Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: 59603-MK

PROJECT PAPER

ON A

PROPOSED ADDITIONAL LOAN

IN THE AMOUNT OF EURO 14 MILLION

TO AD MEPSO

WITH THE GUARANTEE OF THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA FOR

THE ENERGY COMMUNITY OF SOUTH EAST EUROPE PROGRAM FYR MACEDONIA COMPONENT – AD MEPSO PROJECT

MARCH 9, 2011

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.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective March 7, 2011)

Currency Unit = Denar (MKD) MKD 43.9 = US$1

MKD 1 = .00228 US$ US$1 = .715 €

FISCAL YEAR

January 1 – December 31

ABBREVIATIONS AND ACRONYMS AF Additional Financing APL Adaptable Program Loan CPS Country Partnership Strategy EAFD Environmental Assessment Framework Document EC European Commission ECSEE Energy Community of South East Europe EIA Environmental Impact Assessment ELEM Macedonian Power Generation Company EMP Environmental Management Plan ENTSO-E European Network of Transmission System Operators for Electricity ESIA Environmental and Social Impact Assessment EU European Union GWh Giga Watt hours ICB International Competitive Bidding IFI International Financing Institutions kV Kilovolt kWh Kilowatt hours MEPSO Macedonian Power Transmission System Operator MK Former Yugoslav Republic of Macedonia MKD Macedonian Denars OHTL Overhead Transmission Line OPGW Optical Ground Wire PAD Project Appraisal Document PIU Project Implementation Unit

Vice President: Philippe Le Houerou Country Director: Jane Armitage Country Manager Lilia Burunciuc Sector Manager: Ranjit Lamech

Task Team Leader: Peter Johansen

MACEDONIA, Former Yugoslav Republic Of Additional financing for ECSEE Program

CONTENTS

Project Paper Data Sheet Project Paper

Page I. Introduction ............................................................................................................. 1

II. Background and Rationale for Additional Financing. ............................................ 1

III. Proposed Changes ................................................................................................... 3

IV. Appraisal Summary ................................................................................................ 5 Annexes

1. Revised Results Framework and Monitoring Indicators

2. Operational Risk Assessment Framework

3. Description and Technical Assessment of the Stip – Serbian Border Overhead Transmission Line

MACEDONIA, FORMER YUGOSLAV REPUBLIC OF ENERGY COMMUNITY OF SOUTH EAST EUROPE PROGRAM

ADDITIONAL FINANCING FOR THE FYR MACEDONIA COMPONENT – AD MEPSO PROJECT

ADDITIONAL FINANCING DATA SHEET

Basic Information - Additional Financing (AF)

Country Director: Jane Armitage Sector Manager/Director: Ranjit J. Lamech Team Leader: Peter Johansen

Sectors: Power (100%) Themes: Infrastructure services for private

sector development (67%); Regional integration (33%)

Project ID: P096217 Expected Effectiveness Date: July 15, 2011

Environmental category: Financial Intermediary Assessment

Expected Closing Date: March 31, 2014 Lending Instrument: Specific Investment Loan Additional Financing Type: Scale Up/Financing Gap

Joint IFC: Joint Level:

Basic Information (Original Project) Project ID: P082337 Project Name: Energy Community of South

East Europe Program - FYR Macedonia Component – AD MEPSO Project

Environmental category: Financial Intermediary Assessment

Expected Closing Date: September 30, 2011 Joint IFC:

Lending Instrument: Adaptable Program Loan Joint Level:

AF Project Financing Data [X] Loan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other: Proposed terms: Flexible Loan at 6 month EURIBOR for Euro plus variable spread with 22

years maturity and 6 years of grace, with level repayment pattern in the amount of €14.0 million (US$19.1 million equivalent).

AF Financing Plan (US$m) Source Total Amount (US$m)

Total Project Cost: 31.3 Cofinancing: Borrower: 12.2

Total Bank Financing: IBRD

19.1

Client Information Borrower: Responsible Agency: MEPSO AD (Macedonian Transmission System Operator) Orce Nikolov Macedonia, former Yugoslav Republic of Tel: (389-2) 3149-093 Fax: (389-2) 311-1160

AF Estimated disbursements (Bank FY/US$m) FY 2011 2012 2013 2014 Annual 0 5.00 6.00 8.10 Cumulative 0 5.00 11.00 19.10

Project Development Objective and Description

Original Project development objective The objective of the Project is to support the functioning of AD MEPSO in the context of the regional power market through financing investments necessary to rehabilitate and upgrade the power transmission network, increase the level of interconnection with neighboring power systems, and to strengthen the institutional capacity of AD MEPSO.

Project description The proposed additional loan would finance:

(1) a financing gap in the ongoing project estimated at US$ 4 million equivalent leaving insufficient funds for the financing of one sub-project, the replacement of an overhead transmission line (OHTL) from Skopje to Tetovo.

(2) scaled-up activities that include construction of a 400 KV overhead transmission line (OHTL) from the existing Stip Substation in FYR Macedonia to the Serbian Border (IBRD financing equivalent to US$15.1 million out of a total cost of US$ 27 million equivalent).

Safeguard and Exception to Policies Safeguard policies triggered: Environmental Assessment (OP/BP 4.01) Natural Habitats (OP/BP 4.04) Forests (OP/BP 4.36) Pest Management (OP 4.09) Physical Cultural Resources (OP/BP 4.11) Indigenous Peoples (OP/BP 4.10) Involuntary Resettlement (OP/BP 4.12) Safety of Dams (OP/BP 4.37) Projects on International Waters (OP/BP 7.50) Projects in Disputed Areas (OP/BP 7.60)

[X]Yes [ ] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [X]Yes [ ] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No

Does the project require any waivers of Bank policies? Have these been endorsed or approved by Bank management?

[ ]Yes [X] No [ ]Yes [ ] No

Conditions and Legal Covenants: Financing Agreement Reference Description of

Condition/Covenant Date Due

Loan Agreement, Schedule 2, Section I. C.1

The Borrower shall not incur any debt, unless the net revenues of the Borrower for the fiscal year immediately preceding the date of such incurrence or for a later twelve-month period ended prior to the date of such incurrence, whichever is the greater, shall be at least 1.5 times the estimated maximum debt service requirements of the Borrower for any succeeding fiscal year on all debt of the Borrower, including the debt to be incurred.

Throughout the life of the Project

Loan Agreement, Schedule 2, Section I. D

Preparation of site-specific environmental management plans and land acquisition plans in accordance with the environmental and land acquisition frameworks, and submission to Bank for review prior to commencement of construction or implementation of investments.

Throughout the life of the Project

Loan Agreement, Article V, paragraph 5.01

Project Operations Manual, satisfactory to the Bank, has been finalized and adopted by the Borrower.

By effectiveness (effectiveness deadline is ninety days after signature of Loan Agreement, unless extended)

Loan Agreement, Article V and General Conditions

Executed Legal Agreements and receipt by Bank of satisfactory legal opinions related to them.

By effectiveness (effectiveness deadline is ninety days after signature of Loan Agreement, unless extended)

1

I. Introduction 1. This Project Paper seeks the approval of the Executive Directors to provide an additional loan in an amount of Euro 14 million (US$19.1 million equivalent) to MEPSO1

2. The ongoing project has a financing gap estimated at Euro 3 million (equivalent to about US$4 million) needed to complete the financing of one sub-project, an overhead transmission line (OHTL) from Skopje to Tetovo. This is an important sub-project since the existing Tetovo Line (built in 1957) is in poor shape and subject to frequent outages. The outcome would be improved system stability and fewer outages in the Tetovo area.

(the electricity transmission system operator) with the guarantee of Former Yugoslav Republic of Macedonia (MK) in support of the third phase of the Energy Community of South East Europe Adaptable Program Loan (ECSEE APL3). The proposed additional loan would help finance the costs associated with: (1) a financing gap for the ongoing project; and (2) scaled-up activities to enhance the impact of the ongoing project. The ongoing project will be restructured and the Project Closing Date extended by 30 months to March 31, 2014.

3. The scaled-up activities proposed to be financed from the additional loan (Euro 11 million equivalent to about US$15 million) is a 400 kV OHTL of about 70 km in length from Stip in Macedonia to the Serbian border where it would connect to a 400 kV transmission line from Nis in Serbia to the MK border. The Serbian portion is presently under construction and is expected to be completed in the first half of 2011. This new north-south 400 kV interconnection would provide benefits to most of the Balkan countries but especially MK. These benefits consist of increasing system stability, allowing increased electricity flows between winter and summer peaking countries and between capacity short countries and those with surplus capacity, reducing voltage fluctuations and helping provide emergency generation capacity for back up purposes.

II. Background and Rationale for Additional Financing in the Amount of Euro 14 million. 4. Background. The original project was a loan to MEPSO in 2006 of Euro 20.7 million (US$25 million equivalent at the time) approved on January 10, 2006, effective on May 25, 2006, for the third phase of the US$1,000 million Adaptable Loan Program for the Energy Community of South East Europe (ECSEE). This Program was designed to help implement the Energy Community Treaty between the countries in South East Europe and the EU which aimed at creating open, competitive national and regional electricity markets and a much higher level of trade in electricity. 5. Project Status. MK has made good progress in achieving the objectives set by the Energy Community Treaty. In particular it has: (1) unbundled its integrated power company into generation, distribution and transmission companies; (2) established an independent regulatory commission to license participants in the electricity sector and set tariffs; (3) liberalized the market by making the largest private electricity consumers eligible to purchase power on the Balkan market; (4) begun to further increase the liberalization of the market2

1 The official name of MEPSO is “Operator na elektroprenosniot sistem na makedonija, akcionersko drustvo za prenos na elektricna energija i upravuvanje so elektroenergetskiot sistem vo drzavna sopstvenost- AD MEPSO Skopje”. AD MEPSO or MEPSO are typically used by the company as abbreviations for most purposes.

with a new law

2 The new Energy Law establishes a timetable for market liberalization of non-residential electricity consumers

2

which was passed by Parliament in January 2011 and expand substantially the number of eligible customers. 6. The Project in MK has progressed steadily but not as rapidly as expected. There was a change in MEPSO’s management soon after the project became effective in May 2006 and this significantly delayed the project as the new management had severe financial issues to deal with during 2006-2008. As a result the loan is currently only about 55% disbursed. However, good progress is currently being made on procurement and disbursing funds and those sub-projects which have been completed are generally outperforming their targets. The current project ratings are: Project Development Objective: Moderately Satisfactory, Implementation Progress: Moderately Satisfactory. There is substantial compliance with the project’s financial loan covenants. 7. Consistency with Country Partnership Strategy. The most recent Country Partnership Strategy3

was approved on October 21, 2010 and includes as one of the Bank’s activities in FY 2011 the additional funding for the APL3 Loan in order to finance the transmission line to Serbia. Bank financing is being provided because this investment directly contributes to MK’s EU Accession by helping meet its requirements under the Athens Treaty and by linking it more closely with the regional electricity grid and the EU grid. Also this line helps reduce electricity losses in the region thus reducing carbon dioxide emissions and has numerous benefits to MK (see below).

8. Rationale for Additional Financing. One part of the AF will cover the costs of finalizing the Skopje 1 – Tetovo 1 OHTL. This will improve reliability of supply to the Tetovo area where unstable power supply is presently adversely affecting the quality of life and economic development. The financing gap is due to exchange rate fluctuations. The original PAD estimated the foreign costs of the five components at Euro 23.6 million. However, the US$25 million set aside for the Project was only equivalent to Euro 20.7 million using the exchange rate at the time of the Project approval leading to a financing gap of just under Euro 3 million.

9. A scale-up part of the AF will support the construction of the MK portion (70 km) of a 400 kV overhead transmission line from Stip to the Serbian border. This transmission line was selected as a key priority in the power system development program by the Government of MK. The new line will have significant local and regional benefits and will increase network stability and reliability, and support needed increase of power flows in the region. The need for speedy implementation of the Macedonian portion of the Nis-Stip line is emphasized by the fact that the Serbian portion is under implementation and is expected to be ready for operation before the end of 2011. 10. The rationale for World Bank additional financing rather than sourcing financing from other IFIs is the operational ease with which these activities can be integrated into the ongoing work program of the ongoing ECSEE APL3 project, which will minimize preparation time and costs.

3 IBRD and IFC Country Partnership Strategy for MK for the period FY 2011-2014, Report 54928- Mk approved October 21 , 2010.

3

III. Proposed Changes 11. Project Development Objective. The objective of the ECSEE APL 3 Project is “to support the functioning of MEPSO in the context of the regional power market through financing investments necessary to rehabilitate and upgrade the power transmission network, increase the level of interconnection with neighboring power systems, and to strengthen the institutional capacity of MEPSO.” This objective will also apply to the additional financing. 12. Project Description. The Additional Loan Project consists of Part B.1 of the ongoing Project, namely replacement of an existing 110kV transmission line from the Skopje 1 substation to the Tetovo 1 substation to reduce outages and to reduce risks to the general public, and an additional sub-component under Part B.2 of the ongoing Project (see below). 13. New Investment Sub-Component Under Part B.2. A new investment will be added for the Stip – Serbian border OHTL. It will be similar to the three OHTL subcomponents and therefore the project description of the original loan already covered this type of investment4. The subcomponent will support construction of the MK portion (70 km) of a 400 kV OHTL from Nis in Serbia to Stip in MK5

. This transmission line was selected as a key priority in the power system development program by the Government of MK. More details on the new investment sub-component are presented in Annex 3.

14. The institutional arrangements, financial management and disbursement arrangements remain unchanged (except that there will be a new designated account opened for the additional loan). 15. Restructuring. The ongoing project will need to be restructured as outlined below:

• There is a discrepancy between the Project Development Objective (PDO) in the original Loan Agreement and the one used in the PAD dated December 8, 2005, for the ongoing project (as set forth in paragraph 11 above). This will be addressed as part of the AF package and the PDO definition used in the PAD will be introduced in the amended Loan Agreement.

• The project description will be amended so as to specify that Part B: “Rehabilitation and Construction of Overhead Lines” consists of (1) Replacement of an existing 110kV transmission line from the Skopje 1 substation to the Tetovo 1 substation to reduce outages and to reduce risks to the general public; and (2) Construction of new lines to reduce losses, improve system security, and increase the level of interconnection with neighboring systems, from: (a) the Bitola 3 substation to the Bitola 4 substation; and (b) the Bitola 2 substation to the border with the Hellenic Republic.

• Two of the three financial covenants, i.e. (i) accounts receivable in any year should be 18% or less of revenue, and (ii) funds from internal sources should be greater than 35% of capital investments, will be eliminated. This is due to the changed nature of MEPSO’s business (the elimination of the financially risky single-buyer obligation), which means

4 However, at the explicit request of the Borrower and Guarantor, the project description will be made more specific in both the original loan agreement and the new loan agreement.. 5 The transmission line construction includes a 400 kV line bay in the Stip substation

4

that the two covenants are no longer appropriate to measure MEPSO’s level of financial health. No new financial covenants will be added.

• Some specific implementation covenants, in which it was specified which departments of MEPSO would implement which parts of the project, will be deleted from the Loan Agreement and instead included in the Project Operations Manual.

• The Project Closing Date will be extended from September 30, 2011 to March 31, 2014. This will be the second extension of the Closing Date. The original Closing Date was March 31, 2011, which was extended by six months in January 2011 in order to allow the Additional Financing to become effective before the closing of the Loan.

• Procurement under the Project for both original loan and additional loan must follow the Guidelines: Procurement under IBRD Loans and IDA Credits dated May 2010 and the Guidelines: Selection and Employment of Consultants by World Bank Borrowers dated May 2010.

• Some definitions of the original loan agreement will be updated (e.g. name of Borrower; revised environmental and land acquisition frameworks; inclusion of definition of land acquisition plan and the newly developed project manual).

• Some adjustments will be made to the implementation covenants to reflect the current project reality (e.g. requirement to prepare site-specific land acquisition plans; compliance with newly developed project manual).

16. Project Costs. For the rehabilitation of the Skopje 1 - Tetovo 1 OHTL the financing gap is estimated at about Euro 3 million out of the total estimated cost of Euro 33.1 million for the original five components of the APL3 project. For the Stip – Serbian border OHTL the estimated total project cost of Euro 20 million. The total cost of the Project after additional financing will be Euro 53.1 million.

17. Financing Plan.

Euro million Original Project Components

New investment (OHTL Stip – Serbian border)

Total

Borrower 9.4 9.0 18.4 IBRD 23.76 11.0 34.7 Total 33.1 20.0 53.1

18. Implementation Schedule. The Closing Date for both original and additional loan will be March 31, 2014 in order to accommodate the implementation schedule for the remaining components and scaled-up activities. A detailed Implementation Schedule for the Stip – Serbian border OHTL construction is presented in Annex 3. 19. Expected Outcomes. No change is foreseen in the outcomes for the ongoing project’s five existing components. However, as a result of constructing the Stip – Serbian border OHTL it is

6 Euro 20.7 million from the original loan and Euro 3 million from the AF

5

expected that power transit through Macedonia will increase by 61 MW. This will be monitored by introducing a new results indicator in the Results Framework (Annex 1).

IV. Appraisal Summary 20. Economic Analysis of Subproject Related to Financing Gap. The Skopje 1 - Tetovo 1 OHTL was built in 1957 and is in bad shape with outages estimated in 2005 at 3.4 GWh per year. The estimated cost at that time was Euro 7.18 million, of which Euro 5.4 million would cover equipment and erection and the rest taxes and duties, and the estimated ERR was 20%. However, based on the cost of recent OHTL projects in the Region the current estimate has been reduced to Euro 5.7 million including taxes and duties. With no significant change in the expected benefits a revised ERR well in excess of 20% is anticipated. 21. Economic Analysis of Scaled-Up Activities. The benefits of the Stip – Serbian border OHTL are numerous to both the region and MK. The Bank and MEPSO analyzed the economic benefits to MK of building its segment of the line. Only two benefits were considered; (i) additional transit fees for electricity moving through the Macedonian grid to Serbia or Greece, and (ii) capacity payments to reserve access to the line. Other benefits, such as reduced voltage fluctuations, increased access to lower cost power, grid stability, increased telecoms capacity etc. were not considered. These analyses showed that the project had a real rate of return of about 6.3% with a 20 year life and 9.0% with a 40 year life. These estimates were made with conservative assumptions. Also, because the analysis does not include the other benefits mentioned above these rates of return are conservative. 22. Financial Benefits. From a financial point of view the Stip – Serbian border OHTL is profitable to MEPSO. Estimated congestion payments on the line and transit fee payments indicate it would have a satisfactory financial rate of return.

23. Fiduciary Impact. The fiduciary risk will be low. The Procurement Guidelines of May 2010 will be applicable to the new subcomponent of 400 kV Stip - Serbian border OHTL and the partially financed 110 kV Skopje-Tetovo OHTL. The detailed Procurement Plan with the new subcomponent has been updated. The ICB method and Standard Bidding Document for Supply and Installation of Plant and Equipment will be used. Financial management responsibilities for the additional financing will remain with the MEPSO Project Implementation Unit (PIU), which has been responsible for the original credit. Financial management arrangements under the existing project were assessed to be satisfactory at the last supervision (July 2010). The unit is suitably staffed, has acceptable controls and accounting and reporting systems. No abnormalities were identified in checks of transactions and controls. The project audit for 2009 financial statements was unqualified and audit reports were received in reasonable time. The entity audit for MEPSO was also satisfactory in accordance with Bank requirements. Interim financial reports prepared by the PIU have been satisfactory and provided within acceptable timeframes. 24. Environmental Impact. The environmental assessment category for the AF is FI as with the ongoing project, no new safeguards policies are to be triggered and the mechanism for assessing subprojects remains the same. The project’s Environmental Assessment Framework Document (EAFD) was updated to reflect changes in Macedonian environmental legislation since 2005 as

6

well as experiences from the team in MEPSO to facilitate subproject preparation and implementation. Neither of the two OHTLs financed under the AF will be passing near or through highly populated areas, nor environmentally sensitive areas, and they will not have large-scale, significant or irreversible impacts beside visual changes to the existing landscape and scenery. 25. The updated EAFD was disclosed on February 16, 2011. The EIAs and EMPs for the two OHTL subprojects have been prepared in Macedonian and English, and have subsequently been disclosed in-country on December 31, 2010 and consultations held. The EMPs and EIAs were disclosed in accordance with Bank requirements and two public consultations were held for each study7

.

26. The capacity in MEPSO for following and monitoring environmental performance under project implementation remains strong and the team in MEPSO has sufficient experience and knowledge to carry on the work. 27. Social Impact. Once in operation, the two OHTLs will benefit the population of MK including the poor. It will allow the country to access additional less expensive electricity from outside its borders and will assist in providing better quality and more reliable electricity at a lower cost. It will also provide benefits to the populations of neighboring countries especially Serbia and Greece. 28. The lines, as currently configured, will involve no actual physical relocation. Rights of way will, however, need to be obtained for the route and small parcels of land (each maximum 40 meters square) will need to be acquired/expropriated for the foot prints of the towers.

29. The Land Acquisition Framework Document (LAFD) has been updated to ensure full compliance with the Bank’s safeguard policies. The updated LAFD was disclosed in country on February 16, 2011. The LAFD provides that a Land Acquisition Plan, following the format prescribed by the Bank’s safeguard policies (OP 4.12), needs to be prepared for each investment and should include a template/checklist of items that each LAP needs to cover. 30. Risks. The main risks are: (i) delays related to land acquisition; and (ii) the possibility of a change in MEPSO’s management, both of which have slowed down project implementation in the past. An Operational Risk Assessment Framework (ORAF) has been prepared and is attached in Annex 2.

7 For Stip – Serbian border a consultation was held in Stip municipality on May 11, 2010 and another in Sveti Nikola municipality on July 21, 2010. For Skopje 1 - Tetovo 1 a consultation was held in Tetovo on April 28, 2010 and another in Skopje on May 4, 2010

7

Annex 1: Results Framework and Monitoring COUNTRY: Project Name

Results Framework

Revisions to the Results Framework Comments/ Rationale for Change

PDO Current (PAD) Proposed The objective of the Project is to support the functioning of MEPSO in the context of the regional power market through financing investments necessary to rehabilitate and upgrade the power transmission network, increase the level of interconnection with neighboring power systems, and to strengthen the institutional capacity of MEPSO.

Continued

PDO indicators

Current (PAD) Proposed change APL3 projects are completed successfully. The Macedonian power transmission network operates reliably and efficiently.

Continued

Intermediate Results indicators

Current (PAD) Proposed change Comp. 1: (i) Satisfactory completion of substation expansion; (ii) Voltages at Skopje 5 are within their operating limits; (iii) Incremental supply of at least 50 MW from Skopje 5 substation.

Continued

Comp. 2: (i) Satisfactory completion of the component’s sub-projects; (ii) Increase cross border trade between Macedonia and Greece of at least 20%; (iii) Reduce number and amount of energy interruption due to outages of Skopje 1 – Tetovo line by 80%. (iv) Putting into operation the Nis-Stip transmission line

(i) (ii) and (iii) Continued (iv) and (v) New

(iv) and (v) are indicators that relate to the the new investment supported under the additional loan

8

Revisions to the Results Framework Comments/ Rationale for Change

(v) Increasing transit volumes through the MK power system by 61 MW Comp. 3: (i) Satisfactory completion of the EMS and planning software expansion

Continued

Comp. 4: (i) Satisfactory completion of the component’s sub-projects; (ii) Reduce substations operating and maintenance costs by at least 25% for the unbundled substations.

Continued

Comp. 5: (i) Successful deployment of Business Information System at MEPSO

Continued

9

Revised Project Results Framework

Project Development Objective (PDO): Click here to enter the revised PDO of your operation

PDO Level Results Indicators

Cor

e

UOM8

Baseline

Original Project Start

(2006)

Progress To Date (2011)

Cumulative Target Values

Frequency Data Source/ Methodology

Responsibility for Data

Collection Comments 2012 2013 2014

1. APL3 subprojects are completed successfully. The Macedonian power transmission network operates reliably and efficiently.

Nil 3 of 8

subprojects completed

All subprojects

completed

Annual WB Aide Memoires WB

Intermediate Results and Indicators

Intermediate Results Indicators

Cor

e

UOM

Baseline Original (2006)

Progress To Date (2011)

Target Values

Frequency Data Source/ Methodology

Responsibility for Data

Collection Comments 2012 2013 2014

Intermediate Result 1: Component 1 – Expansion of Skopje 5 substation

2. (i) Satisfactory completion of substation expansion; (ii) Voltages at Skopje 5 are within their operating limits; (iii) Incremental supply of at least 50 MW from Skopje 5 substation.

Nil

(i)complete (ii)achieved (iii) 50 MW of new load

Bi-annual MEPSO progress reporting

MEPSO Targets achieved

8 UOM = Unit of Measurement.

10

Intermediate Results and Indicators

Intermediate Results Indicators

Cor

e

UOM

Baseline Original (2006)

Progress To Date (2011)

Target Values

Frequency Data Source/ Methodology

Responsibility for Data

Collection Comments 2012 2013 2014

Intermediate Result 2: Component 2 – Construction of OHTLs

3. (i) Satisfactory completion of the component’s sub-projects; (ii) Increase cross border trade between Macedonia and Greece of at least 20%; (iii) Reduce number and amount of energy interruption due to outages of Skopje 1 – Tetovo line by 80%.

(i) Nil (ii) 624 MWh,

(iii) 1480 minutes

(i) MK - GR line completed (ii) cross border trade increased by 200% (iii) N/A

(i) All components are completed (ii) N/A (iii) 80% reduction of outages

Bi-annual MEPSO progress reporting

MEPSO

4. (iv) Putting into operation the Nis-Stip transmission line (v) Increasing transit volumes through the MK power system by 61 MW

Nil N/A (i) Line Operational (ii): 61 MW transit volume achieved

Bi-annual MEPSO progress reporting

MEPSO New investment financed from Additional Loan

Intermediate Result 3: Component 3 – Upgrade of EMS and Planning Software

5. Satisfactory completion of the EMS and planning software expansion Nil (i) Task

completed Targets achieved

Intermediate Result 4: Component 4 – Rehabilitation and Upgrade of 110 kV Substations

6. (i) Satisfactory completion of the component’s sub-projects; (ii) Reduce substations operating and maintenance costs by at least 25% for the unbundled substations.

(i) Nil (ii) see

attachement of PAD for

baseline

(i) 50% of substations completed (ii) N/A

(i) All substations completed (ii) 25% reduction in substations O&M costs

Bi-annual MEPSO progress reporting

MEPSO

Intermediate Result 5: Component 5 – Support for Institutional Development

7. Successful deployment of Business Information System at MEPSO Nil Consultant

hired FMIS installed Bi-annual MEPSO progress reporting

MEPSO

11

Annex 2 Operational Risk Assessment Framework (ORAF)

{Macedonia, Former Yugoslav Republic of} {ECSEE APL3 – Additional Financing}

Project Development Objective(s)

The APL 3 Project Development Objective including the Additional Financing is: “To support the functioning of the new transmission company ( AD MEPSO) in the context of the regional power market through financing investments necessary to rehabilitate and upgrade the power transmission network and increase the level of interconnection with neighboring power systems, and to strengthen the institutional capacity of AD MEPSO“

PDO Level Results Indicators (for Additional financing):

Increase in transit volume through MK’s power system

Risk Category Risk Rating Risk Rating Explanation Risk Description Proposed Mitigation

Measures

Status C= completed

O=ongoing NYD=not yet due

N/A=Not Applicable

1. Project Stakeholder Risks

1.1 Stakeholder

Medium-Impact

In some cases the expropriation decisions may be appealed and go into a court procedure. Recent experience with similar expropriation shows that projects of national priority benefits from shorter processing time in court. However, in case court

Project Affected People The land acquisition (LA) process will take more time than expected and delay implementation

A land Acquisition Framework has been prepared mandating Land Acquisition Plans for each expropriation to ensure compliance with OP 4.12. The Bank will monitor that any LA is carried out as per Bank procedures.

O

12

Risk Category Risk Rating Risk Rating Explanation Risk Description Proposed Mitigation

Measures

Status C= completed

O=ongoing NYD=not yet due

N/A=Not Applicable

decision is delayed it will directly impact the starting date of the line construction and thereby also the completion date.

2. Operating Environment Risks

2.1 Country Low

Government stability is expected to continue, and the risks that remain over the pace of EU membership and uncertainty over the name issue are expected to have limited implications for project implementation

Parliamentary elections scheduled for 2012 (but could happen earlier) may lead to management changes and slow the pace of project implementation; but major policy changes are unlikely.

An interruption in progress toward EU membership could weaken public support for reforms. Prolonged status quo, accompanied by the persistent and high unemployment could undermine Government support and increase social tensions.

Political events leading to changes in management of state-owned companies, which may cause a loss of institutional momentum and deterioration of commitment to timely project implementation

The Bank will continue to monitor developments closely, including any impact a delay in EU accession might have on political and macroeconomic stability as well as on the Bank’s program.

Through continued dialogue and supervision, the Bank will maintain close relations with the counterparts and ensure adequate implementation progress.

O

O

2.2 Institutional (sector & multi-sector Level) Low

The need for more transmission capacity in the regional grid makes it unlikely that transit fees and congestion charges will be reduced

Changes in transit fees, congestion charges and other regional sources of revenues upon which the financial viability of the transmission line depends.

Continued dialogue with regional players including the Energy Community

O

13

Risk Category Risk Rating Risk Rating Explanation Risk Description Proposed Mitigation

Measures

Status C= completed

O=ongoing NYD=not yet due

N/A=Not Applicable

3. Implementing Agency Risks (including FM & PR Risks)

Medium –Impact

MEPSO has good capacity for project implementation but is vulnerable to the impact of leadership changes dictated by e.g. political circumstances

Project implementation will slow down due to inadequate project management in MEPSO

Continued support to and monitoring of the procurement and FM function in MEPSO

O

3.1 Capacity Low

MEPSO has assigned dedicated financial and procurement specialists to the project who have experience with other Bank projects and have been trained in Bank financial and procurement procedures. Experience with the APL project indicates that the staff and systems are effective and that turn-over is low.

MEPSO will fail to retain people with adequate capacity in procurement and financial management and experience with similar Bank projects

Continued support to and monitoring of the procurement and FM function in MEPSO will ensure that changes in staffing will have minimal effect on fiduciary performance

O

3.2 Governance

Medium –Impact

A leadership change in 2008 led to a virtual halt in project progress demonstrating the importance of dedicated and motivated management. Unlike then, the project activities are already ongoing with work teams assigned so likelihood of a management shift to have impact on progress is low.

Change of management in MEPSO leading to lack of interest in project and poor follow-up on timetables and fiduciary requirements

Tight monitoring of MEPSO performance. Taking up performance shortfalls at joint portfolio meetings and bringing issues to attention of GoM leadership. This has proven effective measure in the past

O

3.3 Fraud & Corruption Low Based on experience with Fraudulent behavior in Vigilance in supervision, O

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Risk Category Risk Rating Risk Rating Explanation Risk Description Proposed Mitigation

Measures

Status C= completed

O=ongoing NYD=not yet due

N/A=Not Applicable

MEPSO’s performance since project inception there is no indication of high risk

managing loan funds Corrupt practices in procurement

monitoring of procurement and financial audits

4. Project Risks

4.1 Design Low

The construction of the OHTLs will be based on familiar designs and technologies that are tested in the construction of Greece and Bulgaria interconnections in 2007 and 2009.

Serbian part of Nis-Stip OHTL fails to be implemented with same design parameters for line, line bays and control and protection on both sides. Both sides fail to decide the border point and coordination time of implementation which will delay the commissioning of Macedonian part.

MEPSO and WB will follow up with EMS in Serbia to follow progress. MEPSO and EMS have an agreement for border point, line connection points on both sides, technical parameters of the line and line bays on both sides as well as control and protection coordination, implementation and commissioning schedule.

C

4.2 Social & Environmental Low

For Social issues please refer to Stakeholder risks in 1.1 Environment: MEPSO has a good track record of observing the Bank’s env. safeguards procedures so far in APL3. In conclusion both the likelihood of reputational exposure and the risk of non-compliance with our procedures are considered to be low.

For Social issues please refer to Stakeholder risks in 1.1 Environment: MEPSO will fail to follow agreed procedures (EMP disclosure, compliance monitoring) thereby putting safeguards at risk

For Social issues please refer to Stakeholder risks in 1.1 Environment: Close compliance monitoring through regular reports from MEPSO, quarterly visits and/or conference calls from env. safeguards person.

O

A - Proposed Rating before Decision Meeting:

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Project Team Risk Rating: Preparation

Risk Rating: Implementation Date Comments

Overall Risk

Low

Medium – Impact

Feb 9, 2011

The main issue that has driven the M-I rating for implementation is the uncertainty related to land acquisition.

B - Review by IL Risk Team for Decision Meeting:

Risk Team Risk Rating: Preparation

Risk Rating: Implementation Date Comments

Overall Risk

Low

Medium - Impact

Dec. 10,

2010

Based on the documentation provided, the ILRT agrees with the above ratings proposed by the team.

Final Decision Meeting Rating:

Appraisal Decision Chair Risk Rating: Preparation

Risk Rating: Implementation Date Comments

Overall Risk

Low

Medium - Impact

Feb 16, 1011

The main issue that has driven the M-I rating for implementation is the uncertainty related to land acquisition.

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Annex 3

Description and Technical Assessment of the Stip – Serbian Border Overhead Transmission Line

Background Electricity generation in MK is mainly based on thermal sources, accounting for 80% (5,000 GWh/y), with hydro making up the remaining 20% (1,100 GWh/y). Additional generation is being planned and will soon be able to contribute with additional 2,000 GWh/y. Based on the data collected and calculations done by MEPSO experts and figures given in Macedonian Energy Strategy the demand and peak load for next 10 years are illustrated in the following table.

Demand and Peak load forecast

The detailed forecast is shown below

Source – Energy Strategy and MEPSO Consequently MK will continue to be a net electricity importer despite the addition of some thermal and hydro generation capacity. There will also continue to be a peak load deficit. MK is geographically well placed to provide transmission interconnection amongst neighboring countries for power exchange. At present there are four 400 kV Overhead Transmission Lines (OHTLs) between the electric power system of MK and the neighboring power systems as Kosovo (KS), Bulgaria (BG) and Greece (GR):

1) 400 kV OHTL Skopje (MK) – Kosovo B (KS) in northern MK 2) 400 kV OHTL Dubrovo (MK) – Thessaloniki (GR) in southern MK 3) 400 kV OHTL Bitola (MK) – Florina (GR) in southern MK 4) 400 kV OHTL Stip (MK) – C.Mogila (BG) in northeastern MK (in operation since

January 2009)

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Two 220 kV OHTLs between MK and Kosovo have been out of operation for a long time9

The main transmission system of MK consists of five other 400 kV lines (Skopje 4 - Skopje 5, Skopje 4 - Bitola, Skopje 4 - Dubrovo, Bitola - Dubrovo and Dubrovo - Stip. Only one 220 kV line is in operation connecting the Vrutok hydropower plan (HPP) with the Skopje 5 substation. There are five 400/110 kV substations: Skopje 4, Skopje 5, Bitola, Dubrovo and Stip (the Stip substation has recently been constructed and an Operation Acceptance Certificate is still pending).

. There are presently no high-voltage interconnections to two of the neighboring countries: Serbia (RS) and Albania (AL).

The North-South Power Flow and Supply of Skopje Since 1999 both 220 kV OHTLs that connect Kosovo with the important Skopje 5 substation have been out of operation. This had a negative impact on the reliability of the power system in MK and the power supply in Skopje, the main load center, and led to the need to upgrade Skopje 5 to 400 kV/220 kV/110 kV level and connecting it to the 400 kV line to Kosovo and, through the Skopje 4 substation, to thermal power plants (TPPs) in south of MK. This allows electricity supply of Skopje to be covered by generation from TPP Bitola and imports. In the summer months Greece has peak demand and needs to import from other power systems. Transmission capacity and reliability of the whole north – south interconnection (through the path Nis – Kosovo – Skopje – Dubrovo – Thessaloniki) is affected, particularly when n-1 events occur such as outages due to short-circuits in the 400 kV busbar in Kosovo or tripping of the 400 kV line Kosovo – Skopje 5. The electricity would then flow from north to south by the other paths with the risk of overloading other interconnection links e.g. Kosovo-Montenegro-Albania-Greece and Bulgaria- Greece, and that could lead to cascade outages and power supply interruptions in the region. Indeed such events have been the reason for blackout in MK, part of Albania, Greece, Serbia and Montenegro (most notably event in July 2007). The construction of two new 400 kV OHTLs to Bulgaria and Greece has significantly improved the reliability and 9 There are no plans for rehabilitation of these lines since the level of 220 kV is no longer part of the transmission system development planning.

F Y R

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transfer capacity of the north-south transmission path. The physical flows of electricity through MK’s transmission system are show in the figure below.

Physical yearly flows of electricity (Source MEPSO 2010) The positive contribution in the north-south power flows came from 400 kV OHTL Kosovo-Skopje which would use the Macedonian transmission system was a wheeling system. Since November 2008, the role of Kosovo interconnection has diminished and now about half of physical north-south flows are flowing through the Bulgaria – MK - Greece interconnections. However the role of wheeling system is not only maintained but it is increased four times (from 1100 GWh in 2008 to 3800 GWh 2009). The trend is that the need to wheel power through MK will continue to grow: (i) the power exchanges between MK and Serbia are set to grow, (ii) the imports of MK, Albania and Greece from the countries of the region are set to increase, and (iii) the number of transactions of other SEE countries and market players in the open electricity market will grow. The following table shows hourly power flows assuming that energy flows constantly during all the year:

Interconnection Bottlenecks and the East-West Power Flow The main interconnection bottlenecks in the SEE region have been the congested interconnectors Romania-Serbia and Bulgaria Serbia, since both Romania and Bulgaria are electricity exporting countries. The recently constructed Bulgaria – MK OHTL (C. Mogila - Stip) has improved the situation and congestion on both Serbian-Romanian and Serbian-Bulgarian borders are less frequent. However, in an n-1 situation the most critical event is tripping of the line Nis – Kosovo, which will cause problems in the north-south path. The transmission system of MK is not interconnected with Albania. This is an obstacle for east-west transits from Bulgaria/Turkey to Albania and in the future to Italy. The east-west flows presently take the same path as the north-south flows i.e. through MK to Greece and then to Albania or Italy (through a DC submarine cable) which results in congestion.

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The Impact of the Proposed Interconnection MK – Serbia. Bulgaria intends to develop new generation facilities and to maintain its status as a power exporter. Romania is also large exporter in the SEE region and will strive to maintain this role in the future. The power import/export of countries like Greece and Albania partly depends on hydrological conditions. The establishment of a regional electricity market will provide incentives for numerous electricity trading arrangements on day-ahead and long term basis. Italy, who has some of the highest electricity prices in Europe, significantly higher than price levels in Balkans, will be interesting export market for SEE countries with generation surplus. New flow pattern are likely to emerge from this situation and there will be need of a robust regional network to accommodate the trade. A MK - Serbia 400 kV OHTL has been evaluated in the framework of several regional studies and it has been designated as a line to be in operation after 2010 since it will contribute to maintain the security and reliability of the transmission network in the region. The rationale was recognized in the feasibility study carried out in 200310

and many other regional studies under Energy Community Treaty in South East Europe as well as in Ten Year Network Development Plan Study carried out by ENTSO-E.

Below is a list of transmission lines that are estimated to provide a substantial reinforcement of the existing transmission network in the SEE region.

The proposed Serbia – MK interconnection will have the following advantages:

(i) Provide a direct connection between MK and Serbia as well as Greece to Serbia; (ii) Close the loop flow between Serbia – Bulgaria – MK, ensuring the suitable elimination of

the n-1 events in this loop; (iii) Increases significantly the reliability of the north-south transmission path and vice versa; (iv) Release the congestions in northern border of MK and increase the transfer capacity

north-south; (v) Increase the network flexibility during operation and maintenance;

10 Technical and Economical aspects for Interconnection of Power Systems of Serbia and MK with 400 kV OHTL Nis-Leskovac-(Vranje)-Skopje – EKC-September 2003.

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(vi) Reduce the need for reactive power “exchange” in the region and to ensure the proper voltage profiles;

(vii) Brings a 400 kV line to the south of Serbia (Leskovac and Vranje areas) and increase the security of supply for Serbian customers in those areas; and

(viii) Eliminate the load shedding in case of unavailability of particular lines, which in high-load conditions and avoid operational problems during periods with significant transits to the electric power system of Greece.

Selection of the appropriate connection point Most of the studies carried out regarding interconnection between MK and Serbia have suggested a connection from Nis via Leskovac and Vranje to Skopje. In Serbia, the choice of Nis as connection point is clear since it provides the only 400 kV node in the southern part of Serbia and because Serbia wants do develop 400 kV system in this area by constructing two 400/110 kV substations in Leskovac and Vranje. For the connection point on the Macedonian side the original suggestion of Skopje as a connection point was due to: (i) the importance of Skopje as the biggest load center in MK and (ii) the reduced investment cost as this line is shorter than the Stip alternative on Macedonian site. However this connection point imposes other difficulties especially in the implementation phase. Firstly, it is very difficult to bring an OHTL into Skopje because the area will be densely populated - consequently the land acquisition and the right-of-way issues will pose immense problems. Secondly, the network configuration would not be ideal from a security-of-supply point of view since all the northern interconnections would connect to the same point in Skopje. MEPSO experts therefore carried out a study to define a more suitable point for connection of the new interconnection with Serbia. Many variants are studied and the conclusion was that the new Stip substation is the most appropriate connection point.

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Regional main 440 kV transmission network To support the conclusion of the detailed analysis of MEPSO’s experts, the team performed a short intuitive technical estimation: • The main change of the

transmission network configu-ration after year 2010 is the putting in operation of the 400 kV line Elbasan - Tirana - Podgorica, which will close the loop in the western part of the SEE region (Kosovo – MK – Greece – Albania - Montenegro) and will improve the direction of the physical flows. The flows in Albania (a power import country) will partially be from Greece and partly from Montenegro, which means that the path north-south in MK will be partially relieved.

• However, the loop Serbia – Bulgaria – MK still remains open because the loop through Kosovo is closed. That is why it is important to connect the new interconnection line to Stip substation, since this will close the loop Serbia – Bulgaria – MK and create a network in MK that provides two powerful main paths for north-south flow.

Brief technical description of the project The new 400 kV interconnection Stip – Serbian border includes a 400 kV line bay in the Stip substation. The starting point of the 400 kV OHTL in the MK power system will be Stip SS, which is a new substation (partially put in operation by the end of 2009) with a 400 kV busbar ready for another new connection. From the Stip substation the line corridor passes in north-western direction to the villages of Nemanjicas, Kokosinje and Zubovce crossing through hilly land with pastures, agricultural areas and low-density forests. From Zubovce it goes north-west to the villages of Zebrnjak and Nikuljane going north where it crosses the Kumanovo – Kriva Palanka motorway. After Nikuljane it goes

FYR

22

further north-west to the border point with Serbia, The altitude throughout the corridor ranges between 250 and 650 m above sea level. The total length of the 400 kV OHTL is estimated to be approximately 70 km. The Technical parameters of the 400 kV OHTL are:

• Rated voltage 400 kV and Rated Capacity 1400 MVA • Towers: lattice type steel towers • Conductors: ACSR 490/65 mm2, 2 conductors per phase • Earth wire: AWG 19/9, 126.1 mm2 (OPGW)

Project Cost Estimation The estimation of costs has been based on the 400 kV OHTL Stip – Bulgarian border which was contracted in 2007 adjusted by an increment of 40% to take account of cost escalations. Accordingly, the cost of 1 km 400 kV OHTL was increased from Euro 133,000 to Euro 186,000 per km. This leads to an estimated total project cost of Euro 20 million (cost for consulting services is not included). The basic equipment and installation costs are estimated at Euro 14 million with additional expenses of Euro 5.2 million for right-of-way/land acquisition, administrative cost, taxes, duties, etc. and contingencies of Euro 0.8 million. The updated OHTL costs are shown in the tables below.

OHTL Line costs

Project Costs Euro Foreign

cost Local cost

Total IBRD MEPSO

A 400 kV OHTL Stip – Serbian border 8,150 5,850 14,000 11,000 3,000 B Other Project Costs 5,189 5,189 5,189

B1 Land acquisition, right of way and compensation (20 kEUR/km) 1,400 1,400 1,400 B2 Project Administration and other services 500 500 500 B3 Taxes, custom duties and VAT 3,289 3,289 3,289

VAT for civil works and erection 18% 1,053 1,053 1,053 Custom duties for materials 8% 652 652 652 VAT for materials 18% 1,584 1,584 1,584

C Contingencies 811 811 811 Total Costs with Contingencies 8,150 11,850 20,000 11,000 9,000

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The foreign costs (materials and equipment) are estimated at Euro 8.15 million and local costs before taxes and duties are estimated at Euro 5.85 million. Assessment of increased transmission border capacities In order to assess the increase in available transmission capacities resulting from the new line, calculations of the net transmission capacity (NTC) have been carried out. MEPSO experts carried out simulations with and without the new line in year 2015. The result of the simulations is shown in the adjacent table. The existence of the new line will increase the transmission capacity (i) on the northern border of MK (bordering Serbia and Kosovo) from 412 MW to 571 MW or with 159 MW increase and (ii) on the southern border (bordering Greece and Bulgaria) from 735 MW to 847 MW, i.e. and increase of 139 MW. But the new line will increase the transmission capacities for the entire region with an additional 300 MW. Based on MEPSO calculation, the capacity will reach the value of 570 MW on the northern border and 875 MW on the southern border of MK. It is likely that only the northern capacity will be leased after year 2015, when region-wide transactions are expected to be developed. Therefore MEPSO will benefit from leasing an additional 159/2 = 79 MW when the new line will be in operation. Assessment of increased transit volumes In order to assess the increase of transits through the MK power system with the new line MEPSO’s experts provided estimates from network simulations with and without the new line in the year 2015. Three scenarios of electricity exchanges were expected to reflect most the typical operational regimes in the transmission network: (i) Base case exchange scenario where no exchanges are assumed and each country covers the demand with own generation and with planned imports, (ii) exchange from north to south of 1500 MW and (iii) exchange south to north of 1000 MW.

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The summary of simulation results is shown in the table above. The existence of the new line will increase the transits through the Macedonian power system as follows: (i) Base Case Scenario shows an increase in transits from 219 MW to 280 MW meaning an addition of 61 MW, (ii) Scenario 1 with exchange north-south of 1500 MW shows an increase in transit from 369 MW to 402 MW meaning an addition of 15 MW, and (iii) Scenario 2 with exchange south-north of 1000 MW shows an increase in transit from 453 MW to 541 MW meaning an additional 88 MW. Project implementation schedule The tentative implementation schedule is shown in the table below. This project schedule takes into account many uncertainties related to the project preparation phase. It is estimated that he project can be completed by the end of 2013.