PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE Report No.: PIDA268 Public Disclosure Copy Project Name Energy Efficiency Project (P116680) Region EUROPE AND CENTRAL ASIA Country Armenia Sector(s) Energy efficiency in power sector (100%) Lending Instrument Specific Investment Loan Project ID P116680 Focal Area Climate change Borrower(s) Republic of Armenia Implementing Agency Renewable Resources and Energy Efficiency Fund Environmental Category B-Partial Assessment Date PID Prepared 07-Feb-2012 Estimated Date of Appraisal Completion 01-Apr-2011 Estimated Date of Board Approval 27-Mar-2012 Decision I. Project Context Country Context Armenia has sustained economic reforms leading to significant improvements on its income levels over the past decade and a half. Growth advanced 12 percent on average between 2001 and mid-2008, driven by an increased inflow of remittances and foreign investments, high commodity prices, the transition rebound and strong reform efforts. This, and improved social service provision, led to a sharp drop in poverty from over half of the population in 1999 to about 23.5 percent in 2008. Key among the various reforms undertaken are the land privatization in early 1990s, establishment of sound regulatory framework for the banking system, and unbundling and the attraction of private capital into a number of infrastructure sectors, including water and energy. The global financial crisis hit Armenia severely despite swift government response. Actual outcomes of 2009 indicate that the economy Public Disclosure Copy contracted by 14.2 percent while poverty rose by nearly 5 percentage points and the fiscal deficit increased to about 8 percent of GDP. The Government responded swiftly with re-prioritization of government expenditures towards those that protect or create jobs in the short term and protected its priority social spending programs such as pensions and the last resort targeted social assistance program, which helped Armenia avoid even worse poverty outcomes. A slow economic recovery is underway - the economy grew by 2.1 percent of GDP in 2010. 2011 growth is projected at 4.2 percent. Global conditions will affect significantly the medium-term prospects via remittances, trade (particularly exports of copper and molybdenum), and tourist flows. Overall, Armenia is likely to face possible contagion effects from the ongoing euro-zone crisis. The energy sector is essential for the sustainable economic development of the country and investments in the energy sector underpin growth prospects. Utilities (energy, water and gas supply) account for around 3.5 percent of the country’s annual GDP and the energy sector contributes the largest share of about 3 percent. Furthermore, the energy sector is among the largest tax payers in the country. Energy and infrastructure reforms contributed significantly to Armenia’s success through the 2000s, directly via investments, and indirectly through an increased reliability of energy supply and elimination of large quasi-fiscal deficit. II. Sectoral and Institutional Context The energy sector of Armenia has achieved remarkable results through reforms and restructuring. The sector has strong payment discipline with collections for electricity and gas nearly at 100 percent of sales. There are no explicit or implicit subsidies to the energy sector and the sector entities are among the largest tax payers in the country. There is a competent regulatory agency for the sector. Despite these achievements, the energy sector faces a number of challenges. Public Disclosure Copy The key challenges of the energy sector include: (a) emerging power supply gap; (b) threatened energy security; and (c) increasingly unaffordable energy tariffs. 1. Emerging power supply gap: Armenia currently has sufficient capacity to meet its demand. However, depending on electricity demand growth scenarios, generation capacity shortage of 800-1100 MW to meet the peak electricity demand is estimated to emerge after the planned shut- down of the nuclear power plant (currently scheduled for 2016), and the phasing out of inefficient and old (>40 years) thermal power plants. 2. Threatened energy security: Heavy reliance on imported fuels and the old and under-maintained transmission and distribution assets put Armenia at risk of supply interruptions, price fluctuations, and possible outages. The average age of the transmission lines is around 45 years and the transmission company did not make any substantial investments in rehabilitation of the lines. Moreover, fuel for more than 90 percent of the country’s energy needs is imported. Armenia is dependent on the imports for all of its transport fuel, all gas used for heating (whether industrial or residential) and cooking, and gas and nuclear fuel used to generate over two-third of the country’s electricity. 3. Increasingly unaffordable energy tariffs: Rising fuel prices and the need for new, more expensive generating units make the energy tariffs less affordable for low-income consumers. In 2009, the poor Armenian households spent roughly 8 percent of their total household budgets on electricity and gas. The affordability issue will exacerbate as the fuel prices continue to rise and the required significant investments are made in new generation assets and rehabilitation of existing generation and transmission assets. The Energy Sector Strategy and the Sustainable Development Program of the Government recognize these challenges. The increase of the power supply reliability and improvement of energy security are among the key strategic objectives of the sector. To that end, the Government prioritizes realization of economically viable energy efficiency potential as means for achieving the above strategic objectives. Thus, the Government requested the Bank to support with rehabilitation of key backbone section of power transmission network, improvement of energy efficiency of public facilities and creation of an enabling environment for energy efficiency. Currently, the Bank is implementing the Electricity Supply Reliability Project to improve the reliability of power supply through replacement of around 230 km section of transmission network backbone. Armenia has significant potential for energy efficiency and can recoup sizable economic benefits through utilization of this potential. While Armenia is one of the less energy intensive economies in the region, largely due to the structural changes of the economy, large potential remains for further efficiency improvements. The 2008 World Bank Study found that Armenia could save 132 billion Armenian Drams (more than US$360 million) annually, equivalent to 4.3 percent of its 2009 GDP, through energy efficiency investments. The World Bank study estimated the energy efficiency investments in public facilities having the highest returns with paybacks of two to ten years. The Government has taken important steps to encourage realization of the energy efficiency potential. In 2005, the National Parliament passed the Law on Energy Savings and Renewable Energy, creating a legal basis for energy efficiency in Armenia. The Government also adopted the Public Disclosure Copy National Program on Energy Savings and Renewable Energy, which identifies the sectors with the largest energy efficiency potential and provides an outline of technical measures/solutions to be taken to realize the identified technically viable potential. Additionally, under the Development Policy Loan (DPL) of the World Bank, the Government adopted a time-bound Energy Efficiency Action Plan for 2010-2013 that prioritizes energy efficiency measures for various sectors. The project will help to reduce the power supply gap and enhance the energy security by improving the utilization of the country's energy efficiency potential. III. Global Environmental Objective(s) The project development objective is to reduce energy consumption of social and other public facilities. The global environmental objective is to decrease greenhouse gas emissions through the removal of barriers to the implementation of energy efficiency investments in the public sector. IV. Project Description Component Name Energy efficiency investments in public facilities Technical assistance V. Financing (in USD Million) For Loans/Credits/Others Amount BORROWER/RECIPIENT 8.84 Global Environment Facility (GEF) 1.82 Total 10.66 VI. Implementation The Renewable Resources and Energy Efficiency Fund (R2E2 Fund) will implement the project since it has adequate capacity and significant experience of implementing Bank financed projects. The R2E2 Fund is a non-profit organization established by the Government in 2005 with the mandate to promote the development of renewable energy and energy efficiency markets in Armenia and to facilitate investments in these Public Disclosure Copy sectors. The implementation of the project as well as overall R2E2 Fund operations will be supervised by the Board of Trustees (BOT), consisting of representatives of government agencies, NGOs, and the private sector, thus, ensuring required professional expertise. The BOT is chaired by the Minister of Energy and Natural Resources. The funds available under the investment component of the project will be channeled through the R2E2 Fund. The R2E2 Fund will channel the funds by entering into energy service agreements with: (i) municipalities and legally independent public facilities, and (ii) eligible social facilities that are not legally independent. For municipalities and public entities with revenue streams independent of the state budget (e.g., municipal administrative buildings and street lighting, universities, hospitals) and with demonstrated financial discipline and adequate administrative and institutional capacity to be involved in the project, the R2E2 Fund will provide loans for energy efficiency improvements. These loans will be provided under a broader Energy Service Agreement, whereby the R2E2 Fund will also provide additional services. However, the loans will be treated as municipal debt, with fixed repayment obligations to be made within their budget provisions in future years. In addition to the loans, the R2E2 Fund will provide the following services: conduct a preliminary screening to identify the general scope of the energy efficiency sub-projects; develop bidding documents; carry out the procurement of design and works on behalf of municipalities; oversee construction and commissioning; pay the contractors for services provided (from the proceeds of the loan); and monitor the sub-projects. The municipalities and public entities will be responsible for properly maintaining the systems, repaying the loan, and paying a service fee to the R2E2 Fund in accordance with the Energy Service Agreement. The amount of the repayments will be designed to allow municipalities and public entities to repay the investment costs and service fee from the accrued energy cost savings. In the case of eligible social and other public facilities, which are not legally independent, the R2E2 Fund will enter into Energy Service Agreements without loans. The R2E2 Fund will first determine the average baseline energy use, identify the general scope of an efficiency subproject, develop bidding documents, conduct the procurement, finance the project, oversee construction and commissioning, and monitor the subproject. The Energy Service Agreement will obligate the social and other public facilities to pay the baseline energy costs over the life of the agreement. These baseline payments will be subject to adjustments, should the social facility's base payments increase. With these payments, the R2E2 Fund will pay the energy bills (gas, oil, power) on the facility’s behalf and reimburse itself for its investment cost and service fee. The agreement should not be longer than ten years. The agreement will also be designed so that the duration can be adjusted if the R2E2 Fund recovers its full investment earlier or later. To promote the development of the local ESCO industry and ensure sustainability of energy efficiency services within the country, the R2E2 Fund will enter into contracts with construction/ESCO firms. The contracts will include project design, and supply, installation, commissioning, and possibly maintenance of equipment. In addition, the contract will include provisions to allocate some project performance risks to the contractors based on the actual energy savings generated from the project. Public Disclosure Copy VII. Safeguard Policies (including public consultation) Safeguard Policies Triggered by the Project Yes No Environmental Assessment OP/BP 4.01 ✖ Natural Habitats OP/BP 4.04 ✖ Forests OP/BP 4.36 ✖ Pest Management OP 4.09 ✖ Physical Cultural Resources OP/BP 4.11 ✖ Indigenous Peoples OP/BP 4.10 ✖ Involuntary Resettlement OP/BP 4.12 ✖ Safety of Dams OP/BP 4.37 ✖ Projects on International Waterways OP/BP 7.50 ✖ Projects in Disputed Areas OP/BP 7.60 ✖ VIII.Contact point World Bank Contact: Ani Balabanyan Title: Operations Officer Tel: 458-2277 Email: abalabanyan@worldbank.org Borrower/Client/Recipient Name: Republic of Armenia Contact: Title: Tel: (+374 10) 59 53 04 Email: minister@minfin.am Implementing Agencies Public Disclosure Copy Name: Renewable Resources and Energy Efficiency Fund Contact: Title: Tel: +37410-58-80-11 Email: IX. For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-4500 Fax: (202) 522-1500 Web: http://www.worldbank.org/infoshop Public Disclosure Copy