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GPOBA COMMITMENT DOCUMENT

Project Name: Ethiopia Electricity Access Rural Expansion Project (P105651)

Executive Summary: Ethiopia has a GDP of US$11 billion, corresponding to US$155/capita, significantly less than the Sub-Saharan Africa average. Although the country has abundant resources and good potential for development, poverty is pandemic. 44% of the population was below the poverty line in the last survey in 1999/00. In rural areas, 70% of the population was below the poverty line (with US$60 cents/day).

Ethiopia presents one of the lowest electrification rates in the region. Only 17% of the population lives in electrified areas, but overall national access is only 7% (2% in rural areas). Biomass still represents 90% of the country’s total energy needs. The pattern of energy consumption in the country has led to increasing deforestation, shortage of wood fuel and degradation of the rural ecosystems. As a consequence, the Government of Ethiopia (GoE) launched, two years ago, a 10.5 billion Birr (or US$1.3 billion) Universal Electricity Access Program (UEAP). Its objective is to triple overall national grid access from 17% to 50% in a 5-year timeframe. Under the UEAP, donors[1] provide funds to the GoE. The state-owned Ethiopian Electric Power Corporation (EEPCo) is responsible for the execution of the UEAP. Within the UEAP, there is the Second Electricity Access Rural Expansion Project (EAREP II), a US$130 million IDA loan. The Output-Based Aid (OBA) scheme discussed in this Commitment Document was originally envisioned to blend into the EAREP II project only; however, GPOBA funds will now also apply to other donor-funded projects under the UEAP.

The main objective of the GPOBA project is to increase access to electricity in rural towns and villages with grid-access, by assisting EEPCo in its connection fee[2] financing program, extending loan tenors of five years. In addition, the GPOBA grant will finance two energy efficient Compact Fluorescent Lamps (CFLs) for poor households (hhs) as part of the connection package to both ensure an affordable tariff bill for hhs, and O&M cost recovery for EEPCo. The GPOBA funds, amounting to up to US$10 million, will provide 286,000 new and/or regularized rural connections and 572,000 CFLs, benefiting a population of 1,430,000. The increased access to electricity will improve the quality of life, enhance educational services, and provide income-generating opportunities.

GPOBA subsidy:

GPOBA will provide a subsidy of US$35 per hh. The subsidy level has been determined by: (1) the cost of financing (US$29) pertaining to the 5-year loans for the connection fee; plus (ii) the cost of providing CFLs to target hhs (US$6). In comparison to other GPOBA projects in energy where connection subsidies vary from US$135-650, a connection subsidy of US$35 per hh represents excellent value for money. Given an average of 5 people per hh in rural Ethiopia, the subsidy is expected to be US$7/capita.

To encouraging accountability of and risk sharing by the provider, EEPCo will bear all construction and commercial risks as it will not receive the subsidy after certain conditions have been met. It should be noted that the hh is responsible for the internal wiring costs, estimated at US$20 per hh, although typically cheaper solutions are implemented by the hh. This could represent a reputational risk to GPOBA.

The proposed OBA scheme will create incentives to execute a large number of new connections to poor hhs. Subsequent connections should take place using the proceeds from the amortization of the loan. A kind of “revolving fund,” once established, can provide capital to finance new or to regularize connections even after the completion of the 3-year GPOBA intervention. Currently in Ethiopia there are 15,000,000 hhs, many of them poor and most without access to electricity; so, there is scale-up potential for the project. The project might also be replicated in similar situations in other countries where user contributions need to be subsidized.

In conclusion, the GPOBA project will accelerate by 20% the pace of regular connections to poor hhs in rural areas: Based on experience, it is expected that 40% of the customers will request connection in year 1, increasing to 80% in year 5. If no connection fee financing scheme is available, it is expected that in the first year only 20% of potential residential customers would be able to pay the fee and get connected. This percentage is assumed to gradually increase to 60% after 5 years. To ensure that those hhs that would have connected without a subsidy do not benefit from the GPOBA project, the loan program to the poor hhs will be delayed for one year in a newly electrified town. For already electrified towns, the connection financing scheme will be implemented immediately for both new and to be regularized connections[3].

Project Data Sheet

Project Name: Ethiopia Electricity Access Rural Expansion Project

Scope: To increase access to electricity for poor hhs in rural towns and villages with grid-access.

Total Project Costs: US$203 million (US$10 million GPOBA subsidy[4] and US$US$193 million funding from other sources).

Total GPOBA Contribution Requested: US$10,200,000

• Subsidy funding (W3) = US$10,000,000 (5% of total cost)

• Monitoring & Evaluation/Auditing (W3) = US$150,000

• Supervision = US$50,000

Funding Leveraged from Other Sources:

• GoE/EEPCo: US$171,600,000.00 (approximately 84% of total cost) to cover the cost of extending access to the grid to rural towns and villages.

• User Fees: US$21,450,000.00 (11% of total cost) for connection fees

GPOBA W3 Funding: SIDA (US$1,800,000), DFID (US$3,200,000) and other donors (as available)

Outputs: a 286,000 operative electricity connections; and

b) 572,000 energy efficient CFLs (2 per hh).

Expected beneficiaries: 286,000 rural hhs (1,430,000 people)

Targeting: Geographic targeting in those rural areas where the UAEP is being rolled out, with the EEPCo connection fee financing program to the poor hhs being delayed for one year in a newly electrified town to ensure that hhs who can afford the connection fee do not benefit from the GPOBA subsidy, as typically they connect within the first year of electricity being made available. For those towns already electrified for a year or more, the GPOBA funded project will be implemented immediately for the benefit of hhs not yet connected and those hhs with irregular connections.

Economic Rationale: The EIRR of the GPOBA support is expected to be approximately 23% (without CFLs) and 28% (with CFLs). The FIRR is 22% (with GPOBA subsidy) and -6% (without GPOBA subsidy).

GPOBA subsidy “efficiency”: The average subsidy is US$35 per hh (including US$6 for the CFLs), or US$7 per person.

Sustainability: In Ethiopia, poor hhs are financially constrained to pay for the connection fee and this is a significant barrier in a country with limited micro-credit and where the average GNI per capita is only twice as much. Empirical evidence whereby EEPCo in the past has been providing loans, have shown the important role that hhs financing can play to accelerate the pace of direct connection significantly. With this GPOBA Project, poor hhs would be able to obtain financing for the connection fees and once connected, EEPCo will continue to supply electricity and provide services (assuming that the tariff payment is made on time). The current tariff is not cost-covering but it would be with: a) the 20% tariff increase approved in 2006 and deferred for poor hhs, which should enter into effect in the next 2-3 years; and b) the reduction of consumption via energy efficiency with the introduction by EEPCo of the CFLs to the poor hhs. CFLs (which will reduce the hh consumption by 55%) should help make the bill more affordable to the poor, increasing the affordability and chances of prompt payment in the long run.

Grant recipient: EEPCo.

Financial Management: Same as the IDA-financed EAREP I and II projects.

Procurement: The GPOBA project will be implemented by EEPCo. A Procurement Assessment was carried out for EEPCo as part of EAREP I and II, and the utility was found to have adequate capacity to extend the distribution network and proceed with the installation of thousands of customers, as it has been doing in the last few years.

Disbursement: GPOBA will reimburse US$35 to EEPCo upon independent verification as follows:

i) 50% after the customer has received a 5-year loan and EEPCo has provided an operative connection and 2 CFLs; and,

ii) 50% after three billing cycles (i.e., bills being sent out to the customer).

Environmental clearance: The ISDS for EAREP II, describing the GPOBA component, has been submitted and reports have been posted on Infoshop.

Government endorsement: A letter of confirmation is in the process of submitted by GoE to GPOBA. EAREP II was approved by the WB Board in July 2007, ratified by the Ethiopian Parliament in March 2008, and became effective on March 31, 2008.

Exchange Rate: 8.89 Birr = 1US$

Summary Responses to the Comments Raised by the Panel of Experts at Eligibility Stage

1. Merits of structuring the GPOBA subsidy in a way that it does not cause the impression of being interest-free to the customers. To achieve this, the subsidy could be used to lower the loan amount, which then would have to be repaid including nominal interest payments.

The team incorporated this request into the project design and will request EEPCo to redraft its current loan agreement with the customers to incorporate a nominal interest rate. The GPOBA subsidy will help EEPCo to “buy down” the loan to the hhs.

The loan to be given to the hhs would be based on the real connection costs (US$75) to be charged to the customer. The customer will make a US$15 down payment and obtain a US$36.69 loan at 19%. This loan will be repaid during five years with principal payments and interest payments totaling US$12/year according to the schedule of payments in Table 1 below:

Table 1

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2. A clearly understandable assessment of economic benefits of the scheme. In particular, energy savings due to the scheme should be considered and clearly set out as part of the benefits.

The team’s economic analysis is provided in detail in Annex 2 of this document

3. Relationship between this project and its dependency on a wider Bank project.

This issue has been address in detail in the Executive Summary above.

ABBREVIATIONS AND ACRONYMS

|AfDB |African Development Bank |

|BADEA |Arab Bank for Economic Development in Africa |

|CFL |Compact Fluorescent Lamp |

|EAREP | Electricity Access Rural Expansion Project |

|EEPCo | Ethiopian Electric Power Corporation |

|EIRR |Economic Internal Rate of Return |

|ERR |Economic Rate of Return |

|FM |Financial Management |

|GNI |Gross National Income |

|GoE |Government of Ethiopia |

|GPOBA |Global Partnership on Output-Based Aid |

|ISDS |Integrated Safeguards Datasheet Stage |

|kWh |Kilowatt hour |

|kV |Kilovolt |

|IDA |International Development Association |

|M&V |Monitoring and Verification |

|MW(h) |Megawatt (hour) |

|NPV |Net Present Value |

|OBA |Output-Based Aid |

|O&M |Operations and Maintenance |

|SDPRP |Sustainable Development and Poverty Reduction Program |

|SIDA |Swedish International Development Cooperation Agency |

|TWh |Terawatt hour |

|UEAP |Universal Electricity Access Program |

|WB |World Bank |

TABLE OF CONTENTS

A. STRATEGIC CONTEXT AND RATIONALE ….……………………………………..2

1. Country and sector context 2

2. Rationale for GPOBA involvement 5

3. Higher level objectives to which the project contributes 6

B. PROJECT DESCRIPTION………….………………………………………………………..6

1. Project development objective and key indicators. ……..….6

2. Description of the project: 6

3. Economic and financial analysis 9

4. Lessons learned and reflected in the project design 10

C. IMPLEMENTATION………………………………………………………………..............10

1. Milestones for project implementa………………….…………………………………………….10

2.Institutional and implementation arrangements 10

3 Reporting 11

4. Sustainability 11

5. Critical risks 12

D. TECHNICAL ANNEXES……………………………………………………………………13

Annex 1. Project Costs 13

Annex 2. Economic and Financial Analysis 14

Annex 3. Financial management and Disbursement (OP/BP 10.02 and 12.00) 15

Annex 4. Procurement. 16

Annex 5. Safeguards 17

Annex 6. Results and monitoring 18

Annex 7. Project Preparation and Supervision 20

A. STRATEGIC CONTEXT AND RATIONALE

Country and Sector Context

Ethiopia is the third most populous country in Africa, with 71 million inhabitants. With a fertility rate of 5.3 births per woman, it will soon become the second most populous country after Nigeria. Although the country has abundant resources and good potential for development, poverty is pandemic and often linked to environmental and natural resource degradation. Ethiopia has a GDP of US$11 billion, corresponding to a US$155 per capita significantly less than the Sub-Saharan Africa average. Approximately 44% of people fell below the basic needs poverty line in the last comprehensive national survey done in 1999/00. External aid contributes with US$1.8 billion. In the last few years, the country has experienced a high and sustainable economic growth. In 2005, the growth rate was 8.7%. Agriculture, which is still very dependent on rainfall, is the main source of value added in the economy, representing about half of GDP. The country does not produce oil or natural gas, but has a yet to be exploited hydro potential of about 30,000 MW.

Ethiopia presents one of the lowest electrification rates in Sub-Saharan Africa. Only 17% of the population lives in electrified areas, but overall national access is only 7%. Biomass still represents 90% of the country’s total energy needs. This pattern of energy consumption has led to increasing deforestation, shortage of wood fuel and degradation of the rural ecosystems. As a consequence of that, Ethiopia launched the 10.5 billion Birr UEAP to achieve universal access in 10 years. Donors provide funds to the GoE, which in turn, on-lends to EEPCo to execute the UEAP. So far, those institutions have co-funded specific projects encompassing about US$4.13 billion Birr to serve 780 towns and villages. This amount represents about 40% of the overall UEAP requirements and 13% of the total number towns and villages to be electrified. Ongoing dialogue with a number of donors regarding financing the investment program has to date resulted in continued and/or new commitments from BADEA, Kuwait Fund, AfDB, the Indian Government and IDA. Other donors have expressed interest, such as the Islamic Development Bank and the Government of China, and may formalize commitments for various portions of the investment program shortly.

The majority of people in Ethiopia are supplied by the state-owned EEPCo, a vertically integrated power utility. EEPCo serves about 1,130,000 customers, including 360,000 in Addis Ababa, where the connection rate is 33 per cent. In other urban areas, the rate is about 20-30%. However, 85% of the population lives in rural areas, where the access rate is less than 2%. EEPCo, as per table below, has been able to almost double the number of electrified towns and customers served in the last 5 years thanks to the support of the Bank and other donors.

Table 2: Number of Customers & Electrified Towns in Ethiopia

|Fiscal Year |2002 |2003 |2004 |2005 |2006 |

|Total # of customers directly connected |654,885 |698,360 |797697 |947697 |1,126,464 |

|# of customers directly connected per | | | | | |

|year |29,389 |43,475 |99,337 |150,000 |178,767 |

|Electrified towns per year |23 |66 |74 |32 |227 |

|Number of electrified towns |492 |558 |632 |664 |891 |

EEPCo has an installed capacity of almost 900 MW, which should double in the next 2 years, with the ongoing construction of three new hydro electricity plants, namely Beles, Tekeze and Gilgel Gibe II. Those plants have been funded by EEPCo, the GoE, the Italian Government and the Chinese Government. Hydro expansion to serve the domestic market and for exports has represented a significant financial commitment both for EEPCo and for the GoE. Demand in 2005/06 reached 2.9 TWh. In the last 5 years, it has grown at a high yearly rate of 9.6%. EEPCo has a strong technical and stable management team, and is operating profitably with an internal cash generation of about US$50 million per year. Its operating costs are low since generation is predominantly hydro, which also reduces exposure to oil price volatility. EEPCo has satisfactorily responded to the GoE commitment to provide universal access in a ten year period and has technically responded to the challenge of developing the country’s hydro generation potential. The ambitious investment program (two thirds in generation) has been well beyond EEPCo’s financial capacity to invest. The GoE has supported the company via loans and equity, to keep it operationally sound. EEPCo invests US$600 per hh for the sub-transmission and distribution cost.

Tariff Structure:

In Ethiopia, hhs in the lowest consumption bracket[5] have to pay a two-part tariff consisting of: a) a fixed monthly payment (service charge) of US$16 cents; and,b) a variable payment on a per kWh basis (lifeline tariff) of US$3 cents/kWh up to a consumption of 50 kWh. A typical, poor hh in rural areas falls under this lowest bracket consuming approximately 15 kWh/month. This results in a monthly payment of about US$61 cents or US4 cents/kWh, which is slightly lower than EEPCo’s cost to serve that poor hh (US$4.6 cents/kWh). Therefore, this structure is currently not cost-covering for the lowest strata of the population, and the deficit is financed by cross subsidies from higher consumption customers. Furthermore, in 2006, a tariff increase of 20% was deferred for poor customers, but is expected to be implemented in the next 2-3 years. Taking this tariff trajectory into account, as well as the assumption of a 10% cost increase during that period, EEPCo would be able to cover costs for the poor hhs in the lowest consumption bracket (please refer to Table 3 below).

However, in addition to this monthly two-part tariff, the hh needs to pay: a) a one-time connection fee of U$50-100 (on average US$75); and b) wiring costs of the house, which may represent about US$20, if a “Ready Board” panel is to be installed. In most cases, a much simpler wiring solution is envisioned. Wiring is an additional cost to be borne by the customer upon connection. As is customarily the case, the utility is not responsible for providing the wiring inside the customer’s house, which is considered private property. It is envisaged that for this project, the consumers will continue to bear the cost of wiring their houses. In future interventions, the pros and cons of financing Ready Boards may be considered.

Poor hhs: Service Charge Fee (monthly) US$16 cents

Tariff for basic consumption (monthly) US$3 cents/kWh

Upfront Connection Fee (one-time) US$75

Internal Wiring (one-time) US$20

Based on the above tariff structure, there are two main barriers for the poor hhs to be able to have access to electricity in rural Ethiopia:

1) Tariffs: They are not cost-covering for the lowest strata of the population and to compensate for this fact the tariff structure contains cross subsidies from higher consumption customers. Despite the apparent low tariff, they may still represent a significant part of hh’s budget. For the 42% poorest, whose hh annual income is US$105, cost of electricity is about 7.3% of the hh’s budget. For the second economic strata, (29%), whose hh annual income is US$150, and assuming the same level of consumption, the cost of electricity represents 5.1% of the hh’s budget.

2) Connection Fee: It is not affordable for many poor hhs in rural areas to have a metered connection installed as the one-time US$75 connection fee needs to be paid upfront to EEPCo before it makes the connection. This led to an increase in the number of indirect connections, which entails a sub-standard service and a poor targeting mechanism. To solve the problem, and in the absence of micro-credit institutions, EEPCo started providing 5-year loans to the poor hhs. Under these loans, the hhs paid a down payment of US$15 (20% of the connection fee) and received a US$60 interest-free loan (80% of the connection cost). Unfortunately, EEPCo decided to reduce the term of payment to 2 years, and is now considering discontinuing this practice, since working capital is necessary in other parts of the company, given the utility’s ambitious expansion plan. Empirical evidence shows that when EEPCo was able to provide the loans, the pace of direct connection increased by 20%.

The average ability to pay of the overall population is 49 Birr or US$5.7 per month, based on their actual expenditures on kerosene, candles and batteries, as shown in the following graph.

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However, 60% of the population has a monthly ability to pay for electricity of US$2.3 or less, based on the cost of fuel spent today. If the electricity bill is excluded from this amount, this segment of the population could barely afford a connection fee of up to US$100, assuming that financing is provided. Among the poorest, the ability to pay is only US$80 cents per month. Excluding the electricity bill, they could afford at best a connection costing no more than US$30. It is clear that there is a segment of the population who are not able to afford connection to the service. It is assumed that about 37% of the population could potentially afford a connection. 25% have a willingness to pay of US$7.6 per month while 12% would have a willingness to pay of US$20 per month.

To solve these barriers, the GPOBA subsidy will make access more affordable to poor hhs by:

1) Enabling EEPCo to continue the successful connection fee financing program, and re-extending the length of the loans from 2-years to 5-years, which should solve issue #2 above; and

2) Supplying two CFLs as part of the connection package: This will allow tariffs to cover EEPCo’s costs to serve the poor hhs and solve issue #1 above. With the provision of CFLs, it is expected that the hh consumption will be reduced by 55% via energy efficiency. The total bill would fall to US$34 cents and the cost to EEPCo to US$31 cents, slightly generating a profit margin for the utility (even not taken into consideration the 20% tariff increase and 10% cost increase in the future) as shown below:

Table 3

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Rationale for GPOBA Involvement

This project meets GPOBA operational criteria, as well as the core OBA principals of:

Payment linked to performance: A fixed subsidy per hh would be given to EEPCo after the following conditions have been met: (i) connections have been made, (ii) customers have received a 5-year loan; and (iii) EEPCo has gone through three billing cycles;

➢ Explicit targeting of subsidies to the poor: It is expected that the GPOBA grant will enable new or regularized connections to 286,000 customers representing a population of about 1,430,000. A targeting mechanism will be put in place to minimize leakage (please refer to Section B.2.1. below);

➢ Encouraging accountability of and risk sharing by providers: EEPCo bears all construction and commercial risks as it will not receive the subsidy after certain conditions have been met. Furthermore, given the “fixed” nature of the subsidy (as opposed to a “cost-plus” reimbursement to the utility), EEPCo will have incentives to provide the physical connection at the lowest possible cost, following quality standards spelled out in the applicable regulatory framework. EEPCo is responsible for connecting the rural customers, and for supplying power and providing customer services;

➢ Leveraging: To provide access to towns and villages, GoE/EEPCo have been investing significant resources close to US$600 per hh. However, unless customers get connected to the grid, benefits of this upstream investment do not materialize. Customers have a high willingness to pay, as they appreciate the value of electricity. However, they are financially constrained and most can not afford the average US$75 user contribution. Providing lending to those customers over a 5-year period enables them to rapidly connect to the grid, therefore leveraging all the upstream investment carried by the utility. The proposed GPOBA scheme will help GoE and the customers to achieve their goals of obtaining real access to electricity;

➢ Innovation: This is the first GPOBA project in energy that helps to increase access by extending the repayment period of loan that fund connection costs. The connection cost will be borne by the target group itself. The rationale is to mitigate the impact of the connection cost as a barrier to entry, therefore accelerating the pace of connections among poor hhs. The other innovative aspect is to use part of the subsidy to provide energy efficient CFLs to the beneficiary customers in order to reduce their electricity bill and assure that they can afford the electricity services once connected;

➢ Encouraging sustainability. Once the customer is connected, EEPCo will continue to supply electricity and provide services, assuming that payment is made on time. CFLs should help make the bill more affordable to the customer, increasing chances of prompt payment. In addition, the provision of CFLs will cut total electricity consumption by about 55%; therefore, contributing to further reduce customer’s expenditures on energy and the long term to the project sustainability;

➢ Monitoring of results is an integral part of the project since verified outcomes will trigger subsidy payments.

A.3 Higher Level Objectives to Which the Project Contributes

The higher level objective to which the project contributes is reducing poverty through a combination of measures to increase economic growth. The GoE developed the Sustainable Development and Poverty Reduction Program (SDPRP) in 2002. Despite numerous shocks, such as the drought in 2002-2003, implementation of the SDPRP has resulted in important recent gains, especially on human development indicators, transport, the investment climate, small town development, and the fight against food insecurity. Pro-poor spending as a share of the budget has risen from 28% in 1999/2000 to 57% in 2004/05. The World Bank Country Economic Memorandum 2006 on Growth and Governance finds that important progress has been achieved in the past decade, largely driven by improved institutions, including at the regional and local levels, which have been able to deliver a scaling-up of services and infrastructure. The GPOBA grant will help GoE achieve its access targets under the UEAP program and contribute to the achievement of its overall macro-economic goals.

B. PROJECT DESCRIPTION

B.1 Project Development Objective and Key Indicators

The main objective of the GPOBA project is to increase access to electricity in towns and villages with grid-access, by financing connection costs and providing two Compact Fluorescent Lamps (CFLs) for poor hhs. The GPOBA funds, amounting to up to US$10 million, will provide 286,000 new rural connections and 572,000 CFLs, benefiting a population of 1,430,000. The increased access to electricity will improve the quality of life, enhance educational services, and provide income-generating opportunities.

B.2 Description of the Project

B.2.1 Project Design

This GPOBA project is part of the IDA-financed EAREP II, which was approved by the Bank Board on July 3, 2007. However, connections made under other rural electrification programs will be eligible for GPOBA subsidies, too. GPOBA subsidies are not earmarked to a particular donor. EEPCo is responsible for the execution of UEAP associate projects and is also responsible for the connection of all customers to its network, including the ones who will benefit from the GPOBA subsidy. The GPOBA Project will allow the continuation of the loan program for poor hhs to connect in addition to the introduction of energy efficiency with the CFLs. In the absence of a connection fee financing program, it is expected that in the first year only 20% of potential residential customers would be able to pay the fee and get connected. This percentage is assumed to gradually increase to 60% after 5 years. With OBA subsidies it is expected that 40% of the customers will request connection in year 1, increasing to 80% in year 5.

Targeting:

The GPOBA was blended into the WB EAREP project, but funds are not earmarked. The idea is that GPOBA funds can be allocated to any electrification project. For practical reasons, it is assumed that those funds will support connections among poor customers in any donor funded (loan or grant) intervention, which has the necessary monitoring and control processes in place. Excluding GoE, donors are funding about 1,225 towns and villages, from which the WB is funding about 830 as part of the UEAP umbrella effort.

There are a few possible ways to target those who do need the GPOBA intervention. The first is to define the subsidy on a need-basis. Unfortunately there is not a good administrative process in place in Ethiopia to do so. The second possibility is to segment the provision of financing on a geographical basis. It is known that some areas in Ethiopia are significantly better off than others. For example, coffee growing rural areas have an income higher than the national average. The disadvantage of geographical is that even within those richer pockets there may be poor customers. Furthermore, it would not be perceived as a mechanism that fosters regional equity, one of the cornerstones of the government policy. The third possibility, which seems to be the most practical and which will apply for the GPOBA project is to provide the 5-year connection fee financing to hhs only after certain period after a town is electrified – for example one year. Experience has shown that the hhs who are able to pay the full connection fee will do so right after a village is electrified. The connection fee financing program to the target population will be delayed in a newly electrified town or village, until some time has passed and those who can afford it have already paid for their connection. Those who need financing will wait until the financing scheme is in place. They would then pay US$15 upfront and the balance through installments over 5 years. This alternative will focus on those rural areas where electrification is being carried out using donor funding. In those areas, given the presence of donor funding, it is assumed that a good system of monitoring and evaluation is in place. Of the 1,225 towns and villages supported by the donor community (including the WB), it is estimated that 40% is already electrified. In those towns and villages electrified for more than a year, the connection fee financing program supported by GPOBA will be implemented immediately for both new and regularized connections. For towns and villages still to be electrified, there will be a one year time lag to offer the connection fee financing program to ensure that only those who cannot afford the connection fee will benefit from the program. It is estimated that upon the completion of the GPOBA project, 85% of the eligible connections in the 1,225 towns and villages will have been made. In sum, the GPOBA intervention would have a material impact on the volume and pace of connections.

Empirical evidence has shown that OBA target population would use electricity primarily for lighting at the outset. Other uses include over time a small radio, TV and possibly a refrigerator, as families adapt to having electricity and can afford the additional costs of buying the appliances and a higher electricity bill. Better quality lighting helps children study at night and families to increase family income by additional home-based economic activity. Replacement of kerosene lamps will reduce indoor pollution; reduce negative impact of inadequate illumination on eyesight and represents monetary savings. Radio and TV are primary source of information and will fulfill educational and entertainment purposes. The following table illustrates a typical consumption profile for a poor hh. It also includes the potential benefits of energy conservation in the consumption pattern.

Table 4

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About 70% of the population in rural areas is below the poverty line, earning about US$60 cents per day. Of the remaining population, 16% earn US$1 per day, 12% earn US$2.4 per day and only 1% earn up to US$4.0 per day. Agriculture, which is subject to the vagaries of rainfall, represents 62% of the income. Even poorer strata of the population are expected to be able to pay fees for service charge and basic consumption (even though they might not be able to pay the connection fee). The provision of CFLs will cut the electricity costs for lighting by about 75% and total consumption by about 55%, thereby contributing to further reduce the customer’s expenditures on energy or enabling the poorest to enjoy the use of electricity for uses other than lighting only. With energy efficiency devices, for the 42% poorest, the cost of electricity will drop from 7.3% to 4.1% of the family’s budget. For the second economic stratum (29%) whose hh annual income is US$150, and assuming the same level of consumption, the cost of electricity will drop from 5.1% to 3% of the family’s budget. With the provision of CFLs, it is expected that the hh consumption will be reduced by 55%. The total bill would fall to US$34 cents and the cost to EEPCo to US$31 cents, slightly generating a profit margin for the utility, even at the current tariff rates. It is also expected that tariffs will increase 20% over the next 2-3 years and costs 10%.

B.2.2 Project Components:

GPOBA’s total contribution consists of the following components:

1. Subsidy (up to US$10 million): The GPOBA subsidy is a 3-year program consisting of a payment of US$35 (including US$6 for two CFLs) per connected hh to EEPCo in order to help the utility defray its working capital costs of providing a 5-year loan to the customer.

2. Output Monitoring and Verification (M&V)/Auditing (US$150,000). This component will finance the monitoring and verification of outputs and auditing over the 3-year period. In addition, the project will be subject to an external audit. An independent credible organization, yet to be identified, will be contracted.

The GPOBA project will use the existing monitoring and evaluation functions built into EAREP, with minor adaptation in internal processes and controls. For those GPOBA funded connections that are not related to the WB-EAREP project, EEPCo has an organization in place that is able to monitor the number of connections, the 5-year loans granted by EEPCo, and the required number of billing cycles for EEPCo to be eligible for the US$35 subsidy. As part of the monitoring and evaluation, EEPCo will also carry out surveys to compare the impact of the 5-year loans on the pace of connection, using a control group as a reference.

3. World Bank Supervision (US$50,000) to be performed over the three years of the GPOBA project. Project supervision covers the work of the task team leader, the technical specialists, and the fiduciary and safeguards staff for the supervision of GPOBA subsidies. Supervision will take place in conjunction with the other three energy access projects currently financed by the WB, which will enable a reduction in costs and better synergy among the multiple electrification efforts.

B.2.3 Disbursement Schedule

GPOBA will reimburse US$35 per hh to EEPCo, upon independent verification, as follows:

(i) 50% after the customer has received a 5-year loan and EEPCo has provided an operative connection and 2 CFLs; and,

(ii) 50% after three billing cycles.

Please refer to table below for the planned schedule for connections and disbursements. For the sake of simplicity, the lag between real connections and disbursements (in particular the three billing cycles) was not taken into account:

Table 5

[pic]

B.3 Economic and Financial Analysis

a) Economic Analysis

The EIRR for the project is 23% or 28% if CFLs are provided as part of the connection package. Please refer to Annex 2 for more details.

From an economic standpoint, the proposal enables most of the customers in electrified areas to fully enjoy the benefits of electricity at the outset. Given the demonstrable willingness to pay (estimated at US$170/MWh for very basic electricity services) the reduction in the connection cost has the potential to generate a benefit of US$124/MWh) represented by the difference between the willingness to pay and variable cost of energy (estimated at US$46/MWh). If consumption at the outset for the poorest hhs is 15kWh per month, the connection generates an incremental, potential economic benefit of US$21 per year per hh connected. Additionally, if CFLs are provided, the portion of the electricity used for lighting is reduced by 75% and the total hh consumption by about 55%, increasing the annual economic benefit per hh to US$26.

The benefits for regularized customers would be similar. Despite having access to electricity, supply is limited to one lamp for a few hours per day (5 to 6 hours). Initial estimates suggest that the monthly payment made by those customers to their “meter lords” is similar to their current ability to pay for alternative fuels. Therefore, one can assume that the regularization of those customers generates as much economic benefits as the connection of a new customer to the grid. From a societal perspective, the distribution of CFLs to regularized customers creates incentives to save energy and therefore represents an additional economic benefit.

b) Financial Analysis: The FIRR is 22%. In the absence of GPOBA intervention, the project FIRR becomes -6%. Details are provided in Annex 2.

B.4 Lessons Learned and Reflected in Project Design

The main lesson learned is that customers in newly electrified towns and villages have a high willingness to pay for electricity services, but in many cases are budget constrained – that is, their ability to pay is more limited, particularly among the poorest. Electricity is a superior source of fuel when compared, for example, to kerosene for lighting or batteries for radios or portable TVs. It also enables the use of a wider array of appliances which would be virtually impossible otherwise. However, the cost of connection has proved to be a barrier for poor customers to get connected. Despite US$600 per hh investment made upstream by the utility company in providing access to new towns, when it comes to connections per se, the process takes longer because the customer is financially constrained to pay for the US$75 upfront contribution. This is a significant barrier, in a country with limited micro-credit and where the average GNI per capita is only twice as much. The main lesson is that to bridge this gap some sort of financing is necessary. Empirical evidence whereby the utility in the past has been providing 5- and 2-year loans, have shown the important role that customer financing can play. Those utility-financed programs have accelerated the pace of direct connection significantly, therefore enabling more people to enjoy the benefits of having their own metered connection. A typical connection pace with or without 5-year loans is shown in the following table.

Table 6

| |Hh Connection (Cumulative %) |

| |Year 1 |Year 2 |Year 3 |Year 4 |Year 5 |Year 6 |Year 7 |

|With 5-year loans |40 |

|GPOBA provides subsidy commitment |April 2008 |

|GPOBA Grant Agreement signed |July 2008 |

|Service provision begins |August 2008 |

|GPOBA disbursement begins |December 2008 |

|GPOBA disbursement ends |December 2011 |

C.2 Institutional and Implementation Arrangements

The project will be able to use the existing institutional and implementation arrangements under EAREP II. The Project will be implemented by EEPCo, under the Ministry of Energy. The UEAP Office, within EEPCo, will carry out the grid-extension component. The different roles and responsibilities will be as follows:

• EEPCo, will be the implementing agency of the Project and will supervise the Independent Verification Agent.

• Independent Verification Agent as per Section B.2.2. above.

The formal relationships between the parties will be regulated through the GPOBA Grant Agreement. In addition to the Grant Agreement, there will be an Operations Manual which will describe the modus operandi of the proposed project.

C.3 Reporting

(a) Quarterly Progress Project Reports and Interim unaudited Financial Reports;

(b) Semi-Annually Results and Monitoring Report (with indicators) as per Annex 6;

(c) Annual audit reports;

(d) A Completion Report not later than six (6) months after the Closing Date in the Grant Agreement.

(e) Two Post Project Reports, each of such scope and in such detail as the World Bank shall reasonably request, not later than one month after the expiry of one year and two years, respectively, from the Closing Date in the Grant Agreement.

The team is in the process of finalizing the Financial Management (FM) and reporting requirements and any additional financial management, fund flows and reporting agreements, when finalized, might be included in the Operations Manual and Grant Agreement.

C.4 Sustainability

Once the customer is connected, EEPCo will continue to supply electricity and provide services, assuming that the tariff payment is made on time. CFLs should help make the bill more affordable to the customer, increasing the affordability and chances of prompt payment. With the provision of CFLs, it is expected that the hh consumption will be reduced by 55%. Tariffs are roughly covering the O&M cost to serve poor customers, which is a reasonable indicator of program sustainability. Use of energy efficient devices creates some room for tariff increase.

Scale-up and Replication:

The proposed OBA scheme will create incentives to execute a large number of new connections to poor customers. Subsequent connections should take place using the proceeds from the amortization of the loan. A kind of “revolving fund,” once established, can provide capital to finance new or to regularize connections even after the 3-year GPOBA intervention. Currently in Ethiopia there are 15,000,000 hhs, many of them poor and most without access to electricity so that there is scale-up potential for the project. The project might also be replicated in similar situations in other countries where user contributions need to be subsidized.

Further, similar GPOBA interventions may consider support to the customer wiring. A solution (not necessarily the cheapest) is the provision of a “Ready Board” which consists of a wooden panel with sockets, plugs and outlets, which works as a mini-distribution center for the hh. Utilities are usually reluctant to go “beyond” the meter for statutory and legal reasons. The current GPOBA program may assess the importance and impact of the cost of internal wiring to the poorest for the target market of this project. This will help define future interventions.

C.5 Critical Risks

|Risk |Mitigation |Rating |

|Affordability and willingness to pay by|There are ability to pay studies (based on hh money currently spent in alternative |Low |

|customer |fuels). EEPCo’s experience with the 5-year credit program was been positive. | |

| |Additionally the project will allow the target group to reduce expenditures on | |

| |kerosene, batteries and candles. CFLs will allow further reductions in the | |

| |electricity bill. | |

|Measurement/verification of outputs |Based on ex-post connections in tandem with new 5 year loans, after a successful |Low |

| |three-billing cycle period. GPOBA can leverage on existing Monitoring and Evaluation | |

| |functions developed for EAREP I. | |

|Sustainability of project |Customer will be able to save money and obtain significant economic benefits. This |Low |

| |will not entail foregone profits for EEPCo, since it operates very close to the | |

| |breakeven point to serve the poorest customers. | |

|Willingness of regulator to ensure |A recent comprehensive tariff study was carried out by GoE, which identified the need|Medium |

|tariff structure covers at least O&M |to better target subsidies for those who need it most. The existing block rate tariff| |

| |scheme is under revision, to better target subsidies embedded in life-line rates. | |

| |Subsidies for the very poor will remain, but the amount of cross-subsidies may be | |

| |reduced in the future upon a review of the tariff structure, improving targeting. | |

| |Currently, EEPCo has its operating and maintenance costs covered and generates some | |

| |resources for investments. | |

|Lack of community involvement in |The community is eager to get access and oftentimes allocates a significant part of |Low |

|designing scheme |its budget to fund the connection costs. The introduction of the 5 year loan was well| |

| |received and showed increased connection rates. EAREP I is currently working with the| |

| |communities to better identify the monetary and non-monetary barriers to connection | |

| |and refine the subsidy scheme, as necessary. | |

|Reputational for GPOBA due to the |The original project design did not envision for GPOBA to subsidize the internal |Medium |

|internal wiring of the hhs |wiring of the hhs. If wiring costs were to be covered by GPOBA’s limited available | |

| |funds to this Project, the number of beneficiaries and the target market would be | |

| |reduced by more than 50% and to 22%, respectively. However, there is a reputational | |

| |risk for GPOBA not to cover the wiring costs due to safety concerns in the internal | |

| |wiring of the hhs in Ethiopia. EEPCo, as most of the utilities, is reluctant to go | |

| |“beyond” the meter for statutory and legal reasons. | |

|Overall Risk | |Low |

Annex 1: PROJECT COSTS

Scenario 1

|Expenditure categories |Local |Foreign |Total Cost |

| |(US$) |(US$) |(US$) |

|Projected subsidy expenditure |0 |10,000,000 |10,000,000 |

|(GPOBA W3) | | | |

|Supervision |0 |50,000 | 50,000 |

|Monitoring&Evaluation and Audit (GPOBA |75,000 |75,000 | 150,000 |

|W3) | | | |

|Total costs |75,000 |10,125,000 |10,200,000 |

Scenario 2

|Expenditure categories |Local |Foreign |Total Cost |

| |(US$) |(US$) |(US$) |

|Projected subsidy expenditure |0 |4,850,000 |4,850,000 |

|(GPOBA W3) | | | |

|Supervision |0 | 50,000 | 50,000 |

|Monitoring&Evaluation and Audit (GPOBA |75,000 | 75,000 | 150,000 |

|W3) | | | |

|Total costs |75,000 |4,975,000 |5,050,000 |

Annex 2: Economic & Financial ANalysis

a) Economic Analysis

Monthly consumption per hh of 15kWh

Marginal cost of supply = US$46/MWh

Service Charge – US$2 per year (embedded in the cost of supply)

Willingness to pay = US$170/MWh

Time horizon = 10 years, and 5 years for CFLs (assuming no replacement)

Investment costs = Single connection = US$75.00, (not including 2 CFLs at US$3 each)

Connections executed over a three year horizon.

[pic]

b) Financial Analysis

Annex 3: financial management and disbursement (op/bp 10.02 and 12.00)

this is currently under discussions with the financial specialist. The connection, lending, verification and amortization procedures are summarized in the following chart.

[pic]

Annex 4: PROCUREMENT

The electrification projects (EAREP I and II) with which the GPOBA grant is associated, will be implemented by EEPCo.

A Procurement Assessment was carried out for EEPCo as part of the Bank’s processing of the EAREP I and II projects, and the utility was found to have adequate capacity to carry out the related activities including, extending the distribution network, providing two CFL bulbs per consumer, and providing connections to thousands of customers. For these activities EEPCo will use International Competitive Bidding, National Competitive Bidding, and other procurement arrangements as agreed with the Bank under the two project loan documents. With respect to consumer connections, material will be obtained both internationally and locally and the erection work will be done using both force-account and local sub-contracting.

These are activities being carried out under EEPCo’s normal business practices. In general, the Bank is satisfied on the procurement practices and standards followed by EEPCo in carrying out these activities and these have been reviewed under IDA credits for the EAREP I and II projects. The practices are in compliance with Bank procurement guidelines.

The project funds are not disbursed against procurement activity and funds are disbursed based on the loans provided to consumers. Hence the Bank’s procurement policy will not apply under this GPOBA grant; except for the hiring of the IVA. The hiring of the IVA will conducted in accordance with “Guidelines – Selection and Employment of Consultants by World Bank Borrowers” (May 2004).

ANNEX 5. SAFEGUARDS

The parent project EAREP II has already prepared an ESMF for both implementing agencies (who will also manage these funds). It would seem that any potential issues related dropping down wire from the distribution lines financed under the projects can be handled within the scope of the existing ESMFs.

ANNEX 6. RESULTS AND MONITORING

The overall responsibility for monitoring and verification lies with EPPCo. EEPCo will use the same organization structure and processes which are now carrying out EAREP I and II and monitoring their specific performance indicators. UEAP should work in conjunction with EEPCo’s treasury to provide the required indicators.

In addition, the following information would be used as a guideline for Results and Monitoring of the GPOBA Project. Figures presented are merely illustrative.

Table 1: Output table

|Year |2008 |2009 |2010 |

| |P1 |P2, … |P1 |P2, … |P1 |P2, … |

|Number of connections receiving 5 year |planned |50 | |120 | |116 | |

|loan[6] (000) | | | | | | | |

| |actual | | | | | | |

|Number of CFLs distributed (000) |planned |100 | |240 | |232 | |

| |actual | | | | | | |

|Subsidy per output if changes over time |planned |1.75 | |4.2 | |4.05 | |

| |actual | | | | | | |

|Disbursements (US$ million) |planned |1.75 | |4.2 | |4.05 | |

| |actual | | | | | | |

Table 2: Static data (to be provided at the beginning of the project and updated when necessary)

|Outputs |Definition of outputs |Electricity connection to poor hhs that receive a 5-year loan plus two CFLs |

| |Disbursement milestones |50% at connection 50% after 3 billing cycles |

|Access |Number of people per hh in project area |Typically From 4.7 to 5.0 |

|Targetin|Targeting |National focusing on Donor’s lending areas, where Monitoring and Evaluation |

|g | |processes exist (usually of national coverage as well). Loan scheme being |

| | |introduced after 1 year of electrification in the target areas. |

| |Average hh expenditure on alternative service |For lighting, about 90% use kerosene and 10% other forms, including candles, |

| |provision |torches, and wood |

|Aid |Actual unit subsidy |US$35.0 per hh |

|efficien| | |

|cy | | |

| |Comparator information from output or input-based |Availability of 5-year loans in tandem with connection will enable a faster |

| |projects |connection rate in the target areas |

| |Time (months) to design OBA scheme |3 months |

| |Cost of project development (TA) |US$40,000 |

|Provider|Description of service provider |National Public electricity utility (EEPCo) |

|selectio| | |

|n | | |

| |Type of contract/ certification |Typical Connection and Loan Agreement Public incumbent |

| |Competitive bidding used? |No, since there is one single service provider of grid-connected services |

|Dev. |Development impacts recorded by the project |Reduction in time and resources spent or distance traveled for procuring service; |

|Impacts | |health benefits; children can study at night, potential for hh productive |

| | |activities, as recorded by the project. Energy savings by virtue of use of CLFs |

| | |for lighting (primary use in the first years) |

| |Gender impact |Connection to the grid creates potential for productive activities to be carried |

| | |out by women in the hh. Girls can improve the quality of learning at night. |

Table 3: Indicator tracking table

|Year |Unit |Base-li|2008 |2009 |2010 |

| | |ne | | | |

| | | |Q1 |

|GPOBA connection subsidy |planned |US$ |35 |10,000,000 |

| |actual | | | |

|User contribution |planned |US$ |75 |21,450.000 |

| |actual | | | |

|Funding from the GoE/EEPCo.|planned |US$ |600 |171,600,000 |

| |actual | | | |

|Total |planned |US$ |710 |203,050,000 |

| |actual | | | |

ANNEX 7: PROJECT PREPARATION AND SUPERVISION

A. Institutions responsible for preparation of the project:

EEPCo.

Primary contacts: Ato Mihret Debebe, Managing Director

Ato Shiferaw Telila, EAREP II Project Coordinator

B. GPOBA/World Bank Team:

|Name |Title |Unit |

|Luiz Maurer |Task Team Leader |AFTEG |

|Carmen Nonay |Transaction Advisor |GPOBA |

|Johnathan Pavluk |Senior Counsel |LEGAF |

|Nina Chee |Senior Environmental Specialist |AFTSD |

|Luis Schwarz |Financial Management Specialist |LOAFC |

|Chrisantha Ratnayake |Procurement Specialist |AFTEG |

|Helena Kofi |Procurement Analyst |AFTEG |

|Janine Speakman |Operations Analyst |AFTEG |

|Tigest Tirfe |Program Assistant |AFTEG |

Advisory team:

|Name |Title |Role |Unit |

|Patricia Veevers-Carter |Program Manager |Peer Review/ |GPOBA |

| | |Advisory | |

|Irving Kuczynski |Panel of Experts |Advisory |GPOBA |

|Alejandro Jadresic |Panel of Experts |Advisory |GPOBA |

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[1] The main donors have been: Arab Bank for Economic Development in Africa (BADEA), Kuwait Fund, African Development Bank (AfDB), the Indian Government and IDA.

[2] Here defined as the drop wire, an additional pole (if necessary), meter, circuit breakers, two efficient bulbs and labor installation costs. What is being called connection cost for the purpose of the OBA intervention, excludes any upstream investment.

[3] It is assumed that only poor hhs have irregular connections. If the hh had funds to pay the connection fee, it would have paid for a new connection rather than tapping into a neighbor’s connection.

[4] Please note that this Commitment Document assumes that US$10 million subsidy will be provided. However, up to date, only US$5million in funding has been identified. Therefore, benefits will be proportional to the subsidy amount provided.

[5] The current tariff system in Ethiopia includes several consumption brackets with higher tariffs for hhs with a higher consumption.

[6] Only if subsidy is to be paid separately for loan and CFL.

[7] As defined for each individual project, may include average hours of service availability or costumer satisfaction surveys.

-----------------------

Pace of Disbursements

10.00

4.05

4.0

1.75

Disbursements

285714

115714

120000

50000

Connections

TOTAL

2010

2009

2008

(US$ MM)

49299

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