Document of The World Bank FOR OFFICIAL USE ONLY Report No: 74709-TR PROJECT PAPER ON A PROPOSED RESTRUCTURING AND ADDITIONAL LOAN IN THE AMOUNT OF US$400 MILLION TO BORU HATLARI ILE PETROL TAŞIMA A.Ş. WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR THE GAS SECTOR DEVELOPMENT PROJECT JUNE 12, 2014 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. TURKEY - GOVERNMENT FISCAL YEAR January 1 – December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of April 30, 2014) Currency Unit: Turkish Lira US$1.00 = TL2.10 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AF Additional Financing bcm billion cubic meters BOTAŞ Petroleum Pipeline Corporation of Turkey BP Best Practice CPS Country Partnership Strategy DPL Development Policy Loan DSI State Hydraulic Works EC European Commission EIA Environmental Impact Assessment EIB European Investment Bank EMP Environmental Management Plan EMRA Energy Market Regulatory Authority ERR Economic Rate of Return ESES Environmental Sustainability and Energy Sector EU European Union EÜAŞ Electricity Generation Corporation of Turkey IBRD International Bank for Reconstruction and Development IDA International Development Association IFRS International Financial Reporting Standards INT World Bank Group’s Institutional Integrity Vice Presidency IPA Instrument for Pre-Accession Assistance ISE Istanbul Stock Exchange LAP Land Acquisition Plan LAPF Land Acquisition Policy Framework LNG Liquefied Natural Gas M&A Monitoring and Evaluation MENR Ministry of Energy and Natural Resources MoD Ministry of Development MEU Ministry for EU Affairs OECD Organisation for Economic Co-operation and Development OP Operational Policy PAP Project Affected Person SOE State-Owned Enterprise TEIAŞ Turkish Electricity Transmission Corporation TL Turkish Lira TPAO Turkish Petroleum Corporation TPIC Turkish Petroleum International Company Tuz Golu tuz golu = salt lake in English Vice President: Laura Tuck Country Director: Martin Raiser Sector Director: Laszlo Lovei Sector Manager: Ranjit Lamech Task Team Leader: Kari Nyman Co-Task Team Leader: Yesim Akcollu REPUBLIC OF TURKEY GAS SECTOR DEVELOPMENT PROJECT ADDITIONAL FINANCING TABLE OF CONTENTS Project Paper Data Sheet ............................................................................................................................. ii  I. Introduction ............................................................................................................................................ 1  II. Background and Rationale for Additional Financing in the amount of US$400 million ..................... 1  III. Proposed Changes ................................................................................................................................ 5  IV. Appraisal Summary ............................................................................................................................. 6  Annex 1: Results Framework and Monitoring......................................................................................... 13  Annex 2: Operational Risk Assessment Framework (ORAF) .................................................................. 17  Annex 3: Economic Assessment of Tuz Golu Gas Storage Facility ....................................................... 20  The Gas Sector Development Project Additional Financing was prepared by an IBRD team consisting of Yesim Akcollu, Esra Arikan, Seda Aroymak, John Balafoutis, John Butler, Zeynep Darendeliler, Joseph Formoso, Salih Kalyoncu, Selma Karaman, Audrey Maignan, Jasna Mestnik, Regina Nesiama, Shinya Nishimura, Kari Nyman, Yasemin Orucu, Alessandro Palmieri, Margaret Png, and Selcuk Ruscuklu. Peer reviewers were Mohinder Gulati (SEG), Sameer Shukla (ESMAP), and Maria Vagliasindi (SEGEN). REPUBLIC OF TURKEY GAS SECTOR DEVELOPMENT PROJECT ADDITIONAL FINANCING Project Paper Data Sheet Basic Information - Additional Financing (AF) Country Director: Martin Raiser Sectors: Oil and Gas Sector Manager/Director: Themes: Ranjit Lamech/Laszlo Lovei Environmental category: A Team Leader/Co-Team Leader: Expected Closing Date: 12/31/2020 Kari Nyman/Yesim Akcollu Joint IFC: no Project ID: P133565 Joint Level: n/a Expected Effectiveness Date: 9/30/14 Lending Instrument: IPF Additional Financing Type: Cost overrun and project restructuring Basic Information - Original Project Project ID: P093765 Environmental category: A Project Name: Gas Sector Development Expected Closing Date: 9/30/2014 Project Lending Instrument: SIL Joint IFC: no AF Project Financing Data [ X] Loan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other: Proposed terms: IBRD Flexible Loan, variable spread, 16-year repayment period with a 8-year grace period, repayments linked to commitments, level repayment of principal, front-end fee financed from the loan proceeds, with all conversion options. AF Financing Plan (US$m) Source Total Amount (US $m) Total Project Cost: 589.1 Cofinancing: - Borrower: 189.1 Total Bank Financing: IBRD 400.0 Client Information Recipient: Boru Hatlari Ile Petrol Taşima A.Ş. (BOTAŞ) Responsible Agency: BOTAŞ Bilkent Plaza A - II Blok, Bilkent 06800 ANKARA TURKEY Contact Person: Mehmet Gazi Dulger Telephone No.: (90-312) 297-2018 Email: mgazi.dulger@BOTAŞ.gov.tr AF Estimated Disbursements (Bank FY/US$m) FY FY15 FY16 FY17 FY18 FY19 FY20 Annual 140 60 60 60 60 20 Cumulative 140 200 260 320 380 400 i Project Development Objective and Description Original project development objective: The objective of the Project is to increase the reliability and stability of gas supply in Turkey by implementing critically needed gas storage and network infrastructure; and support BOTAŞ in strengthening its operations as a financially stable and commercially managed corporation. Project description: The Project consists of two components: (a) gas storage facility; and (b) network expansion. The proposed additional loan would finance US$400 million of the cost overrun in the Tuz Golu gas storage facility. Expected results have been modified accordingly. Safeguard and Exception to Policies Safeguard policies triggered: Environmental Assessment (OP/BP 4.01) [X]Yes [ ] No Natural Habitats (OP/BP 4.04) [X]Yes [ ] No Forests (OP/BP 4.36) [ ]Yes [X] No Pest Management (OP 4.09) [ ]Yes [X] No Physical Cultural Resources (OP/BP 4.11) [ ]Yes [X] No Indigenous Peoples (OP/BP 4.10) [ ]Yes [X] No Involuntary Resettlement (OP/BP 4.12) [X]Yes [ ] No Safety of Dams (OP/BP 4.37) [X]Yes [ ] No Projects on International Waterways (OP/BP 7.50) [ ]Yes [X] No Projects in Disputed Areas (OP/BP 7.60) [ ]Yes [X] No Is approval of any policy waiver sought from the Board (or MD if [ ]Yes [X] No RETF operation is RVP approved)? Has this been endorsed by Bank Management? (Only applies to [ ]Yes [ ] No Board approved operations) Does the project require any exception to Bank policy? [ ]Yes [X] No Has this been approved by Bank Management? [ ]Yes [ ] No Conditions and Legal Covenants: Financing Agreement Description of Condition/Covenant Date Due Reference Loan Agreement Schedule BOTAŞ will maintain a debt service coverage Annual obligation. 2, Section V.A.1. ratio of not less than 1.2. Loan Agreement Schedule BOTAŞ will, submit to EMRA a proposal for Not later than May 31, 2, Section I. A.2. the regulation of: (a) approach for setting 2015. tariffs for the storage business, including an acceptable rate of return on the regulated asset base; and (b) determination of the regulated asset base for transmission and storage on a depreciated replacement cost basis which adequately compensates for domestic and international inflation. ii I. Introduction 1. This Project Paper seeks the approval of the Executive Directors to provide an additional loan to Boru Hatlari Ile Petrol Taşima A.Ş. (BOTAŞ) in the amount of US$400 million for the Gas Sector Development Project [P093765; 73420-TU]. 2. The proposed additional loan would finance US$400 million of the cost overrun in the Tuz Golu gas storage facility. A sequence of procurement setbacks, corruption investigations and the debarment of the lowest evaluated bidder for both of the two project components on account of a procurement case in another country caused a five-year delay to the start of the Tuz Golu construction. Commodity prices associated with the project (especially important are the prices of steel, aluminum and copper) increased substantially during the five-year period. A number of other factors also contributed to cost overrun, including: (a) geological risks allocation was changed from BOTAŞ to the contractor; and (b) a 42 km high-voltage transmission line for water pumps and the cost of operating phase 1 while phase 2 is under construction were added to the scope of the contract. 3. The investment cost of the gas storage facility has doubled since 2005 but so have the benefits to be derived from using the storage and the project remains economically attractive. The project will improve Turkey’s energy security, improve its ability to cover natural gas demand peaks during the coldest days, lower the cost of gas imports by providing seasonal storage, lower network investments costs and improve operational flexibility. Natural gas accounts for almost one-third of Turkey’s primary energy supply and fuels almost 50 percent of electricity generation. Current storage capacity is low at 2.6 billion cubic meters (bcm), about 5 percent of Turkey’s annual gas consumption and slow (primarily seasonal storage with only a low daily withdrawal rate). The project will increase storage capacity to 3.6 bcm, still low at about 7 percent - other large European gas importing countries have storage capacities accounting for 20-30 percent of their annual consumption - and will introduce to Turkey its first fast storage (storage with high daily withdrawal capacity). II. Background and Rationale for Additional Financing in the amount of US$400 million 4. BOTAŞ was established on August 15, 1974 by the Turkish Petroleum Corporation (TPAO) under Decree No. 7/7871, for the purpose of transporting Iraqi crude oil to the Ceyhan (Yumurtalık) Marine Terminal, in accordance with the Iraq-Turkey Crude Oil Pipeline Agreement signed on August 27, 1973 between the Governments of the Republic of Turkey and the Republic of Iraq. Because of Turkey’s increasing need for diversified energy sources, in 1987 BOTAŞ expanded its original purpose of transporting crude oil through pipelines to cover natural gas transportation and trade activities, thereby becoming a trading company. BOTAŞ’ monopoly rights on natural gas import, distribution, sales and pricing which was granted by the Decree of Natural Gas Utilization No. 397 dated February 9, 1990, were abolished by the Natural Gas Market Law No. 4646 of April 18, 2001. 5. The Gas Sector Development Project was approved in November 2005. The original IBRD loan amount was US$325 million. The loan became effective in March 2006. The original closing date was December 31, 2012. A one-year extension to December 31, 2013 was granted 1 in December 2012 to continue Bank support for project implementation through exhaustion of loan proceeds. The loan was fully disbursed in July 2013. A six-month extension of the closing date to June 30, 2014 and a further three-month extension to September 30, 2014 were, nevertheless, granted in December 2013 and May 2014, respectively, to respond to delays in the finalization of the proposed Additional Financing. BOTAŞ started making repayments in April 2013. 6. The objective of the Project is to increase the reliability and stability of gas supply in Turkey by implementing critically needed gas storage and network infrastructure; and support BOTAŞ in strengthening its operations as a financially stable and commercially managed corporation. The Project consists of two components:  Underground Gas Storage: The establishment of a gas storage facility in an underground salt formation located close to Tuz Golu through the provision of financing for: (a) surface and subsurface facilities including engineering and construction, solution mining, the gas pipelines and the compressor facility; (b) water and brine discharge pipelines; (c) cushion gas; and (d) consultants’ services to assist in the supervision and monitoring of the implementation, environmental monitoring and regulatory aspects of the Project; and  Gas Network Infrastructure: The construction of two compressor stations in Erzincan and Corum and other network infrastructure to assist in transmitting the increasing volumes of gas expected to be imported into the Republic of Turkey from existing and new sources. Tuz Golu Implementation Delays 7. Implementation experienced major difficulties and delays in 2007-2011. Although there have been no material changes in the project’s scope and development objectives, the expected results (as reflected in the indicators) have been revised to reflect the five-year delay. 8. The Tuz Golu underground gas storage facility constitutes the largest component of the project, accounting for about 85 percent of the cost, excluding cushion gas for the initial charging of the storage1. Following a series of setbacks, the facility’s construction started in early 2012 and has since then been progressing in a satisfactory manner and on schedule. The contracted completion dates are May 2016 (phase 1) and February 2020 (phase 2), five years after the original target dates. The Corum and the Erzincan compressor stations have been completed. 9. A sequence of events and setbacks caused the multi-year delay to the start of the Tuz Golu construction, including:  Contractor pre-qualification had to be done twice in 2007/2008 and 2008/2009. The original procurement plan contained a separate package for the supply and installation of the water supply and brine discharge systems. This package was bid out and failed twice. 1 Cushion gas remains in the storage as long as the storage facility is in operation and may or may not be recoverable at the end. For regulatory and accounting purposes, cushion gas is treated as a capital asset. 2 Instead of a third attempt, the systems were added to the scope of the main Tuz Golu contract, and as a result, its original prequalification which had been launched in August 2007 had to be repeated. It was restarted in August 2008 and completed with the Bank’s no-objection of the list of prequalified bidders in June 2009;  The bidding process required much more time than had been anticipated as the prequalified bidders had a number of questions and required numerous clarifications. As a result, seven addenda were issued and the bid submission deadline had to be extended twice, finally to September 2010. Despite the protracted delay, the bidding process was carried out professionally by BOTAŞ and its owner’s engineer as evidenced in the lack of complaints; and  The bid evaluation required much more time than anticipated (including due to global suspension of one of the bidders during bid evaluation as discussed below) requiring that BOTAŞ request bidders to extend the validity of their bids three times, finally to May 2011. All bidders agreed and finally the lowest evaluated responsive bidder could be determined and contract awarded (following World Bank review and no-objection) to the China Tianchen Engineering Corporation. 10. It must be emphasized that the US$605 million Tuz Golu contract is a very complex and very high value contract (representing one of the largest procurement contracts in World Bank history and the first-ever contract of its kind). It would be appropriate to attribute a considerable part of the delay to an overly-optimistic original processing implementation schedule. 11. Various procurement investigations at BOTAŞ by Turkish authorities also contributed to the significantly delayed Tuz Golu procurement process. The Tuz Golu contract itself was not a subject of complaints. Authorities investigated the procurement for the supply and installation of the water supply and brine discharge systems (later procured as part of the main contract as discussed above) and the two consulting services contracts under the project. Authorities made no final judgments on the two consulting services engagements. The Bank concluded that since no judgments had been rendered, the Bank had no objection to BOTAŞ’ award of the contracts in question. 12. An investigation by the World Bank Group’s Institutional Integrity Vice Presidency of a procurement case in another country led to a global suspension of contract awards to a Turkish firm which was a member of a joint venture that had participated in the procurement of both the Erzincan compressor station and the Tuz Golu Storage Facility. Though the joint venture was the lowest evaluated bidder in both procurements, it had to be eliminated. The firm was eventually debarred in 2011 and will remain in this status until September 2014. 13. The resulting delays in the main procurement processes under the project were reflected in project development and implementation progress ratings which were downgraded to unsatisfactory in 2008. Both ratings remained in this status until mid-2011 when the procurement challenges had been resolved and the main construction contract was awarded at which point the ratings were upgraded to moderately satisfactory (MS). Although construction of the Tuz Golu gas storage facility has progressed in a satisfactory manner since 2012, the MS ratings were retained through 2012 due to non-compliance with financial covenants. Preliminary information 3 for 2013 indicates that BOTAŞ complied with the financial covenants. The project is furthermore in compliance with agreed financial management arrangements. There is, however, a persistent issue of qualified entity audits that is expected to be resolved from 2015 when Turkish Financial Reporting Standards will become compliant with the International Financial Reporting Standards (IFRS) in accordance with the new Commercial Code and the supporting Council of Minister`s decision. Cost Overrun and Financing 14. The total baseline cost of the project (excluding cushion gas) has doubled, from US$373.6 million (appraisal estimate) to US$750.4 million (latest available estimate) and the cost of cushion gas has increased even more, from US$80 million (appraisal estimate) to about US$200 million (latest estimate by BOTAŞ). The total baseline cost of the project has therefore increased from about US$453.6 million to US$950.4 million. 15. The baseline cost of the Tuz Golu gas storage facility has increased from US$272.6 million (2005 cost estimate) to about US$605.0 million (2011 contract award). A number of factors have contributed to this increase, including: (a) commodity prices associated with the project have increased substantially, (especially important are the prices of steel, aluminum and copper); (b) geological risks allocation was changed from BOTAŞ to the contractor; and (c) a 42 km high-voltage transmission line for water pumps and the cost of operating phase 1 while phase 2 is under construction were added to the scope of the contract. The cost estimate was reviewed and revised several times during the procurement process to reflect these changes, including most notably to US$501.9 million at the pre-qualification stage in 2008 and US$692.2 million during bid evaluation in 2011. The winning bidder was significantly below the consultant’s updated estimate (and an even lower price bid was submitted by the joint venture that had to be eliminated as discussed above). 16. The original and currently projected costs and financing plans for the project are presented in Table 1 and Table 2, respectively. Table 1: Project Costs (US$ million) Original a/ Latest b/ Increase (%) Tuz Golu storage facility 272.6 605.0 121 Gas Network Expansion 88.5 127.4 44 Cushion Gas 80.0 200.0 150 Consulting Services 12.5 18.0 44 Total Baseline Cost 453.6 950.4 109 Contingencies 68.1 141.9 108 Total Project Cost 521.7 1,092.3 109 IDC and Fees 16.4 34.9 112 Total Financing Required 538 .1 1,127.2 109 a/ 2005 Project Appraisal Report, Annex 5 b/ BOTAŞ, 2014 4 Table 2: Project Cost and Financing (US$ million) Project Cost Financing Original a/ Latest b/ Additional Financing b/ BOTAŞ 213.1 577.2 189.1 World Bank 325.0 550.0 400.0 Total 538.1 1,127.2 589.1 a/ 2005 Project Appraisal Report, Annex 5 b/ BOTAŞ, 2014 17. Various options for funding the US$589.1 million cost increase were considered. The final choice is a US$400 million loan as additional financing from the Bank to help finance the project with the exception of the cushion gas which would be financed by BOTAŞ. Payments made by BOTAŞ for eligible expenditures prior to the signing of the Loan Agreement but on or after August 1, 2013, can be financed retroactively from the loan proceeds up to an amount of US$80 million (20 percent of the total loan amount). III. Proposed Changes 18. The proposed additional loan would finance US$400 million of the cost overrun in the Tuz Golu gas storage facility. The proposed project restructuring comprises the following changes:  The Project’s results framework will be modified, as detailed in Annex 1;  The financing of cushion gas and the associated covenant on the submission of information about the cost of cushion gas will be removed from the loan agreement, and related loan proceeds reallocated to the goods category;  The Self-financing covenant will be removed;  The due date for the submission of tariff filing by BOTAŞ for the Tuz Golu gas storage will be changed from January 31, 2009 to May 31, 2015 in view of the implementation delay in the Tuz Golu gas storage component;  The policy for Natural Habitats (OP/BP 4.04) will be triggered because the Tuz Golu salt lake, the final discharge location of the brine solution, is a “Specially Protected Environmental Area”; and  An addendum to the original 2005 Environmental Impact Assessment, a revised Land Acquisition Plan (LAP), and an Operations and Maintenance Manual for the Hirfanli Dam were prepared for the additional loan and will apply to the project. 5 19. The legal agreement applicable to the original loan will be revised to reflect the above changes. There are no other changes to the institutional, financial management, procurement and disbursement arrangements agreed under the original loan. IV. Appraisal Summary Project Justification 20. The project will improve Turkey’s energy security and its ability to cover demand peaks during the coldest days, lower the cost of gas imports by providing seasonal storage, lower network investments costs and improve operational flexibility. Natural gas accounts for almost one-third of Turkey’s primary energy supply and fuels almost 50 percent of electricity generation. Current storage capacity is low (2.6 bcm, about 5 percent of Turkey’s annual gas consumption) and slow (primarily seasonal storage with only a low daily withdrawal rate). The project will substantially increase storage capacity (to 3.6 bcm, still low at about 7 percent2) and will introduce to Turkey its first fast storage (storage with high daily withdrawal capacity). While, the investment cost of the gas storage facility and the cost of cushion gas have risen considerably since 2005, so too has the value of the benefits to be derived from using the storage. The currently projected economic rate of return (ERR) is about 15 percent. Details are provided in Annex 3. An ERR of 17 percent was projected in the original 2005 economic assessment, with slightly more optimistic assumptions. Compliance with Covenants 21. BOTAŞ was not able to achieve the agreed financial targets in 2011 and 2012. The Government approved a cost-based pricing mechanism for electricity and gas in March 2008. The mechanism provides for quarterly adjustments by the Energy Market Regulatory Authority (EMRA) in the price of electricity and for quarterly (even monthly if needed) adjustments by BOTAŞ in the wholesale price of gas charged by BOTAŞ. EMRA and BOTAŞ make the formal notifications about electricity and gas price adjustments, respectively. EMRA has consistently applied the electricity pricing mechanism since 2008. However, full and timely pass-through of BOTAŞ’ gas import costs was not applied in 2011 and 2012, resulting in BOTAŞ making losses in both years. Increases in April and October 2012 raised BOTAŞ gas price by over 30 percent. Although due to their timing, the increases were not sufficient for BOTAŞ to meet the financial covenants for 2012, preliminary information for 2013 indicates that BOTAŞ complied with the financial covenants in 2013. Financial Analysis 22. Key financial indicators for 2011-12 (actual), 2013 (preliminary) and 2014-2018 (projections) are provided in Table 3. Two significant gas price adjustments were effected in April and October 2012, respectively. While too late to help BOTAŞ return to compliance with financial covenants for 2012, based on preliminary information and projections BOTAŞ exceeded in 2013 and is projected to continue to exceed the debt-service coverage ratio, notwithstanding the recent depreciation of the Turkish Lira (TL) which increase the TL cost of 2 Other large European gas importing countries have storage capacities accounting for 20-30 percent of their annual consumption. 6 gas imports. Price reductions in some of BOTAŞ’ gas import contracts and gas deliveries paid earlier under take-or-pay contracts help reduce the average foreign currency cost of gas purchases. The transfer of the Turkish Petroleum International Company (TPIC), a subsidiary of TPAO, to BOTAŞ in 2013 helps BOTAŞ generate additional revenue and income. Table 3: BOTAŞ Key Financial Indicators Financial Summary * 2012 2013 2014 2015 2016 2017 2018 Net Income (TL billion) -0.6 1.2 0.9 0.9 0.9 0.2 0.2 Annual Investments (TL billion) 0.4 0.4 0.5 0.6 0.3 0.6 0.3 Gross Profit Margin (TL billion, %) -3.6 7.3 5.8 5.2 4.6 1.2 0.8 Return on Assets (%) -10.5 16.5 10.0 8.3 7.2 1.8 1.2 Return on Equity -0.6 1.2 0.9 0.9 0.9 0.2 0.2 Financial Covenants Debt Service Ratio (>1.2) -9.1 13.3 8.6 8.1 7.8 1.9 1.3 * Audited information for 2012, preliminary for 2013, BOTAŞ projections for 2014-18 23. BOTAŞ transmission tariffs are regulated by EMRA under a well-functioning regulatory framework. Gas storage services will also be fully regulated by EMRA. EMRA has completed consultations on its new gas storage tariff methodology and expects to issue it by mid-2014. The application of the new methodology is expected to provide a reasonable financial rate of return for the Tuz Golu project. Tariffs for Tuz Golu will be established by EMRA before the completion of the phase 1. BOTAŞ will initiate the process with a tariff filing in accordance with EMRA’s forthcoming tariff regulation not later than May 31, 20153. Financial Management 24. BOTAŞ has established and maintained satisfactory financial management (FM) arrangements for the project. The audited project financial statements were received on time and the auditors have issued a clean opinion on these financial statements. The entity financial statements, however, were delayed and received in October 2013. As in previous years, the auditors issued a qualified audit opinion on BOTAŞ entity financial statements. These qualifications are mainly due to differences between the current Turkish Accounting Standards applied by BOTAŞ and International Financial Reporting Standards (IFRS) according to which the audited financial statements were prepared. BOTAŞ is currently strengthening its capacity in the application of IFRS as IFRS compliant Turkish Financial Reporting Standards (TFRS) will be mandatory for BOTAŞ beginning January 1, 2015 in accordance with the new Commercial Code and the supporting Council of Minister`s decision. 3 The original loan included a covenant for BOTAŞ to make this submission not later than January 31, 2009. The date is being moved to May 31, 2015 in line with the delay in the implementation of the Tuz Golu gas storage component. Phase 1 of Tuz Golu is contracted to be completed by May 2016. 7 Environmental Aspects 25. The project has a Category A environmental rating and, accordingly, an environmental impact assessment (EIA) including as an annex an Environmental Management Plan (EMP) was prepared and disclosed in 2005. Since then, there have been some changes in the size and design of the Tuz Golu storage caverns. The Ministry of Environment and Urbanization has informed BOTAŞ that the original EIA does not need to be modified or updated because of these changes as the gas storage capacity remains unchanged. Further, the original EIA did not fully cover the access roads and electricity transmission line required for the construction and operation of the project. While the Bank agrees with the Ministry’s assessment about the design changes being minor, it was agreed that BOTAŞ would nevertheless prepare and submit for Bank review, an addendum to the EIA including a revised EMP addressing the design changes, impact and mitigation measures related to access roads, and electricity transmission lines. The final version was disclosed by BOTAŞ on March 30, 2013 and in the InfoShop on April 25, 2013. Implementation will be monitored by expert consultants engaged by BOTAŞ under the project as well as by the Bank. 26. The EIA Addendum concludes that the revisions/updates to the project will not result in significant additional environmental impacts. The major impact from the change in the design will be the increase in the use of fresh water for leaching the salt caverns and the corresponding increase in the amount of the brine solution discharged to the Tuz Golu salt lake. 27. The Tuz Golu salt lake is a designated Special Environmental Protected Area by the Turkish Ministry of Environment and Urbanization. The project’s possible impacts on the protected area was assessed as part of OP/BP4.01 Environmental Assessment, and given the conclusion that there were no significant impacts on Tuz Golu, OP/BP4.04 Natural Habitats was not triggered during preparation of the original project. During the preparation of the AF, the final designation status of the Tuz Golu salt lake, update on habitat properties of the lake and the impact of additional brine discharge featured prominently in the dialogue with BOTAŞ, and OP/BP4.04 was triggered to emphasize the importance of the habitat. The detailed assessment was again integrated into the EIA Addendum. 28. The EIA and its addendum make it clear that the project is not creating any negative impact on the Tuz Golu salt lake. The brine solution has the same characteristics as the natural inflows to the Lake and the total amount of brine solution discharged is not significantly affecting the amount of water in the salt lake. The ongoing environmental monitoring program, which is conducted by BOTAŞ with the support of their environmental monitoring consultant, covers the impacts on Tuz Golu Salt Lake. 29. The Addendum confirms that the increased use of freshwater from the Hirfanli reservoir will not impact negatively on downstream users. Subsequently, the revised permit for increased amount of fresh water was granted to BOTAŞ by the State Hydraulic Works (DSI). Environmental impacts of electricity transmission lines and access roads are expected to be limited since the routes are not close to any sensitive/protected areas. The possible cumulative impacts (impacts of other planned/existing projects when considered together with the proposed project) are also discussed in the Addendum and the assessment indicates that significant cumulative adverse impacts in the area are not expected. 8 Social Aspects 30. The overall social impact of the project will be positive since the gas storage at Tuz Golu will substantially increase the availability of natural gas during the winter heating season and reduce the possibility of interruptions in gas and electricity supply as discussed above under project justification. However, there are unavoidable local social impacts due to the need for land acquisition by BOTAŞ for project facilities. The World Bank’s Resettlement Policy (OP 4.12) was triggered for this project. In 2005, two documents were produced and disclosed, a Land Acquisition Plan (LAP), the equivalent of a Resettlement Action Plan, for Tuz Golu project area and a Land Acquisition Policy Framework (LAPF), the equivalent of a Resettlement Policy Framework, to provide guidance for producing subsequent LAPs if land was to be acquired elsewhere. 31. The land acquisition for the natural gas, water and brine pipelines for the Tuz Golu project was completed in 2007 and 2008, and constitutes a total of 389 hectares of long term easements. Permanent land acquisition for the pump stations, water storage tanks and the Tuz Golu Surface Facility were completed in September 2012, with a total area of 40 hectares. Lastly, the location for Well 8 (less than 1 hectares) was completed in November 2012. The completed land acquisition affected land only, did not affect any structures, and did not physically displace any persons. In the upcoming months, land will be acquired for the remaining wells and the security perimeter between and around them (about 320 hectares). 32. The land at the Tuz Golu Surface Facility was acquired without informing the Bank of the acquisition process via quarterly monitoring reports and without collecting the necessary information on the situation of the project affected persons (PAPs) prior to concluding the acquisition. BOTAŞ submitted a draft social audit report in December 2012. The Bank requested further information on the timing of the consultations, the compensation payment and the grievance resolution mechanism, which were discussed between the Bank team and BOTAŞ during the January 2013 mission. During the same mission, the Bank team conducted a field visit and met with some of the PAPs and the local Muhtar (village head) about this acquisition and verified that compensation had been made available to those affected. 33. For the Tuz Golu Well area, BOTAŞ informed the Bank in September 2012 of the need to acquire additional land beyond what had been planned in the original 2005 LAP. BOTAŞ was advised that they would need to revise the original LAP to include the additional land and update the 2005 LAP. BOTAŞ accordingly revised the LAP. The revised LAP was disclosed in-country on February 22, 2013 and in the InfoShop on March 5, 2013. Implementation will be monitored by expert consultants engaged by BOTAŞ under the project as well as by the Bank. BOTAŞ has confirmed that there will be no further land acquisition beyond what is covered in the revised LAP. A social survey of landowners was carried out in 2013 and disclosed by BOTAŞ on February 11, 2014. 34. Gender analysis and monitoring and evaluation of this issue are not relevant for the project. Gas storage facilities and compressor stations do not have direct operational impacts on men or women. The project’s footprint as designed will not have a direct impact on the ultimate gas end-users/beneficiaries at the household level, and therefore, disaggregating the different project outcomes between men and women will not be attempted. 9 Dam Safety Aspects 35. The construction of the Tuz Golu storage facility will require water for the “solution mining” of the underground storage caverns. That water will be drawn from the existing Hirfanli reservoir. The State Hydraulic Works (DSI) and the Electricity Generation Corporation of Turkey (EUAŞ) are responsible for the Hirfanli dam structures and the hydro power plant, respectively. Because of the involvement of a dam with the project, the Bank’s Policy on Safety of Dams is applicable, and agreements were reached with DSI and EUAS in 2005, on actions needed to monitor the safety of the dam. During the September 2012 visit by the Bank dam safety expert to the Hirfanli dam, measures were agreed with BOTAŞ, DSI, and EUAŞ, for implementation by the DSI field organization. These measures did not involve significant and complex remedial works. Implementation was reviewed by DSI’s General Directorate (Ankara) and reported to the Bank in February 2013. DSI is the national regulator of dam safety and runs an effective dam safety program including periodic inspections and safety assessments of its dams. The operations and maintenance manual was also updated. Implementation will be reviewed by DSI and during future supervision visits by the Bank’s dam safety expert. Procurement 36. The proposed loan would provide financing for three contracts for the Tuz Golu component procured and signed under the original loan (Table 4). These existing contracts will continue to be implemented in accordance with the World Bank’s "Guidelines: Procurement under IBRD Loans and IDA Credits" dated May 2004; and “Guidelines: Selection and Employment of Consultants by World Bank Borrowers” dated May 2004, and the provisions stipulated in the Legal Agreement of the AF loan. These contracts were formed based on the Bank’s latest Standard Bidding Documents and Request for Proposal Documents issued at the time of respective procurements. 10 Table 4: Ongoing Contracts for the Tuz Golu Component No Contract Name Amount Contractor/Consultant Envisaged Contractual Completion Date 1 Supply and Installation of Surface US$555,893,700 The China Tianchen February 2020 and Subsurface Facilities and + TL 77,224,900 Engineering Corporation Water Supply and Brine Discharge (US$604,554,623 (China) Pipelines and Cavern Leaching of equivalent) Tuz Golu Underground Gas Storage Project 2 Consultant's Services for the EUR 12,000,000 DBI Gas und February Project Management and (US$15,377,400 Umwelttechnik Gmbh 2020 Implementation Support for Tuz equivalent) (Germany/Lead) and Golu Underground Gas Storage TROYA Dogalgaz Project Petrol Muh. San. Tic. Ltd. Sti. (Turkey) Joint Venture 3 Consultant's Services for US$2,600,000 Cinar Muhendislik, February 2020 Environmental Monitoring for Tuz Musavirlik ve Proje Golu Underground Gas Storage Hizmetleri Ltd. Sti Project (Turkey) Sectoral Risks Gas Pricing 37. The Government approved a cost-based pricing mechanism for electricity and gas in March 2008. The mechanism provides for quarterly adjustments by the energy regulator EMRA in the price of electricity and, if needed, even monthly adjustments by BOTAŞ in the wholesale price of gas it charges its customers. EMRA has applied the electricity pricing mechanism consistently since 2008. However, BOTAŞ has not been able to apply the mechanism consistently. As a result, BOTAŞ made a loss in 2011-12. The deprecation of the Turkish Lira since mid-2013 is increasing the cost of BOTAŞ gas imports. Although compliance with financial covenants is projected, the gas price risk remains and cannot be effectively mitigated as long as the full and timely pass through of BOTAS gas import costs is not consistently taken into account in setting gas sales prices. However, it must be emphasized that BOTAŞ’ revenue shortfalls do not threaten the fulfillment of BOTAŞ’ obligations to its financiers, suppliers and contractors including the Tuz Golu project contractor. 11 Unbundling of BOTAŞ 38. An amendment to the Natural Gas Market Law is under preparation. The 2001 Natural Gas Market Law No. 4646 provided a strong legal foundation for gas sector reform and private sector participation. Particularly noteworthy is the country-wide entry of private companies into gas distribution urban areas. EMRA played a key role in that effort through its program of competitive tendering of distribution licenses. However, the 2001 Law has proven less effective in attracting private sector participation into the import and wholesale supply segments of the gas sector. This reflects: (a) the lack of commitment to implement the envisioned (highly ambitious) measure of ownership unbundling of BOTAŞ; and (b) insufficient wholesale gas market development. The forthcoming amendment of the Law is setting out to address these issues. Several drafts have been prepared in the past few years. The Ministry of Energy and Natural Resources first posted a complete draft amendment on its web-site for public feedback in October 2012. A final draft amendment has been submitted to the Council of Ministers for approval for submission to the Parliament. A firm timeline for the enactment of the amendment has not yet been established at this time, but the amendment is expected to become effective within 2014. 39. The final draft amendment provides for the unbundling of BOTAŞ into three separate companies. BOTAŞ would focus on gas imports and supply. New companies would be established for transmission and system operations; and gas storage and liquefied natural gas (LNG) terminals. The separation of trading (imports and supply) and infrastructure (networks and storage) functions is an important policy measure to help attract private investment and increase competition in the gas sector. The Tuz Golu project would be placed in the gas storage and LNG terminals company for implementation and operation. The original and the proposed additional finance loans would be restructured to facilitate such unbundling. Until restructured the loans will remain with BOTAŞ. 40. The forthcoming EU/IPA-financed WB-administered energy sector technical assistance project includes components for: (a) the unbundling of BOTAŞ; (b) design of, and regulations for, a gas trading platform; and (c) a review of the alignment of Turkey's legal and institutional framework for electricity, natural gas, energy efficiency and renewable energy with the EU's energy acquis. EU’s Gas Directive 2009/73/EC provides EUs’ framework for the unbundling of transmission, storage and LNG system operators. 41. Further modernization of the governance of BOTAŞ and other state-owned energy enterprises in line with the “OECD Guidelines on State-Owned Enterprises” that serve as a global benchmark for SOE governance reform is an important policy priority. The Bank is providing technical assistance to examine issues and options in the SOE reform process. 12 Annex 1: Results Framework and Monitoring TURKEY: Gas Sector Development Project Additional Financing Results Framework Revisions to the Results Framework Comments/ Status Rationale for Change PDO Current (PAD) Proposed The objective of the Project is to No change. Continued. increase the reliability and stability of gas supply in Turkey by implementing critically needed gas storage and network infrastructure; and support BOTAŞ in strengthening its operations as a financially stable and commercially managed corporation. PDO indicators Current (PAD) Proposed change Change in phasing: Tuz Golu Gas Storage Revised Functioning Gas Storage Facility Functioning Gas Storage Facility will be built in built in three phases with an Facility commissioned in two two phases of six ultimate storage capacity of phases in 2016 and 2020 with caverns each, instead of about 0.90-0.96 bcm. an ultimate storage capacity the original plan of three of about 0.96 bcm. phases of four caverns each. Increased carrying capacity of Increased carrying capacity of BOTAŞ has completed Revised the Turkish gas transmission the Turkish gas transmission the Corum compressor system through the completion system through the station outside the of two compressor stations. completion of the Erzincan project with its own compressor station. resources. Storage operates as separate No change. Final draft amendment Continued business unit. of the Natural Gas Market Law envisions storage and LNG terminals as a separate company. Intermediate Results indicators Current (PAD) Proposed change Change in phasing and Revised Construction of phase I of timing: Updated phasing and storage capacity. Construction of phase I and completion dates in phase II of storage capacity. view of the delay in the Storage capacity is built: Tuz Golu project Phase 1: 320 mcm (2009) Storage capacity is built: implementation and Phase 2: 640 mcm (2012) Phase 1: 480 mcm (end-2016) projected completion. Phase 3: 960 mcm (2015) Phase 2: 960 mcm (end-2020) Compressor capacity of system No change. Continued increasing. 13 Revisions to the Results Framework Comments/ Status Rationale for Change Comprehensive costs available No change. Continued for storage on a “stand alone” basis. BOTAŞ will maintain a debt Added as an explicit New service coverage ratio of not indicator of the project less than 1.2. supporting BOTAŞ in strengthening its operations as a financially stable and commercially managed corporation. 14 REVISED PROJECT RESULTS FRAMEWORK Project Development Objective (PDO): The objective of the Project is to increase the reliability and stability of gas supply in Turkey by implementing critically needed gas storage and network infrastructure; and support BOTAŞ in strengthening its operations as a financially stable and commercially managed corporation. Baseline Cumulative Target Values Data Responsibi Original Progress 4 2013- 2015 2016 2017- 2020 Source/ lity for PDO Level Results Indicators UOM Project To Date Frequency Comments Methodolo Data Core Start (2012)5 2014 2019 gy Collection (2005) Phase 1 0.48 bcm end- 1. Increased Natural Gas Storage bcm 0 0 0 0 0.48 0.48 0.96 Annual BOTAŞ BOTAŞ 2016, phase 2 0.96 Capacity bcm end-2020. Project target 40 2. Increased Capacity of bcm/yr 22 40 40 40 40 40 40 Completed BOTAŞ BOTAŞ bcm/a achieved by Transmission lines to carry gas 2012. 3. Storage operates as separate business unit to ensure Yes/no no no no yes yes yes yes Annual BOTAŞ BOTAŞ independence and open access. 4. Achievement of agreed financial Yes/no n/a no yes yes yes yes yes Annual BOTAŞ BOTAŞ targets. Beneficiaries Number of gas Number 12.8- consumers in Turkey Project beneficiaries 9.9- (mln.) 6.0 9.2 11.4 12.1 13.6- 15.0 Annual EMRA EMRA (mostly households in 10.7 14.3 terms of number of consumers). About the same % number of females and Of which female (beneficiaries) 50 50 50 50 50 50 50 Annual EMRA EMRA males in Turkish households. 4 UOM = Unit of Measurement. 5 For new indicators introduced as part of the additional financing, the progress to date column is used to reflect the baseline value. 15 Intermediate Results and Indicators Baseline Target Values Unit of Original Progress Responsibility 2013- 2015 2016 2017- 2020 Data Source/ Comm Intermediate Results Indicators Measur Project To Date Frequency for Data Methodology ents Core ement Start (2012) 2014 2019 Collection (2005) Intermediate Result 1: Storage capacity is built with completion of phase I in 2016 and phase II in 2020 (% completion) 100/ 0/ 35/ 50-65/ 85/ 100/ 100/ 1. Completion of phase 1/2 % 0 5 10-15 25 35 55-75- 100 quarterly BOTAŞ BOTAŞ 95 Intermediate Result 2: Compressor capacity of system increasing (MW). Original 2. Compressor capacity MW 0 30 70 70 70 70 70 quarterly BOTAŞ BOTAŞ target achieved. Intermediate Result 3: Comprehensive costs available for storage on a “stand alone” basis 3. Project cost information Yes/no yes yes yes yes yes yes yes quarterly BOTAŞ BOTAŞ collected. 4. Storage business established Yes/no no no no yes no yes yes annual BOTAŞ BOTAŞ Intermediate Result 4: Achievement of Agreed Financial Targets 5. Debt Service Coverage Ratio >1.2 n/a negative >1.2 >1.2 >1.2 >1.2 >1.2 annual BOTAŞ BOTAŞ Note: after the proposed unbundling of BOTAŞ, responsibilities will be transferred to the appropriate successor entity/entities. 16 Annex 2: Operational Risk Assessment Framework (ORAF) Turkey: Gas Sector Development Additional Financing (P133565) 1. Project Stakeholder Risks Rating: Low Description: Risk of stakeholders (beneficiaries, energy Risk Management: BOTAŞ implements the project without further delays and keeps regulator EMRA, government and financiers) losing faith in stakeholders informed of project progress. BOTAŞ ability to complete Tuz Golu gas storage. Status: in Resp: BOTAŞ Stage: Implementation Due Date : ongoing progress 2. Implementing Agency Risks (including fiduciary) 2.1 Capacity Rating: Moderate Description: Risk of further delays in project implementation. Risk Management: Adequate staffing of the field organization and proactive project management with the assistance of the owner’s engineer. Status: in Resp: BOTAŞ Stage: Implementation Due Date: ongoing progress 2.2 Governance Rating: Substantial Description: Risk of delays in major decisions and key Risk Management: BOTAŞ is included in the Government’s priority group of companies for appointments. reform of governance of state-owned enterprises, including unbundling. Status: in Resp: Government Stage: Implementation Due Date: ongoing progress 3. Project Risks 3.1. Design Rating: Low Description: Risk of unproven and/or risky design. Risk Management: Design by internationally recognized experts, application of proven technology, review and implementation support by experienced technical expert as part of the Bank team. Status: Resp: BOTAŞ Stage: Preparation Due Date: 2005 Completed 3.2. Social & Environmental Rating: Moderate Description: Risk of inadequate/delayed implementation of Risk Management: Training of BOTAŞ field staff, close supervision by the Bank. environmental management plans and land acquisition plans. Status: training in Resp: BOTAŞ and January 2013; Stage: Implementation Due Date: ongoing WB implementatio n support to continue. 3.3. Program & Donor Rating: Low Description: Risk of delay in contracting additional financing. Risk Management: Current additional financing loan will cover the needs until 2018, by which 17 time BOTAŞ or its successor entity is expected to be able to contract financing for project completion (possibly from the Bank). Status: in Resp: BOTAŞ Stage: Implementation Due Date: ongoing progress 3.4. Delivery Monitoring & Sustainability Rating: Moderate Description: Risk of inadequate monitoring and reporting. Risk Management: Monitoring by the owner’s engineer and environmental and social monitoring consultants, quarterly progress reporting by BOTAŞ, close supervision by the Bank team including an expert consultant on gas storage in salt caverns. Resp: BOTAŞ and Status: in Stage: Implementation Due Date: ongoing WB progress 3.5. Financial Management Rating: Low Description: Risk of BOTAŞ not completing company audits Risk Management: Strengthen financial management staffing and systems. and reconciliation of project and entity accounts in a timely Status: in manner. Resp: BOTAŞ Stage: Implementation Due Date: ongoing progress 3.6. Safety of Hirfanli Dam Rating: Low Description: Risk of Hirfanli dam failing and Tuz Golu Risk Management: Implementation of safety measures and the new operations and maintenance construction losing its water source. manual by DSI’s field organization and monitoring by DSI General Directorate (Ankara), Turkey’s national regulator of dam safety. Status: Safety measures implemented; Resp: DSI Stage: Implementation Due Date: ongoing operations and maintenance to continue 3.7. Financial Viability of BOTAŞ Rating: Substantial Description: Risk of BOTAŞ not being able to adjust its Risk Management: Long-term gas import contracts provide some price stability. Foreign wholesale gas price fully and in a timely manner. currency risk remains – currently substantial. Status: in Resp: BOTAŞ Stage: Implementation Due Date: ongoing progress 3.8. Financing Capacity of “BOTAŞ storage company” Rating: Moderate Description: Risk of an unbundled “gas storage/LNG terminals Risk Management: BOTAŞ remains responsible for project financing until project restructuring company” not being able to raise financing to complete the Tuz has been completed. A possible additional measure could be to bring TPAO’s existing Golu project. operational gas storage capacity into the new gas storage/LNG terminals company. 18 Status: in Resp: Government Stage: Implementation Due Date: end-2015 progress 4. Overall Risk 4.1 Implementation Risk Rating: Moderate Comments: Most of the risks are either low or moderate. Gas price risk is rated substantial but does not threaten project implementation. 19 Annex 3: Economic Assessment of Tuz Golu Gas Storage Facility TURKEY: Gas Sector Development Project Additional Financing Summary 1. The increase in investment and operating costs compared to the original economic analysis has been accompanied by a large increase in the value of the benefits to be derived from using the storage. Two of the four primary benefits are tied to the prices of petroleum products, which have risen very sharply since the 2005 appraisal; the third benefit is partially tied to natural gas prices which have also risen sharply while the fourth benefit is tied to inflation in construction costs in Turkey. As a result the estimated Economic Rate of Return (ERR) for the project is 15.1 percent compared to 17.3 percent in 2005 with slightly more optimistic assumptions. The project remains economic. Costs of Storage and Cushion Gas 2. The economic assessment of the Tuz Golu Gas Storage was completed in 2005 based on estimated investment costs at that time. There were a number of delays in undertaking the investment but the implementation contract has now been signed and construction is underway. The construction and consulting costs (Table 1 of the main text) are largely fixed by the contracts but the cost of the cushion gas could vary depending on the cost of natural gas in 2015 and later in 2019 when it is injected into the storage. Besides investment costs, estimated operating costs have been increased in line with the increase in the price of gas since appraisal (discussed below). 3. Cost of Cushion Gas The cost of cushion gas is part of the project but not included in the implementation contract since BOTAŞ will supply it. The cost of cushion gas depends on the weighted average cost of natural gas (WACOG) purchased by BOTAŞ. The cushion gas will not be purchased until 2016 and 2020, ahead of completion of phase 1 and 2, respectively, and the price of gas would depend on the WACOG in those years. BOTAŞ estimated the cost at about US$200 million in 2013. This figure has been retained in the analysis but BOTAŞ currently expects to be able to purchase the gas at a lower price. An estimate based on the Bank’s average crude oil price forecast results in about US$152 Million in 2011 dollars. Appraisal estimate was US$80 million, for a lower volume of gas. This increase and is due to the sharp rise in crude oil prices since 2005 as the prices for most natural gas that Turkey imports are indexed to oil prices. Benefits 4. There are four primary benefits from the project all of which have increased significantly in value, partly as a result of rising oil prices. These benefits are given below. a. Seasonal Storage: The Tuz Golu storage would allow more gas to be bought in the summer when it is readily available and generally less expensive, injected into storage and withdrawn in winter, when gas may be in short supply and additional volumes will generally be very expensive. Although there is no seasonal gas market 20 with differential summer and winter prices in Turkey today, based on functioning gas markets a price difference is expected to emerge in the future also in Turkey - reflecting the different values of summer and winter gas. b. Avoided Costs: The proposed Tuz Golu storage facility will lead to a reduction in compressor station and loop line investments and associated operating costs. These investments would be needed to support gas supply and pressure in the south western part of the transmission system if Tuz Golu were not built. These avoided costs are benefits to the storage project. c. Peak Shaving: Storage can be used to meet demand on above average cold days, thereby avoiding a shortfall between average contracted import quantities and peak winter day demand. Depending on the weather patterns, the typical (normal) winter might have 30 days when peak demand would need to be met from storage, otherwise some customers’ supply (e.g. EUAŞ or private power plants) would be interrupted and they would be forced to use petroleum fuels instead. d. Security of Supply and reliability: Storage provides a contingency supply source that can be used to avoid short-or long –term gas supply shortfalls resulting from unplanned interruptions in supply, e.g. loss of import capacity. This benefit can be valued at the cost of an interruption (e.g. higher prices of substitute petroleum fuels and other costs) and the probabilistic analysis of the loss of each main import source. 5. Seasonal Storage would allow BOTAŞ to better match its customers’ seasonal peak demand with its relatively flat annual contracted import profile. The peak winter requirement is largely caused by heating demand in winter especially among residential and commercial customers. The value of the storage used to meet peak winter seasonal demand is determined by the difference between the value of summer and winter gas, often referred to as the value of the ‘swing’. Gas can usually be bought at lower prices in the summer on a short term basis. Correspondingly extra gas (above contract) is usually more expensive in the winter, if available at all. While Turkey does not yet have seasonal gas prices, they would develop as the market develops and there is increased linkage of Turkish Gas Prices to European Gas Prices. However, even without seasonal gas prices the value of gas in Turkey does vary seasonally. 6. In order to estimate the variation in the value of natural gas between winter and summer, or the difference in prices if there were a seasonal gas market; comparisons have to be made with other countries. In the 2005 PAD a comparison was made primarily with the UK market where there was a larger variation between winter and summer prices and secondarily with the US market where there was less variation. Based on this comparison it was estimated that US$40 per thousand cubic meters (tcm) was a conservative estimate of the difference between summer and winter values of gas for Turkey. While the swing seems to have increased somewhat in the UK more data is now available on other European markets where the swing tends to be lower than in the UK. It was decided therefore to be conservative and to continue to use US$40/tcm as the difference between summer and winter values of gas. 21 7. Avoided Costs are the investments and associated operating expenses that BOTAŞ would need to make if the Tuz Golu Storage Facility were not built. These investments are:  New compressors of 24 MW in the Western part of the National Transmission Line;  New compressors of 48 Mw in the Eastern Part of the Transmission Line; and  New loop line of length of around 200 km in the Eskisehir Region. 8. In the 2005 appraisal these investments were estimated to cost US$148 million. In order to get a current estimate the 2005 estimate was: (1) converted from dollars to TL at the 2005 average exchange rate, (2) escalated using the Turkish Statistical Institute Construction Index and (3) converted back into dollars at the 2012 TL/Dollar exchange rate. This approach produced an estimated cost of US$160 million for these investments which will be avoided by building the Tuz Golu Storage. (If we assume that the avoided cost of building the compressors and line have had escalated as fast as the cost of building the Tuz Golu Storage, then the avoided cost would be US$327 Million and the ERR on the project would be increased to 18.5 percent.) 9. Peak Shaving is achieved when gas from Tuz Golu is used to meet the peak demand on the coldest days in a “normal” winter, by withdrawing extra gas on those days (typically around 25-35 days) and then re-injecting gas on warmer days, and/or withdrawing gas at a slower rate on warmer days. This peak shaving role is possible because not all of the deliverability capacity of the storage facility would be used for normal winter supplies. 10. The value of peak shaving is estimated at the cost of the alternatives. In this case it is assumed that if natural gas is not available interruptions would occur to gas supplied to power plants. In turn these plants would likely replace the interrupted natural gas with petroleum products in order to power their turbines. The value of this alternative is taken as:  The estimated extra volume of natural gas which ,on very high demand days, would be at risk of interruption in the absence of storage, multiplied by:  The cost of interruption, estimated as the extra cost of replacement fuel, which is most likely to be gas oil. 11. The number of days for which peak shaving is assumed to occur is 30 and the extra value of the gas supplied for peak shaving is taken as the cost of gas oil, expressed in dollars per MCM, minus WACOG, minus the premium for winter gas, the so called swing, discussed above. 12. Security of Supply is the benefit the storage provides by helping avoid gas shortfalls due to exceptional or unexpected events such as:  Unplanned supply restrictions due to problems with the import pipelines or in one of the transit countries (for example Ukraine) or in one of the supplying countries (for example Iran); 22  Dry hydropower conditions requiring a sharp increase in electricity generated from natural gas and thus in gas supplies; and  An exceptionally cold winter as might be experienced in every 20 to 50 years. 13. Three possible events are examined and each is given a probability of occurring in any given year ranging from 5-10 percent. The cost of offsetting the gas shortage is assumed again to be the extra cost of using gas oil rather than natural gas. Sensitivity Analysis 14. The cost of building the Tuz Golu natural gas storage (including construction and consulting but excluding the cost of cushion gas) could rise to US$1 billion and the facility would still generate an ERR of about 10 percent: Economic Rates of Return at Various Construction Costs for Tuz Golu Storage Construction Costs ERR (%) (excluding cushion gas) US$623 million (projected cost) 15.1 US$800 Million (sensitivity case) 11.9 US$1000 Million (sensitivity case) 9.6 . 15. The project would also be economic with a deep decline in oil or gas prices. This is for two reasons: (1) oil and gas prices have already increased a lot- about double the 2005 forecast; and (2) two of the major benefits, seasonal storage and avoided costs, are not closely tied to oil or gas prices. The forecast on which the original economic analysis was done in 2005 assumed that oil prices rose to an average of US$45 per barrel in 2007 and remained at that level in real terms throughout the life of the project, that is until 2038. Gas prices (WACOG) were assumed to move with oil prices since BOTAŞ’ gas contracts are indexed to petroleum prices. The current forecast, which is based on the Official World Bank Oil Price Forecast, is that oil prices peak in real terms at about US$108 per barrel in 2012 and then decline 2-3 percent per year in real terms until 2025. After 2025, no World Bank Crude Price Forecasts are available so oil prices are assumed to rise 2 percent per year in real terms in line with the forecasts of the EIA. The analysis assumes that gas prices move with these oil prices. 16. As the table below shows it takes major drops in oil prices to lower the ERR. These can also be viewed as declines in gas prices since in our model oil and gas prices move together. If gas prices are unlinked from oil they could be expected to decline somewhat further although how much is unsure. 23 Economic Rates of Return at Various Oil Price Levels Oil Price Path ERR Base Case 15.1% -10% 12.3% -20% 10.5% -30% 9.0 % 24