Docwnunt of

The World Bank

FOR OMCIL USE ONLY

MICROFICHE COPY

Report No. 10334-YU Type: (PCR)MAUPRIVEZ,/ X31709 / T9069/ OEDD3 ReportNo. 10334

PROJECT COMPLETION REPORT

YUGOSLAVIA

MIDDLE NERETVA HYDRO PROJECT(LOANS 1561-0-YU AND 1561-1-YU)

JANUARY 24, 1992

Energy and Environment Operations DivisionEuropean DepartmentMiddle East and North Africa

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY AND EQUIVALENT UNITS

Currency Unit - Now Dinar

Market Rates(at year end)

1977 US$1 = ND 0.002 1986 US$1 = ND 0.0461978 US$1 = ND 0.002 1987 US$1 = ND 0.1241979 US$1 = ND 0.002 1980 US$1 = ND 0.0031981 US$1 = ND 0.00e 1988 US$1 = ND 0.5211982 US$1 = ND 0.009 1989 US$1 = ND 11.8161963 US$1 = ND 0.013 1990 US$1 = ND 10.6571984 US$1 = ND 0.021 1991* US$1 = ND 23.0001985 US$1 = ND 0.031

WEIGHTS AND MEASURES

m = Meter (3.28 feet)Km = Kilometer (0.62 miles)Kg = Kilogram (2.2 pounds)

ton = Metric tonne (2,205 pounds)1 kilovolt (kV) = 1,000 Volts (V)1 kilowatt (kW) = (Commercial unit ot sale of electric power) 1,000 Watts1 Megawan (MW) = (Commercial unit of sale of electrical power) 1,000kW1 kilowatt-nour (kWh) = (Commercial unit of sale of electrical energy) 1,00OWh1 Megawatt-hour = (Commerical unit of sale of electricity) 1,00OkWh1 Gigawatt-hour (GWh)= 1 million kilowatt-hours

ABBREVIATIONS AND ACRONYMS

BH = Bosnia - HercegovinaBOAL = Basic Organization of Associated LaborEBH = Elektroprivreda Bosne I HercegovinaERR = Economic Rate of RetumHEN = Hidroelektrane Na Neretvi (Neretva)HPP = Hydro power projectJUGEL = Union of Yugoslav Electric Power IndustryLRMC = Long Run Marginal CostSDK = Sluzba Drustvenog Knjigovodstva or Social Accounting Service

(SAS)

BORROWER'S FISCAL YEAR

January 1 - December 31

*end-April

THE WOiaD SANKFOR OMFCIA6L USE ONLYTHE WOiZLC BANK Ro u BWashington. D.C. 20433

U.S.A.

nE Dw.ctoq.Gnrwal)Pfinnsmew EvaIuatk,

February 4, 1992

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Completion Report on YugoslaviaMiddle Neretva Hydro Project(Loans 1561-0-YU and 1561-1-YU)

Attached, for information, is a ccipy of a report entitled "Project

Completion Report on Yugoslavia - Middle Neretva Hydro Project (Loans 1561-0-YU

and 1561-1-YU)" prepared by the Middle East and North Africa Regional Office.

No audit of this project has been made by the Operations Evaluation Department

at this time.

Attachment

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

FOR OFICIAL USE ONLY

PROJEC COMPLETION REPORT

MIDDLE NEREA) HYDRO PROJECT(LOANS 1561-OYtT AND 1561-1-Y)M

TABLE OF CONTENTS

Page No

PREFACE. iEVALUATION SUMMARY ..................................... ii-iv

PART I PROJECT REVIEW FROM THE BANK'S PERSPECTIVE 1

Project Design and Organization .............................. 3

Project Implementation ......................, 4

Project Results ..................... 8

Project Sustairnability ..................... 11

Bank Performance ..................... 12

Performance of the Borrower and Executing Agency ................ 12

Performance of Consultants ...................................... 13

Performance of Contractors ...................................... 13

Project Relationship ............................................ 14

Project Documentation and Data .................................. 14

Lessons to be Learned ........................................... 14

PART II PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE........ 16

FART II STATISTICAL INFORMATION ............................... 17

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not othervvise be disclosed without World Bank authorization.

PROJECT COMPLEMION REPOR1

YfUGO-SLA VIA

MIDDLE NEREIVA HYDRO PROJECT(LOANS 1561:-O- AND 1561-1-YU

PREFACE

This Project Completion Report (PCR) is for the Middle Neretva

Hydro Project in the Republic of Bosnia - Hercegovina (BH) in Yugoslavia. Atotal loan o; $134 million was made by the Bank, in two tranches, to

Elektroprivreda Bosne X Hercegovine (EBH) for the construction of the projectin two phases, phase I and phase II. The first tranche -Loan 1561-0-YU for

US$73 million-was approved on May 2, 1978 for phase I for construction ofGrabovica and Salakovac hydro power stations (para 3.02). The second tranche

-Loan 1561-1-YU for US$61 million- was approved on June 21, 1983 for phase II,

as a supplemental loan to the first, for construction of Mostar hydro power

station (para 3.02). The loan was officially closed on June 30, 1989, one

year behind schedule, although disbursements continued through to April 20,

1990. Except for an unutilized amount of $5,191,243.76 which was cancelled,the loan was fully disbursed.

The PCR was jointly prepared by the Energy and Environment

Operations Division of the Eastern European Department of the Europe and

Central Asia Regional Office (Preface, Evaluation Summary, Parts I and III),

the Borrower, EHB, and Neretva , the project executing agency (Part II).

Preparation of this PCR was started during the Bank's final Supervision

mission of the project in November 1989 and is based, inter alia, on the Staff

Appraisal Report, the Loan, Project and Guarantee Agreements, supervision

reports, correspondence between the Bank, EBH and Neretva, and internal Bank

documents.

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PROJECr COMPLETION REPORT

YUGOSLAVTA

MIDLE NEREIVA HYDRO PROJEC(LOANS 1561-0-YU AND 1561-1-YU)

EVALUATION SUMMARY

Obiective

The project was designed to meet the need for peaking capacity inthe power system of Bosnia - Hercegovina at least-cost, to contribute tomeeting the overall energy requirements of Yugoslavia through the generationof electricity for the national interconnected transmission network and topromote the economic development of indigenous energy resources. It was aimedat furthering coordination amongst the various republican and provincial powerentities and amongst the constituent organizations within EBH. It furtheraimed at pursuing the institution-building objectives of the First and SecondPower Transmission Projects (Loan 836 and Loan 1469), specifically atimproving efficiency of operations, economic and financial planning,forecasting and budgeting procedures within EBH (para 3.01).

Im_lementation

Phase 1 of the Project, comprising the two schemes at Grabovicaand Salakovac, was commenced in March 1977 and was mostly completed and cameinto commercial oDeration by March 1983 (para 5.02). However, a leakage ofthe Salakovac reservoir, which poses no danger to the dam structure, wasnoticed during its filling. Since then, extensive investigations and groutingin the reservoir to reduce the leakage have been on-going. However, so far,these have proved futile (paras 5.03 and 6.01(c)). Disbursements continuedthrough to April 20, 1990, mainly to enable withdrawals against expendituresincurred on the account of the on-going works on the Salakovac reservoir(para 5.12).

Phase II of the Project, comprising the Mostar scheme, wascommenced in early 1983, about four years later than originally plannedbecause of the need for additional geological studies and a shortage offinancial resources, especially foreign exchange (para 5.02). It wassatisfactorily completed and came into commercial operation by end-1988.However, the reservoir has been temporarily maintained at elevation 77 meters,instead of the design maximum operating level of 78 meters, because atelevation 78 meters, the groundwater on the left bank of the reservoir beganto enroach on the underground structures of a nearby textile mill and otherindustrial structures leading to their endangerment (paras 5.03 and 6.01(e)).So far, the required protection measures have not been put in place by Neretvato enable the full production of the power station to be realized.

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Proiect Results

The project was a partial success. It was completed with about12X cost over-run compared to appraisal estimate mainly because of about 26Xlocal cost over-run. The physical objectives of the project were mostlyachieved despite a continuing seepage of water at the Salakovac reservoir(para 5.03) and the current temporary restriction on the full utilization ofthe Mostar reservoir (para 5.03). The three plants are used for peakingpurposes as planned and except for the shortfalls in production due to leakageat Salakovac, the restriction on full utilization of Mostar, and some minorfall in energy production due to incomplete works on river bed deepening,deliver almost the expected output. The revenue loss to EBH due to theshortfalls in production is about $6 million, equivalent, per year at currentelectricity prices (para 6.01). The economic rite of return (ERR) on theinvestment in the project is re-estimated at 10.21 compared to 11.21 atappraisal.

The project did not achieve the objective of furthering inter-republic coordination, neither did it achieve the objective of improvingeconomic and financial planning, forecasting and budgeting procedures. As aresult of inadequate tariff action by the republican authorities, the projectresults in the financial area fell below expectations. In 1979-81 EBH's self-financing level was about 261 as against the covenanted 35Z. FurLhermore, EBHcould not on its own comply with the s'i1qtitute long run marginal cost (LRMC)pricing covenant introduced in 1983 under the Third Power Transmission Project(Loan 2338-0-YU) which called for adjustment of electricity prices to LRMClevels by December 31, 1987, since it required decision at the power industrylevel and that of the Federal Government. EBH's electricity prices have sinceremained low relative to cost which has resulted in deterioration in itsfinancial position. However, the project has been successful in improvingexpertise in technical operations of hydro plants.

Sustainability

Neretva has emerged from the project as an enterprise withexperienced and competent technical management and staff with the skillsnecessary for the efficient operatiors of the three plants. This isreinforced by the experience gained in the operations of the two upstream Ramaand Jablanica power stations. EBH and Neretva would also need to continuouslykeep the problem of seepage of water at the Salakovac reservoir under reviewso that the seepage does not worsen and scuttle the benefits of the project.Also, Neretva should endeavor to solve, as soon as possible, the realizationproblem of groundwater enroachment on structures on the left bank to enablefull operation of the Mostar power station (para 6.01). Above all, to sustainthe benefits of the project, through adequate and continuous maintenance ofthe plant and equipment, EBH will need to maintain a sound financial position,which will also ensure its ability to meet its obligations and to generateadequate internal funds for expansion. EBH, like other power entitlescurrently face the formidable task of maintaining efficiency of operations andmeeting financial obligations. In the light of the unfavorable macro-economicsituation, which has affected the ability of major consumers to pay for

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electricity supplies, the extent to shich EBH would k able to maintainefficiency of operations and meet financial obligations, would depend on therate at which the broader macro-economic problems of the country areaddressed, ard public utilities are able to charge prices that meet financialand eco- - objectives. This does not appear to be achievable in the short-run bu- o situation is expected to gradually improve over time.

Findings and Lessons Learned

The project demonstrates the dangers posed by karstic conditionsat a dam site and how the best of precautions cannot entirely overcome therisks. The project also demonstratfs the significant financial difficultiesfor a Borrower to implement a project on schedule and fulfill financialcovenants, when electricity prices are kept below levels that will ensurefinancial viability. In addition, the financial weakness led to some worksbeing only partially fulfilled, e.g the river bed deepening and delays insolving the problem posed by the groundwater level near the Mostar reservoir(para 5.03).

The lessons learned are that in dam construction in karsticconditions, scientific investigations should be carried out more extensivelywith the most modern technology and should be a cnntinuous -'Q--wity during theperiod of project implementation. The Borrower must not only have thenecessary financial resources to implement the project but must be able toengage the expertise, including the appropriate technology to meet thechallenges of works in such conditions. In view of the autonomy of republicsand the political system, a republican project cannot be used to fostersector-wide objectives. In addition, the inability of EBH to comply with theLRMC covenant shows the difficulties in obtaining sector-wide agreement onmatters that affect the investment choices of republics.

PROJECT COMPLEIION REPORT

YfUGOSL&VIA

MIDDLE NERETVA RO PROJEC(LOANS 1561--YU AND 1561-1-YU)

PART I - PROJECT REVIEW FROM THE BANK'S PERSPECTIVE

1. Proiect Identit'r

Project Name Middle Neretva dydro ProjectLoan Nos. 1561-0-YU and 1561-1-YURVP Unit EHENA RegionCountry YugoslaviaSector : EnergySubsector Power

2. Background

2.01 In the decade preceding the appraisal of the project, the growthin generating capacity to the Yugoslav power system was inadequate to meet th0demand for electricity which was growing at about 10% per year on the average.The retardation in the construction of new generating facilities was due tothe increasing decentralization of Yugoslavia's economy fragmenting the sub-sector into autonomous organizations, and the consequential reduction inFederal government funding for power development. Beginning early 1971,Federal funds for power development was abolished altogether, and the powerenterprises which had hitherto maintained low tariff rates and achievedlimited internal cash generation, were unable to finance expansion when theselow-cost long-term federal credits were no longer available. Consequently theconstruction of new power plants lagged.

2.02 Yugoslavia's 1976-80 Five Year Plan placed the highest priority onincreasing the role of domestic energy resources in meeting the country'senergy needs. In this regard, construction of thermal power plantsaccelerated and moreover, financing was easier to obtain through suppliers'*credits and barter trade arrangement because of the large equipment andmachinery component of such schemes. On the other hand financing for hydroplants was much more difficult to obtain because the civil works, whichconstitutes a large proportion of hydro projects have always been awarded tolocal contractors. In view of this and in order to assist in improving theplant mix, a hydro power project was appropriate for Bank financing.

2.03 It was in tbe above context that the project was formulated. Theproject was first reviewed by the Bank in 1974 in the context of 12 projectssubmitted to the Bank by the various republics. The project was selectedamong four, judged most economic, for closer study. Following the inabilityof Bosnia - Hercegovina to proceed with the Buk Bijela project, for which theBank approved a loan of $73 million in 1976 but failed to become effectivebecause of inter-republican dispute, the Yugoslav authorities requested theBank to review alternative schemes. A Bank mission visited Yugoslavia in May1977 to identify a suitable power project in one of the less developedrepublics and the subject project was selected for appraisal in October 1977.

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3. Project Ob1ectives and Description

3.01 Proiect Objectives. The project is designed to meet the need forpeaking capacity in the power system of Bosnia - Hercegovina at hlast-cost, tocontribute to meeting Yugoslavia's overall energy needs through thegeneration of electricity for the national interconnected power transmissionnetwork, and to promote economic development of domestic energy resources. Inaddition, the project would continue to further coordination between Bosnia -Hercegovina and the other republican and provincial power entities, throughJUGEL, and strengthen coordination among the constituent organizations withinBosnia - Hercegovina's power sector composite organization (ElektroprivredaBosne I Hercegovine or EBH). Moreover, the project would enable the Bank topursue more closely, the implementation of the consultants' recommendationsunder the studies already undertaken or being initiated as part of the Firstand Second Power Transmission Projects. These studies were aimed atestablishing improved proceadures for the efficient operation and management ofthe Bosnia - Herzegovina power system wiciiin the context of the Yugoslaviainterconnected system, as well as improving EBH's capability in economic andfinancial planning, forecasting and budgeting procedures.

3.02 Proiect DescriRtion. The project consisted of three dams(Grabovica, Salakovac and Mostar) and their associated power stations andtransmission links the republican power grid. The project would be executedin two phases. Phase I would comprise the Grabovica and Salakovac schemes andphase II would comprise the Mostar scheme. The power capacities of the threestations would be 116 MW, 205 MW and 75 MW, respectively. The thre concretegravity dams would impound the river waters in continuous cascade; the lowerreservoir at Mostar would regulate the water discharge from the upper twoschemes which would be operated primarily during periods of peak load. TheSalakovac dam would be equipped with a take-off conduit allowing 4mJ/s ofwater to be supplied to the area north of Mostar for eventual irrigation ofsome 2,000 ha and for water supply purposes. Although the Grabovica andSalakovac developments, without the lower dam and reservoir at Mostar, couldbe justified independently at lower electrical power capacities, the Mostarscheme was included in this project because it would be needed for downstreamriver regulation thus assuring efficient utilization of the Grabovica andSalakovac developments and consequently, for the most economic development ofthis stretch of the river. The construction of Mostar would allow optimaloperation of the Salakovac plant, enabling an increase of 30 GWh of output andincrease in power production by 120 MW and peak energy production by about240 GWh. Mainly due to financial constraints, and the need for additionalgeological investigations, construction of Mostar was to follow once theconstruction of the two upstream plants were well underway. Accordingly, thecompletion of firm engineeriig plans supported by geological studies andupdated capital cost estimates and assurances of EBH and Neretva to provideadequate financing for the Mostar station, would be a condition ofeffectiveness of the first proposed loan of $73 million for phase I of theProject. The foreign exchange financing requirements for Mostar were then tobe obtained from sources other than the Bank (4.05).

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4. Proiect Design and Organization

4.01 The project design concep_. and timing was considered appropriateand timely to ensure the most economic plant mix in the Bosnia - Hercegovinapower system. The feasibility studies and design had been prepared by Neretvawith the assistance of several Yugoslav consulting firms. In view of thekarstic nature of Neretva river basin, extensive explorative drillings wereundertaken. The design provided for the establishment through groutingprocedure.s of a barrier against water leakage. As part of the investigationsfor the design, a grout curtain was constructed in 1965 in a trial section ofthe Salakovac dam and it provided evidence of the effectiveness of theprocedure

4.02 EBH, the Borrower, was origina.,.y established in 1973 as a workorganization responsible for coordinating the power development and operationsof the Republic's generation and transmission enterprises. In 1977,distribution enterprises were also incorporated into EBH and the whole staffof EBH's constituent organizations then amounted to 9,800. Training ofpersonnel was an ongoing activity coordinated by EBH. EBH agreed to submit tothe Bank by December 31, 1978, its subsequent program for training andmanpower development for review and comment before implementation. Thepurpose of the training was to ensure that the program would providesufficient numbers of adequately qualified and trained staff for the newfacilities being constructed.

4.03 Although EBH was selected as the Borrower in view of its status asthe apex power sector organization in the Republic and its role as a borrowerunder the First and Second Power Transmission Loans, the physical constructionof the project was to be executed by Hidroelektrane na Neretvi (Neretva), oneof EBH's constituent work organizations. Neretva entered into a ProjectAgreement with the Bank and the proceeds of the Bank loan were to be madeavailable to Neretva on the same terms and conditions as the Bank loan.Neretva's Management and staff were experienced and well-qualified. It wasoperating and managing the Rama and Jablanica hydro plants.

4.04 Construction supervision foL the two sites of Grabovica andSalakovac was by separate site staff coordinated and employed by Neretva.This arrangemeat was proving effective. The consultants for the project werean experienced Yugoslav firm who had a cortinuing responsibility for adviceand engineering design through project execution. Neretva agreed to continueto employ c -sultants, satisfactory to the Bank, for the execution of theproject. ' view of the uncertainty and potential risks associated wit'k damsin karstic conditions both EBH and Neretva agreed to establish a panel ofexperts, independent of the designers of the project, to familiarizethemselves with the design and to advise in the event of unforeseen problemsarising during construction. The appointment of a panel, satisfactory to theBank, was a condition of effectiveness of the loan. In addition, Neretvaagreed to set up an expert Engineering Review Board to undertake periodicinspections of the hydro works, to ensure that they would be carried out inaccordance with sound engineering practice.

4.05 Apart from the two Bank loans of $73 million and $61 million forphases I and II, respectively, arrangements were made for obtaining the restof tht project financing. The submission to the Bank of a local bank(Privredna Bank) guarantee to provide the balance of the funds needed tocomplete phase I of the Project, including cost over-runs and interest duringconstruction, was a condition of effectiveness of the Bank loan for phase Iand also for phase II. The Bank agreed in 1983 to provide the foreignexchange financing for phase II because of the inability of EBH to obtainalternative sources of financing (paras 3.02 & 5.02), and on the basis of thefindings of a Bank mission which carried out a review of the technical andfinancial aspects of the project, and concluded that the conditions in Loan1561-YU regarding Mostar had been satisfactorily met by the EBH and Neretva.

4.06 Actions were also taken to assure the financial viability of EBHand to secure an adequate level of internal cash generation. EBH agreed toachieve internal cash generation of a minimum of 35% of investment as against30% required under the Second Power Transmission Loan of 1977. This wassubsequently replaced by the LRMC covenant under Loan 2338-YU to raiseelectricity prlces to LRMC levels by December 31, 1987. In addition,arrangements were made to obtain consumer contributions towards the projectfinancing. Arrangements for audit of the Borrower's accounts by the Sp,"ialAudit Group of the Social Accounting Service (,AS) were made, which amonLother things, would provide adequate informaticn on the financial position ofEBH and Neretva for remedial actions on project financing to be taken asnecessary.

4.07 With the above actions, there was reasonable assurance that theproject would be completed satisfactorily in accordance with the plannedschedule.

5. Prolect Implementation

5.01 HLoan Effectiveness and Project Start-Up. Although, Loan 1561-0-YU was approved on May 2, 1978, it was not declared effective until November15, 1978. This was due to delays in securing local bank guarantee (para 4.05)for financing of the local cost component and the completion of the localprocedures for obtaining the World Bank loan. Loan 1561-1-YU was approved onJune 12, 1983, but became effective on December 15, 1983 for similar reasons.Under Yugoslav conditions, the delays were not unexpected. However, they hadno effect on the start-up of the project components, since the civil workswere already on-going (para 5.02).

5.02 Implementation Schedule. At appraisal, construction of the twoupstream plants, Grabovica and Salakovac, was estimated to take about56 months to complete. The actual construction took 74 months to complete.The civil works not proposed for Bank financing, started in March 1977 and wasprogressing satisfactorily at appraisal. Construction of Mostar was commencedin October 1983 and was mostly completed by June 30, 1988, one year behindappraisal schedule.

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5.03 The delays in project completion were due to the following five majorreasons:

(a) light Construction Schedule. The construction schedule preparedat appraisal was rather optimistic. Although, the main civilworks contractor and the contractor for engineering supervision,on whose proposals the implementation schedules were based, hadalready been engaged then (para 5.01), experience in similarprojects in karstic areas would have suggested a more conservativeimplementation estimate, to take into account difficulties andcontingencies inherent in this kind of project.

(b) Problems with Contractors. The main civil works contracts wereawarded to Yugoslav firms with both extensive local andinternational experience in the construction of major dams andcivil works. There were different contractors for the civil worksand supervision for phases I and II. The civil works contractorfor phase I had initial financial difficulties in procuring heavydutv construction equiDment and machinery and, therefore, could not pro-ceed to the site in time. Some of the equipment and machinery hadto be transported from previous work sites in the Middle East toYugoslavia. These led to considerable initial delays inimplementation. However, once the required equipment andmachinery were on site, the contractor accelerated the work, andimplemented activities that could be carried out in parallel inorder to make up for some of the lost time.

(c) Bad Weather. Unexpected heavy rains in early 1977 causedsignificant rise in the waters of the Neretva river and floodingof the diversion tunnel outlet and stoppages of works on riverdiversion. The heavy r-ins also caused significant rise in thegroundwater levels and ,looding of the construction pit. This ledto delays in works on the grouting curtain, and c3ncreting for thedam and power house. Exceptionally cold winter, at times, alsohampered construction works.

(d) Geological Problems.

(i) As advised by the Bank, a panel of independent experts hadbeen established to advise Neretva in the event of unforseenproblems arising during construction. During the construction,numerous unexpected geological problems were encountered. Thesewere mainly larger caverns in the river bed than anticipated inthe design both at Grabovica and Salakovac. Extensive groutingand concreting was required to solve the problems. A reinforcedconcrete structure had to be constructed for the power house andportions of the dams immediately above the caverns. In addition,because of the karstic formations, the high levels of groundwaterand its seepage into the construction pit required extensivegrouting to prevent their persistent occurrence. Similar problemswere encountered on Mostar, but on a smaller scale. These led tosignificant increases in the volume of excavations, construction

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of embankments, and concreting compared to estimates at appraisal.During the filling of the Salakovac reservoir, new springsappeared on the left bank, downstream of the dam and the flowsfrom pre-existing springs increased by as much as about 35 cubicmeters per second in the dry season. The panel of expertsconcluded that significant quantities of water were leaking fromthe reservoir through the left bank. However, it was noticed alsothat the leakage did not pose any danger to the dam structure.The panel recommended further scientific investigations andgrouting works to address the problem.

(ii) In an attempt to locate the leakage holes in the Salakovacreservoir, the reservoir was emptied and grouting works werecarried out in the suspected areas of leakage. This wassuccessful in reducing the flow from the springs by about 4-5cubic meters per second to about 30 cubic meters per second. TheBank further retained the services of an expert engineeringgeologist with international experience from 1985 through 1989, onan adhoc basis, to review periodically the works carried out andthe method of investigations and recommend further actions. Inaddition, the closing date of the loan was extended by the Bank byone year to allow completion of additional grouting works thatwere then on-going. The Bank suggested some new techniques forthe investigations. The problem remains unsolved.

(iii) During the filling of the Mostar reservoir, the groundwateron the left bank upstream of the dam rose to unexpectedly highlevels. This led to flooding of the foundations and undergroundstructures of a near-by textile mill and an agricultural complexin spite of the extensive grouting protection works carried outalong the left bank. This was yet another example of the hazardsof the geological conditions. The panel of experts confirmed noleakage of the dam structure. To avoid endangering thosestructures, and as a temporary measure until the problem issolved, the reservoir level has been maintained at elevation 77meters instead of the design maximum operating level of 78 meters.This has added a new dimension to the environmental aspects of theproject (para 5.04).

(e) Financial Difficulties. Low electricity tariffs and the inabilityof the Borrower to raise them, led to serious weakness in thefinancial position of the Borrower and difficulties to meet, on atimely basis, payments to local contractors. The financialdifficulties combined with unexpected increases in the consumptionof basic materials (cement, reinforced steel, fuel, etc.) led toan acute shortage of materials at various stages of constructionof phase I and consequent delays in implementation. Eventually,the republican authorities had to levy special taxes onelectricity consumption to meet the local financing gap. Theshortage of local funds also led to partial completion of works onthe river bed deepening.

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5.04 Environmental Aspects. The environmental component of the Projectwas studied in detail and was reviewed by the Bank at appraisal. It coveredresettlement of affected families, compensation for agricultural land andother immovable properties, relocation of roads and other socialinfrastructure, protection of endangered fish life, and ancient relics. Forthe protection of endangered fish life, a fish hatchery was constructed atMostar for research and development of rare and endangered fish life in therivers in the Republic. This has developed into a modern fishery researchcenter. The environmental component was satisfactorily carried out inaccordance with republican requirements and as was agreed with the Bank atappraisal. However, until, appropriate preventive measures are taken againstthe potential dangers to the underground facilities of the structures(para 5.03 (iii)) near the Mostar reservoir, the full production of thestation cannot be realized. In early 1989, the Bank retained the services ofan expert engineering geologist to review the problem and recommend possiblesolutions. The major constraint to implementing the recommendations has beenlack of local funds. Meanwhile, the Mostar power station continues to loseabout 7% (20 GWh) of energy generation per year, as well as a reduction in itspeaking capacity and a loss of about 2% of peak energy production fromSalakovac.

5.05 Procurement. On the whole, procurement action on the itemsfinanced by the Bank proceeded satisfactorily, and was in accordance with Bankguidelines. There was a minor issue of use by Neretva of some constructionmaterials, cement and reinforcement steel for the construction of communityswimming pool for the city of Mostar and housing for the operators of theMostar power station, without prior Bank approval. The Bank supervisionmission reviewed the situation and accepted Neretva's explanation.

Project Costs and Financing

5.06 Proiect costs. The estimated project cost, including physical andprice contingencies at appraisal was US$444.9 million, equivalent. The finalcost at completion was US$500.2 million, equivalent. Details showing costs ofphases I and II are provided in Part III paras 4.01 and 4.02. The increasesin the total cost of about 12% is because of a 25% increases in the actuallocal costs compared to appraisal estimate. There was a cost under-run in theforeign component of about 17% due to a relatively strong US dollar and thefavorable responses to the internationally tendered competitive bids for thesupply of hydro-mechanical and electrical equipment and for constructionequipment (para 5.08).

5.07 Project Financing. At appraisal of phase I, the Bank loan of $73million equivalent was projected to cover the foreign cost component of thatphase. Foreign exchange financing for the Mostar scheme, which was to followlater, was to be obtained from sources other than the Bank (para 4.05).However, due to the inability of EBH to obtain the financing from othersources, the Bank agreed to the request of EBH to provide the foreign exchangefinancing of $61 million equivalent. As a result, the Bank loan increased to$134 million equivalent (para 5.08), to cover the entire foreign exchange costcomponent, about 30%, of the estimated total project cost. Sufficient

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arrangements were made to ensure adequate financing of the local costcomponent from EBH's internal sources, consumer contributions throughsurcharges on electricity consumption (para 4.06), loans from local commercialbanks, and contribution from the federal fund for underdeveloped republics.Because of EBH's inability to meet its contribution to the financing, asoriginally planned, the shortfall in local financing was made up throughadditional borrowing from local banks, increased consumer contributions, andfrom the Social Reproduction Funds of the republic. There were significantdelays in obtaining the additional contributions from these sources, whichaffected implementation (para 5.03 (e)). Details are provided in Part III,section 4.

Loan Allocation

5.08 The original loan agreement for $73 million loan was amendedwhen the supplemental loan was made in October 1983 for a revised total loanamount of $134 million. For phase I, the Bank loan was allocated to theprocurement of hydro-mechanical and electrical equipment. For phase II, theallocation of the loan covered machinery and equipment, construction machineryand materials, fuel, cement and reinforcement steel. The original allocationin the Amending Loan Agreement was revised in the light of che responses tothe bids, which provided the possibility for the Bank to finance interestduring construction on the Bank loan ( phase II) at the request of theBorrower.

Disbursements

5.12 Estimated and actual disbursements are shown in Part III,psaras 3.01 and 3.02 for phase I and for phase II, respectively. To expeditedisbursements under phase II, Special Account was provided. The disbursementdelays were due to the project implementation delays. The official loanclosing date was extended once from June 30, 1988 to June 30, 1989. Inaddition, the loan account was kept open until April 20, 1990 to allow fordisbursements against eligible expenditures incurred on the project prior toJune 30, 1989, to be made. The unutilized amount of $5,191,243.76 of the loanwas cancelled on October 31, 1989.

6. Project Results

6.01 The first unit of the Grabovica HPP was commissioned on January22, 1982 and the second unit on September 22, 1982. The first unit of theSalakovac HPP was commissioned on January 27, 1982 and the second unit in July1982. There was a delay of about 18 months in the original plannedimplementation schedule. At Mostar, installation of the plant and equipmentwas achieved in accordance with the revised implementation schedule, about oneyear behind appraisal schedule. The three generating sets were commissionedon October 31, 1987, December 17, 1987 and April 15, 1988 respectively. Allthe tests were satisfactory and the plants delivered the output required bythe bid documents. There were, however, some shortfalls in the possibleproduction of the plants as detailed below mainly because of (i) substantialseepage from the Salakovac reservoir, (ii) non-completion of works on river

9

deepening and development at all three plants arising from lack of local fundsand (iii) limitation of the water level at Mostar to 77 meters instead of thedesign maximum normal operating level of 78 meters:

(a) the long-term average annual energy capability possible ofGrabovica would be only 337.1 GWh, a 2.7% reduction in theappraisal estimate of 546.4 GWh because of non-completion of riverbed deepening;

(b) a reduction of about 1.7% at Salakovac as compared to theappraisal estimate due to non-completion of river bed deepening;

(c) a reduction of about 12% (70 GWh) at Salakovac as a result ofseepage of water from the reservoir;

(d) a reduction of about 5% (14 GWh) at Mostar due to non-completionof bed deepening;

(e) a reduction of about 7% (20 GWh) at Mostar owing to the limitationof the reservoir water level to 77.0 meters; and

(f) a reduction of about 1.8% at Salakovdc due to the limitation ofthe Mostar reservoir level.

Currently, the annual revenue loss to EBH due to these shortfalls inproduction is about $6 million, equivalent.

6.02 The substantial and continuing leakage from the Salakovacreservoir needs careful watching with a view to ensuring that it does notincrease to alarming proportions and scuttle the benefits of the plant. TheYugoslavs are well aware of the need for extreme vigilance in this regard.

6.03 One of the benefits accruing to Neretva from the project was thatits staff gained valuable experience in hydro plant construction andsupervision. Their technical expertise in these matters was raised to a muchhigher level as a result of the project. The manpower training program focusedon technical training but was weak in the areas of economics and finance.

6.04 The objective of furthering co-ordination among the variousrep'ublican and provincial power entities through JUGEL was not achieved, butthe project succeed-d in improving co-ordination between the memberorganizations of EBH.

6.05 The project did not fulfill the expectations in the financialarea. Its self-financing level was an average of only 25.8% in 1979-81 asagainst the covenanted 35%. As with the rest of the power industry, the LRMCcovenant was observed by EBH in default. No doubt, the macro-economicconditions were a partial explanation for the weak financial performance ofEBH. Details of the increases in electricity prices are given in theAttachment.

6.06 The project results were not wholly satisfactory in the audit area

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as well. The quality of audits improved as a result of the project, but notits timeliness. EBH was not able to adhere even to the extended time limit ofnine months for the submission of audited accounts. There were and continueto be significant qualifications raised by the auditors on the financialstatements, although, some of the qualifications have been due to persistentchanges in the Yugoslav accounting laws.

6.07 Economic Justification of the Project. The Appraisal Reportjustified the investment in the proposed project because:

(i) it provided the least-cost means of meeting the projected peakingcapacity requirements of the power system of Bosnia - Hercegovina;and

(ii) the economic rate of return on the investment was estimated to beabout 11.2% compared to the opportunity cost of capital of about10%.

The least-cost justification was established from the republican viewpointbecause at that time the concept of a national least-cost investment programas a strategy of sector development was under discussion with the powerindustry and the federal authorities. A national least-cost generationexpansion study which was to serve as a basis for further discussions was alsounder preparation by Yugoslav Consultants. Meanwhile, and as with theprevious projects, the Bank found the republican approach to system planningacceptable. In the case of this project, it was considered that its potentialfor significant deviations from the overall national least-cost developmentprogram would be minimal, because the republic was rich in energy resource andwould only construct the projects that would still be of high priority in anational context.

6.08 The least-cost Justification was established by comparing theestimated costs of the proposed project to costs of alternative thermal powerplants that would otherwise be constructed to provide the same output and rolein the power system as the proposed project. The appraisal report confirmedthe proposed project as the least-cost among the tue*m" alternativesconsidered.

6.09 On the basis of actual project costs, current output andsimulation of expected generation of the power station, taking the energylosses into account (para 6.01), the economic cost of generation from thepower station is estimated at about US 5.2 cents/kWh. This is lower than thecost of generation of about US 6 cents/kWh from an alternative peaking gasturbine unit firing distillate fuel and the cost of imported electricity byYugoslavia of about US 6-8 cents/kWh from Europe at winter peak period.Therefore, on the basis of peak incremental electricity cost, the projectoffers the least-cost means of meeting peaking requirements.

6.10 The rate of return on the investment in the project was estimatedat appraisal to be about 11.2% on the basis of comparison of quantifiableproject costs and benefits following standard Bank approach. Costs wereappropriately shadow priced and the output was valued at prevailingelectricity tariffs as a proxy for the project benefits. In re-assessing the

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economic rate of return, actual project costs were used. Firm energy outputof the stations were valued at the average consumer tariff at winter peakperiod. Secondary energy output was valued at the average consumer tariff atthe summer off-peak period. The consumer average tariffs is a compositeaverage of capacity charge and the rate for energy. The tariffs were used asproxy for the consumers' willingness to pay and hence the benefit derived. Allcosts and benefits were expressed in 1978 prices to enable the application ofthe same factors in converting financial costs to economic terms. Theeconomic rate of return is re-assessed at about 10.2%. The re-assessed ERRunderestimates the project benefits since it does not consider the increase inelectricity production when the restriction on the operation of Mostar iseventually resolved. As at appraisal, the benefits due to improvedagriculture through irrigation, using water drawn from the lake, was not takeninto account.

6.11 The least-cost comparison and the re-assessed economic rate ofreturn, confirm the economic justification of the Project.

7. Proiect Sustainability

7.01 When the leakage of water from the Salakovac reservoir as a resultwas noticed (para 5.03 (i)), appropriate steps were immediately taken inconsultation with the Bank and independent experts to stop the seepage. Thesteps taken included emptying of the reservoir and carrying out extensivegrouting works in the possible areas of leakages, improving the techniques andtechnology for investigations and grouting. As a result,the situation hasstabilized with the water loss level currently estimated at about 30m3/secondduring the dry season. The problem needs to be studied over a long period todetermine what, if any, measures could be undertaken to arrest the continuousloss, for which substantial funds would be needed. More recently, on therecommendations of the Bank, new techniques of investigations are being usedby Neretva, which would enable investigations to be carried out over a widerbed of the reservoir. In order to reap in full the benefits of the project,the seepage has to be controlled, and the Yugoslav authorities would need toshow extreme and continuous vigilance to keep the problem under constantreview. EBH has to continue to be a well-managed and financially strongutility if the project benefits are to be fully sustained. For this, EBHneeds to review its tariffs and its assumption of debt constantly so as tokeep a healthy balance between its revenues and its obligations and togenerate, internally, adequate funds for expansion. Unfortunately, EBH doesnot have a satisfactory record in this respect. For example, at the end of1985, YDinars 3.3 billion of annuities due were not paid. With the presentlow levels of electricity prices, the unfavorable macro-economic conditions,and the inability of major consumers, especially industry, to meet theirelectricity bills on a timely basis, the danger of liabilities outstrippingrevenues is a constant one, needing continuous vigilance. Even though, EBH,like the other power entities, now has the legal authority to set electricityprices, its ability to achieve financial viability and sustain it will dependto a large extent on the macro-economic well-being of the country, and whenthe major consumers would be able to pay prices that meet the cost of serviceto them. In the short-run, this does not appear achievable, but the situation

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is expected to gradually improve over time.

8. Bank Performance

8.01 The project was a partial success. Despite problems arising froma shortage of financial resources for construction, the project could havebeen rated an unqualified success were it not for the Borrower'sunsatisfactory financial performance and the seepage of water from theSalakovac reservoir. During 1979-81, EBH's self-financing level came to anaverage of only 25.8% as against the covenanted 35% and its performance in1982 was even worse. In dealing with this situation, the Bank showedunderstanding and flexibility inasmuch as a new covenant was negotiated andapplied to the project. At appraisal, the Bank identified the right issuesfacing the project and provided appropriate covenants for handling them. Thepossibility of difficulties that might arise from karstic conditions wasforeseen by the Bank and the establishment of an independent panei of expertswas specifically provided to handle such a situation. In the end, the Bank'sfears proved true. The Bank also showed flexibility in allowing the thenunutilized amount of $3.3 million out of the loan ($73 million) for thespecific purpose of works to help reduce the seepage from the Salakovacreservoir and in further extending the loan closing date to June 30, 1989.

8.02 The difficult situation created by the water seepage at theSalakovac reservoir was a unique one that required the advice of an expertgeologist, which led the Bank to engage such an expert to advise the executingagency, on the remedial action to be taken to reduce the leakage. This extraprecaution was taken despite the panel of experts (with an expert geologist asone of its members) being already available to the executing agency foradvice. The Bank found it necessary to provide additional internationalexpert advice, since the panel comprised only local experts.

8.03 The Bank did not succeed in improving financial planning andmanagement, and auditing in the Borrower organization. This is because, since1983, the Yugoslav accounting laws have been under constant revisions. Theinevitable discontinuity of staff over the long project period of well over adecade (from 1977 through 1990) and the relatively low frequency of Banksupervision missions were also contributing factors.

9. Performance of the Borrower and Executing Agency

9.01 EBH. the Borrower. The overall performance of EBH was marred byits unsatisfactory financial performance. Its self-financing level was, onaverage, 25.8% in 1979-81 as against the covenanted minimum of 35% and waseven worse in 1982. For this unsatisfactory performance, EBH was not entirelyto blame because tariff action required the concurrence of other authoritiessuch as the Community of Interest, and later the Federal Government whichstrictly controlled the prices.

9.02 Neretva. the executing agency. The overall performance of Neretvain regard to the execution of the project was very good. There was a delay ofabout a year and a half in the completion of phase I of the Project as

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compared to the tight implementation .chedule planned at appraisal. But thisdelay was due mainly to factors most of which were outside Neretva's control,such as changes in design during project execucion, relocation of adjoininghighway and railroad, additional grouting works, a shortage of cement. badweather etc. All problems were handled as efficiently and as soon as they arose.One serious problem still continues, namely, seepage of water from theSalakovac reservoir as a result of the karstic formations and the enroachmentof the groundwater on nearby structures limiting the full potential operationof Mostar, but these were not entirely unexpected. Immediate measures wereundertaken to try to reduce the leakage and the amount of seepage has beenstabilized at Salakovac. In the handling of all the problems that aroseduring project execution, Neretva showed extreme vigilance and professionaljudgement.

9.03 At appraisal in 1977, commencement of phase II of the Project wasplanned for 1979. This was not done owing to the need for additional studiesof site conditions and a shortage of financial resources, especially foreignexchange. However, phase II was commenced only after the grant of the Banksupplementary Loan in 1983. Neretva completed the project satisfactorily,although with about one year's delay

10. Performance of Consultan,s

10.01 The performance of the Yugoslav firm of Consultants that wasresponsible for the design of the project and the supervision of its executionwas fully satisfactory. It had previous expetrience of similar constructionjobs and fully lived up to the expectations of Neretva, the Borrower and theBank in regard to their design and supervision capabilities.

11. Performance of Contractors

11.01 The main civil works contractors (Yugoslav firms) had initialdifficulties of mobilization because of financial problems. However, theirperformance on the whole was more than satisfactory. Construction techniqueswere changed to solve unexpected problems encountered during construction.Parallel activities, where possible, were undertaken to make up for lost timedue to initial mobilization difficulties, and other unforseen problems. Theconstruction works on the dam and power house were completed in accordancewith final designs. The performance of the other contractors, both local andforeign, who supplied and erected the mechanical and electrical machinery wasalso satisfactory.

12. Proiect Relationship

12.01 Bank relationship with Federal and Republican Governments, theBorrower, EBH, and the implementing agency, Neretva on the project has beengood.

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13. Project Documentation and Data

13.01 Both the loan and project agreements were appropriate forachieving the physical objectives of the project. The loan agreement also wasadequate in providing measures to improve accounting, auditing and corporatefinancial planning. With hindsight, where it was weakest was the LRMC pricingcovenant because its implementation required agreement at the power industrylevel on a national least-cost investment program which has been unattainable.The Appraisal Report of the project provided a useful framework for the Bank,EBH and Neretva for regular review of project implementation. Neretvaprovided contributions (Part II) to the Project Completion Report.Documentation and eata on the project is very adequate and are available inthe Project Files.

14. Lessons to be Learned

14.01 There are a few lessons to be learned from this lending operation:

(a) The project demonstrates the danger and uncertainty posed bykarstic conditions when they occur at a hydro plant site.Thorough site investigations had been conducted before appraisal.Trial holes had been drilled and water flows studied over a longperiod. Groundwater flows were also studied using dye andradioactive traces. Various methods of investigation wereundertaken, and EBH and Neretva were satisfied that the projectcould be undertaken at the site without any adverse and specialrisks. Yet, despite grouting and other measures, substantialseepage occurred and is still continuing, posing a loss of projectbenefits. In such situations, more investigations, using the mostmodern technology and up to date techniques, are required andshould be an on-going activity during the period ofimplementation.

(b) The project also shows the difficulties for a Borrower to fulfillfinancial covenants when the country is faced with serious macroeconomic problems. e.g. Tariffs were raised thrice in 1983 (25%form March 1983, 16% from early December i983 and again 24% fromlate December 1983) and yet EBH failed to achieve the covenantedfinancial performance because of their inadequacy due to the highrate of inflation. A similar situation continued in thesubsequent period as well. Financial difficulties could lead todelays in project implementation and substantial cost over-runs.

(c) The project demonstrates also that in Yugoslavia, it is almostimpossible to attain sector-wide objectives through a self-standing republican project. It also demonstrates thedifficulties in obtaining sector-wide agreement on matters thataffect the investment choices of the republics. These should be

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taken into consideration in the formulation of covenants in thefutura.

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PART II - PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE

1. Bank's Comments on the Borrower's Review

1.01 Neretva, the Executing agency for both phases I and II of theProject, has submitted to the Bank, in two parts in December 1983 and June1990, its review of the Project. The review covers mostly the technical andeconomic aspects of the Project. The review did not cover the environmentaland institutional development aspects, neither did it provide analysis offinancial performance of EBH.

1.02 Neretva, in its review, expressed its appreciation for the co-operation of and the good relations with the Bank throughout the entire periodof project preparation and implementation. However, Neretva drew attention ofthe Bank to the initial long delays on the part of the Bank in processingWithdrawal Applications, especially, prior to the introduction of the SpecialAccount. Neretva suggested also that consideration be given by the Bank, inthe future, to have reporting on projects with three or more yearsconstruction on semi-annual basis instead of the quarterly reporting.

1.03 As comment on Neretva's observations, the main reason for theinitial delays in the processing of withdrawal applications by the Bank wasthat Neretva was not submitting the required documentation in full which oftenrequired resubmission by Neretva. There were also delays in receipt ofapplications in the Bank due to the mailing system used by Neretva. Withregard to the periodic project reporting, Neretva's suggestion may be suitablefor project that are relatively problem free. The geological problemsencountered on the subject project, in fact, shows that more regularsupervision and reporting on progress on implementation is necessary to ensuretimely identification of potential problems as well as their resolution.

1.04 The contributions of Neretva to the PCR are available in ProjectFiles.

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PART III - STATISTICAL INFORMATION

1. Related Bank Loan

Year ofLoan Title Purpose Approval Status Comments

Loan 1469-YU Development 1977 The project The project onlySecond Power of the was completed partly achievedTransmisslon second phase in 1983. its institutlonProject of the 380-kV building

transmission objective. Itnetwork attempted to

encourage theemergence of astrong nationalcoordinatinginstitution ln thepower subsector,which wasdlfficult toachieve in thedecentralizedsystem ofYugoslavia. ThePCR was circulatedto the ExecutiveDirector inJanuary 1985.

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PART III. STATISTICAL INFORMATION, TABLES:

2. Proiect Timetable

2.01 Phase I

Item Date Planned Date Revised Date Actual

Identification March 1973 - September 1973Preparation March 1977 - May 1977Predppraisal June 1977 - July 1977Appraisal September 1977 October 2-26,1977Loan Negotiation3 March 1978 - March 13-22,1977Loan Signature April 1978 - May 31, 1978Loan Effectiveness August 31, 1978 November 15, 1978Loan Closing June 30, 1983 June 30, 1988 June 30, 1989Project Completion June 30, 1982 June 30, 1988 June 30, 1989

2.02 The main issues facing the project at the Issues Paper stage ofphase I and the decisions reached on them were as follows:

(a) One issue was whether the project description and cost shouldinclude only the first two stations at Grabovica and Salakovac, orshould also include the third station at Mostar (phase II of theProject). Since the Bosnians planned to construct the Mostarplant by 1982, it was decided that the project description andcovs should include the Mostar plant (phase II of the Project).The Bank loan would only finance the first two stations (phase I),with disbursement for the third unit at the second station to beconditional on the technical and economic justification of theproject including the third station at Mostar;

(b) A second issue was the amount of the Bank loan. On the basis thatthe turbine contract would be won by foreign suppliers, theforeign cost of the project, and hence the amount of the Bankloan, would be $70 million (the then estimate). This was acceptedby the Decision Committee;

(c) A third issue was whether the new composite organizationresponsible for not only generation and transmission (as the oldcomposite organization was) but also for distribution had assumedthe rights and obligations of the old composite organization andwould meet the financial covenant entered into by the compositeorganization under the Second Transmission Project. It wasdecided that the appraisal mission should review the

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appropriateness of either (a) zontinuing the covenant under theSecond Transmission Project which applied only to generation andtransmission, or (b) changing the covenant to include distributionactivities, in which case the adequacy of the self-financingpercentage of investment would have to be reviewed;

(d) Another issue was whether the project financing plan (as presentedto the Bank) which involved assured financing by negotiationsshould be accepted and how the interest during construction of theBank loan was to be financed. It was decided that the Borrower'sfinancing plan be accepted and that the Borrower be requested toinform the Bank by negotiations of the source of financing of theinterest during construction on the Bank loan; and

(e) Whether the institution building objectives under the Second PowerTransmission Project should be expanded under the proposedproject. It was decided that the objectives under the SecondPower Transmission Project were sufficiently comprehensive topreclude the need for any enhancement thereof under the proposedproject.

2.03 The following two major changes were made at the Loan Committeestage and during negotiations:

(a) The loan amount was raised to $73 million in keeping with theincrease in foreign costs; and

(b) The level of internal cash generation by EBH was raised to 35X ofinvestments including distribution investments

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Phasgn 1II (Mostar)

2.04 Project Timetab]

Item Date Planned Date Actual

Identification March 1973 September 1973Preparation March 1977 May 1977Preappraisal June 1977 July 1977Appraisal September 1977 January 17-28, 1983Loan Negotiations June 13, 1983 May 31 - June 7, 1983Board Approval June 22, 1983 August 2, 1983Loan Signature August 1983 October 5, 1983Loan Effectiveness November 1983 December 30, 1983Loan Closing June 30, 1988 June 30, 1989Project Completion June 30, 1987 June 30, 1989

2.05 There were three major issues facing the project at the IssuesPaper stage:

(a) Loan Amount. One issue was what should be the size of the Bankloan. The proposal was to grant a Bank loan of $65 million tocover the full foreign exchange cost of the project. It wasdecided to grant a loan of $61 million to cover the revisedforeign exchange costs;

(b) Local Financing. The proposal was that as a condition ofnegotiations, the Yugoslavs be asked to provide documentaryevidence in support of the financing plan for the project,including local Bank guarantee of the coverage of any project cost(both local and foreign) not foreseen at that time. The decisionwas to leave the matter to be decided during negotiations; and

(c) Financial Performance. EBH had achieved a self-financing level ofan average of only 25.8% in 1979-81 as against the covenantedminimum of 35%. A lower level of cash generation was expected in1982 as well. The proposal was that the supplemental loan for thesubject project be processed only if agreement could be reachedwith the Yugoslavs on the implementation of tariff increasessufficient to produce, beginning with the year 1984, a net cashgeneration of at least 30% in Bosnia - Herzegovina. The decisionwas to leave the matter to be discussed and agreed upon during thethen on-going negotiations for the Third Power Transmission Loan.

PART III

Cumulative Istinated and Actual DisbursMents

3.01 Part I of Proiect (Loan 1561-0-YU)

Bank FY 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Appraisal Estimate 13.4 44.8 73.0

Actual - 7.4 23.1 34.9 53.2 68.7 69.6 69.8 70.7 71.7 71.7 72.99

Actual as X ofAppraisal Estimate - 16.5 31.6 47.8 72.9 94.1 95.3 95.6 96.8 98.2 98.2

99.9

Date of Last Disbursement: April 20, 1990

Note: An amount of $14,039.17 remaining unutilized was cancelled on October 31, 1989.

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3.02 Part II of Project (Loan 1561-1-YU)

Bank FY 1984 1985 1986 1987 1988 1989 1990

Appraisal Estimate 1.9 17.5 34.9 52.4 61.0

Actual 0.15 13.00 28.27 44.25 55.70 56.09 55.82

Actual as X ofAppraisal Estimate 7.9 74.3 81.0 84.4 91.3 92.0 91.5

Date of Last Disbursement: April 20, 1990.

Note: An amount of S5,177,205, remaining unutilized out of the loan, wascancelled on October 31, 1989.

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4. PROJECT COSTS AND FINANCING

PROJECT COSTS

4.01 Phase I (Grabovica and Salakovac)

Appraisal Estimate Actual

Item Local Foreignvn Total Local Foreign Total

(US $ Millions)

CivilWorks 122.3 9.0 131.31 132.1 12.8 144.9

E & M Equipt 41.8 51.9 93.7 89.9 60.2 150.1

Other 20.2 - 20.2 27.3 - 27.3Base Cost 184.3 60.9 245.2

ContingencyPrice 18.8 12.1 30.9 - --Physical 14.2 0.1 14.3 -

Total 217.3 73.1 2904 ,249.3 73.0 322.3

u Exchange rate as of mid-1978 ($'.00=Din 18.00) used in computing foreigncosts.

Actuals in US dollar terms were about llX higher than the appraisal estimates.However, in dinars the actuals were 98X higher than the estimate. Thedifference is because of the high rate of inflation in the country and thesteep fall in the value of the dinar (average of 102 dinars to US$1.00 in thesecond half of CY 1983 as against 18 dinars to the dollar at appraisal).

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PROJECT COSTS

4.02 Phase II (Mostar)

Appraisal Estimate Actual

Item Local Foreign Total Local Foreign Total

(US $ Millions)

CivilWorks 47.9 21.0 68.9 77.4 15.0 92.4

E & M Equipt - 41.9 41.9 44.7 30.0 74.7

Other U(Design, landpurchase,supervision,etc) 11.0 - 11.0

Base Cost 58.9 62.9 121.8

ContingencyPrice 12.8 11.7 24.5Physical 4.4 3.6 8.0-Sub-Total 76.1 78.2 154.3 122.1 45.0 167.1

Front EndFee & Interest - 0.2 0.2 - 10.8 10.8During Constr. - -

Total 76.1 78.4 154.5 122.1 55.8 177.9

U The other expenditures such as on design, land purchase, supervision etc.have been merged under the heads, Civil Works and E & M Equipment, in theactual figures.

Nte: The actual costs in US dollars ($167.1 million) were about 8.4X morethan the appraisal estimate. However, expressed in dinars, the total costswere 13.6 times the appraisal estimate. This is mainly because of the highinflation in the country and the steep fall in the value of the dinar vis-a-vis the US dollar.

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PROJECT FINANCING

4.03 Phase I (Grabovica and Salakovac)

Planned Revised Actual(Loan 1561-0-YU)Agreement

US$ Million US$ Million US$ Million

World BankExpenditureCateeQries-

Hydro-Mechanicaland ElectricalAssociated Services 73.0 73.0 72.9Total World Bank 73.0 73.0 72.9

Co-FinancingInstitutions

Borrower Contribution 64.6 64.6 65.4Consumer Contribution 16.6 - -Federal Fund 11.1 - -Social ReproductionFunds 17.4 70.0 63.7Privreda Bankaof Sarajevo 36.2 45.0 44.8

Foreign Creditsand Other LocalCommercialBanks 71.3 75.5 _75.5Total 290.2 328.1 322.3

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PROJECT FINANCING

4.04 Phase II (Mostar)

Planned Revised Actual(Loan 1561-0-YU)Agreement

US$ Million US$ Million US$ Million

World BankExpenditureCategories

Hydro-Mechanicaland ElectricalEquipment,ConstructionMaterials andEquipment forCivil Worksand AssociatedServices 58.0 47.92 44.95

Front-EndFee 0.152 0.152 0.152

IDC - 10.72 10.72

Unallocated 2,85 2.21 -Total World Bank 61.00 61.00 55.82

Co-FinancingInstitutions

Borrower Contribution 37.53 10.53 7.26

Consumer Contribution 15.61 55.0 53.37

Federal Fund 8.22 12.0 10.98

Commercial Banks 32.14 _52.0 50.47Total 154.5 190.53 177.9

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Annex A

5. Project results

Economic Impact

Appraisal ActualEstimate (At Final DeveloRment)

EconomicRate of Return 11.2Z 10.2X

The economic rate of return waj calculated by comparing the measurableproject costs and benefits. The underlying assumptions used at time ofappraisal and at project completion are given below.

UnderlyingAssumotions

1. The measurable costs comprised (i) the capital cost of the projectconsisting of the three power stations; (ii) the associate fixed and variableoperation and maintenance cost; (iii) the incremental costs (marginal costs)transmission and distribution to supply the output of the project to the finalconsumer. At appraisal the estimates of these costs were used. Theincremental costs of transmission and distribution were based on proposedexpansion program of EBH for the period 1978-83. Local costs of projectconstruction were converted to border value equivalent by a factor of 0.83.The rest of local costs were converted with a factor of 0.93. Foreign wereassumed to reflect border values. A construction period of five years wasassumed. All costs were expressed in 1978 prices. At project completion,actual costs have been used and an expenditure stream of thirteen years (1978-91), but also expressed in 1978 prices to enable the same conversion factorsto be used to convert local costs into border values.

2. The measurable benefits comprised (i) revenue from sale of output of theproject and (ii) consumer contributions to the investment in the project.At appraisal, the expected output of the project by season and time of day wasapplied to the tariff structure as a reflection of the consumers willingnessto pay. Consumer contributions were based on estimates at appraisal. Atcompletion, the revenue benefits were based on firm and secondary outputs ofthe project valued at the average final consumer tariffs at winter peak periodand the summer off-peak period, respectively. The firm energy output of theproject was estimated from simulation studies by Neretva to be about 65% ofthe average annual energy capability of the project. Consumer contributionswere based on the actual collections.

3. Details of computations are available in the Project Files.

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6. Status of Covenants

Deadline for Extent ofSection Subiect Compliance Compliance

Loans 1561-0-YUand 1561-1-YU

Section 3.02 EBH to submit itsof LA proposed program for

training and manpowerdevelopment to the Bankfor review and comment Dec. 31, 1978 Compliedbefore implementation. with.

Section 3.04 EBH to supply statisticalof LA and monitoring information

annually in the project Annually Compliedprogress reports. with.

Section 3.05 EBH to set specialof LA electricity supply

agreements for newconsumers so that thecharges will adequatelyreflect the estimatedcosts of supply and providefor their adjustment in the Dec. 31, 1987 Not compliedevent of cost increases. with.

Section 5.02 EBH to arrange for SAS toof LA undertake a pilot audit of

Neretva work organizationin 1978 and a full audit inthe following year by thespecial audit group of theSAS and thereafter extension The periodof these audits to other of fourpower sector organizations months wasand to submit audited neverconsolidated accounts observed.to the Bank within six Even aftermonths of the end of the the periodyear for 1977 and 1978 and waswithin four months of the extended,end of each year from 1979. there were(The period of four months minorwas later extended to nine infractions.months.)

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EBH to have the SpecialAccount for each fiscal Compliedyear certified by SAS. with.

Section 5.04(b) EBH to increase the cash Consistentlyand generation to 35% of failed toSection 5.06 investment including reach theof LA distribution and to exchange covenanted

views with the Bank before 35% cashmaking any modification to generationthe investment program in duringexcess of 1 billion dinars. 1979-83.(Beginning with 1984, the Even aftercash generation covenant was the Covenantchanged to one requiring was changed,adjustment of electricity EBH failedtariffs to economic costs.) failed to

comply.Section 5.08 EBH to furnish, on theirof LA completion, the results of

the study of the internalfinancial relationshipbetween the variousgeneration, transmission and Complieddistribution organizations. with.

Section 2.02(b) Neretva to establish a panelof PA of experts,independent of the

designers of the project, tofamiliarize themselves withthe design and advise in theevent of any unforeseenproblems arising during Compliedconstruction. with.

Section 3.03(d) Neretva to arrange periodicof PA inspections of the project

hydro works, including thedam in accordance withappropriate engineering CompliedPractice. with.

The following were conditions of effectiveness:

Section 7.01of LA (a) completion of the technical

designs and estimates forMostar;

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(b) establishment of the panelof independent expertswhose members and termsand conditions should beacceptable to the Bank;

(c) submission to the Bank,Privredna Bank's guaranteeto provide the balance offunds needed by Neretva forphase I of the Project,including cost over-runsand interest duringconstruction; and

(d) confirmation that All thePrivredna Bank guarantees conditionsto provide such funds as wereEBH is unable to secure compliedand are needed by Neretva with beforefor phase II of the the loanProject (relevant was declaredagreements to be completed effectiveby June 30, 1979). on November

15, 1978.

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ATTACHMENT

Increase in Electricity Rates in Bosina - Hercegovina

1. The cash generation covenant under The Second Power TransmissionProject (Loan 1469-YU) was replaced by the LRMC covenant in October 1983 underthe Third Power Transmission Project (Loan 2338-YU). The LMRC was neverestimated and the covenant has been observed in default by the power entitiesin the country due to lack of agreement on a national least cost investmentprogram which would have served as basis of LRMC estimation. Mainly toimprove financial position of the power entities, price increases continued tobe made. However, as inflation began to accelerate, the price increases beganto lag behind the inflation. Between 1983 and 1985, electricity prices wereincreased by a total of 130% compared to the rise in the wholesale price indexof industrial products of about 266%. In March 1986, the Common Elements (CE)basis of setting electricity prices was introduced. The CE sets target pricesbased on historical financial costs of electricity supply and some elements ofelectricity prices in international exchanges. The calculated target pricefor EBH was Din 2.07/kWh (US cents 9/kWh). Periodic adjustments inelectricity prices continued but were always behind inflation which had risento unprecedented levels. As of January 1989, the average electricity pricewas only 41% of the CE target. In 1989, a total increase of about 3,200% wasmade in electricity prices compared to the rise in the wholesale index priceof industrial products of about 2,700% ii. the same period. In September 1989,a yet another basis of electricity pricing-the so-called Common Criteria (CC)-was introduced. The CC defines a price ceiling based on the average ofelectricity prices in 5 Western european countries and prices in internationalelectricity exchanges. Currently, the ceiling price is about Din 2.33/kWh (UScents 10/kWh)*. The current average price of EBH is Din 1.606/kWh (US cents7/kWh), which is about 70% of the CC ceiling price.

2. The adjustments in electricity prices since October 1983 throughApril 1991 are given below. All increases apply to winter and summer prices.EBH continues to face serious financial difficulties mainly because some themajor electricity customers, especially industry, are unable to meet theirelectricity bills. The fundamental problem is linked with the weakness of theeconomy.

1983

(i) 16% increase in November;(ii) 50 para/kWh increase in all kilowatt-hour rates (equivalent to

about a 25% increase in the average revenue per kilowatt-hour);

*Exchange rate: 1US$ - 23Din

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ATTACHHENT

liA

(i) differential increases in various RAPs averaging about 30%(ranging from 31.8% to 28.8%) effective October 1, 1984;

(ii) 33.5% in December;

19 35

(i) 20% in July;

1986

(i) differential increase in various RAPs averaging 16% in February;(ii) 17% in April;(iii) differential increase in various RAPs averaging 39.1%;(iv) 26% in November;

1987

(i) 12% in January;(ii) 16.9% in April.(iii) 39.6% in August(iv) 69.4% in November

(i) 31.4% in June(ii) 39.95% in August(iii) 29.3% in November

1989

Mi) 48% in February(ii) 79% in April(iii) 58.9% in May(iv) 54.9% in July(v) 49% in August(vi) 69% in October(vii) 100.2% in December.

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ATTACHMENT

1990

(i) 27.5% in April(ii) 24% in August(iii) 8% in December.

(i) 25.9% in February(ii) 28.7% in April.

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PART IIX

7. MigJions

Stage of Month No. of Days in Project Type ofProiect Cycle Year Persons Field SDecializatl2n' Performann_ Pr2blems 2

Identifcation May 1977 2 10 PEGR (2)

Appraisal Oct 1977 3 23 PEGR, FNA,MAA (part-time)

Appraisal Jan 1983 2 12 PEGR,FNA(Stage II)

supervision

I Apr 1979 2 2 PEGR, FNA 1 0

II Nov 1979 1 1 PEGR 2 NA

III May 1980 1 3 PEGR 1 NA

IV Dec 1980 1 11 PEGR 2 T

V Jun - Jul1982 3 6 PEGR, FNA (2) 1 T

J./PEGR - Power Engineer; FNA - Financial Analyst; ECN - Economist; MAA -Management; ES - Environmental Specialist; GLG - Geologist, PREGR -Procurement Engineer.

2/T - Technical, F - Financial; 0 - Other