Republic of Uganda Privatization and Utility Sector Reform Project (Credit 3411-UG) Proposed Amendment to the Legal Agreements 1. Sector Reform Project (Credit 341 1-UG) aim to support the concessioning o f the distribution assets o f the publicly owned Uganda Electricity Distribution Company Limited (UEDCL), to a Ugandan company (UMEME Limited) formed by a private consortium o f investors selected by UEDCL and the Government o f the Republic o f Uganda (GOU). The concession will entail entering into additional contractual arrangements among the parties including several with IDA (para. 6 and Sections IV and V). The proposed amendments to the legal agreements for the Privatization and Utility I. BACKGROUND 2. Privatization and Utility Sector Reform Project was approved on August 24,2000 and signed on December 18,2000. The Project was declared effective on January 3 1, 200 1. As of November 16, 2004, about SDR14.9 million of the Credit has been disbursed. There has been one amendment to the Development Credit Agreement dated November 19,2002, which was to add a second Special Account specifically for severance payments and a new category of expenditures for audits, to reallocate funds to fully cover Project Preparation Facility expenditures, and to revise aggregate procurement amounts for National Competitive Bidding and National Shopping. A mid-term review of the project is scheduled for January 2005, and the original Closing Date o f the Project is January 3 1,2006. All legal, financial, and audit covenants under the project are being met. A Credit in the amount o f SDR 36.2 million (US$48.5 million equivalent') for the 3. The four main project components cover: (a) privatization of remaining industrial and commercial public entities; (b) institutional support for a Parastatal Monitoring Unit to oversee the financial performance of parastatals in the Ministry of Finance, Planning and Economic Development (MFPED); (c) implementation o f sector reforms in the telecommunications, electricity, railways and water and sewage sectors; and (d) the effective functioning o f a Project Coordinating Unit in the MFPED. The overall project implementation rating is satisfactory (see Section I1 on project implementation performance). 4. sector participation in the power distribution business of UEDCL. Earlier, in March 200 1, with IDA support under this project, the former Uganda Electricity Board (UEB) was unbundled into three successor entities, for generation, transmission and distribution. While the generation entity, the Uganda Electricity Generation Company Limited (UEGCL), was already successfully concessioned on April 1,2003, there were delays in reaching agreement with the proposed distribution concessionaire due to the need to adequately mitigate certain perceived regulatory and GOU-related payment risks which were beyond the control o f the private investor. A critical component of the security package negotiated between UMEME, UEDCL and GOU, is recourse to a Liquidity Facility during the first seven years following the privatization. This Liquidity Facility can be accessed o n the occurrence o f certain In October 2002, the GOU requested IDA support in relation to securing private ' As ofNovember 16, 2004, the value o f the original Credit of SDR36.2 million was about US$52.3 million due to the appreciation o f the SDR against the US DoIlar. Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
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Republic o f Uganda
Privatization and Utility Sector Reform Project (Credit 3411-UG)
Proposed Amendment to the Legal Agreements
1. Sector Reform Project (Credit 341 1-UG) aim to support the concessioning o f the distribution assets o f the publicly owned Uganda Electricity Distribution Company Limited (UEDCL), to a Ugandan company (UMEME Limited) formed by a private consortium o f investors selected by UEDCL and the Government o f the Republic o f Uganda (GOU). The concession will entail entering into additional contractual arrangements among the parties including several with IDA (para. 6 and Sections IV and V).
The proposed amendments to the legal agreements for the Privatization and Utility
I. BACKGROUND
2. Privatization and Utility Sector Reform Project was approved on August 24,2000 and signed on December 18,2000. The Project was declared effective on January 3 1, 200 1. As o f November 16, 2004, about SDR14.9 mi l l ion o f the Credit has been disbursed. There has been one amendment to the Development Credit Agreement dated November 19,2002, which was to add a second Special Account specifically for severance payments and a new category o f expenditures for audits, to reallocate funds to fully cover Project Preparation Facility expenditures, and to revise aggregate procurement amounts for National Competitive Bidding and National Shopping. A mid-term review o f the project i s scheduled for January 2005, and the original Closing Date o f the Project i s January 3 1,2006. All legal, financial, and audit covenants under the project are being met.
A Credit in the amount o f SDR 36.2 mil l ion (US$48.5 mi l l ion equivalent') for the
3. The four main project components cover: (a) privatization o f remaining industrial and commercial public entities; (b) institutional support for a Parastatal Monitoring Unit to oversee the financial performance o f parastatals in the Ministry o f Finance, Planning and Economic Development (MFPED); (c) implementation o f sector reforms in the telecommunications, electricity, railways and water and sewage sectors; and (d) the effective functioning o f a Project Coordinating Unit in the MFPED. The overall project implementation rating i s satisfactory (see Section I1 on project implementation performance).
4. sector participation in the power distribution business o f UEDCL. Earlier, in March 200 1, with IDA support under this project, the former Uganda Electricity Board (UEB) was unbundled into three successor entities, for generation, transmission and distribution. While the generation entity, the Uganda Electricity Generation Company L imi ted (UEGCL), was already successfully concessioned on April 1,2003, there were delays in reaching agreement with the proposed distribution concessionaire due to the need to adequately mitigate certain perceived regulatory and GOU-related payment r isks which were beyond the control o f the private investor. A critical component o f the security package negotiated between UMEME, UEDCL and GOU, i s recourse to a Liquidity Facility during the f i rs t seven years following the privatization. This Liquidity Facility can be accessed on the occurrence o f certain
In October 2002, the GOU requested IDA support in relation to securing private
' As ofNovember 16, 2004, the value o f the original Credit o f SDR36.2 mill ion was about US$52.3 mill ion due to the appreciation o f the SDR against the U S DoIlar.
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UEDCL/GOU-related default events defined in the Privatization Agreements (these Agreements and the IDA-backed Events are described in Section I V below). The Liquidity Facility would be established by means o f a Standby Letter o f Credit (L/C) issued for the benefit o f UMEME by Citibank Uganda Limited (the L /C issuing bank). If the L /C i s drawn, U E D C L would be obligated to repay the L /C issuing bank within one year (including interest), pursuant to the Reimbursement and Credit Agreement between UEDCL and the L/C issuing bank. I t i s proposed that US$5.5 million’ equivalent o f the proceeds o f Credit 341 1- UG be utilized as a contingent Credit to: (a) backstop UEDCL’s obligation to repay principal plus accrued interest to the L /C issuing bank under the Reimbursement and Credit Agreement in the event the L /C i s drawn; and (b) disburse the balance o f the amount o f the L /C into the Escrow Account (as defined in paragraph 6 (k) below), in the event the L/C i s not renewed for the full seven year period in accordance with i t s terms.
5. stated in the Development Credit Agreement (DCA), which are to:
The proposed amendments are in l ine with the original objectives o f the project as
“Support the Borrower in the carrying out o f i t s policy to improve the quality, coverage and economic efficiency o f commercial and utility services through: (a) the divestiture and restructuring o f the remaining Public Enterprises s t i l l operating in the Borrower’s economy; (b) increased private sector participation in the provision o f infrastructure in sectors such as telecommunications, energy, water and ra i l transport; and (c) the strengthening o f the regulatory framework and institutions required to carry out the said policy.”
6. The proposed amendments to the D C A would include the following:
(a) adding a new component (Part E) to the project description: IDA backstop o f UEDCL’s repayment obligations under the Reimbursement and Credit Agreement in respect o f amounts drawn under the L / C established in support o f the concessioning o f UEDCL’s distribution assets and the provision for disbursement o f the Credit proceeds directly into the Escrow Account in the event that the L /C ceases to be in effect for the full seven year period;
(b) introducing new definitions as well as new covenants and a condition o f effectiveness o f the component pertaining to the GOU’s obligations, such as the need for a supplementary legal opinion on the proposed new component (Part E o f the project);
(c) a corresponding modification to the allocation o f the proceeds o f the Credit by introducing a separate category in Schedule 1 o f the DCA. The amount that would be allocated to this category would be the full amount o f the Credit that i s currently unallocated (SDR5,475,165), which i s the equivalent o f US$8,270,072 at the prevailing exchange rate. I t i s expected that this amount o f SDRs would be more than adequate to fund the USS5.5 mi l l ion that could be required to be disbursed under the new component (Part E) o f the project. There i s a potential risk that in the future, the US$ could appreciate significantly against the SDR, such that the Credit proceeds allocated to this new component would be inadequate to fund the entire US$ amount o f the L/C facility. To mitigate against this risk, a provision would be added to the DCA which would provide for the amount o f the Credit to be increased by the additional amounts required to fund the US$ amount;
This includes US$5.0 mi l l ion for LIC coverage and US$500,000 to cover any accrued interest payments.
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(d) extension of the Closing Date to January 3 1,2013, to allow for disbursements from the Credit to the L/C issuing bank in the event o f a repayment default by U E D C L under the Reimbursement and Credit Agreement. T h i s would be handled by means o f a Side Letter which would provide for an extension o f the new Closing Date for this component, prior to the expiry o f the existing Closing Date;
(e) a waiver o f the GOU’s right to cancel and IDA’s right to suspend disbursements for this new project component (Part E o f the project) until the Closing Date o f January 3 1,20 13 (as discussed in (d) above), so as to provide the L /C issuing bank and UMEME the assurance o f an irrevocable commitment from IDA; and
(0 the cancellation o f any undisbursed Credit for this new component after the new Closing Date.
In addition to the above amendments to the DCA, the following Agreements will be concluded:
(h) a Project Agreement between IDA and UMEME, which would outline UMEME’s undertakings to IDA in relation to the proposed IDA commitment to repay amounts owed by UEDCL under the Reimbursement and Credit Agreement with the L/C issuing bank;
(i) an IDA Commitment Agreement between IDA and the L /C issuing bank, providing the terms o f IDA’s support o f UEDCL’s obligation to repay the L/C issuing bank for amounts drawn under the L/C and owed by UEDCL under the Reimbursement and Credit Agreement by means o f the contingent Credit;
(‘j) a Reimbursement and Credit Agreement between the L/C issuing bank and U E D C L providing for UEDCL’s repayment to the L/C issuing bank o f amounts drawn under the L /C within an agreed loan term o f 12 months plus accrued interest; and
(k) an Escrow Agreement between UMEME, UEDCL, and the Escrow Agent (Citibank N.A., London). T h i s Agreement will provide for the payment by UMEME o f rent due to UEDCL under the Privatization Agreements into an escrow account (the Escrow Account) with the Escrow Agent.
The foregoing agreements have been substantially negotiated and will be finalized following approval by the Executive Directors o f the recommendation contained in this Memorandum. In the unlikely event there i s any significant change in those agreements, Management wil l revert to the Executive Directors.
7. Since the power sector and GOU have set aside adequate finance for staff retrenchment, funds originally intended for power sector staff retrenchment under Credit 341 1-UG would be reallocated to support the L /C (see para. 9). Also, because the amount o f the credit enhancement i s small, i t was determined that i t would be more expedient and cost- effective to process this operation through an ongoing project. A stand-alone guarantee operation could considerably delay the concessioning beyond the currently scheduled contractual Transfer Date for the assets in December 2004, thereby jeopardizing the power sector reform program and the Government’s overall privatization efforts. A project supervision budget would be provided for the new component through the extended Closing Date for supervision by the Afr ica Energy Group. An Implementation Completion Report on
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the main project would be prepared within six months after the Closing Date. Following the extended Closing Date for the proposed new component, a supplemental Implementation Completion Report would be prepared.
11. PROJECT IMPLEMENTATION PERFORMANCE
8. objectives. The main development objective i s to improve the quality, coverage and economic efficiency o f commercial and utility services, through privatization, private participation in infrastructure and an improved overall regulatory framework. Important outcomes o f a higher level o f private investment and divestiture o f the remaining public enterprises would be improved quality and access o f services in the telecommunications, water, electricity and transport sectors, a reduction o f the fiscal burden o f uti l i t ies in Uganda, increased competition, and lower costs for consumers and businesses.
The Project i s moving satisfactorily towards meeting al l o f i t s development
9. Privatization and Divestiture o f Industrial and Commercial Public Entities (US$25.5 million), including technical assistance, environmental audits and severance payments for retrenched workers. As mentioned earlier, the Uganda Electricity Board was unbundled into three successor companies in March 200 1 : the Uganda Electricity Generation Company Limited (UEGCL), the Uganda Electricity Transmission Company L imi ted (UETCL), and the Uganda Electricity Distribution Company Limited (UEDCL). The UEGCL was concessioned to Eskom (South Africa) in March 2003 and the Privatization Agreements were concluded with UMEME on M a y 17,2004 for the concessioning o f U E D C L (see paras. 24-30). Implementation o f the privatization programs for the railways and water sectors i s ongoing. To build consensus on the overall privatization program and accelerate i t s implementation, the project i s supporting an active communication campaign. Several workshops were successfully conducted, including some targeting parliamentarians and other politicians. About US$5 mi l l ion o f the estimated US$14 mi l l ion in funds under the Credit targeted for employee retrenchment has been disbursed. The Government has about USh 60 b i l l ion (US$34 mi l l ion equivalent) in i t s privatization account which can be utilized for retrenchment payments for the Postal Office, Uganda Railways Corporation and the National Water and Sewerage Corporation. Since the Uganda Electricity Board and i t s successor companies set aside adequate funds for power sector staff retrenchment, additional funds under the Credit for this purpose will not be required. Hence, US$5.5 mi l l ion originally envisaged for power sector staff retrenchment under the project i s proposed to be reallocated to support the L/C Facility in the form o f a contingent Credit. Most o f the allocation for environmental audits (US$6 mill ion) under the Credit has not yet been committed.
10. Monitoring Unit supported under the project i s monitoring progress made on Public Enterprise restructuring and the reduction o f Government subsidies. One o f the key issues continues to be the level o f public enterprise debt. The Project Monitoring Unit’s 2003 report and summary o f performance indicators show that the net performance o f the public enterprise sector has improved: subsidies have declined by 76 percent during 1994-2001, and there are no new Government agency accumulated arrears with utility service providers in 2004. In addition, there has been an improvement in public enterprise statutory compliance including the divulging o f information on such areas as audited accounts and operating plans.
Strengthening o f Financial Oversight o f Parastatals (US$l.9 million). The Parastatal
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Utilitv Sector Reform (US$9.0 million).
The Telecommunications Sector. Substantial improvements have been recorded in the telecommunications sector. The market size has grown to 600,000 subscribers in 2003, o f which 550,000 are mobile subscribers. The capacity for fixed l ines has also doubled to 120,000 lines, compared to 60,000 l ines in 1999. There are 3,300 public phones in the country. The penetration rate has increased from 0.28 telephones per 1,000 people in Uganda in 1998, to 2.5 per 1,000 people in 2003, The future strategy for the sector i s to increase the penetration rate and reduce the cost o f services.
0 The Electricity Sector, The concessioning o f UEGCL and UEDCL experienced init ial delays due to changes in the intemational market and perceived global risk which were outside o f Uganda’s control (see Section 111).
The Water and Sewerage Sector. The Cabinet approved a sector reform strategy paper in October 2003, and a Sector Reform Implementation Committee was established in November 2003. A new Performance Contract between the GOU and the National Water and Sewerage Corporation (NWSC) was signed in December 2003. The Performance Contract regime has continued to provide a basis for the implementation o f bold performance improvement programs within NWSC. The latest o f these programs i s the Internally Delegated Area Management Contracts, an initiative to create autonomous business units or “water partnerships” in the NWSC towns akin to mini-utilities operating under contracts. This initiative i s consistent with the overall agreed reform direction, and i s a step towards a separation o f the operations functions from the asset holding function. The various programs initiated by NWSC under the Performance Contract regime have inculcated a performance-oriented attitude and culture. As a result, significant performance improvements have been recorded since 1999 when the f i rst Performance Contract was signed, including higher billing and collection ratios, almost a doubling o f water connections to about 100,000 in 2004, and a one-third reduction in staff.
0 The Railways Sector. Substantial progress has been made under the Government’s railways sector reform program. A joint Memorandum o f Understanding, signed in July 2004 by the Ministers o f Finance and o f Transport in Kenya and Uganda, sets out the objectives, structure, approach and methodology for achieving the jo in t concessioning o f the Kenya Railways Corporation and the Uganda Railways Corporation, and i s based on market consultations held with interested parties in the United States and Canada, the United Kingdom, South Africa and in Kenya. In addition, stakeholder workshops were held in Uganda and Kenya. Advertisement for pre-qualification was sent out on September 1, 2004. Fifteen f i r m s registered for pre- qualification, o f which nine f i r m s submitted bids by the submission due date, and the applications are under evaluation. The pre-qualified bidders should be announced before the end o f 2004. The estimated timetable for pre-qualified f i r m s to submit their bids i s April 2005. The award and signing o f a concession agreement i s envisaged in June 2005, with the transfer o f operations by December 2005.
0 Regulatory Reform. The Project i s supporting the Uganda Communication Commission and the Electricity Regulatory Agency (ERA) through acquisition o f essential equipment, technical assistance and capacity building activities.
1 1. Project Coordination Unit i s satisfactory. Adequate counterpart funds are available and
Proiect Management (US$8.9 million). The financial management capacity o f the
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internal controls are also sufficient. Project implementation has been delayed due to slow procurement processes. To rectify this shortcoming, a procurement monitoring system has been established which permits rapid follow-up on outstanding requests.
111. POWER SECTOR REFORM AND PERFORMANCE
13. the Government's power sector reform program. In June 1999, the GOU approved a comprehensive power sector reform strategy. In November 1999, a new Electricity Ac t was promulgated. The Government established the ERA in April 2000; the UEB was unbundled into three successor companies, one each for generation, transmission and distribution in March 200 1; the ERA substantially increased tariffs in June 200 1, and with assistance from the donor community, a debt restructuring proposal for the power sector was implemented at the end o f 2001. The concessioning o f UEGCL was completed in March 2003 and the Government i s now in the process o f successfully concluding the concessioning o f UEDCL. The objective i s to transfer key U E D C L operational and investment responsibilities to the private sector in December 2004.
Over the past f ive years, substantial progress has been made towards implementing
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14. The expected impact o f these changes will be to transform the commercial operation o f the system, improve the quality o f supply, and facilitate the development o f commercially funded new supplies to serve the market. Economic growth and poverty alleviation are built into the Government's power sector reform program in the following ways:
0 The private distribution concessionaire will commit to a multi-year investment program which will ensure the availability o f new capital for system improvements and expansion;
0 Tarif f adjustments will be linked to the quality and recovery o f investments for expansion o f service to new consumers; the distribution concessionaire will have strong incentives to
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reduce losses, eliminate theft, and ensure full collection. The concessionaire will also be penalized if agreed performance targets are not met;
The autonomous ERA established in 2000 to regulate the sector will protect consumers and investors, and ensure that distribution and generation concessionaires comply with the terms o f their operating licenses, including quality o f service standards (see paras. 24, 25, 44 and 45); and
A Rural Electrification Fund, designed to partially subsidize init ial capital costs, was established under the Electricity Ac t to help foster electricity service expansion into unserved areas by new private rural electrification companies, and i s part o f the Government’s Rural Electrification Strategy for 2001 -20 10.
15, A successhl concessioning o f UEDCL’s distribution assets i s a fundamental necessity to underpin the commercial viability o f the sector and to support future new generation investments. Increased electrification and improvement o f the commercial operations o f the sector are the primary objectives o f the distribution privatization. It will help to improve service delivery, expand access for households and social infrastructure such as schools, clinics, hospitals, and water systems. The collective impact o f the Government’s power sector reform program will be to contribute to poverty alleviation through income and employment generation, thereby improving the quality o f l i f e in Uganda. In addition to eliminating budgetary subsidies by placing the power sector on a commercial basis, the provision o f adequate and least-cost power will foster economic activity and generate fiscal revenues, thereby increasing budgetary resources which the Government can direct to health, education and other activities benefiting the poor.
Power Sector Financial and Operational Performance
16. The financial performance o f the power sector has improved since the implementation o f significant retail tar i f f increases in June 200 1 and the power sector debt restructuring program at end 200 1, UEB’s successor companies are now in a position to service their debts to Government to a large extent, and were able to finance U S 3 7 mi l l ion o f investments from internal resources during 2002/03. UEDCL made encouraging progress in i t s billing collection performance until November 2003; thereafter, the performance steadily declined until April 2004, to reach the lowest monthly collection o f USh8.9 b i l l ion since 2002. Collections returned to their normal level in June 2004. Following an intensive collection drive, UEDCL collected an exceptionally high sum o f USh l8 b i l l ion in July 2004. The monthly collection during the three months to October 2004 i s expected to average around U S h l 2 bil l ion.
17. in spite o f the dip in UEDCL’s billing collection during December 2003 to April 2004. The principal factors contributing to the improvement are:
The overall financial performance o f the sector has improved over the past two years
0 Growth in energy generation o f 8.8% and 3.5% in 2002 and 2003, respectively. Hydropower output increased by 4.5% during the first seven months o f this year over the corresponding period in 2003.
An increase in monthly average billing collection, from USh7.8 bi l l ion in 2001 to USh12.4 b i l l ion in 2004.
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0 The appreciation o f the Shilling vis-a-vis the US dollar since December 2003 helped reduce the burden o f foreign exchange dependent revenue requirements, amounting to about 35% o f total requirements (net o f export revenues).
18. UEGCL and UETCL are both financially viable. UETCL’s liquidity i s very strong. Apart from funds set aside for the bulk supply tari f f stabilization fund, UETCL has built up approximately USh48 bi l l ion in liquid resources. The principal reasons for this accumulation o f cash are the appreciation o f the Shilling and UETCL’s slow uptake in implementing i t s investment program. However, UEDCL’s collected revenues in 2003 and 2004 are almost equal to i t s recurrent operational expenditures and debt service requirements.
19. 139.7 UShkWh, equivalent to O.O8US$/kWh at the current exchange rate. The last tariff review in January 2004 led to a decrease in the weighted average retail revenue by about 34% due to a rebalancing o f tariffs. Energy tariffs for large and medium industries and commercial businesses were reduced and domestic use tariffs were increased. Power sector revenue requirements will increase significantly after the take-over o f the distribution concession by UMEME which i s scheduled for December 2004 and because o f the addition o f new debt service burdens associated with the Urban Power and Power IV on-lent loans (the African Development Bank (ADB), IDA, the Nordic Development Fund (NDF) and the Norwegian Agency for Development (NORAD)) between 2005 and 2008. In order to avoid the extent o f tari f f increases in the init ial years o f UMEME’s operations when the full benefits o f the concessioning would not have materialized, the Govemment has proposed various tariff relief measures including funding from the BST stabilization provision which would reduce the overall revenue requirements o f the power sector. On the assumption that tariffs are adjusted at six monthly intervals on M a y 1 and November 1, 2005, the indicative tariff increases would be approximately 10% and 14% respectively. The anticipated commissioning o f units 14 and 15 (8OMW capacity) at the K i i ra Power Plant in M a y and July 2005, respectively, will increase energy supply and help to generate additional sales revenues, which will moderate the required increases in tariffs. The US$16 mi l l ion o f urgent distribution investments in the f i rst 18 months o f the distribution concession, o f which US$5 mi l l ion will be provided by UMEME and US$11 mil l ion i s proposed by IDA under Credit 3545-UG, will also help to increase UMEME’s revenue eaming capacity over the next two years, and hence mitigate the pressure on electricity tariffs. The financial analysis indicates that as efficiency improvements take effect, tariffs would come down each year in real terms beyond the f i rst two years. The weighted average revenue would decline from 0.099US$/kWh in 2005/06 to about O.O91US$/kWh by 2009. Because significant investments in generation are l ikely to be required in 2010 and beyond, the Govemment i s reviewing the structure and buildup o f a stabilization fund, which would permit electricity tariffs to be smoothed out over the medium- to long-term so as to avoid radical changes in tari f f levels from year to year. Attachment 2 provides more detailed information on the financial situation and prospects o f the power sector.
Electricitv Tariffs. The present weighted average retail electricity revenue3 i s about
The Bujagali Hydropower Project and Future Power Generation Prospects
20. An IDA Partial Risk Guarantee o f US$115 mil l ion and IFC support of: (a) an “A” loan o f up to US$60 million; (b) a “B” loan o f up to US$40 million; and (c) a risk management instrument o f up to US$10 mi l l ion for the Bujagali Hydropower Project were approved by the IFC and IDA Executive Directors on December 18,2001. The A E S
Average retai l electricity revenue i s the amount accruing to UMEMEAJEDCL and excludes 17% VAT w h i c h i s added to end-use customer bills.
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Corporation (the private sponsor) and the project encountered several difficulties which eventually led to a pull-out o f AES and termination o f the project with the Government in September 2003. The main issues confronting the project were threefold. The f i rs t was the wavering support o f export credit agencies for the project due to the high level o f perceived country and business risk. This created a financing gap o f about US$234 mi l l ion for which a promising option was pursued with the Multilateral Investment Guarantee Agency. Secondly, in parallel, there were ongoing investigations in the US, Norway, the UK and Uganda concerning allegations o f corruption involving one o f the engineering/procurement/ construction contractors, and links to another private power generation project under preparation in Uganda. Third, the private sponsors’ financial situation continued to deteriorate following a severe downturn in the global economy, a worldwide change in market conditions and the shrinking o f investor interest in emerging markets. Following intensive discussions between AES and the Government, on August 13,2003, AES announced i t s intention to withdraw from the project. Subsequently in September 2003, the Government and AES terminated the Implementation Agreement which gave the Government the right to take ownership o f the intellectual property and land, and IDA cancelled the Partial Risk Guarantee (PRG). In August and September 2003, the World Bank Group fielded several missions to discuss with the Government i t s options, the transition arrangements including the need to ensure the integrity o f the project site and handover o f intellectual property, and the maintenance o f a unit to monitor the project, including the environmental and social aspects. The Government has taken appropriate action on all o f these matters.
2 1. decided to continue to pursue the Bujagali Hydropower Project since it believes this project remains both the best option and least-cost generation alternative for Uganda. I t s preference would be for private sector participation over a public sector project. In this regard, in January 2004, the Government initiated a transparent process to solicit the interest o f prospective private sponsors. The Government understands that a re-assessment o f the scope, design, and economic, technical, financial, institutional and environmental and social aspects o f any new power generation project, would be required in the context o f Uganda’s power demand requirements. The Government has already initiated the selection process for a developer o f the new project. The short-listing has been completed and the selection process i s expected to be concluded in March 2005.
In assessing the Government’s options and power sector needs, the Government
22. As part o f IDA’S normal supervision activities in connection with the ongoing Power IV Project (Credit 3545-UG), sector work on an assessment o f electricity demand since 2001 has been undertaken. Also, legal advisory and technical consultancy assistance has been provided to the Government under Credit 3545-UG to support the Government’s efforts to revive the Bujagali Hydropower Project. IDA’S immediate focus in the power sector has been to support the concessioning o f distribution which i s key to the operational and financial turnaround o f the sector, and to attracting private investment for the future needs o f the power sector. IDA i s also working with the Government on i ts plan to address the current power supply shortage.
23. possible resurrection o f the Bujagali Hydropower project in a different form or structure, will take note o f the various issues raised by the Inspection Panel in i t s report o f M a y 23,2002 and Management’s Response dated June 7,2002, and will address them in the context o f the feasibility studies, design and social and environmental assessment o f any new private power generation project involving the Wor ld Bank Group. The main lessons learned from the collapse o f the Bujagali Hydropower Project are the importance of: (a) confirming the financing plan (the export credit agencies unexpectedly pulled out o f the project one month
The due diligence for any new power generation project in Uganda, including the
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after the IFC/IDA joint Board presentation); (b) a transparent and competitive process for the selection o f the c iv i l works and electro-mechanical equipment contractors; and (c) ensuring the efficient operations o f the power sector's distribution business including improved quality o f supply and access. A financially viable distribution business will help to mitigate the perceived risks o f potential private investors since this i s the primary source o f the power sector's cash flow and i s a crucial aspect upon which investors will assess the power sector's capability to repay new investments.
IV. PROPOSED NEW COMPONENT: SUPPORT FOR THE POWER DISTRIBUTION CONCESSION
24. concessioned to the private sector. In 2003, UEDCL supplied 1036GWh to 235,000 customers and generated revenues o f USh155 bi l l ion (about US$SO million). UMEME will have the right to collect revenues from all connected customers based on tariffs approved by the ERA. With technical assistance from NORAD, the ERA has achieved independence in economic regulatory matters although it i s s t i l l required to consider Policy Guidance o f the Ministry o f Energy and Mineral Development. In June 200 1, the ERA implemented a new tari f f structure which reflected full cost recovery and the removal o f cross subsidies between consumer classes, though a lifeline electricity tari f f s t i l l exists. This brought average electricity revenues to about US$0.084 per kWh, which was the f i rst adjustment in about a decade during which time tari f f revenue denominated in USh had deteriorated to about US$0.052 per kWh. The June 2001 increase helped to set the stage for the sector's financial recovery. The average electricity tariff revenue had dropped to US$0.072 per kWh during 2003; however, it has since recovered to about US$O.OS per kWh due to the recent appreciation o f the Shilling. A tariff review undertaken in 2004 substantially confirmed the justification for earlier increases, and also demonstrates that the ERA has been successful in asserting i ts autonomy.
UEDCL i s the f i rs t unbundled distribution network in Sub-Saharan Africa to be
25, ERA to develop a tariff methodology that has been encapsulated in the Privatization Agreements, to undertake "twinning" arrangements with other utilities, and has enabled ERA to participate in the African Forum for Utility Regulators. Also since i t s inception, the ERA has received technical assistance from the Norwegian Regulatory Agency in the form of: (a) resident technical advisors; (b) the technical support o f a management consulting firm in developing a comprehensive tariff model; (c) international field visits to other regulatory agencies; and (d) specific training in electricity regulation. In addition, under the Power IV Project (Credit 3545-UG), technical assistance to the ERA i s being provided to build i t s regulatory capacity and help manage a stabilization fund whose purpose i s to smooth out the tari f f trajectory when significant new investments materialize in the future. The Utility Reform Unit o f this project i s coordinating a Training Needs Assessment Study, one o f i t s objectives being to identify the capacity building requirements o f the existing and proposed regulatory and asset holding institutions.
The ERA capacity building component financed by Credit 34 1 1 -UG has helped the
26. Commonwealth Development Corporation o f the UK, and Eskom, the state-owned utility o f South Africa, was selected to undertake the concession following a transparent and competitive bidding process undertaken by the GOU with transaction advisor support under Credit 341 1-UG. The Consortium has since formed UMEME Limited, a company established in Uganda and joint ly owned by Globeleq Ltd. o f Bermuda (56%), a wholly-owned subsidiary of Globeleq Ltd., and Eskom Enterprises (44%), a wholly-owned subsidiary o f Eskom. Globeleq will bring commercial and financial expertise to the company; and Eskom, with i t s
A consortium consisting o f Globeleq Limited, a wholly-owned subsidiary o f the
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experience in distribution, will provide the technical expertise required to turn around the underlying business. UMEME will be operated as a joint venture company with an independent culture, but with strong support from both o f i t s shareholders. Under the Shareholders Agreement, Globeleq nominates the General Manager and Chief Financial Officer, Eskom nominates the Head o f Technical Services and Head o f Customer Services, and the Board appoints the nominees. The intention o f the joint venture partners was to combine Globeleq’s commercial expertise in structuring, negotiating and managing independent power projects with Eskom’s wealth o f knowledge and resources in the electricity distribution business. In order for the project to succeed, both shareholders agreed to build a strong culture within UMEME combining the best aspects from Globeleq, Eskom and the current UEDCL business. Shareholders adopted the approach o f a limited expatriate top-management team, with the intention o f including as much local managerial talent into the structure as possible. Also, both shareholders would make available their specialist services in their respective domains o f expertise: financial/commercial (Globeleq) and technical/ business processes (Eskom), as and when required.
27. Globeleq i s the fastest growing emerging markets power company with a particular focus on Africa and South Asia. In the past three years, Globeleq has acquired six Independent Power Producer projects (a total o f almost 2000MW) in five countries on three continents, all o f whom it i s currently managing. All o f Globeleq’s projects thus far are in generation, which i s why it sought to form a joint venture with Eskom which has substantial distribution expertise. Globeleq’s commercial approach, i t s strategic commitment to emerging markets and strong, recognizable financial support from the CDC Group, make it an energy developer o f choice in many developing countries.
28. Eskom i s a vertically integrated utility that generates, transmits and distributes electricity in South Africa, ranking ninth in the world in terms o f energy sales. I t s ability to mobilize appropriate technical and managerial resources, together with strong financial backing, make it a player that ranks high above all others on the continent. Eskom has demonstrated i ts capability to supply and distribute electricity in Africa by using first-class standards, and has been a key factor in South Africa’s economic growth. In addition to successfully serving i t s existing industrial, commercial and residential customers, in the past decade, Eskom has delivered a very ambitious electrification plan. Hence, a relevant body o f knowledge has been developed on how to build, maintain and manage electricity distribution businesses in an African context, from which UMEME will benefit.
29. Power Sales Agreement with UETCL (for the bulk supply o f electricity) and a GOU Support Agreement (GSA) with GOU (collectively, the Privatization Agreements). The Privatization Agreements were signed on M a y 17,2004. UEDCL and UETCL are wholly-owned GOU entities that own Uganda’s distribution and transmission assets, respectively. Under the Lease and Assignment Agreement, UMEME will lease the operating assets o f UEDCL, for which it will pay rent to UEDCL on a monthly basis. UETCL transmits the energy generated by Eskom Uganda Ltd., a wholly-owned subsidiary o f Eskom Enterprises which i s operating the two adjacent hydro-electric facilities -- Nalubaale and Kiira, under a 20-year concession agreement. The GSA details GOU undertakings to support UMEME (e.g. to ensure USh convertibility and to issue Consents when applied for properly), and the principal terms and conditions o f Buy Out Amounts to be paid by the GOU to UMEME in the event o f termination o f the Concession for GOU and UMEME events o f defaults, for Force Majeure events, as well as for the retransfer o f the Distribution System to UEDCL.
UMEME i s the signatory to a Lease and Assignment Agreement with UEDCL, a
.
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30. The 20-year distribution concession will require a minimum investment from UMEME over the f i rst f ive years o f US$65 million, o f which US$45 mi l l ion wil l be funded in the form o f equity and shareholder loans, and the balance through the company’s internal cash generation. There would also be a working capital facility o f US$5 mill ion. A transmission and distribution needs study was carried out as part o f the Government’s due diligence process. I t indicates the type o f investments required to strengthen the distribution system and reduce technical losses, to absorb the additional power to come on l ine in 2005 at the K i i ra power plant, and to expand access to new consumers. UMEME i s required to discuss and agree with the ERA the specific details o f the investment plan to ensure the efficiency o f investments and the resultant tariff implications. The GOU and UMEME have agreed to an eighteen month preliminary operating and investing period in which UMEME’s investment obligation will be limited to US$5 mi l l ion o f the total o f US$65 mill ion. UMEME would have the right to withdraw from the Concession during this preliminary period under the terms and conditions agreed in the GSA. Other key obligations o f UMEME over the f i rs t five years o f the Concession will be to provide for up to 60,000 new connections, reduce technical and non-technical distribution system losses and improve collection rates. Should UMEME fai l to invest an amount o f US$65 mil l ion by the end o f the fifth year o f the Concession or to carry out i t s other obligations outlined above, the GOU would have the right to call on al l or part o f the US$15 mi l l ion Performance Guarantee posted by UMEME, and to terminate the Concession.
3 1. requested support for UMEME under the Power I V Project (Credit 3545-UG). This would be in the form o f the proposed funding o f US$11 mi l l ion o f urgent distribution investments to help enhance revenue generation and maximize the chances that early operational and financial improvements would be realized. This would also help to smooth out the tari f f trajectory during the init ial UMEME takeover period.
In addition to the proposed credit enhancement mechanism, the Government has
V. PROPOSED A M E N D M E N T S
Rationale
32. through rapid economic growth which depends upon increased foreign and domestic private investment. The Bank’s strategy in the power sector consists o f a three-pronged approach to support this objective by: (a) promoting efficient operations o f the power sector through implementation o f a comprehensive sector reform program and increasing the role o f the private sector in i t s operation and fiture development; Cp) providing adequate, reliable and least-cost power generation capacity to meet local demand; and (c) increasing the percentage o f rural households with direct access to electricity and revitalizing rural development.
A major objective o f Uganda’s Country Assistance Strategy i s to reduce poverty
33, IDA support for the proposed Concession i s critical to ensuring the successful concessioning o f UEDCL’s power distribution system assets to UMEME. IDA’S role in providing revenue support for the Concession, in the event o f regulatory or GOU non- compliance o f i t s contractual undertaking which could affect the operations o f the company, will help provide assurances to UMEME concerning the viabil ity o f the Concession. IDA’S ongoing involvement in the sector and regular supervision should help to ensure the sustainability o f the distribution business, particularly in the earlier years o f the Concession when it could be most susceptible to political intervention or other related project issues.
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Escrow Account and IDA Backed L/C Security Structure in Support o f UMEME
34. Under the Privatization Agreements, the GOU has undertaken to provide a Security Package consisting o f the Escrow Account and the L/C Facility to be in place for seven years following the privatization. The Escrow Account i s to be funded init ially by U E D C L in the amount o f US$2.5 mi l l ion and then with UMEME’s rent while the L/C Facility would be backstopped by the proposed IDA contingent Credit component o f Credit 341 1-UG. The Security Package has been designed to provide compensation to UMEME for any loss o f revenues resulting from non-compliance o f certain UEDCL/GOU undertakings specified in the Privatization Agreements. Any loss o f revenues would be recovered by UMEME in the following order: (a) a rent offset; (b) a draw-down from the Escrow Account; and (c) a draw- down from the L/C Facility. In addition to providing funds for UMEME’s loss o f revenue, the Escrow Account will also be available to pay any Buy Out Amounts due to UMEME which are not paid by the GOU. However, the L/C Facility could only be accessed for a Buy Out Amount o f US$2.5 million, in the event o f early termination o f the Concession during the init ial eighteen month period which resulted from a breach o f the Privatization Agreements by the GOU and i t s entities.
35. Escrow Account at the Transfer Date which will be supplemented by monthly deposits o f rent payable by UMEME, estimated at the equivalent o f US$1.35 mill ion. If, at any time, the amounts in deposit in the Escrow Account plus the balance in the L/C Facility exceed the “Required Amount” (an amount equal to US$5 mi l l ion or i t s equivalent at the Transfer Date, increasing to US$8 mi l l ion 12 months after the Transfer Date and rising to a cap o f US$20 mi l l ion or i t s equivalent), then any surplus amounts will become payable to UEDCL each month by the Escrow Agent. The Escrow Account would be in operation for the duration o f the Concession.
Escrow Account: UEDCL will deposit an init ial amount o f US$2.5 mi l l ion in the
36. IDA Backed L/C Facility: To supplement the cash deposit in the Escrow Account, UEDCL i s required to establish a Standby Letter o f Credit for an init ial amount o f US$2.5 mi l l ion at the Transfer Date, increasing to US$5 mi l l ion at the f i rst anniversary thereof, and then remaining at that amount (unless reduced by a drawing which i s not replenished). The L / C i s required to be in effect for seven years following the privatization. Because o f certain Ugandan regulatory requirements, the init ial term o f the L /C will be three years to be renewed twice for two year periods for the balance o f the seven year term. In the event the L/C i s not renewed or replaced beyond i t s initial term, such that the L/C ceases to be in effect for the full seven year period, the GOU has agreed that UMEME could draw from the Credit, for deposit into the Escrow Account, an amount equal to the amount that would have been available for draw under the L /C prior to i t s expiration.
37. the occurrence o f the “IDA-Backed Events” covering loss o f revenues (see paras. 41-47), if there were insufficient funds in the Escrow Account to satisfy the amounts claimed after rent offset. As part o f the L/C arrangements, the L /C issuing bank will enter into a L /C Reimbursement and Credit Agreement with UEDCL. Under this agreement, UEDCL would undertake to repay the L/C issuing bank the amounts drawn, plus accrued interest, within a period o f up to 12 months (the L/C Repayment Period). First, however, the L /C would be replenished during the LK Repayment Period through a claw-back from rent payments deposited in the Escrow Account by UMEME. Alternatively, the GOU or UEDCL could choose to replenish the L/C from i ts own resources. If by the end o f the L /C Repayment Period, however, the amount o f the drawing was s t i l l outstanding, then U E D C L would be
UMEME would be entitled to draw any revenue shortfall amounts from the L/C upon
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LC replenishmentv
obligated to make the necessary repayment to the L /C issuing bank, in US dollars, to the designated account stipulated in the Reimbursement and Credit Agreement. Repayment would normally be required to be made to the L/C issuing bank’s account in Uganda. If because o f Ugandan restrictions, UEDCL were unable to make payments in US dollars to such account, or UEDCL were unable to transfer payments made to such account outside Uganda, UEDCL will be required to make payment to the designated account o f the L / C issuing bank outside o f Uganda. Following a repayment from any o f the above sources, the L/C would be reinstated by the amount o f the repayments.
........................ within 12 months UC Issuing Bank
38. Repayment Period, the L/C issuing bank would be entitled to claim from IDA the repayment o f the due amounts plus accrued interest. Following a submission o f a valid claim to IDA for payment, IDA would repay the L/C issuing bank through a disbursement from Credit 341 1 - UG up to an amount not exceeding US$5.5 million. Following a repayment by IDA to the L/C issuing bank, on behalf o f UEDCL, neither the L/C nor the amount o f IDA’S support would be reinstated for such amounts. The proposed IDA support would be available for a total term o f 8 years and 25 days to allow for a seven year L /C availability period, a 12 month UEDCL Repayment Period, plus the 25 day IDA claim and disbursement period. The principal terms o f the L/C and IDA support are outlined in Attachment I.
In the event U E D C L fails to make the required repayment by the end o f the L / C
UMEME Escrow and IDA-Backed L/C Security Structure
I I I
r E i LC repayment ......
I In case Escrow Account balance is higher than required.
Risks Underpinned by the Security Package
39. under the Privatization Agreements which would give UMEME the right to offset rent payments and draw from the Escrow Account, for the purpose o f ongoing revenue payments, as well as to satisfy GOU’s obligation for the Buy Out Amount in the event o f termination o f the Concession. O f these events, only the f irst three ((a ), (b) and (c) below) are “IDA-backed Events” that would entitle UMEME to access the IDA-backed L/C Facil ity following a rent offset and a draw from the Escrow Account (see paras. 41-48 below).
There are seven events listed below related to UEDCL/GOU contractual undertakings
a) Failure by the ERA to approve tari f f adjustments according to the pre-agreed Tarif f Methodology set forth in the Distribution and Supply License.
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Non-payment by G O U entities o f their Electricity Bills.
Early Termination o f the Concession by UMEME resulting from a breach o f the Privatization Agreements by GOU and i t s entities during the init ial 18 month period. In this case, UMEME would be entitled to receive compensation o f US$2.5 mil l ion (the “Early Termination Amount”) if other funds available to UMEME (cash and unutilized investment funds in the Company Escrow Account) were insufficient to recover the full Early Termination Amount.
Early Termination o f the Concession by UMEME for reasons relating to the company, within the init ial eighteen month period, which would entitle UMEME to a compensation o f U S 2 . 5 mi l l ion for the init ial investment o f US$5 mill ion.
Refunds made by UMEME o f Connection Fee and Security Deposits provided by customers o f UEDCL prior to the Transfer Date.
Indemnification obligations to third parties and property damage resulting from the condition o f the Distribution System, within the f i rst eighteen months o f the Transfer Date.
Termination o f the Concession due to U E D C L or G O U Events o f Default, and Political or Other Force Majeure Events.
As noted above, the Security Package i s essentially designed to protect UMEME against UEDCL/GOU risks, and cannot be accessed for UMEME Events o f Default except in the case o f Termination which would entitle UMEME to compensation for a reduced amount (80%) o f any approved but un-depreciated investments that UMEME has made, and which have not been recovered through the tariff.
Description o f the “IDA-backed” Risks
41. event o f a revenue shortfall caused by the occurrence o f the two IDA-backed Revenue Events and for the Buy Out Amount in the event o f Early Termination by UMEME for U E D C L and GOU related events. These “IDA-backed Events” are described in more detail below.
As outlined in para. 39, the IDA-backed L/C Facility can only be accessed in the
42. the ERA to adjust retail tariffs in accordance with the Distribution and Supply Licenses within 45 days o f a legitimate claim from UMEME, in accordance with the pre-agreed Tar i f f Methodology (contained in Annex A o f the Supply License), which results in a corresponding loss o f revenue to UMEME, including interest on any overdue amounts. Under the Licenses, UMEME would be required to make an annual tariff submission to the ERA at least 30 days prior to the effectiveness o f the tariff. Tariffs may, however, be adjusted quarterly on an automatic basis to reflect changes in bulk tariff supply costs, inflation and exchange rate movements.
Non-Compliance by ERA o f the Regulatorv Framework: This covers the failure o f
43. consists o f two elements: (a) the Power Supply Price determined on a quarterly basis for each twelve month period beginning on the Transfer Date; and (b) the Distribution Price determined annually for each Tarif f Year. The Distribution Price consists o f the following components: (a) operation and maintenance costs which will be fixed at the bid cost plus
The retail tariff, as calculated in accordance with the agreed Tar i f f Methodology
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indexation for inflation; (b) the Retum on Investment fixed in accordance with the bid proposal; and (c) Lease Rent payable to UEDCL. The US dollar components o f the Distribution Price are identified in the Distribution License and are to be provided in the tariff at prevailing USh/US$ exchange rates. Since the components in the tariff are generally pre- determined in terms o f either being fixed or outlined in a contract such as the Lease and Assignment and Power Sales Agreements, the probability o f risk o f disputes on interpretation appears fairly limited. In the event that there are disputes on interpretation between UMEME and the ERA, the License and Privatization Agreements provide for a dispute resolution mechanism through recourse to an expert’s determination on an expedited basis. If either party were to disagree with the expert’s determination, i t could resort to binding arbitration. The GOU and UEDCL recognize that i f UMEME draws on the L / C Facility for an IDA- backed Event, pending a dispute, UEDCL will not be relieved o f i t s obligation under the L/C Reimbursement and Credit Agreement to repay the L/C issuing bank after the 12-month Repayment Period. I f an arbitration i s ongoing at the end o f that period and an L/C draw should result in a claim to IDA, any disbursements under the Credit will remain a GOU obligation even should a later arbitral award be issued in favor o f UEDCL/GOU. In this case, UEDCL/GOU’s recourse would be to seek reimbursement from UMEME under i t s contractual obligations if the Concession i s continuing, through refunds into the Escrow Account; and under the award and at law if the Privatization Agreements have been terminated and an improper Buy Out Amount (or early Termination Amount) has been paid prior to the award having been rendered.
44. or GOU renege on the contractually pre-agreed Tar i f f Methodology. The ERA has been involved in the formulation o f the pre-agreed regulatory framework contained in the Supply License (also incorporated as Annex E o f the Lease and Assignment Agreement). Since i t s inception, ERA has developed as an institution which has proven to be capable and transparent in dealing with the earlier phases o f privatization o f generation. To date, i t has preserved i t s independence and the integrity o f i t s processes, including consultations with the public. The ERA i s currently working in a coordinated manner with the MOF, MEMD, UMEME, and IDA, supported by i ts Advisers, to lay the groundwork for the formal tariff submission from UMEME. The ERA has been involved throughout the privatization process and has intimate understanding o f the Privatization Agreements, especially the tari f f framework and methodology. This experience should help in providing stability to the regulatory framework as the Concession becomes operational.
The other potential risk to IDA relating to the tariff framework i s that either the ERA
45, require additional investments in generation, transmission and distribution, and hence electricity tariffs are likely to gradually increase in real terms over the medium term. The bulk supply tariff stabilization fund, described in para. 19, will help to mitigate against potential sudden hikes in the retail tariff. As with most regulatory agencies in developing countries with limited track records, the future politicization o f tariffs i s a risk that cannot be ruled out. However, given the GOU’s commitment to i t s power sector reform program and the positive track record o f the ERA over the past four years, the risk o f a G O U breach o f the Privatization Agreements i s considered moderate, particularly as such a breach could lead to a termination o f the Concession and a payout to UMEME o f the agreed Buy Out Amounts. Because o f the critical need to improve the operational and financial performance o f the sector and the expansion o f electricity service as a basis to sustain future significant generation investments, there should be sufficient incentives for the GOU to stay the course, thereby making the probability o f a policy reversal unlikely.
Despite the significant power sector efficiency improvements envisaged, Uganda will
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46. Non-Payment bv GOU Entities o f Electricitv Bills: This deals with the failure o f Government entities (listed in Annex B o f the GSA) to pay their electricity bills within 60 days from the due date, which results in a loss o f revenue for UMEME including interest on the overdue amounts. In the event that the relevant GOU entity makes a payment o f the due amounts following a drawing o f the amounts by UMEME from the Escrow Account or L /C Facility, UMEME shall repay al l such amounts into the Escrow Account plus interest equivalent to the prevailing LIBOR rate plus 3 percent. The amounts deposited in the Escrow Account wil l then be applied f i rs t to replenish the L/C Facility to the extent it has been drawn.
47. monthly electricity bills o f around US$800,000 account for about 10% o f sector revenues. Assuming that no payments were received from the Govemment and i t s entities, such monthly electricity bills would be offset by the monthly rental payments o f around US$1.35 mi l l ion (increasing to about U S 1 . 5 mi l l ion from 2007), as well as the Bulk Supply Tarif f payments, before any recourse to the security package could be made. Furthermore, UMEME would have the right to disconnect the nonpaying entities. Finally, the risk o f non-payment occurring i s considered l o w because the GOU i s now making more realistic provisions in the departmental budgets o f GOU entities to enable them to meet their electricity bills. A call on IDA support would occur only in the event that unpaid GOU bills exceeded the amount o f the monthly rent and only once the Escrow Account has been depleted.
The largest single UMEME customer today i s the Govemment and i t s entities, whose
48. Payment o f Early Termination Amount Resulting; from a Breach o f the Privatization Agreements by GOU and i t s Entities: UMEME would be entitled to access the L/C Facility in the event o f a termination within the init ial eighteen months o f the Concession for a breach o f the undertakings provided by the GOU, UEDCL, or UETCL, under the Privatization Agreements. For this event, the Early Termination Amount i s capped at US$2.5 mill ion. This amount would be recovered from other sources such as the Company Escrow Account (established by UMEME to fund required investments) and the init ial cash amount o f US$2.5 mi l l ion deposited by U E D C L in the Escrow Account on the Transfer Date, prior to recourse to the L /C Facility. Therefore, the risk o f a drawing from the L/C to fund this modest Buy Out Amount, within the limited period o f eighteen months, i s considered low.
49. Failure o f L/C Facility to Remain in Effect for Seven Years after Privatization because o f Non-Renewal or Inabil ity to Replace: As noted above, one o f the requirements o f the Security Package i s that the L/C Facility be in place for seven years following the privatization. Under Uganda regulations, the maximum init ial term o f the L/C Facility cannot exceed three years. Hence, there i s a risk (although quite low) that the L /C Facil ity may not be renewed or be capable o f being replaced through a substitute bank up to the full seven year period. There would be a clear incentive for the L/C issuing bank to renew the L/C in order to preserve i t s interest and fee income. If this risk were to materialize, UMEME would be able to draw directly under the IDA Credit in an amount equal to the amount available under the L /C Facility, immediately prior to i t s expiration, for the purpose o f placing such amounts in the Escrow Account.
IDA Support Fees
50. In order to provide alignment with the pricing policies o f IDA guarantees, the following pricing i s proposed. Under the current Credit agreement, the GOU pays the applicable commitment fee currently set at 0.35% per annum on the undisbursed Credit amount and a service charge o f 0.75% on the disbursed amounts o f the credit. This arrangement would continue for this component. In addition, i t i s proposed that UMEME would pay a guarantee fee o f 0.75% per annum on the available amount o f the contingent
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Credit (which has not been disbursed), payable six months in advance during the term o f the IDA support. Of this, an amount equivalent to the then-prevailing commitment fee (0.35% per annum for FY05) would be paid to the GOU, and the balance amount (0.40% for FY05) would be paid to IDA, to take into account that IDA would be irrevocably committed to honor payments due from UEDCL to the L/C issuing bank under the Reimbursement and Credit Agreement. The amounts payable to GOU and IDA out o f the total guarantee fee o f 0.75% would be annually adjusted based on the IDA commitment charges which will be communicated by IDA to UMEME. In addition, UMEME would pay an Initiation Fee o f US$lOO,OO.OO and a Processing Fee o f up to 0.50% o f the contingent Credit amount o f US$5 mi l l ion available to UMEME under the L/C, to cover IDA’S reimbursable expenses.
MIGA Coverage
5 1. loans for an amount o f US$45 mi l l ion in support o f the Government’s Buy Out obligations to UMEME, in the event o f termination o f the Concession. Wor ld Bank Group support has been closely coordinated to achieve a complementary risk mitigation package whereby IDA, because o f i t s close involvement with the sector and i t s monitoring ability through regular supervision, would backstop the policy and ongoing revenue-related events critical to project sustainability, while MIGA would mitigate the political risk for the equity investments by guaranteeing the termination payments o f the Government. MIGA i s expected to provide Breach o f Contract, Transferability and Expropriation cover to UMEME and will be seeking Board approval in December 2004.
UMEME intends to seek MIGA insurance in support o f i t s equity and shareholder
Procurement and Disbursements
52. there will be no procurement for this component. Selection o f the commercial bank that will be issuing the L / C was carried out on a competitive basis and in a transparent manner.
The proposed new component does not entail IDA financing any investments. Hence,
53. Except as described in para. 49, the disbursement o f IDA funds would only take place following the occurrence o f an “IDA-backed Event” as described in paras. 41-48, and only in the event o f a failure by UEDCL to repay the amount o f a valid drawing under the L/C Facility made in favor o f UMEME, within a period o f 12 months as provided for in the Reimbursement and Credit Agreement. At the Closing Date o f this component o f the project, any remaining funds that would not have been disbursed would be cancelled.
54. There i s a possibility that as a result o f movements in SDR/US$, the obligations under the contingent portion o f the Credit in US$ could exceed the amount o f SDR allocated for this project component. To address this risk, SDR5,475,165 will be allocated to this component. This amount i s equivalent to US$8,270,072 at current exchange rates and should provide a sufficient cushion to ensure that there wil l be enough SDRs available under the Credit to meet the U S dollar amounts o f up to US$5.5 mil l ion that may be required to be disbursed to the L/C issuing bank or UMEME. In the unlikely event that the available SDR amounts would be less than the U S dollar amounts required, the Credit amount would be increased by the additional amount o f SDRs required to meet the full US dollar disbursement amount.
Auditing
55. UMEME will have i t s financial statements for each fiscal year audited in accordance with internationally acceptable auditing standards, by an independent auditor and would have
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the obligation to provide these to IDA under the Project Agreement between UMEME and IDA.
Safeguard Policies and Impacts
56. policies since there are no physical investments related to the proposed new component. Nonetheless, thorough environmental and social due diligence i s being undertaken by UMEME through i t s compliance with Uganda’s environmental policies, laws, regulatory and administrative frameworks for the duration o f the lease agreement. An understanding has been reached between UEDCL, UMEME and the Utility Reform Unit that UMEME would develop and implement an environmental management plan for the distribution network that would be consistent with Ugandan Law. In this regard, funding would be obtained through the tariff.
The backstopping o f the L /C facility would not invoke any World Bank safeguard
Benefits and Risks
57. secure a private investor for the concessioning o f the country’s power distribution facilities; (b) lead to more efficient delivery o f electricity service through agreed operational performance milestones; and (c) catalyze US$65 mil l ion o f investments in the f i rs t five years o f the concession for the expansion o f services.
The principal benefits o f the proposed new component are that i t will: (a) help to
58. the performance o f the power sector and decides to exit at the end o f 18 months; and (b) there i s a drawdown on the IDA-backed L/C Facility which i s not repaid by UEDCL by the due date. The f i rst o f these r isks will be mitigated by the Government’s continued support and commitment to the power sector reform agenda and the importance accorded to improving the efficiency o f the power sector as a basis to support large private hydropower generation transactions. Concerning the second risk, the likelihood o f a drawdown on the IDA-backed L/C Facility has been mitigated through the design o f a comprehensive security package, with minimal IDA support. The amounts o f the IDA component are modest as noted above, compared to the estimated amounts o f annual rent build up o f over US$12 mill ion. Furthermore, except in the circumstance described in para. 49, there are only three risks (see para. 39) which would be backstopped by IDA and only for a limited period o f seven years. Most importantly, IDA would be at risk only when the rent payment and the moneys in the Escrow Account have been exhausted and only in the event o f a failure o f UEDCL to reimburse the L /C issuer, within a period of twelve months. This would provide IDA twelve months to work with UEDCL and the GOU to resolve issues and to ensure that UEDCL i s in a position to make the required payment on the due date, thereby preventing a claim on the proposed IDA contingent Credit. An important feature o f the security package i s that the L /C would be replenished by means o f any accumulated rental payments, following a drawing. This would serve as additional protection for UEDCL and a further risk mitigant for IDA. Furthermore, there i s minimal reputational r isk to IDA that the Concession would not be realized since UMEME has already adequately demonstrated i t s commitment to this transaction: the company i s established in Uganda and has expended substantial resources prior to the Transfer Date. In addition, the Financing Documents have been substantially negotiated which reflects the parties’ commitment to the transaction.
The two principal r i sks o f the operation are that: (a) UMEME i s unable to improve
20
Attachment 1
PROPOSED TERMS OF THE IDA-BACKED L/C FACILITY
Principal Terms of the Letter of Credit Facility and IDA Support
L/C Applicant: IDA-Backed L/C:
L/C Issuing Bank: L/C Issuing Date: L/C Beneficiary: L/C Currency: L/C Amounts:
L/C Validity Period:
L/C Reimbursement Period: Validity Period o f IDA Support:
IDA Backstop Fees: Front-end Fees:
IDA-Backed Events:
Conditions Precedent to the Effectiveness of the IDA Support:
U E D C L A Standby Letter o f Credit (LE) issued by the L /C Issuing Bank and backstopped by IDA by means o f a contingent Credit. Citibank Uganda Limited (Citibank N.A. London Branch wil l act as Escrow Agent). Scheduled Transfer Date (December 2004). UMEME. U S Dollars. Up to a principal amount o f US$5 million, wi th an init ial amount o f US$2.5 mi l l ion at the Transfer Date and increasing to US$5 mi l l ion on the anniversary thereof (plus interest o f up to US$500,000). Init ial ly 3 years renewable for up to 7 years. Available for drawing by the L /C Beneficiary upon filing o f a claim by the L /C Beneficiary on the basis o f validated documentation.
Repayment by U E D C L to Citibank within twelve months f rom each L /C drawing.
Up to 8 years and 25 days. 0.75 % per annum o n the available amount o f the IDA contingent Credit, payable by UMEME.4
0 An Initiation Fee o f 0.15 % o f the L /C amount (but not less than US$lOO,OOO) for Project
0 A Processing Fee o f up to 0.50 % o f the L /C amount to cover IDA-designated reimbursable
To provide a guarantee for recovery o f a loss o f revenues subsequent to: (a) a failure by the E R A to approve tari f f increases in accordance with the pre-agreed Tar i f f Methodology set forth in the Supply License; (b) a failure by GOU entities to pay their electricity bills; and (c) payment o f the balance o f any Early Termination Amount not recovered from other specified sources (including the Escrow Account) upon a termination o f the Concession within the ini t ia l 18 months for breach o f the Privatization Agreements by G O U and i t s entities. Usual and customary conditions for financings o f this type, including the following:
preparation and development costs payable by UMEME.
expenses payable by UMEME upon receipt o f invoices.
0 Execution, delivery and effectiveness o f a l l privatization and financing agreements each in form and substance satisfactory to IDA;
0 All host country environmental approvals and other Consents required for the operation o f the Concession and compliance with a l l applicable IDA safeguard requirements;
0 Provision o f relevant satisfactory legal opinions which may be required under the transaction documents;
0 Payment in f i l l o f the Initiation Fee and Processing Fee, and the f i rs t installment o f the Guarantee Fee;
0 Conclusion o f an L /C Reimbursement and Credit Agreement between UEDCL and Citibank Uganda Limited, o f an IDA Commitment Agreement between IDA and Citibank Uganda Limited, o f a Project Agreement between UMEME and IDA, and o f an amended IDA Development Credit Agreement with the GOU.
UMEME would be required to remi t to the GOU a port ion o f this fee equivalent to the IDA commitment fee, and the balance to IDA.
21 Attachment 2
Power Sector Financial and Operational Performance
1. Since implementation o f significant increases in retail tariffs in June 2001 and o f the power sector debt restructuring program at end 2001, the financial performance o f the power sector has been transformed. UEB’s successor companies (UEGCL, U E T C L and UEDCL) are now largely in a position to service their debts to Government, and were able to finance US$37 mi l l ion o f investments from internal resources during 2002103.
2. The principal factors contributing to the improvement are the growth in energy generation, increases in monthly collections and the appreciation o f the Ugandan Shilling vis-&vis the U S dollar since December 2003, which helped to reduce the burden o f foreign exchange dependent revenue requirements, amounting to about 35% o f total requirements, net o f export revenues.
The overall financial performance o f the sector has improved over the past two years.
3. strong. Apart from funds set aside for the bulk supply tariff stabilization fund, UETCL has built-up approximately USh48 b i l l ion in liquid resources. The principal reasons for this accumulation o f cash are the appreciation o f the Ugandan Shilling and UETCL’s slow uptake in implementing i t s investment program. UEDCL’s collected revenues in 2003 and 2004 are almost equal to i t s recurrent operational expenditures and debt service requirements.
UEGCL and UETCL are both financially viable. UETCL’s liquidity position i s very
4. Electricitv Tariffs. The present weighted average retail electricity revenue’ i s about 139.7 USh/kWh, equivalent to O.O8US$/kWh at the current exchange rate. The last tari f f review in January 2004 led to a decrease in the weighted average retail revenue by about 4% due to a rebalancing o f tariffs. Energy tariffs for large and medium industries and commercial businesses were reduced and domestic use tariffs were increased. The sector revenue requirements will increase significantly after the take-over o f the distribution concession by UMEME in December 2004 and the addition o f new debt service burdens associated with the Urban Power and Power IV on-lent loans (ADB, IDA, NDF and NORAD) between 2005 and 2008. The impact on retail tariffs will be considerable in the early years o f UMEME’s operations. In order to avoid tariff increases in the f i rst six months o f Umeme’s operations when the full benefits o f the concessioning have not yet materialized, the Government has proposed various tariff relief measures including funding fi-om the BST stabilization provision which would reduce the overall revenue requirements o f the power sector.6 On the assumption that tariffs would be adjusted semi-annually on M a y 1 and November 1, 2005, the indicative tariff increases would be approximately 10% and 14% respectively. The commissioning o f K i i ra units 14 and 15 (8OMW capacity) in M a y and July 2005, respectively, wil l increase energy supply and help to generate additional sales revenues, which will moderate the required increases in tariffs. The proposed US$16 mi l l ion o f urgent distribution investments in the f i rst 18 months o f the distribution concession, o f which US$5 mi l l ion will be provided by UMEME and US$11 mi l l ion i s proposed by IDA under Credit 3545-UG, will also help to increase UMEME’s revenue earning capacity over the next two years, and hence mitigate the pressure on electricity tariffs. The financial analysis indicates that as efficiency improvements take effect, tariffs would come down each year in real terms beyond the first two years. The weighted average revenue would decline from O.O99US$/kWh in 2005106 to about 0.091US$/kWh by 2009. Because significant investments in generation are l ikely to be
Average retai l electricity revenue i s the amount accruing to UMEMEAJEDCL and it excludes 17%
Without such measures, electricity tari f fs w o u l d need to b e increased by around 19% o n UMEME VAT w h i c h i s added to end-use customer bi l ls.
takeover.
22
required in 20 10 and beyond, the Government i s reviewing the structure and buildup o f a stabilization fund. This would permit electncity tariffs to be smoothed out over the medium- to long-term so as to avoid radical changes in tariff levels from year to year.
5 . the effects o f inflation and exchange rate movements. Although this provision has not been invoked to date, the ERA will in future be obliged to put into effect this mechanism as the tari f f methodology under the UMEME license agreement provides for the quarterly indexation o f tariffs for inflation and exchange rate movements. Since 1998, the Ugandan Shilling has depreciated by about 25% against the U S dollar. However, the Uganda Shilling has appreciated by about 15% over the past twelve months, from USh1,997 in September 2003 to USh1,743 in August 2004. The Uganda Shilling i s forecast to depreciate against the US dollar by 2.4% in this financial analysis. On the other hand, i f the recent past appreciation o f 250 Shillings o f the Uganda Shilling were to be reversed over the next few months, the impact on the sector revenue requirements and thus tariffs will be significant. Approximately 55% to 65% o f the sector revenue requirements are foreign exchange dependent, and for every movement o f 100 Shillings in the exchange rate, the impact on tariffs i s approximately 2.1% in 2004/05 and between 3.5% and 4.0% in subsequent years. In the future, it i s proposed that electricity tariffs be adjusted on a regular basis for the effects o f exchange rate movements.
Under the existing regulations, the ERA can adjust electricity tariffs automatically for
6. The ERA i s o f the view that customers will be more willing to accept regular and needed adjustments in tariffs as a result o f exchange rate movements, once consumers start noticing improvements in the quality and availability o f supply and customer service. For these reasons, the ERA believes that it can introduce the automatic tari f f adjustment mechanism six months after UMEME takeover. However, UMEME has the right under i t s license agreement to request quarterly changes in retail tariffs to account for inflation and exchange rate movements. The table below provides estimates o f projected average electricity revenue through 2009.
Table 1: Uganda: Projected Average Electricity Revenue
7. The ERA has recognized the need to set up a bulk supply tar i f f stabilization fund (referred to as the BST stabilization fund) which i s being funded through the bulk supply tari f f each year. The purpose o f the BST stabilization fund i s to mitigate against a spike in the retail tar i f f due to significant hydropower investments in generation which could be realized around 2010. The accumulated fund will be used to provide the necessary security deposits (escrow finds) and to absorb the tari f f shock by smoothening the tari f f path in the early years after the commissioning o f any new plant. Revenue collected so far by UETCL on account o f the BST stabilization fund i s held in a separate bank account and the balance accumulated to date amounts to Shs32 b i l l ion (US$17 million). The ERA i s in the process o f appointing an independent consultant to advise on the appropriate mechanisms and make an assessment o f the l ikely level o f annual provision required for the BST stabilization fund.
23
8. selection o f operational and financial performance indicators for 2003 to 2009. Performance i s based on the assumption that the end customer tariffs over the forecast period are maintained at the levels indicated in the preceding paragraphs, including the requirement for annual provision for the BST stabilization fund.
Future Prospects o f the Power Sector. Table 2 on the following page provides a
9. ERA’s tariff methodology provides for concessionaires’ lease rental payments to UEGCL and UEDCL. Rent includes depreciation on assets funded by the companies from internal resources, debt service and a fee to cover the administration costs o f UEGCL and UEDCL. The Government does not envisage earning any returns on leased assets for the next seven years. On this basis, UEGCL and UEDCL will be in a position to meet their cash f low requirements and remain solvent. As for UETCL’s own revenue requirements, the ERA’s current tari f f methodology makes provision for operating expenses, depreciation on assets acquired since vesting, interest on loans, investment returns and provision for the BST stabilization fund. This approach does not always match UETCL’s cash f low requirements, which have so far proved to be far less than ERA’s approved revenues for UETCL, principally because investment returns allowed for in the tariff have exceeded repayments o f loan principal and investments funded from internal resources. Consequently, UETCL has accumulated cash surpluses over the past three years. The ERA has agreed to review whether UETCL’s cash f low needs would serve as a better basis for determining the company’s revenue requirements in the future (in other words, depreciation and returns would be replaced by investments funded from internal resources and repayments o f loan principal).
10. UMEME’s Future Prospects. Aside from polit ical risks, UMEME has negotiated a good commercial deal and stands to earn adequate profits and returns for i t s shareholders in the medium to long term. UMEME has sufficient safeguards built into the lease agreement, the assignment agreement and the associated transaction documents and agreements with UEDCL and the Government, as well as l imited security guarantees backstopped by IDA to sufficiently protect i t se l f from tariff regulatory risks and non-performance by the Government and i t s agencies over the medium term. The tariff methodology defined in the lease and assignment agreement between U E D C L and UMEME will enable the company to recover the bulk supply costs o f UETCL, i t s own operational and maintenance costs (as bid and subject to cost efficiency factors and indexation for inflation and exchange rate movements), bad debts, lease payments due to UEDCL, interest on loans, capital recovery charges and a return on investment. All foreign exchange dependent costs are to be protected from exchange risks by provision o f quarterly tari f f adjustments for the Shilling/US$ exchange rate movements. In view o f al l o f the above, the future financial prospects for UMEME are deemed to be healthy.
1 1. over the next seven years in terms o f revenue collection, distribution losses, number o f new consumer connections and a distribution cost efficiency factor. Distribution loss targets are subject to review within the f i rst two years o f the transfer date since the underlying distribution losses at the present time are not truly known due to inadequate monitoring/ metering equipment and the inadequacy o f UEDCL’s billing system. Also, adequate funds have been set aside by UEB (for benefits accruing up to March 2001) and UEDCL (for benefits accruing from April 200 1) for the payment o f al l terminal benefits in the event o f any staff retrenchment.
The lease and assignment agreement provides for annual efficiency improvements
24
45 11
285 1420
Table 2: Power Sector Operational & Financial Indicators (2003-2009)
Foi
11 11 295 295
15 15
- UEB - UEGCL - UETCL - UEDCL
11 295
15
3 3 295 295
3 3 - UMEME Customersiemplo yee-UEDCLAJMEME Ave. Uganda revenue (USh/kWh) - UEGCL/Eskom (based on energy sent out) - UETCL (based on bulk supply) - UEDCLAJMEME (based on retail sales) Ave. Uganda revenue (US$kWh) - UEGCL/Eskom (based on energy sent out) - UETCL (based on bulk supply) - UEDCLRJMEME (based on retail sales) Change in ave. Uganda retail revenue (%) - In Uganda Shilling terms - In US$ terms Revenue collected (excl VAT) per kWh o f bulk
nla 1248 813 172 209 343
17.0 11.3 13.7 40.8 30.0 24.0’
150.4 139.7 146.4
0.087 0.061 0.075 0.021 0.016 0.013 0.077 0.075 0.080
-6.1 - 7.1 4.8 - 14.7 -2.4 7.4
18.1 45.5
173.6
0.095 0.024 0.091
- 1.0 -3.4
130.0
- 0.6 5.6 8.1
24.4 6.5
1.1 2.2 0.9 2.1 2.2
17 34
159 40
1.0 2.1 1.1 2.1
- -.
2006 1870 1662
131 4.0
25.0 1247 10.5
89
18.4 19.1 47.2 50.5
175.5 181.7
0.094 0.095 0.024 0.025 0.090 0.091
1.1 3.5 - 1.3 1.0
138.9 146.2
- 0.5 - 0.5 5.5 6.1
12.4 14.2 19.8 16.2 7.0 7.1
1.1 1.0 2.1 2.1 0.9 0.9 2.2 2.3 2.2 2.1
16 15 37 39
168 178 40 39
1.0 1.0 2.0 2.0 1.1 1.1 1.9 1.9
3 04
11 295
15 839 356
17.8 44.8
175.5
0.096 0.024 0.094
19.9 17.0
115.6
- 0.6 6.3 6.2
36.0 6.0
1.1 2.2 1 .o 1.7 2.1
17 32
151 41
1 .o 2.8 1.1 2.3
1 . I
- UEGCL - UETCL - UEDCL - UMEME - Sector Current ratio - UEGCL - UETCL - UEDCL - UMEME - Sector Debvequity ratio (%) - UEGCL - UETCL - UEDCL - Sector Debt service ratio - UEGCL - UETCL - UEDCL - Sector
:ast
- 1.2 -2.0 - 1.5 10.3 5.4 1.0 16.5 1.8 5.9 nla 37.6 39.6 6.3 0.2 1.6
1.5 1.2 1.1 2.3 2.6 2.3 1.6 1.0 1.0 nla 1.7 1.4 2.4 2.6 2.1
12 17 16 35 37 33
109 140 146 38 43 42
2.8 1.1 1.1 9.3 4.7 2.2 2.2 0.4 1.1 2.6 1.3 2.0
’ The drop in bulk supply tar i f f was due to temporary tar i f f rel ief measures.
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