid documents become available. In addition, the Procurement Plan (including all formal updates), SPNs and EOIs for all contracts as well as results of contract awards will be published on the external website of the MEPIU and the World Bank. Other post and prior review thresholds are indicated in the procurement plan. Financial Management and Disbursement 22. The financial management functions of the additional financing will be handled by the Moldova Energy Projects Implementation Unit (MEPIU) in a similar manner to the existing arrangements in place under the Energy I1 project. The audit of the Additional Financing Project financial statements will be combined with the main project audit, will be conducted by independent private auditors acceptable to the Bank, on terms of reference acceptable to the Bank. The existing audit TORS will be expanded to cover the additional financing. The annual audited project financial statements will be submitted to the Bank within six months of the end of each fiscal year. The existing formats of the IFRs will be used and supplemented with additional financing funding source and the Project will prepare a full set of IFRs every quarter throughout the life of the project and will submit them to the Bank within 45 days after the end of each calendar quarter. 23. FM arrangements of existing project. The financial management arrangements of the Energy I1 Project have been reviewed periodically as part of project supervision. According to the financial management supervision carried out in March 2008 the project FM arrangements have been found Moderately Satisfactory (MS), with several minor recommendations made which were subsequently implemented: monitoring of budget information in IFRs, improving data back-up system, and following disbursement rules in order to avoid reductionshejections of withdrawal applications. The latest 2007 audit was performed for the project financial statements and Moldelectrica entity financial statements. The auditor gave an unqualified (clean) opinion on the project financial statements, and qualified-exception opinion for Moldelectrica entity financial statements and provided several internal control issues in the management letter. The entity was advised that in collaboration with MEPIU and Ministry of Economy and Trade, an update of the existing action plan to address the above mentioned qualifications and management letter issues should be drafted (the previous action plan acceptable to the Bank was developed by Moldelectrica management and approved by Ministry of Industry in 2007, and certain actions were initiated but not yet finalized). 24. Disbursements. Loan proceeds will be disbursed using the same procedures as the original project, either as direct payments, or through advances to a designated account (DA) to be opened in an acceptable financial institution, which will be replenished under the transactional disbursement procedures. Withdrawal applications documenting the advances of the DA will be sent to the Bank quarterly. All replenishments for transactions above the prior-review threshold will be fully documented, as stated in the Disbursement Letter. Expenditures below the prior review limit will be disbursed based on Statement of Expenditures. Supporting documentation for such transactions including completion reports, goods received notes and acceptance certificates, will be retained by the MEPIU and made available to the Bank during project supervision. Details on the ceiling of the Designated Account and Minimum Application size are provided for in the Disbursement Letter. 6

11 25. Procedures to be used under additional financing project. Currently, the procedures manuals developed for the Project, including FM manual, are acceptable to the Bank. The FM manual is periodically revised by MEPIU. As part of the preparation of additional financing, the following action plan was agreed with the client and has been completed satisfactorily: Reauired actions 2 management letter issues by Moldelectrica Revise the FM manual to reflect particularities of additional financing, including IFRs formats and audit TORS By Whom Moldelectrica jointly with MEPIU and Ministry of Economy and Trade MEPIU financial By When by November 30, Negotiations condition by November 30,2008. Negotiations condition Environmental 26. The only safeguard policy that applies to this project is Environmental Assessment. Generally it is expected that the project will have no appreciable adverse environmental impacts, but instead will have environmental benefits associated with the replacement of the old boiler equipment with more environmentally-benign ones which have higher energy efficiency, resulting also in lower emissions and reduction of fuel consumption. The Borrower prepared an Environmental Management Plan for the initial phase of Energy I1 project which is also relevant for the project additional financing. A special assessment of institutional and human capacities for environmental safeguards as well as to identify how the Environmental Management Plan (EMF) is being implemented, identifying problems in this regard was conducted in September, It was concluded: (a) the EMP was implemented successfully; (b) there is no need for its revision and/or updating the EMP for the proposed Additional Financing; and (c) the existing human and institutional capacities to ensure EMP implementation are adequate. VI. Expected Outcomes 27 The project indicators reflect the activities performed under the Additional Financing. The number of buildings which will be efficiently heated with modern equipment at least 120 days per year will increase with about 50 additional buildings through the Additional Financing added to the existing 170 buildings heated under the Energy I1 Project. Two new indicators have been added to reflect the social benefits of the project: number of students and hospital patients who will have adequately heated facilities for education and for their health improvement. VII. Benefits and Risks 28. Cumulative benefits from the additional activities will be the increase of the quality of educational, medical, and social services by increasing the number of public buildingdsquare 7

12 meters heated more than 120 days over the winter. Students, patients, and public employees will be the direct beneficiaries of the project, as well as the local communities which will benefit from the efficient models of how the heating systems could be modernized. Critical risks during project implementation 29. Overall the project implementation risks are moderate. The implementation risks are the following: (i) Project implementation delays due to improper project management; (ii) Inadequate maintenance of the buildings and heat production and delivery systems; and (iii) Absence of the co-financing agreement with SIDA. Risks (i) and (ii) were included in the PAD of Energy I1 Project, while risk (iii) was not perceived as such at the time when the PAD was prepared. The mitigation measures for the above-mentioned risks are: (i) Although the implementation teams established in each locality to supervise the selected contractor for the rehabilitation of the heating systems of the selected public buildings may not have the managerial skills to effectively follow up the implementation of the contracted activities, the. consultancy company hired to supervise the investment projects, and the MEPIU staff will back up the local implementation teams, and measures to mitigate the risks of delays during the implementation of the investments will be agreed and followed up; (ii) The Ministry of Finance has verified the financial situation of each local authority before including the specific public buildings in the approved list, therefore adequate budgets should be available; (iii) SIDA is in the process of approving the request of the Government for financing the Technical Assistance for the investment component implementation. By end December 2008 bidding documents are expected to be prepared for the first procurement packages. Moreover, having the Grant Agreement with SIDA signed is one of the Conditions for the Effectiveness of the Project. VIII. Financial Terms And Conditions For The Additional Financing 30. The Additional Financing will be provided on standard IDA terms (40 years maturity, 10 years grace). 8