PROJECT INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB6629 Project Name Lukovo Pole Water Regulation and Renewable Energy Project (LPREP) Region EUROPE AND CENTRAL ASIA Sector Renewable energy (100%) Project ID P112730 Borrower(s) FYR MACEDONIA Implementing Agency ELEM Macedonian Power Plants 11 Oktomvri 9 1000 Skopje Macedonia, former Yugoslav Republic of Tel: (389-23) 149-166 Fax: (389-23) 149-176 nevenka.jakimova.filipovska@elem.com.mk Environment Category [X] A [ ] B [ ] C [ ] FI [ ] TBD (to be determined) Date PID Prepared July 14, 2011 Estimated Date of May 3, 2012 Appraisal Authorization Estimated Date of Board November 1, 2012 Approval 1. Key development issues and rationale for Bank involvement Country Context Prior to the global financial crisis, Macedonia’s economic growth averaged 5.5 percent in 2007 and 2008 and had started approaching the regional average. Macedonia had put in place sound macroeconomic policies that supported stability and accelerated growth and were complemented by structural reforms. Macedonia weathered the crisis better than most countries in the region. Economic activity picked up since the second half of 2010, with GDP growth accelerating to 2.3 percent in the last quarter and bringing the growth rate for the year to 0.7 percent. Growth is expected to accelerate to 3-3.5 percent in 2011. Investments and exports drove the recovery, while consumption was flat, most likely reflecting increased precautionary savings in response to weak labor markets. These trends appear to have continued in early 2011. The current account deficit that fell markedly in 2010 to around 2.9 percent of GDP in 2010 due to sluggish consumption and good performance on transfers, again widened in early 2011 as higher oil prices and stronger economic activity increased imports. In March 2011, the authorities drew from the International Monetary Fund’s (IMF) Precautionary Credit Line (PCL). The IMF broadly endorsed the mix of macroeconomic policies. Industrial production grew 8.5 percent (year-on-year) in the first two months, business confidence continued to improve, while budget revenues increased by 12 percent. Electricity consumption remained strong in March as well. Growth is expected to accelerate to 3-3.5 percent in 2011, though prolonged uncertainty about the early elections may limit the recovery. Sector Context Macedonia’s energy sector comprises electricity generation capacity of about 1400 MW (Hydro-580 MW, lignite fired-800 MW), limited reserves of lignite primarily used for power generation (about 8 million tons a year), and a 210 MW heavy fuel oil-fired power plant that is used very sparingly due to high cost. Macedonia imports natural gas from Russia through the Ukraine-Romania-Bulgaria gas pipeline, with the capacity of the Macedonian branch being about 800 million Nm3 per year with potential to increase it to about 1,200 million Nm3 per year. Its District Heating system comprises of about 630 MW capacity, mostly in Skopje (550 MW), supplying about 10 percent of users in the country. The remaining 90 percent of the population depends on wood biomass for space heating, while the use of solar energy for hot water consumption in residential sector is gaining popularity. On average, fossil fuels account for about 80 percent of electricity generation in Macedonia while the rest is made up by hydropower. Macedonia’s energy intensity is 3.5 times and carbon intensity about 4 times that of OECD. The Government is committed to increasing the share of renewable resources to at least 20 percent by 2020, consistent with the EU2020 vision. The Macedonia energy strategy to 2030 forecasts its electricity demand to grow at about 2.2 percent, assuming improvement in end-use energy efficiency. At present, the country imports about 10 percent to 12 percent of electricity consumption from the regional electricity market, which also has high carbon emission intensity. To support the country in meeting its energy needs and its renewable energy targets, the proposed project will help increase and regulate the water flow into the Mavrovo cascade, increase the reliability and contribution of hydropower in Macedonia’s electricity mix, and reduce its dependence on imports. Institutional arrangements Macedonia has significant private sector participation in its energy sector. It has privatized electricity distribution, oil and district heating, and production of coal for retail distribution. Elektrani Na Makedonija (ELEM), a state-owned company, owns and operates most of the country’s power generation plants except for about 45 MW of small hydropower plants that are owned and operated by EVN the privatized electricity distribution company, and the combined heat and power plants (CHPs) owned by the heating companies. AD MEPSO, a state-owned company, owns and operates the high voltage transmission system. Macedonia is connected to Greece, Bulgaria, and Kosovo through 400 kV transmission lines and plans to strengthen it 400 kV network to Serbia, Albania, and Kosovo. The privatized distribution company, EVN, is responsible for management and operation of the electricity distribution system and the supply to about 720,000 tariff customers connected to its distribution network. ELEM, the borrower of the proposed loan for development of the Lukovo Pole Renewable Energy Project (LPREP), owns two lignite fired power generation plants – Bitola and Oslomej – with an aggregate capacity of 800 MW, and seven hydropower plants with aggregate capacity of 528 MW. All these power plants are more than twenty years old; the oldest thermal power plant is of 1979 vintage, while the three oldest hydropower plants are more than fifty years old. A previous World Bank project had helped rehabilitation of six large hydropower plants. Macedonia has established an independent six-member Energy Regulatory Commission under its 2002 Law on Energy. It has jurisdiction over electricity, natural gas, district heating, geothermal, oil, and oil derivatives. Key challenges faced by Macedonia’s electricity sector are: • Ensuring security of energy supply in response to deteriorating energy balance while managing environmental impact; • Increasing the share of renewable resources in energy production, particularly hydropower, which would also help in addressing concerns of climate change through creation of water infrastructure; • Improving energy efficiency, which will help reduce energy intensity of the economy, make it more competitive in the long run, and reduce greenhouse gas emission intensity; • Further sector reforms to deepen integration into the regional electricity market. Government strategy to address these challenges The government has identified priority actions for realization of its energy strategy that is designed, in part, to meet the challenges listed above. Some of the key priority actions are: • Improvement in energy efficiency in production, transmission, and utilization of energy; • Increase in utilization of natural gas; • Integrating further into the regional and European market of electricity and natural gas by constructing new connections and harmonization of legislation with existing acquis communautaire; • Increase of the utilization of renewable energy sources. The Bank is providing assistance to Macedonia to improve energy efficiency through an ongoing Global Environment Facility (GEF)-funded project to implement a few pilot projects and strengthen its institutional capacity to scale up the programs. An ongoing project, the Energy Community of South East Europe (ECSEE APL), and the recently approved additional financing, is supporting the government’s program to increase its high voltage regional interconnection with Serbia and is strengthening the capacity of the Energy Regulator to improve its regulation as well as establish economic energy prices. The proposed project would help the government achieve its objective of increasing the utilization of renewable resources. A Project Preparation Advance of US$3 million has been provided to ELEM for financing project preparation activities. 2. Proposed objective(s) The Development Objective of the proposed project is to help Macedonia increase the share of renewable energy resources in its energy consumption and contribute to reducing its vulnerability to climate change. 3. Preliminary description The proposed project is located in North-West Macedonia in Korab mountain range at an altitude of 1500 meters, upstream of an existing Mavrovo cascade that includes three hydropower power plants: (i) Vrben (a run-of-river plant upstream of Mavrovo lake), and (ii) Vrutok and Raven (dam-storage plants downstream of the lake). The proposed Lukovo Pole Renewable Energy Project comprises: (a) construction of about 20 kilometer long covered feeder channel, running slope parallel, to transfer water from Korab catchment to Lukovo Pole storage and Crn Kamen river, (b) about 70 meter high dam at Lukovo Pole that will have a storage capacity of about 39 million cubic meters, and (c) a small hydropower project (Crn Kamen) of about 5 MW downstream of Lukovo Pole. The reservoir will be within the Mavrovo National Park, and its area will fluctuate between 1.5 and 0.1 square kilometers at the maximum and minimum reservoir level. Among ECA countries, Macedonia ranks twelfth on vulnerability and fifth on exposure to climate change. The water infrastructure created by the project will act as an adaptation measure against expected reduction and variability in precipitation due to climate change. Total energy generation from the new 5 MW and additional generation from the existing three projects on Mavrovo cascade is expected to be about 160 GWh/year. The dam will be a 320m long, 70m high rockfill structure with an internal clay core. The dam site is located very close to the Kosovo border. An agreement was reached between Macedonia and Kosovo in 2009 to make adjustments to their borders for locating the entire Lukovo Pole reservoir in Macedonia territory. The project area lies in a sub-alpine landscape of considerable natural beauty with diverse fauna and flora and a relatively unspoiled landscape. The wider area around the project location belongs to the “Mavrovo” National Park. Water from the area has been used for hydropower production since the mid 1950’s. ELEM is hiring consultants to prepare Environmental and Social Impact Assessments (ESIA), review and update the engineering designs, and is engaging the panel of experts. ELEM will appoint a Dam Safety Review Panel (DSRP) who will review the updated design and associated studies, and also provide independent review during construction. ELEM operates a good dam safety (DS) system in the context of a satisfactory regulatory framework. ELEM’s internal DS system follows a well defined ISO9001 standard; procedures are described in a document titled “Annual Plan for technical monitoring of dams at ELEM”. Under a previous World Bank project, ELEM carried out rehabilitation of the mechanical equipment of its power plants; the project also included a dam safety component. 4. Safeguard policies that might apply The project has the potential to cause significant negative environmental impacts if not managed well. It will include large scale civil works, material sourcing, and operation of heavy machinery and plant during the construction period. During the operation period it will cause the diversion of water from streams and creeks at the surface into canals and tunnels, change the local hydrology, and also cause some diversion of water (an average of less than 2 m3/s) across the watershed from the Adriatic to the Aegean basin. The sensitivity and vulnerability of the project area is emphasized by the fact that it is under protection as National Park (NP) due to its ecological significance. The European Commission is funding a 3 million study “Mavrovo NP Valorization” to help the National Park Authority (NPA) in park management. Started in 2008, this study is headed by the Department of Forestry of Skopje University and is supported by an Italian NGO as external consultant. The Study includes a comprehensive assessment of the NP’s environmental baseline as well as a park management plan (PMP) for the next decade. According to the NPA, about 80 percent of the study has been completed and would be available to the ESIA consultants. This would be a significant contribution to the project’s ESIA, as more baseline data will be available. Since it is located in a protected area (national park), the World Bank Operational Policy (OP 4.04) is triggered. The Terms of Reference for the planned ESIA includes specific attention to biodiversity and protection of rare and endangered species. During project preparation and specifically the planned ESIA, issues such as the following will be thoroughly investigated: (a) have Natura 2000 sites already been identified in the park/project area? (b) have such sites been legally established and delineated? If so, which protection status do they have? (c) what is the purpose of their protection, and could this purposeful function remain largely intact under project implementation? (d) is the designated project area considered a critical habitat? And (e) is Mavrovo Park a globally important site? Does it contain unique habitats or species (among the “last of their kind”)? The resettlement policy is currently not seen as triggered, as all of the project area lies within the national park; the land is state owned and no individual economic activities are currently allowed. Animal grazing is allowed in the wider park area, but has not been practiced for a considerable time in the immediate project location. No obvious signs of physical cultural properties were detected, however the relevant authorities will have to be consulted on the status of the area. Final clarity will be provided by the ESIA. Due to the diversion of small amounts of water (< 2m3/s) across the watershed from the Adriatic to the Aegean Basin, the World Bank Operational Policy (OP 7.50) would be triggered. A formal notification according to OP7.50 will be sent to the affected riparian countries (Kosovo, Albania and because of increase in flow through Greece to the Aegean basin, notification will need to be sent to Greece as well). While the technical expertise and engineering experience of ELEM staff are good, the organization’s skills and capacity in environmental due diligence and practical environmental management will require upgrading during project preparation and early implementation. There will thus have to be a focus on capacity building early in the project and continuing throughout its initial phases. ELEM has been advised to hire an environmental expert. As the situation of hydropower development within a national park is quite specific and highly sensitive, study tours to Alpine national parks which share the space with hydropower development use was identified as a potential measure, as this could provide examples of both best practice and the associated potential problems and risks. ELEM has been communicating with the government agencies and the municipalities since early stages of the project and public consultations were held in January on the draft Terms of Reference for Environmental and Social Impact Assessment. ELEM has also kept the Ministry of Environment and Physical Planning (MOEPP) and National Park Authority (NPA) fully informed about the due diligence activities undertaken so far for the project. A team from NPA is in place to liaise with ELEM, has been recently provided a summary design report containing the current planning status, and is kept informed of developments on the project. 5. Tentative financing Source: ($m.) Borrower 33 International Bank for Reconstruction and Development 50 Total 83 6. Contact point Contact: Mohinder P. Gulati Title: Country Sector Coordinator Tel: (202) 473-3211 Fax: Email: Mgulati@worldbank.org