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Completion Report

Project Number: 42085-013 Loan Number: 2437 September 2015

Azerbaijan: Power Transmission Enhancement Project This document is being disclosed to the public in accordance with ADB's Public Communications Policy 2011.

CURRENCY EQUIVALENTS

Currency unit – Azerbaijan new manat (AZN)

At Appraisal At Project Completion (15November 2008) (31 December 2013)

AZN1.00 = $1.2356 $1.275 $1.00 = AZN0.8093 AZN1.0517

ABBREVIATIONS

ADB – Asian Development Bank DSCR – debt service coverage ratio EIRR – economic internal rate of return ENPV – economic net present value FIRR – financial internal rate of return FNPV – financial net present value M&E – monitoring and evaluation O&M – operation and maintenance PMU – project management unit RRP – report and recommendation of the President WACC – weighted average cost of capital

WEIGHTS AND MEASURES

GWh – gigawatt-hour km – kilometer kV – kilovolt MW – megawatt MVA – megavolt-ampere

NOTE

(i) In this report, "$" refers to US dollars

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Vice-President W. Zhang, Operations 1 Director General S. O’Sullivan, Central and West Asia Department (CWRD) Director F. Cleo Kawawaki, Energy Division, CWRD Team leader T. Luo, Senior Energy Specialist, CWRD Team members L. Dimayuga, Senior Project Officer, CWRD

F. Golez, Senior Operations Assistant, CWRD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

BASIC DATA i

I. PROJECT DESCRIPTION 1

II. EVALUATION OF DESIGN AND IMPLEMENTATION 2

A. Relevance of Design and Formulation 2 B. Project Outputs 3 C. Project Costs 6 D. Disbursements 6 E. Project Schedule 6 F. Implementation Arrangements 7 G. Conditions and Covenants 7 H. Consultant Recruitment and Procurement 8 I. Performance of Consultants, Contractors, and Suppliers 9 J. Performance of the Borrower and the Executing Agency 10 K. Performance of the Asian Development Bank 10

III. EVALUATION OF PERFORMANCE 11

A. Relevance 11 B. Effectiveness in Achieving Outcome 11 C. Efficiency in Achieving Outcome and Outputs 12 D. Preliminary Assessment of Sustainability 12 E. Impact 12

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 14

A. Overall Assessment 14 B. Lessons 14 C. Recommendations 15

APPENDIXES 1. Project Design and Monitoring Framework 16 2. Project Costs 20 3. Annual Loan Disbursements 21 4. Project Implementation Schedule (Projected versus Actual) 22 5. Chronology of Major Milestones 23 6. Status of Compliance with Loan Covenants 24 7. Contracts and Disbursements Financed by the Asian Development Bank 32 8. Economic Analysis 33 9. Financial Assessment of Project and Executing Agency 35 10. Quantitative Assessment of Overall Project Performance 40 11. Contributrion to ADB Results Framework 41

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BASIC DATA

A. Loan Identification 1. Country 2. Loan Number 3. Project Title 4. Borrower 5. Guarantor 6. Executing Agency 7. Amount of Loan / Grant 8. Project Completion Report Number

Republic of Azerbaijan 2437-AZE Power Transmission Enhancement Project Azerenergy Open-Joint Stock Company Republic of Azerbaijan Azerenergy Open-Joint Stock Company $160,000,000 1549-AZE

B. Loan Data 1. Fact Finding – Date Started – Date Completed 2. Loan Negotiations – Date Started – Date Completed

3. Date of Board Approval Loan 4. Date of Loan Agreement Date of Loan Guarantee 5. Date of Loan Effectiveness – In Loan – Actual

– Number of Extensions 6. Closing Date – In Loan – Actual – Number of Extensions 7. Terms of Loan – Interest Rate – Maturity (number of years) – Grace Period (number of years)

5 May 2008 15 May 2008 16 July 2008 18 July 2008 10 September 2008 6 December 2008 6 December 2008 5 January 2009 26 January 2009 0 30 June 2012 16 June2014 3 LIBOR and 0.6% less credit of 0.4%; commitment charge of 0.15% 25 5

8. Disbursements a. Dates

Initial Disbursement 14 December 2009

Final Disbursement 3 June 2014

Time Interval 53.67 months

Effective Date

26 January 2009 Original Closing Date

30 June 2012 Time Interval 41.16 months

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b. Amount ($ millions)

Category Original

Allocation Last Revised

Allocation Amount

Disbursed

Undisbursed

Balance

1 Equipment and Materials

1a 220 kV Agdash substation 18.30 12.50 12.44 0.06

1b 220 kV transmission line 101.80 52.25 56.10 (3.85)

1c 220 kV Absheron substation 8.30 12.25 12.27 (0.02)

1d Additional transmission line (Shimal–Absheron)

18.00 17.49 0.51

1e Additional substations 27.20 25.05 2.15

2 Civil Works

2a 220 kV Agdash substation 3.10 4.20 6.57 (2.37)

2b 220 kV transmission line 15.80 6.30 5.08 1.22

2c 220 kV Absheron substation 1.40 6.00 3.30 2.70

2d Dismantling work and local transportation

8.50 3.20 0.31 2.89

2e Additional transmission line (Shimal–Absheron)

7.50 7.12 0.38

2f Additional substations 7.80 8.32 (0.52)

3 Unallocated 2.80 2.80 2.80

Total 160.00 160.00 154.06 5.94a

( ) = negative, kV = kilovolt, LIBOR = London interbank offered rate. a

Cancelled on 3 June 2014.

9. Local Costs (Financed) – Not applicable

C. Project Data

1. Project Cost ($ millions)

Cost Appraisal Estimate Actual

Foreign Currency Cost 240.0 187.2

Total 240.0 187.2

2. Financing Plan ($ millions)

Cost Appraisal Estimate Actual

Implementation Costs Borrower Financed 74.1 30.6 ADB Financed 160.0 154.1 Subtotal 234.1 184.7

IDC Costs Borrower Financed 5.9 2.5 ADB Financed 0.0 0.0 Subtotal 5.9 2.5

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Total 240.0 187.2

ADB=Asian Development Bank, IDC=interest during construction.

3. Cost Breakdown by Project Component ($ millions)

Component Appraisal Estimate Actual

Equipment and materials

220 kV transmission line 101.8 56.1

220 kV Agdash substation 18.3 12.4

220 kV Absheron substation upgrading 8.3 12.3

Additional transmission line (Shimal–Absheron)a

17.5

Additional substationsa

25.1

Civil Works

220 kV transmission line 15.8 5.1

220 kV Agdash substation 3.1 6.6

220 kV Absheron substation upgrading 1.4 3.3

Additional transmission line (Shimal–Absheron)a

7.1

Additional substationsa 8.3

Other

Dismantling work and local transportation 8.5 0.3

Detailed engineering design 5.4 b

Consultant services 1.1c 2.2

Value-added taxes 31.6 28.2

Customs duties 0.9 0.2

Price contingencies 26.7 0.0

Physical contingencies 11.2 0.0

Interest during construction 5.9 2.5

Total 240.0 187.2

kV = kilovolt. a Components part of major change of scope in May 2010.

b Figure not available separately, included in the costs for equipment and materials, and civil works.

c Consulting services include environmental handling cost.

4. Project Schedule

Item Appraisal Estimate Actual

Establishment of project management office Not indicated in RRP February 2009 Date of contract with consultants August 2008 27 May 2008 Completion of engineering designs Contract 1: substation September 2009 March 2011 transmission line September 2009 March 2011 Contract 2: substation n/a September 2011 transmission line n/a September 2011 Civil works contract Contract 1: date of award January 2009 November 2009 completion of work September 2011 December 2013 Contract 2: date of award n/a September 2010 completion of work n/a December 2013 Start of operations Testing and commissioning Contract 1 September 2011 December 2013

iv

Contract 2 n/a December 2013 Other milestones Minor change in implementation arrangements March 2010 Major change in implementation arrangements

(additional scope)

May 2010 Minor change in scope (loan covenant waiver) Minor change in scope (loan covenant waiver) Amendment to Loan Agreement

April 2012 June 2013 May 2013

Reallocation of loan proceeds 29 May 2013

n/a = , RRP = report and recommendation of the President.

5. Project Performance Report Ratings

Implementation Period Ratings

Development Objectives Implementation Progress 1 January 2009 to 31 December 2010 Satisfactory Satisfactory Overall Project Rating

a

1 January 2011 to 31 June 2014 On Track a In 2011, e-Operations replaced the project performance rating. The indicators used in performance rating are

technical, procurement, financial management, and safeguards.

D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Members

Inception

25 February–1 March 2009

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15

a,b,c

Review 1 26 August–4 September 2009 1 3 a Review 2 15–19 March 2010 3 9 a, d, e Review 3 28 March–1 April 2011 2 10 a, f Midterm Review Review 5 Review 6 Project completion review

13–20 September 2011 27–30 April 2012

13–19 November 2012 14–24 April 2015

5 3 4 3

23 12 22 33

a, b, d, g, h g, i, j

a, b, c, d a, b, l

a=energy specialist/mission leader, b=project analyst, c=economics officer (RM), d=social development specialist, e=energy specialist; f=portfolio management specialist, g=project officer (RM), h=sector director, i=external relations (consultant), j=resettlement (consultant), k=resident representative, l=economist (consultant).

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I. PROJECT DESCRIPTION

1. Azerbaijan has diverse and abundant energy resources. The power sector in combination with hydrocarbons has supported Azerbaijan’s social and economic growth, contributing about one third of the country’s gross domestic product in 2007, making it the economy’s largest segment. However, while the country was successful in developing its oil and gas resources, power became unreliable, and the power supply was inadequate because of deteriorating facilities, inadequate maintenance and investment, and inefficient use of resources. This undermined industrial competitiveness and constrained economic growth.

2. In 2007, over half of the electricity network facilities were beyond their useful life. The 220-kilovolt (kV) Mingechevir-1 transmission line was placed into service in 1949 and the Mingechevir-2 transmission line in 1954. These two single-circuit transmission lines provided transmission capacity of 250 megawatts (MW) for output from the Mingechevir hydropower station to the Absheron economic region, which had the highest electricity consumption rate in the country. Both lines were partly renovated in the 1980s, but most segments were not adequately maintained, with large numbers of defective pylons, insulators, and wires. This led to increased power losses and voltage drops. In addition, many tower foundations were damaged by landslides and floods. Increased power demand caused these lines to be frequently overloaded, resulting in elevated line losses (6%–7%) and frequent outages (8–17 times annually). Therefore, transmission capacity needed to be enhanced by replacing the existing lines and constructing a new double-circuit 220 kV transmission line. Power supply in the central region was provided by 110 kV transmission lines from the Aghsu 220/110 kV substation, which were built in the 1950s and 1960s, and also overloaded, leading to high losses, frequent outages, and low voltage in the distribution networks. Construction of a new 220 kV substation at Agdash with two 125-megavolt-ampere (MVA) transformers was also required.

3. Funding for essential maintenance and the introduction of new technology in the power sector was inadequate, resulting in deterioration in infrastructure and service quality, and increasing the likelihood of systemic network collapse. In addition, the power system had a shortage of peaking power. Hydropower plants, with only 19% of capacity available and low reliability because of aging equipment, could not meet peak demand. Thermal power plants were used instead, reducing the efficiency and stability of generating units and causing excessive fuel consumption. Electricity was also imported from abroad to meet peaking needs.

4. About 49% of the Azerbaijan’s 8.5 million people lived in rural areas, often with insufficient access to quality basic services. The lack of sufficient power, gas, and heat aggravated regional imbalances in the country. Some areas received only a few hours of electricity a day and there were frequent localized outages and occasional widespread system failures. The unreliable electricity supply was a constraint to business activity and daily life. Almost 7% of annual sales were lost because of power outages. Poor quality and unreliable electricity supply inhibited industrial, agricultural, and commercial activities, constraining economic growth and employment opportunities.

5. The Power Transmission Enhancement Project1 was intended to address these issues through new transmission lines, a new substation and expansion of an existing substation, project management support, and institutional strengthening of Azerenergy Open Joint-Stock Company (Azerenergy). The project was designed to promote the country’s economic development by strengthening infrastructure, removing the power transmission bottleneck, and

1 ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the

Republic of Azerbaijan for the Power Transmission Enhancement Project. Manila.

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improving service efficiency. Strengthening the backbone of the power transmission network was crucial to ensure power supply stability for consumers in the main Azeri industrial and economic hubs.

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation

6. In 2006, a comprehensive energy sector road map was prepared with the support of the Asian Development Bank (ADB), 2 which identified three key areas for ADB assistance: (i) rehabilitation of the power grid for improvement of power supply quality and reduction of losses, (ii) development of renewable energy, and (iii) improvement of demand-side energy efficiency and energy conservation. The government expressed interest in cooperating with ADB to address these issues at a time when ADB was exploring suitable investment projects through public and private sector operations. The power transmission subsector in Azerbaijan had substantial investment demands in terms of strengthening the power grid, reducing losses, enhancing energy efficiency, and minimizing environmental impacts.

7. The principle objectives of the government in the power sector were to use domestic energy resources efficiently, protect the country’s energy security, and ensure the delivery of reliable and adequate electricity services. To accelerate power sector reform and development, the government developed an overall policy framework for the power sector with the following components: (i) sector restructuring to separate the ownership and management of generation, transmission, and distribution; (ii) development of a regulatory framework and institutions to promote competition and ensure the financial viability of sector enterprises; (iii) introduction of targeted social protection programs to mitigate the impact of higher tariffs on vulnerable groups; and (iv) involvement of the private sector in the operation and financing of generation and distribution facilities.

8. The government also recognized the importance of using energy resources efficiently and acknowledged that the delivery of affordable utility service of acceptable quality was an essential requirement for enhancing living standards. Consequently, the government developed a program for the development of the fuel and the energy sectors in Azerbaijan (2005–2015),3 with specific development targets. The program envisaged developing the power sector through restructuring; expansion of generation and transmission facilities, including the construction of new substations and transmission lines; and introduction of a modern management system. On 10 February 2015, the Government of Azerbaijan issued a Presidential Decree partly unbundling the power sector, in which all power distribution assets and functions are to be separated from the Azerenergy and transferred to Azerishiq Open Joint-Stock Company (Azerishiq) (formerly “Bakielektrikshebeke” Joint Stock Company–Baku Power Network). The unbundling will enable Azerenergy to concentrate on power transmission and generation. Transparency will also be improved by separating cost centers into different companies. This reflects the government’s commitment to accelerate difficult but much-needed sector reforms.

9. The energy sector was identified as a priority area for ADB intervention. The 2006, country strategy and program update for Azerbaijan indicated the government requested ADB support relating to energy. 4 The power transmission enhancement project was a strategic

2 ADB. 2006. Preparation of Energy Sector Roadmap for Azerbaijan. Manila.

3 Cabinet of Ministers. 2005. State Program for Development of Fuel and Energy Sector in Azerbaijan (2005–2015).

Baku. 4 ADB. 2006. Country Strategy and Program Update (2006): Azerbaijan. Manila.

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government priority and was in line with ADB’s country strategy and energy policy.5 At the same time, private sector funding in Azerbaijan was not sufficient to fully rehabilitate the power system. Therefore, ADB assistance was intended to help fill the funding gap, and help the government and development partners improve structural, legal, and regulatory frameworks until Azerbaijan was able to attract private sector funding to the sector.

10. The design of the project was sound and addressed the main issue of severely deteriorated strategic transmission lines and the need for rehabilitation on a priority basis. The project was also expected to contribute to optimizing domestic energy resource use, and the reduction of fossil fuel consumption and power imports. Hydropower energy generated in the western region was not delivered efficiently to the central region, where demand was rapidly increasing. Replacement of the 220 kV transmission lines was expected to increase output from the existing Mingechevir hydropower station from 360 MW to its optimal level of 420 MW. Thus, peak power supply was expected to increase, while electricity generated from the gas- and oil-fired plants in the central and eastern regions was reduced.

11. The formulation process included technical assistance to review the project prefeasibility study and refine the project design.6 The assistance was well detailed in terms of strengthening the financial, economic, environmental, and social assessments; addressing key issues; and preparing the engineering design.

B. Project Outputs

12. The expected (appraisal) and actual outputs of the project are detailed below; the project framework—including expected and actual project impacts, outcomes and outputs—is in Appendix 1. The 220 kV transmission line, the 220/110 kV Agdash substation, and the expansion of the Absheron substation components were implemented under a turnkey contract (contract 1). All contract 1 outputs were commissioned in December 2013.

1. 220 kV Transmission Line

13. The project was to construct a 220 kV double-circuit transmission line from Mingechevir hydropower plant to Absheron substation with a total length of about 280 kilometers (km). The new transmission line was to increase the transmission capacity by 300 MW, remove transmission network constraints, and reduce transmission losses. A double-circuit 220 kV transmission line was constructed that was divided into three sections: (i) Absheron–Agshu (99 km), (ii) Aghsu–Agdash (70 km), and (iii) Agdash–Mingechevir (54 km). A change in scope in March 2010 added the Absheron–Khurdalan section (24 km) for a total of 247 km.7 The first circuit connected the 220 kV switchyard at the Mingechevir hydropower station with the new Agdash substation, Agshu substation, and Absheron substation. The second new circuit connected the 220 kV switchyard at the Mingechevir hydropower station with the Agdash substation and the Gebala substation with the Absheron substation.

2. 220/110 kV Agdash Substation

14. The project was also expected to construct a new 220/110 kV substation at Agdash and install two transformers units, each with a capacity of 125 MVA, switches, breakers, protection,

5 ADB. 2000. Energy 2003: Review of the Energy Policy. Manila (adopted in 2000).

6 Small-scale technical assistance for the Power Transmission Enhancement Project.

7 This minor change is scope was included because of the substantially lower cost of the project and consequent

loan savings. The change in scope was justified on the basis that the component was an integral part of the transmission system expansion and the government’s investment plan to deliver electricity to more end users.

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communication and control devices, and associated 110 kV transmission lines in the vicinity of the substation. The new 220/110 kV substation at Agdash was constructed about 50 km east of the town of Mingechevir. It comprised a 220 kV outdoor switchyard in a double busbar arrangement; a 110 kV outdoor switchyard in a double busbar arrangement; two 220/110/10 kV, 125 MVA autotransformers; protection, control and telecommunication systems; an auxiliary system comprising AC and DC distribution panels, two auxiliary transformers, a battery set, and two rectifier systems; and a control building. Also, six 110 kV single-circuit transmission lines (total length of about 70 km) were constructed for connecting the Agdash substation to the grid.

3. Expansion of Absheron Substation

15. The project was to install an additional transformer with a capacity of 400 MVA, along with circuit breakers. At project completion, an additional 330/220 kV transformer with capacity of 400 MVA and related switchgear feeders was installed. Protection relays at the Absheron substation and cabling for the 220 kV switchgear were also installed. The 220 kV switchyard at Absheron was extended and rearranged, including four feeders that were partly rehabilitated and one new spare feeder, along with protection and control for the five new feeders.

4. Change in Scope and Outputs Not Included at Appraisal

16. The price for contract 1 was substantially lower than the original cost estimate of $150 million and loan savings of $63.8 million were realized. The original cost estimate for the turnkey contract was made in early 2008 based on prevailing prices in international markets. Contract bids were prepared in September 2009. The global financial crisis in 2008 and the consequent downturn in economic activity led to a substantial reduction in major equipment and material costs. A single turnkey contract was awarded to a domestic contractor who offered the lowest prices. Consequently, Azerenergy requested ADB to approve using the savings to finance additional components under the project. Due diligence assessment on environmental and social impacts in accordance with ADB’s Safeguard Policy Statement, 2009 was conducted for the additional subprojects. All mitigation measures as agreed for the project applied to the additional components. The major change of scope was approved by ADB in May 2010. These components were implemented under a turnkey contract (contract 2 in this report) and comprised the following:

(i) procurement, design, supply and installation of a 220 kV Shimal–Absheron transmission line, comprising the following items: a. erection of three 220 kV transmission line sections that pass through Baku,

Absheron and Sumgait provinces (total length of 97 km); b. construction of a new 220/110 kV/10 kV substation at Zabrat; c. interconnection between 11 existing 110 kV overhead lines and the Zabrat

substation using 11 new single-circuit overhead lines (total length of about 100 km);

d. installation of three intermediate 220 kV and one intermediate 35 kV underground cable connections including joints, terminations, lightning arrestors, earthing, and testing;

e. extension of two line feeders, including busbar extension and protection and control at the Hovsan substation;

f. extension of two line feeders including busbar extension and protection and control at the Sanaye−Qovshagi substation; and

g. training; (ii) supply and installation of control system and load shedding system at the

Khurdalan substation for the 110 kV switchyard, 14 feeders, and all cabling;

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(iii) supply and installation of protection relays at remote substations at Khurdalan, Aghsu, Gebala and Mingechevir; programmable logic controller equipment at the Gebala substation; and cabling; and

(iv) spare parts.

17. All contract 2 components were successfully implemented. A 97 km double-circuit 220 kV transmission line from Shimal power plant to Hovsan, Zabrat, and Sanaye−Qovshagi was constructed. At Zabrat, two 180 MVA autotransformers were installed and three 220/110 kV substations at Khurdalan, Hovsan and Sanaye-Qovshag were expanded and rehabilitated, including extension of line feeders, and protection and control systems. Interconnection between 11 existing 110 kV transmission lines and Zabrat substation by 11 newly constructed single-circuit overhead lines (total length of 100 km) was completed and these are in operation. Three intermediate 220 kV and one intermediate 35 kV underground cable connections (including joints, terminations, lightning arrestors, earthing and testing) were completed and are also in operation. Commissioning occurred in December 2013. The impact of the change in scope on the project cost is discussed in para. 21, and on the implementation schedule in paras. 27–29.

5. Project Management Support

18. Under the project, international consultants were to be engaged to assist Azerenergy in procurement and bidding for the tendering of design, supply, and installation contracts; implementation supervision; and other capacity building support. The implementation consultant’s contract included 52 person-months of international and 24 person-months of national consultant services.

6. Institutional Strengthening

19. The project was intended to strengthen Azerenergy staff capacity through on-the-job training on (i) project management, including procurement, contract management, financial management, accounting, and auditing; (ii) transmission and substation operation and maintenance (O&M); (iii) environmental management; and (iv) social safeguard implementation. The contractor, along with the project implementation consultants, provided training in the O&M of the new plant. Training was also conducted for 14 days for 18 persons on maintenance of circuit breakers, operation of the control system, and protection. Training was repeated for 1 week after 6 months of successful operation of the substations. Training was sufficient for personnel to operate and adequately maintain the new facilities. Five Azerenergy staff were also trained in ADB’s new environmental and social safeguards guidelines and assessment. Five project management unit (PMU) staff were also trained in procurement and financial management by project implementation consultants; and 15 staff in the investment management department were trained in financial management.

20. With support from ADB and other donors, Azerenergy is following the corporate reform agenda to improve corporate governance and operational efficiency. Key achievements to date include (i) adopting in full the International Financial Reporting Standards, (ii) enhancing institutional capacity through engagement of better-qualified staff and improvement of business administration processes, (iii) improving the functioning of information technology and information systems, and establishing an e-documentation system,8 (iv) engaging international

8 For document registration, preparation, circulation, and dissemination of incoming documents in electronic form.

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credit rating agencies (Fitch and Standard and Poors) to obtain a corporate credit rating, and (v) engaging international consulting firms to develop a long-term power sector master plan.

C. Project Costs

21. The cost of the project was estimated at $240.0 million equivalent at appraisal, including taxes, duties, physical and price contingencies, interest during construction, and other charges. Actual project costs at project completion amounted to $187.2 million, or 78% of the estimated cost. The cost estimates were reasonable at the time they were made. The lower cost at completion was mainly due to (i) lower-than-expected bids under the international competitive bidding system (para. 16); (ii) non-utilization of physical and price contingencies of $37.90 million; and (iii) actual interest during construction was lower than the estimated $3.4 million. Details of estimated and actual project costs by component are in Appendix 2. A reallocation of funds was made to reflect the financing of an additional component (approved as a major change in scope in May 2010).

22. ADB approved a loan to Azerenergy for $160 million from its ordinary capital resources to help finance the project. The ADB loan had a 25-year term, including a grace period of 5 years, an interest rate determined in accordance with ADB’s London interbank offered rate-based lending facility, a commitment charge of 0.15% per annum, and other terms and conditions that were detailed in the loan and guarantee agreements. The Government of Azerbaijan provided a sovereign guarantee, with the foreign exchange risk borne by Azerenergy. Azerenergy was to finance the remaining costs—including consulting services, local taxes and duties, interest during construction, and contingencies—from its own resources, for an estimated $80 million. At completion, total project cost was $187.2 million, with ADB financing $154.1 million and Azerenergy financing the balance of $33.1 million. The lower capital cost of the project had a positive impact on economic and financial viability (paras. 51 and 53, Appendixes 8 and 9).

D. Disbursements

23. Loan proceeds were disbursed in accordance with ADB’s Loan Disbursement Handbook (2007, as amended from time to time) and the loan was fully disbursed by 16 June 2014. Total disbursements under the loan were $154.06 million compared with $160.00 million specified in the loan agreement, or 96% of the approved loan amount. The first disbursement (advance payment for initial civil works) took place on 14 December 2009, 11 months after loan effectiveness and 39 days after the first contract award. The amount cancelled was $5.94 million.

24. The disbursements projected at appraisal were not followed as a result of the additional scope introduced to the project in 2010. Actual disbursements versus revised projections, after approval of the additional scope, averaged about 84%. The actual yearly disbursement schedule is shown in Appendix 3.

25. The loan agreement provided for the establishment of an imprest account in accordance with ADB’s Loan Disbursement Handbook, but no imprest account was established. The project was implemented under two turnkey contracts, with all payments to contractors made using the direct payment procedure.

E. Project Schedule

26. At appraisal, the project was to be implemented from January 2009 to December 2011, with the loan utilization period expected to end in June 2012. Detailed engineering designs, surveys, and investigations were to start in the fourth quarter of 2008 and civil works in the

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second quarter of 2009. The loan agreement was signed on 6 December 2008 and the loan became effective on 26 January 2009. The loan was scheduled to close on 31 December 2011, but closed on 31 December 2013 after three extensions. An implementation schedule showing the estimated and actual timing of activities under the project is in Appendix 4. The chronology of major events is in Appendix 5.

27. The delay in project implementation was caused by several factors. The scope of the project was expanded in May 2010 to use the surplus loan proceeds. The contractors’ initial progress was slow as a result of additional time that was devoted to engineering design, and mobilization of equipment and labor. Additional civil works were needed at several substations because of unexpected geological structures. Azerenergy changed design standards, which required an increase in the quantity of raw materials, and caused a 4-month delay in the delivery of additional steel structures.

28. Implementation of the Mingechevir–Absheron transmission line was delayed by about 8 months, as a result of (i) late mobilization of the contractor; (ii) lack of sufficient labor; (iii) adverse weather conditions in the winter of 2010–2011 that (a) affected access to work locations, and (b) produced unexpected underground water that resulted in the need for additional pilings to strengthen foundations of the control building in Agdash substation; and (iv) additional work required on the line route. Moreover, work on the transmission line stopped for 3 months in 2011 due to unavailability of material and equipment for the stringing of the conductor and optical ground wire.

29. Implementation delays in the Shimal–Absheron transmission line resulted from routing changes around Masazyr Lake and Saray village. The route was changed to cross the lake and avoid populated areas. State-owned land compensation arrangements and landholder negotiations took more time than expected. Also, the transmission line encountered right-of-way problems in military areas.

F. Implementation Arrangements

30. At appraisal, Azerenergy was to be the executing agency. ADB assessed the capacity of Azerenergy and concluded that its staff was able to undertake project implementation, given their technical skills and experience with projects financed by multilateral development institutions. A financial management assessment undertaken during project preparation indicated Azerenergy had satisfactory management capacity and systems for financial and account management, reporting, auditing, and internal controls. As intended at appraisal, a PMU was established, headed by a project manager (head of the Foreign Economic Relations Department), with suitably qualified staff in procurement; contract supervision and management; social and environmental management; and financial management including accounting, financial reporting, loan disbursement, and external auditing. The PMU reported to the chief engineer of Azerenergy, and was responsible for day-to-day project implementation.

31. The project was managed in accordance with arrangements agreed at appraisal. There were no major changes in the arrangements and arrangements were adequate. Overall, implementation arrangements were satisfactory.

G. Conditions and Covenants

32. The loan agreement covenants were for the most part relevant. While a number of these covenants were generally complied with (Appendix 6), compliance was delayed in a number of cases. The more significant covenants that were partially complied with are:

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(i) Financial management. (a) Schedule 5, para. 4: the tariff policy was not implemented; (b) Schedule 5, para. 6(a): the gearing ratio was complied with in 2013 and 2014 but was not complied with in 2012 (it was 76.5%, above the 70% threshold); and (c) Schedule 5, para. 10 (iii): the collection rate was 88% in 2014, 91% in 2013, 89% in 2012, 90% in 2011, 95% in 2010, 83% in 2009, and 75% in 2008;

(ii) Government. Schedule 5, para. 10: The medium-term tariff policy reform was not implemented; and

(iii) Performance monitoring and evaluation. Schedule 5, para. 16: specific performance indicators and data for the project areas, such as annual electricity supply outages, losses, and O&M costs were not established in a systematic manner as envisaged, although statistics for transmission lines and substations operation are recorded by the Azerenergy dispatch center.

33. The debt service coverage ratio (DSCR) was set based on information available and assumptions made during appraisal. At the request of Azerenergy ADB waived compliance for 2012 and 2013 with the covenant (Schedule 5, para. 6[a]) that the DSCR equal 1.5 from 2012. Azerenergy was able to improve cash generation from operations so that it almost complied with the DSCR covenant in 2012 and 2013; ADB recognized the improvement in Azerenergy’s cash generation and granted a waiver for the covenant for 2012 and 2013. The covenant remains relevant and important for the financial health of the executing agency. ADB is continuing its interventions in the power sector, and a series of power sector reforms are ongoing. Distribution assets and liabilities have been transferred to Azerishiq (para. 8). These actions are expected to substantially improve Azerenergy’s financial performance.

34. The non-implementation of the medium-term tariff policy impacted Azerenergy operations (para. 57). 35. The partial compliance with the monitoring and evaluation (M&E) system covenant created difficulties in measuring the impact, outcomes and benefits of the project, especially the system loss reduction and project-related savings in O&M costs. Although the effectiveness or the efficiency of the project is not affected by partial compliance, it renders measurement of effectiveness and efficiency difficult or impossible. This is an important covenant and ADB review missions should have sought to ensure it was fully complied with.

H. Consultant Recruitment and Procurement

36. Consultant recruitment. Selection of the project implementation consultant was carried out by Azerenergy and financed from its own resources. At appraisal, the executing agency had already engaged an international consulting firm under a transmission line project financed by Kreditanstalt fur Wiederaufbau. The consultant, MVV decon GmbH of Dusseldorf, Germany, was subsequently engaged after inviting technical and financial proposals. The selection procedure complied with ADB’s single source selection method.9 The consultant’s experience and competence were assessed and found adequate for the assignment. A 38-month contract for €700,000 was awarded on 13 June 2008. Consulting services began in 2008 for (i) project management, (ii) feasibility studies, (iii) site supervision, and (iv) capacity building. The implementation consultant’s contract included 27 person-months of international and 14 person-months of national consulting services for contract 1.

9 Single-source selection was considered appropriate and cost effective, given that the consulting firm had been

selected through international competitive bidding, had the required professional qualifications, and the scope of services was consistent with the project.

9

37. The first contract variation was made on 29 October 2009 for additional services (25 person-months of international and 10 person-months of national consulting services) for preparation of a feasibility study and tender documents, evaluation of bids, and site supervision related to two 220 kV transmission lines that were part of contract 2. Implementation delays required that the services of the consultant be extended, and a second variation was signed to extend the contract to 1 April 2012.10 A third contract amendment was signed on 30 January 2014 to extend the contract to 30 April 2014 and allow for time for project acceptance certification and preparation of the project completion report. A total of 76 person-months of consulting services were provided, comprising 52 person-months of international and 24 person-months of national services, at a total cost of $2.20 million equivalent.

38. Procurement. Contracts for the procurement of goods and works were conducted in accordance with ADB’s Procurement Guidelines using international competitive bidding and the single-stage, one-envelope bidding procedure.

(i) Contract 1. The estimated contract cost was $150.00 million. Draft bid documents were submitted to ADB for comments on 22 February 2009. After incorporating their comments, an invitation for bids was issued on 13 May 2009. Bids were received from 5 of the 19 firms who purchased bid documents; these were opened on 11 August 2009, and reviewed and evaluated in detail. A bid evaluation report was submitted to ADB in September 2009 and approved in October 2009. The contract for $87.03 million was awarded to the consortium of Azenco Joint Stock Company (Azerbaijan) and AREVA Energietechnik GmbH (Germany) on 6 December 2009. 11 A contract variation approved in March 2010 for extending the 220 kV transmission line to Absheron–Khurdalan and upgrading the associated substations increased the total contract amount to $96.20 million.

(ii) Contract 2. The draft bid documents for the estimated $60.00 million contract were submitted to ADB for comments on 23 February 2010. After incorporating their comments, an invitation for bids was issued on 6 April 2010. Bids were received from 4 of the 14 firms who purchased bid documents; these were opened on 25 May 2010, and reviewed and evaluated in detail. A bid evaluation report was submitted to ADB in May 2010 and approved by ADB in August 2010. The contract for $58.95 million was awarded to Azenco Joint Stock Company (Azerbaijan) with subcontractor ABB Finland on 20 September 2010.

39. The summary of contracts awarded and disbursements made under the loan is in Appendix 7.

I. Performance of Consultants, Contractors, and Suppliers

40. Consultants. Consulting services covered the preparation of bidding documents, assisting Azerenergy’s PMU in bid evaluation, reviewing detailed engineering designs, and providing assistance with construction supervision and technical support. The consultancy team

10

More time was spent on engineering design for additional subprojects; there was also unexpected additional scope of civil works in substations resulting from complex geological conditions.

11 The Transmission Division of AREVA Energietechnik GmbH (Germany) was purchased by ALSTOM Grid GmbH in 2010 and, consequently, the transmission activities and contractual obligations of AREVA relating to contract 1 were transferred to ALSTOM Grid GmbH on 31 January 2011.

10

comprised seven international experts (a project manager and substation engineer, an overhead line engineer, a substation engineer, a site engineer and supervisor, a civil engineer, a communications and system control and data acquisition specialist, and a protection engineer), and two national experts in civil and electrical engineering. The consultant satisfactorily fulfilled the terms of reference and provided all staff inputs required under the contract. The consultant produced monthly reports for the PMU, assisted Azerenergy in preparing quarterly reports, and performed their responsibilities in a timely manner and within the budget.

41. Contractors. Contract 1 experienced delays in completion of about 20 months, and contract 2 delays of about 18 months (paras. 27–29). Remedial measures were taken to recover from the initial delays and accelerate the work (e.g., the contractor mobilized more working teams and equipment in six sections to simultaneously work on erecting towers and stringing conductors, a control time schedule was prepared, and milestones were agreed to). The transmission lines and substations were inspected and commissioned by the consultant and Azerenergy; tests showed they were of high quality, and met the technical specifications. The work quality and overall performance of the contractors were satisfactory. AREVA demonstrated strong capacity and professional practice in executing the contract, while Azenco needs to strengthen its management, improve efficiency, and accelerate preparation of field surveys and engineering designs.

42. Suppliers. Substation equipment and other electrical equipment were generally delivered on schedule. Transmission line materials for both contracts were sometimes delayed due to the contractor’s late orders. The untimely delivery of steel structures often hindered project progress. Azerenergy and the consultant conducted inspections and tests to ensure that equipment was in good condition and complied with the technical specifications before acceptance. The performance of suppliers was generally satisfactory.

J. Performance of the Borrower and the Executing Agency

43. Azerenergy was the borrower and the executing agency for the project. A comprehensive assessment of the executing agency’s technical and financial capabilities was made at appraisal. Azerenergy successfully implemented and completed the project with advisory assistance from the implementation consultants. Counterpart funds for the project were provided as needed in a timely manner. Azerenergy has been responsive and proactive in addressing various project implementation issues, regularly informed ADB about project implementation progress, and complied with ADB guidelines and national laws on the environment, land acquisition, and resettlement. Azerenergy was unable to improve its cash generation from operations to comply with the DSCR covenant in 2014 because the tariff was not increased to take into account fuel and other cost increases. Tariffs are the purview of the government and beyond the control of Azerenergy. The overall performance of Azerenergy is rated satisfactory.

K. Performance of the Asian Development Bank

44. Following the inception mission in early 2009, ADB fielded six review missions, followed by a project completion review mission in April 2015. ADB missions (with strong support from the Azerbaijan Resident Mission) regularly monitored project progress through review measures and quarterly progress reports, and provided useful advice in several areas, including procurement and project management. The missions also participated in progress meetings with Azerenergy and portfolio review meetings with the government, and visited project sites and assisted Azerenergy in resolving issues brought to its attention during procurement and implementation. ADB maintained good relations with the borrower and the consultant

11

throughout project execution, providing guidance and taking decisive actions to improve project implementation. Azerenergy appreciated ADB’s flexibility and timely action in response to its requests for a change in scope and extensions of the loan closing dates, which enabled Azerenergy to fully use the loan.

45. However, ADB should have been more attentive in ensuring that loan covenants were complied with, particularly the covenant related to project M&E. The partial compliance with the covenant for the M&E system created difficulties in measuring project impacts, outcomes and benefits. Nevertheless, ADB’s overall performance is rated satisfactory.

III. EVALUATION OF PERFORMANCE

A. Relevance

46. The project design is rated relevant. In 2007, Azerbaijan’s power sector was unreliable and the power supply inadequate because of deteriorating facilities, inadequate maintenance and rehabilitation, inadequate investment, and inefficient utilization of resources. This undermined industrial competitiveness and constrained economic growth.

47. The unreliability of the power system resulted in some areas of the country receiving only a few hours of electricity per day, with frequent localized outages and occasional widespread system failures. The unreliable electricity supply constrained daily life and business activity, inhibiting industrial, agricultural, and commercial activities and limiting economic growth and employment opportunities. Overall, the project design was sound and appropriate for achieving the stated outcomes, and addressed the main issue of severely deteriorated strategic transmission lines and the need for rehabilitation on a priority basis.

48. The project was in line with the government’s principal objectives in the power sector to use domestic energy resources efficiently, protect the country’s energy security, and ensure the delivery of reliable and adequate electricity services. It was also in line with the comprehensive energy sector road map prepared in 2006. B. Effectiveness in Achieving Outcome

49. The project is rated effective.

50. The expected project outcome was an expanded and strengthened 220 kV power transmission and distribution network backbone, with transmission bottlenecks removed and losses reduced. Success in achieving the outcome was measured by the following performance targets or indicators:

(i) transmission bottlenecks removed by 2012; (ii) power transmission capacity of the 220 kV grid increased by 300 MW in 2012; (iii) distribution capacity of 220 kV substations increased by 650 MVA by 2012; and (iv) reduction of transmission line losses by 95 GWh, from 6% in 2007 to 3% in 2012.

51. All the transmission bottlenecks were removed, and power transmission capacity of the 220 kV grid in the project areas was increased by 300 MW, from 100 MW in 2010 to 400 MW in 2014. The distribution capacity of 220 kV substations increased by 1,010 MVA by 2014.12 Transmission line losses were reduced by 95 GWh per year, from 6% in 2007 to 2.7% in 2014.

12

Including the addition of 400 MVA at Absheron substation, 250 MVA at Agdash substation, and 360 MVA at Zabrat substation.

12

C. Efficiency in Achieving Outcome and Outputs

52. The project is rated efficient. The economic internal rate of return (EIRR) for the project was re-estimated at 15.4%, higher than the threshold level of 12%. Costs included in the EIRR calculation included equipment and material costs, labor, and O&M costs associated with the new facilities. Benefits included the value of the reduction in electricity imports and system losses, and the increase in hydropower output. Actual and forecast reductions in system losses were provided by Azerenergy. Project benefits also included environmental benefits (valued at $37 per ton of carbon dioxide). Details of the re-evaluation of the EIRR are in Appendix 8.

53. In terms of process efficiency, the project was implemented without any major issues. Delays were caused by material and skilled labor shortages, and weather. However, these issues were relatively minor and unavoidable from an implementation perspective.

D. Preliminary Assessment of Sustainability

54. The sustainability of the project is rated less than likely. The recalculation of the financial internal rate of return (FIRR) for the project estimated the FIRR at 2.6% in real terms, compared with 11.7% estimated at appraisal, and lower than the weighted average cost of capital (WACC) of 4.3%.The corresponding financial net present value (FNPV) was calculated at –$48.5 million. Therefore, the project is not financially viable. However, the WACC and FNPV are based on ADB’s minimum rate test that requires a minimum of 4% return on debt or equity capital. Without application of the minimum rate test, the FIRR exceeds the WACC of –0.3% in real terms, the FNPV is positive, and the project could be deemed financially viable. The re-evaluation of the FIRR and FNPV are in Appendix 9. Financial benefits of the project were based on costs saved from reduced electricity imports, system loss reduction in terms of avoiding expenditures on fuel, and increased hydropower output. Azerenergy’s corporate income tax rate is 20%.

55. The financial performance of Azerenergy is becoming a concern. An assessment of Azerenergy’s financial position is in Appendix 9. Azerenergy’s profitability deteriorated substantially in 2014 as a result of increased fuel prices, which are a major cost component in the generation of electricity. These price increases were not accompanied by corresponding increases in the electricity tariff, thus affecting profitability. Azerenergy’s capitalization had a reasonable mix of debt and equity. When Azerenergy borrows to invest in the power system, the government regularly injects equity into the company. In 2014, the debt ratio was 38.9%, partly through a transfer on the balance sheet of long-term debt to current debt. The lack of tariff increases to offset cost increases may decrease Azerenergy’s ability to generate sufficient cash from its internal operations. Azerenergy did not meet ADB’s DSCR covenant in 2012 and 2013 by a small margin; in 2014, the DSCR declined sharply to 0.9. An increase in the electricity tariff is still urgently required, as debt repayments are expected to accelerate. Nevertheless, Azerenergy is a major institution in a sector of strategic importance to the government. It is in the government’s interest to ensure the financial soundness of Azerenergy, and it is expected that timely steps will be taken to maintain Azerenergy’s financial health. E. Impact

56. The impact of the project is rated moderate. The impact expected at appraisal was to improve the power transmission system to provide reliable and adequate electricity for sustained economic growth. Success in achieving the expected impact was assessed against the following performance targets or indicators, which were largely achieved, albeit with delays:

(i) annual electricity supply in the project area increased by 1,000 gigawatt-hours (GWh) by 2012;

13

(ii) annual average electricity outages reduced by 40 times, from 8–10 outages per year to 0.2 outages per year by 2012 (this was subsequently revised to one time per year by 2015);

(iii) transmission system operating and maintained in accordance with technical requirements by 2012;

(iv) optimization of power generation resource use through increased domestic hydropower production (by 200 GWh) and reduction of energy importation (by 650 GWh) by 2012; and

(v) annual net carbon dioxide emissions reduced by 1.3 million tons.

57. The project strengthened the national power transmission system and annual electricity supply through the power grid increased from 18,400 GWh in 2010 to 22,700 GWh in 2014, an average increase of 1,075 GWh per year. Annual average electricity outages (unplanned) in project areas were reduced from 13 in 2010 to none in 2014. The transmission system was operated and maintained in accordance with technical requirements by 2014. Replacement of the 220 kV transmission lines potentially increased output from the Mingechevir hydropower station from 360 MW to its optimal level of 420 MW. 58. However, targets (iv) and (v) were only partly achieved. Drought conditions over 2010-2014 decreased hydropower output at Mingechevir and elsewhere. Azerenergy data indicates that hydropower output for Azerenergy declined from 3,400 GWh in 2010 to 1,300 GWh in 2014; domestic hydropower production failed to increase by 200 GWh as projected in the project design and monitoring framework because of the drought conditions. However, electricity imports fell by 1,643 GWh (from 1,766.1 GWh in 2006 to 124.1 in 2014) because growing domestic demand for electricity was met by increased thermal generation. Net electricity export was achieved, with 365.2 GWh exported in 2014. With a strengthened power transmission network and expanded generation capacity, Azerenenergy is now able to continually increase power exports to neighboring countries. It is expected that the 500 kV cross-border transmission lines (the “Azerbaijan–Georgia–Turkey Power Bridge”) will deliver surplus power from Azerbaijan to Turkey though the Georgian Power Transmission System from 2016. The expected increase of hydropower production was not achieved. Transmission line losses were reduced by 95 GWh per year, which translates to annual net carbon dioxide emission reductions of 0.06 million tons,13 below the expected target of 1.3 million tons. This target was partly achieved. 59. Environmental impact. Azerenergy undertook measures to minimize the project’s impacts on the environment. The contractor carried out construction activities in accordance with an environmental monitoring program and management plan, which was updated by Azerenergy’s Ecology Department. During project implementation, a specialized team was established comprising staff from the Ecology Department and the contractor’s social impact analyst to manage environmental and social issues and to monitor the impact of civil works on areas near and around the project. The team closely interacted with local authorities and regional municipalities, and visited community sites and villages. It disseminated information about the project—the purpose; area of impact; environmental, socioeconomic and demographic impacts; construction stages; and compensation issues. Azerenergy also signed a contract with Azerbaijan Scientific Research and Design Prospecting Power Engineering Institute, a subsidiary of Azerenergy, to assist with monitoring during project implementation.

13

Carbon dioxide emission reduction is calculated by energy loss reduction x the emission factor, or 95,000 MWh/yr x 0.617 tons of carbon dioxide equivalent/MWh = 58,615 tons of carbon dioxide equivalent per year.

14

60. Air quality and noise in the construction area were tested and regularly monitored during implementation; noise, dust, carbon monoxide and carbon dioxide in the construction area were within acceptable norms. Transformers and other equipment used in the project were free of polychlorinatedbiphenyls. Initial environmental examinations concluded that environmental impacts of the project were minor. The contractor adjusted work schedules in agricultural areas to avoid construction during harvest seasons. Olive trees that were destroyed were replanted. Construction was undertaken during fallow periods and materials were stored within the construction site to avoid negative impacts to soil and crops. The contractor avoided random disposal of waste generated from the construction activity. Construction activity in the Masazyr Lake area was in compliance with methods and instructions for field operations.

61. Social impact. Azerenergy was responsible for land acquisition and resettlement of persons affected by the project. Transmission line alignments were selected to avoid crossing villages or other settlement areas and agricultural land. Towers were dismantled and installed piece by piece to avoid negative impacts on nearby houses. A total of 2.28 hectares of land was used temporarily, affecting 10 households and 30 people, during tower assembly. Compensation of AZN65,880 was agreed to and paid. The project was classified as category “C” at appraisal for involuntary resettlement. No permanent negative impacts were recorded, and resettlement was avoided. Support for low-income residents was provided by involving them in the construction of the transmission lines and substations; these included youth who were receiving welfare. Grievances were handled by representatives of the Azerenergy Ecology Department, together with the heads of local authorities, who negotiated a resolution with the affected persons.

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS

A. Overall Assessment

62. The overall rating of the project is successful. Appendix 10 provides a breakdown of the scoring of criteria and rating ranges. The project was relevant because it addressed a key sector issue: improvement of power supply reliability and adequacy. The project was in line with the government’s principal objectives of using domestic energy resources efficiently, protecting the country’s energy security, and ensuring the delivery of reliable and adequate electricity services. The energy sector was also identified as a priority area for ADB intervention.

63. The project was rated effective because it achieved the outcome expected at appraisal. Project outputs were expanded because of loan savings, which were applied to further investment in the transmission system to increase its capacity and improve reliability. The project was efficient: the EIRR was greater than 12% and the project was implemented efficiently without major delays. Sustainability is less than likely, because the FIRR is below the WACC as defined by ADB, and the financial position of Azerenergy is becoming a concern.

64. The impact of the project on the environment was moderate. Similarly, the project complied with social safeguards guidelines and there was little disruption to the lives of those in the project area. The performance of Azerenergy and ADB was satisfactory. B. Lessons

65. The project demonstrated that Azerenergy is a capable implementing agency for power projects and that there is private sector capacity to undertake major construction projects related to augmentation and rehabilitation of power transmission and distribution networks. With proper planning, effective project monitoring mechanisms, and motivated and well-trained personnel, such projects can be successfully and expeditiously implemented. The government,

15

with the assistance of ADB, should continue to upgrade and expand the transmission and distribution networks to ensure system losses are minimized, electricity supplies are reliable, and the growing demand for electricity in the country is met. 66. There was some confusion in Azerenergy about the correct approach to use in calculating the debt–equity ratio and the DSCR. Financial ratios should be defined in loan covenants, particularly if they form part of the financial covenants of the loan. Moreover, ADB should more closely review these covenants during review missions to evaluate—and if needed initiate measures to ensure—compliance.

67. To enhance its operational and financial performance, Azerenergy is (i) streamlining its core business and transferring distribution networks assets and liabilities to Azerishiq, which will improve its financial performance and reduce administrative expenses; (ii) expanding power export to Georgia, Turkey and Russia; (iii) introducing enterprise resource planning, and enhancing internal audit and control to improve budgeting and planning functions; and (iv) accessing capital markets and diversifying financing channels (Azerenergy successfully obtained a corporate credit rating of BBB-/A-3 in February 2013).

C. Recommendations

1. Project Related

68. Further monitoring. All project components were successfully implemented and are operating without problems. Azerenergy has a long and successful record of operating and maintaining the transmission system, so future project monitoring by ADB is not required.

69. However, ADB should monitor, on an ongoing basis, the financial performance of Azerenergy and provide advice on electricity tariffs in case future ADB lending is contemplated. Revenues should cover costs, and the gearing ratio and debt service covenants should continue to be complied with. Electricity tariffs are determined by the government, and close consultation with the authority responsible is thus also recommended. ADB may also consider setting the DSCR to 1.2 (which is sufficient to ensure debt repayments), instead of the current 1.5, in case of future lending assistance to Azerenergy.

70. Further action or follow-up. The project does not require any specific follow-up action by ADB. The reliability and performance of the project components are closely monitored by Azerenergy.

71. Timing of the project performance evaluation report. There are no major outstanding issues regarding the project. The project was implemented successfully and is operating as expected at appraisal, and a project performance evaluation report may not be required.

2. General

72. Partial compliance with the M&E system covenant created difficulties in measuring the project impact, outcomes and benefits, especially the system loss reduction and savings in O&M costs that the project achieved. Non-implementation of M&E systems is common with many ADB projects; staff in charge of administering a project, their supervisors, and other ADB departments should pay close attention to the M&E requirement and ensure the executing agency complies with the covenant.

16 Appendix 1

PROJECT DESIGN AND MONITORING FRAMEWORK

Design Summary

Performance Target/Indicators

Specified at Appraisal

Revised Performance

Target/Indicators

Actual Achievement at Project Completion

Impact Improved power transmission system that provides reliable and adequate electricity for sustained economic growth.

Annual electricity supply in the project area increased by 1,000 GWh by 2012. Annual average electricity outages reduced by 40 times, from 8–10 times per year to 0.2 times per year by 2012. Transmission system operating and maintained in accordance with technical requirements by 2012. Optimization of power generation resource use through increase of domestic hydropower production by 200 GWh and reduction of importation energy by 650 GWh by 2012. Annual net CO2

emissions reduced by 1.3 million tons.

Annual electricity supply in the project area increased by 1,000 GWh by 2015 from 15,580 GWh in 2010. Annual average electricity outages reduced from 8−10 times per year in 2010 to 1.0 time per year by 2015.

Achieved. Power transmission system has been strengthened and the annual generation energy evacuated through the power grid increased from 18,400 GWh in 2010 to 22,700 GWh in 2014, an average increase of 1,075 GWh per year. Achieved. Annual electricity outages (unplanned) in the project areas were reduced from 13 times in 2010 to none in 2014. Achieved. The transmission system was operated and maintained in accordance with technical requirements by 2014. Partly achieved. Replacement of the 220 kV transmission lines potentially increased output from the Mingechevir hydropower station from 360 MW to its optimal level of 420 MW. Domestic hydropower production did not increase by 200 GWh as expected because of the prolonged drought conditions, but electricity imports fell by 1,643 GWh by 2014. Partly achieved. The expected hydropower production increase did not occur, but ttransmission line losses were reduced by 95 GWh per year, resulting in an annual net carbon dioxide emission reduction of 0.06 million tons, below the original expected

Appendix 1 17

Design Summary



Revised Performance

Target/Indicators


target of 1.3 million tons.

Outcomes The capacity of the backbone 220 kV power transmission and distribution network is expanded and strengthened, with transmission bottlenecks removed and losses reduced.

Transmission bottlenecks removed by 2012. Power transmission capacity of the 220 kV grid increased by 300 MW in 2012. Distribution capacity of 220 kV substations increased by 650 MVA by 2012. Reduction of transmission line losses by 25 GWh, from 6% in 2007 to 3% in 2012.

Power transmission capacity of the 220 kV grid increased by 300 MW in 2013 from 100 MW in 2010.

Distribution capacity of 220 kV substations increased by 1,000 MVA by 2013 from 3,100 MVA in 2010.

Transmission losses reduced by 25 GWh, from 5% in 2010 to 3% in 2013.

Achieved. Achieved. All transmission bottlenecks were removed and power transmission capacity of the 220 kV grid in the project areas was increased by 300 MW, from 100 MW in 2010 to 400 MW in 2014. Achieved. The distribution capacity of 220 kV substations increased by 1,010 MVA by 2014. Achieved. Transmission line losses were reduced by 95 GWh per year, from 6% in 2007 to 2.7% in 2014.

Outputs 1. Construction of a new double-circuit 220 kV transmission line. 2. Construction of a new 220/110 kV substation in Agdash with adequate

280 km double-circuit 220 kV transmission line from Mingechevir to Absheron.

Installation of two sets of autotransformers with a total capacity of 250 MVA and

300 km double-circuit 220 kV transmission line (Mingechevir− Absheron−Khurdalan) constructed by April 2012. 97 km double-circuit 220 kV transmission line from Shimal power plant to Hovsan, Zabrat, and Sanaye-Qovshagi constructed by March 2013. Two sets of autotransformers (i) in Agdash with a total capacity of 250 MVA

Achieved. 247 km of double-circuit 220 kV transmission line was constructed from Mingechevir to Absheron and included a 24 km segment from Absheron to Khurdulan. Transmission line was commissioned in December 2013. Achieved. 97 km double-circuit 220 kV transmission line from Shimal power plant to Hovsan, Zabrat, and Sanaye-Qovshagi was completed in December 2013. Achieved. A new 220/110 kV substation at Agdash was constructed, including two 220/110/10 kV,

18 Appendix 1

Design Summary



Revised Performance

Target/Indicators


facilities. 3. Expansion of Absheron substation. 4. Construction of associated 110 kV transmission lines in the vicinity of Agdash substation. 5. Capacity development activities for improving Azerenergy’s performance.

other equipment. Installation of one set of autotransformers with a capacity of 400 MVA, and other equipment. Erection of 110 kV transmission lines in the vicinity of Agdash substation.

Recommended social and environmental mitigation measures are well implemented. Implementation of Azerenergy operation improvement and

installed by June 2012 and (ii) in Zabrat of 350 MVA by March 2013. Expansion of autotransformers (i) in Absheron with a capacity of 400 MVA installed by December 2011; (ii) in Khurdalan by December 2011; (iii) in Hovsan by March 2013; and (iv) in Sanaye-Govshag by March 2013. New 110 kV transmission lines in the vicinity of Agdash substation by June 2012. At least 30 Azerenergy staff (males and females) are trained by end of 2012.

125 MVA autotransformers; at Zabrat, two 180 MVA autotransformers were installed. Completed in December 2013. Achieved. An additional 330/220 kV transformer with capacity of 400 MVA and related switchgear feeders were installed at the Absheron substation. In addition, three 220/110 kV substations at Khurdalan, Hovsan and Sanaye-Qovshag were expanded and rehabilitated including extension of line feeders, protection and control systems. All completed in December 2013. Achieved. Six 110 kV single-circuit transmission lines (total length of 70 km) to connect Agdash substation to the grid were completed and in operation by December 2013. In addition, interconnection between 11 existing 110 kV transmission lines and Zabrat substation by 11 newly constructed single-circuit overhead lines (total length of 100 km) was completed and in operation by December 2013. Three intermediate 220 kV and one intermediate 35 kV underground cable connections (including joints, terminations, lightning arrestors, earthing and testing) were completed and in operation by December 2013. Achieved. 15 Azerenergy staff were trained in technical matters related to the transmission system; 5 staff in ADB’s environmental and social safeguards guidelines and assessment; 5 PMU staff in procurement and financial management; and 15 Azerenergy Investment

Appendix 1 19

Design Summary



Revised Performance

Target/Indicators


training programs.

Department staff in financial management.

ADB = Asian Development Bank, GWh = gigawatt-hour, km = kilometer, kV = kilovolt, MVA = megavolt-ampere, MW = megawatt, PMU = project management unit.

Appendix 2 20

PROJECT COSTS ($ million)

Item Cost and Financing Estimate Actual Cost and Financing

Financing Financing

A. Base Costs Total ADB Azerenergy Total ADB Azerenergy Equipment and Materials 128.40 128.40 0.00 123.36 123.36 0.00 01A 220 kV Agdash substation 18.30 18.30 0.00 12.44 12.44 0.00 01B 220 kV transmission line (Mingechavir–Absheron) 101.80 101.80 0.00 56.10 56.10 0.00 01C 220 kV Absheron substation upgrading 8.30 8.30 0.00 12.27 12.27 0.00 01D Additional 220 kV transmission line (Shimal–Absheron)

a 17.50 17.50 0.00

01E Additional substationsa

25.05 25.05 0.00 Civil Works 34.20 28.80 5.40 30.70 30.70 0.00 02A 220 kV Agdash substation 3.10 3.10 0.00 6.57 6.57 0.00 02B 220 kV transmission line (Mingechavir–Absheron) 15.80 15.80 0.00 5.08 5.08 0.00 02C 220 kV Absheron substation upgrading 1.40 1.40 0.00 3.30 3.30 0.00 02D Dismantling work and local transport 8.50 8.50 0.00 0.31 0.31 0.00 02E Detailed engineering design 5.40 0.00 5.40 …

b 0.00

02F Additional 220 kV transmission line (Shimal–Absheron)a

7.12 7.12 0.00 02F Additional substations

a 8.32 8.32 0.00

Consulting Servicesc

1.01 0.00 1.01 2.20 0.00 2.20 Taxes and Duties 32.5 0.00 32.50 28.40 0.00 28.40 03A VAT 31.6 0 31.60 28.20 0.00 28.20 03B Customs duties 0.90 0.90 0.90 0.20 0.00 0.20 Total Base Cost 196.20 157.20 39.00 184.66 154.06 30.60 B. Contingencies 37.90 2.80 35.10 0.00 0.00 0.00 01 Physical contingencies 26.70 0.00 26.70 0.00 0.00 0.00 02 Price contingencies 11.20 2.80 8.40 0.00 0.00 0.00 C. Interest During Construction 5.90 0.00 5.90 2.50 0.00 2.50 Total Project Cost (A+B+C) 240.00 160.00 80.00 187.16 154.06 33.10 … = not available, ADB = Asian Development Bank, kV = kilovolt, VAT = value-added tax. a

Components resulting from a major change of scope. b Actual cost of detailed engineering design is subsumed in the cost of equipment, materials and civil works figures; separate figures are not available.

c Consulting services include environment handling costs.

Source: Asian Development Bank estimates.

21 Appendix 3

ANNUAL LOAN DISBURSEMENTS

($) Category

a 2009 2010 2011 2012 2013 2014 Total

Equipment and Materials 01A 220 kV Agdash substation 1,244,205 1,493,785 6,477,009 1,976,636 811,408 439,009 12,442,053

01B 220 kV transmission line (Mingechevir–Absheron) 4,613,469 7,774,977 20,481,976 12,597,144 3,682,357 6,979,804 56,104,727

01C 220 kV Absheron substation upgrading 1,104,521 2,263,689 6,243,367 1,181,516 13,668 1,461,947 12,268,707

01D Additional 220 kV transmission line (Shimal–Absheron) 0 1,741,456 1,345,980 12,797,056 0 1,604,730 17,489,221

01E Additional substations 0 2,672,666 5,839,841 11,669,210 903,660 3,968,326 25,053,703

Civil Works

02A 220 kV Agdash substation 416,561 0 1,945,642 2,652,502 19,328 1,531,478 6,565,511

02B 220 kV transmission line (Mingechevir–Absheron) 561,796 549,485 1,434,768 1,852,188 161,194 521,824 5,081,256

02C 220 kV Absheron substation upgrading 470,321 101,294 0 1,860,057 88,670 777,990 3,298,332

02D Dismantling work and local transport 288,400 25,750 0 0 0 0 314,150

02E Additional 220 kV transmission line (Shimal–Absheron) 0 712,485 0 5,340,535 158,320 911,161 7,122,501

02F Additional substations 0 768,466 0 6,008,221 7,936 1,536,181 8,320,805

Total funds disbursed 8,699,273 18,079,053 43,768,583 57,935,066 5,846,541 19,732,449 154,060,966

Cumulative disbursements 8,699,273 26,788,326 70,546,909 128,481,975 134,328,517 154,060,966

Cumulative disbursements (%) 5.6 17.4 45.8 83.4 87.2 100.0

kV = kilovolt. a Categories as specified in the loan agreement.

Source: Asian Development Bank Loan Financial Information System.

Appendix 4 22

ID Tasks

1 Loan Approval

2 Loan Effectivity

3 Advance Recruitment of Consultants

4 Appoint Supervision Consultants

5 Bidding documents preparation

6 Bidding for EPC contract

7 EPC Contract Award

8 220kV Transmission Linea

Detailed Engineering design

Civil Works and installation

Commissioning and testing

Start of commercial operation

9 Agdash Substationa




Start of full commercial operation

10 Expansion of Absheron Substation

Civil worksb

Equipment installation


11 Shimal-Dres Absheron (Transmission Line)c





12 Shimal-Dres Absheron (Substation)b





11 Loan Closing

a Including contract variation extending 220 kV transmission line Absheron-Khurdalan of 24 km and upgrade of associated substations.b

Acual civil works completion included equipment installation, and commissioning.

cAdditional scope.

Legend:

Milestone

Projected

Actual

PROJECT IMPLEMENTATION SCHEDULE, PROJECTED VERSUS ACTUAL

2013

Q1 Q2 Q3 Q4

2014

Q1 Q2 Q3 Q4

2011

Q1 Q2 Q3 Q4

2012

Q1 Q2 Q3 Q4

2008 2009 2010

Q1 Q2 Q3 Q4 Q1 Q2Q1 Q2 Q3 Q4 Q3 Q4

PROJECT IMPLEMENTATION SCHEDULE (PROJECTED VERSUS ACTUAL)

Appendix 5 23

CHRONOLOGY OF MAJOR MILESTONES

Jun 2008 Consultant contract signed with Azerenergy

9 Nov 2008 Consultants mobilized.

Dec 2008–Jan 2009 Contract 1: Mingechevir–Absheron–Khurdalan Draft bid documents preparation

2 Feb 2009 Draft bid documents submitted to ADB

24 Apr 2009 ADB approval of bidding documents

11 May 2009 IFB issued in ADB’s website

8 Jun 2009 Pre-bid meeting

13 Jul 2009 Bid closing

12 Aug 2009 Bid closing extension

9 Sep 2009 Bid evaluation report received

9 Oct 2009 ADB approved award of turnkey contract to JV of Azenco and Areva

28-29 Oct 2009 Contract negotiations

6 Nov 2009 Turnkey contract to JV of Azenco and Areva signed

15 Dec 2009 Advance payment made to JV contractor

1 Jan 2010 Contractors mobilized and contract effectivity

Jan 2010–Jul 2011 Substation: Detailed design, procurement and manufacturing

Jan 2010–Sep 2011 Overhead Lines: Detailed design, procurement and manufacturing

8 Mar 2010 ADB approved request for contract variation of 19 Feb 2010 to extend 220 kV transmission line Absheron–Khurdalan of 25 km and upgrade associated substations

Jan 2011–Dec 2013 Substation: Construction and Installation

Jul–Dec 2013 Substation: Testing and Commissioning

Jan 2011–Dec 2013 Transmission Overhead Lines: Construction, Overhead Lines

Jul–Dec 2013 Transmission Overhead Lines: Testing and Commissioning

Contract 2: Shimal Dres Absheron Transmission Line (Additional Scope)

Dec 2009 Feasibility Study

23 Feb 2010 Submission of draft bidding documents

29 Mar 2010 Final bidding document of Shimal Dres Absheron approved

6 Apr 2010 IFB issued

23 Apr 2010 Site visit and pre-bid conference

25 May 2010 Bid closing (extended for 3 times from 14 May 2010)

28 Jun 2010 Final BER received (draft received on 5 June 2010)

20 Aug 2010 ADB approved award of contract

21 Sep 2010 Contract signed between Azerenergy and Azenco

Mar–Sep 2011 Substation: Detailed design, Procurement and Manufacturing

Sep 2011–Dec 2013 Substation: Construction and Installation

Oct–Dec 2013 Substation: Testing and Commissioning

Mar–Sep 2011 Transmission Overhead Lines: Detailed Design, Procurement and Manufacturing

Oct 2011–Dec 2013 Transmission Overhead Lines: Construction

Oct–Dec 2013 Transmission Overhead Lines: Testing and Commissioning ADB = Asian Development Bank, BER = bid evaluation report, IFB = invitation for bids, JV = joint venture, km = kilometer, kV = kilovolt. Source: Asian Development Ban

24 Appendix 6

STATUS OF COMPLIANCE WITH LOAN COVENANTS

Covenant

Reference in Loan

Agreement Status of Compliance

IMPLEMENTATION ARRANGEMENTS

The borrower shall establish a PMU to be headed by a Project manager and staffed by specialists in technical, financial, procurement, social, and environmental matters. The PMU shall report to the Chief engineer or the Deputy President of the borrower.

Schedule 5, para. 1

Complied with. PMU established by the time inception mission was fielded in February 2009. Head of the Foreign Economic Relations Department acted as project manager and reported to the Chief Engineer.

The PMU shall be responsible for day-to day Project implementation including procurement, contract supervision and management, social and environmental management, and financial management including Project accounting, financial reporting, loan disbursements, and arrangements for external audits.

Schedule 5, para. 2

Complied with.

The borrower shall carry out the Project in accordance with the construction and installation drawings drawn up in line with the specifications in the engineering, procurement and commissioning contracts, and shall adhere to the relevant international practices and standards in the implementation of the Project.

Schedule 5, para. 3

Complied with.

FINANCIAL MANAGEMENT

The borrower shall ensure that (i) ADB is kept informed about the Guarantor’s announcements on the implementation of tariff policy reform, and (ii) it implements the tariff policy in accordance with its terms and defined timetable, so to achieve full cost recovery of its operations by 31 December 2010.

Schedule 5, para. 4

Not complied with. Medium term tariff policy for full cost recovery of the Borrower’s operations was not implemented.

In addition to the provisions of Section 4.05 of the Loan Agreement, the Borrower shall, within six (6) months of the end of each financial year, submit to ADB its consolidated financial statements (in respect of the company and its subsidiaries) drawn up in accordance with International Financial Reporting Standards, and audited by an international auditing firm acceptable to ADB.

Schedule 5, para. 5

Complied with delay. Audited financial statements for the following financial years were received: a) 2009 on 16 July 2010, b) 2010 on 23 June 2011, c) 2011 on 12 April 2012, d) 2012 on 11 April 2013 , e) 2013 on 25 April

Appendix 6 25

2014 , and f) 2014 on 12 May 2015 Audited reports were compliant with International Financial Reporting Standards. Azerenergy has engaged independent auditors acceptable to ADB for the audit of its project accounts and consolidated financial statements annually. The auditor’s terms of reference was shared with ADB.

Within three (3) months of the end of each financial year, the Borrower shall compute its debt service coverage ratio and gearing ratio for each such financial year and submit these to ADB; and from the year 2012 onwards, maintain its debt service coverage ratio of not less than 1.5, and the gearing ratio of not more than 70%.

Schedule 5, para. 6(a)

Partly complied with. Covenant for gearing ratio was complied with in 2013 and 2014. It was not complied with in 2012 when the gearing ratio was 76.5%. In 2014, a substantial portion of long-term debt was transferred to current debt to achieve a gearing ratio of 38.9%. Covenant for the debt service coverage ratio was not complied with in 2012 (1.4),2013 (1.49), and 2014 (0.9). ADB granted a waiver for 2012 and 2013.

ENVIRONMENT

The Borrower shall ensure that (i) the Project is designed, constructed, and operated in accordance with applicable laws and regulations of the Republic of Azerbaijan, ADB’s Environment Policy (2002) and the IEE; (ii) any adverse environmental impacts are minimized by undertaking the mitigating measures detailed in the EMMP; (iii) implementation of the EMMP and any violation of environmental standards are reported semiannually to ADB; (iv) the EMMP is incorporated in bidding documents and bills of quantities of the civil work contracts; (v) the EMMP is updated after detailed design and due diligence, with prior approval of ADB; and (vi) all environmental permits, licenses and clearances are obtained in a timely manner prior to commencement of civil works in the relevant section of the Project.

Schedule 5, para. 7

Complied with. (i) Azerenergy ensured that all applicable laws and standards of the country were observed during design stage. (ii) Dust suppression was undertaken where towers are within 50 meters of houses. Construction material and spoil materials transported by trucks were covered with tarpaulins. Vehicles complied with the national vehicle registration and international emission

26 Appendix 6

standards; noise impact was minimal and far from populated areas; no vibration and blasting effects were observed; waste management was under site supervisor’s control; fueling and refueling process was implemented in special designated areas on site; no dangerous goods were observed or planned to be used during construction. (iii) Construction followed ADB Environmental Assessment Guidelines; Environmental Management and Monitoring Plan was attached to Initial Environmental Examination. (iv) Environmental Management and Monitoring Plan was incorporated in the Environmental Conditions of Contract Agreement. (v) Environmental Management and Monitoring Plan updated, but complied late. Environmental and Social Safeguards Due Diligence Report were submitted. (vi) All environmental permits licenses and clearances were obtained prior to commencement of civil works.

The Borrower shall ensure that (i) the handling of transformers and PCBs is undertaken in compliance with the terms of the Stockholm Convention, of which the Guarantor is a signatory, and with United Nations procedures for safe handling of PCBs; (ii) the new transformers are filled with non-toxic substitute for PCB; and (iii) it closely coordinates with the MENR, and engages the services of a specialized company established by the MENR for handling of hazardous materials.

Schedule 5, para. 8

Complied with. Transformers and other equipment containing PCB were not used. New non-toxic substitute for PCB transformers were installed.

Appendix 6 27

RESETTLEMENT

The Borrower shall ensure that (i) the Project does not require any land acquisition or involuntary resettlement; (ii) the new transmission lines and towers follow the existing alignment and locations, respectively; (iii) before commencement of civil works, a detailed due diligence report is completed on potential social impacts and submitted to ADB for approval; (iv) in the event any land acquisition or resettlement becomes necessary, or any potential impact on indigenous peoples is identified, a suitable resettlement plan is drawn up in consultation with the affected people, and approval of ADB, in accordance with the applicable laws of the Republic of Azerbaijan, ADB‘s Involuntary Resettlement Policy (1995) and Policy on Indigenous Peoples (1998), and is implemented in accordance with its terms; (v) the construction is scheduled in farm areas only during the non-agricultural season (June to September); and (vi) these provisions are incorporated suitably in the bidding documents and made part of the civil works contract.

Schedule 5, para. 9

Complied but late. Updated due diligence report was submitted. Provision of social safeguard requirements was included in the updated implementation schedule for civil works. Agricultural seasons vary along the project areas. Construction schedules in coordination with crop owners and local officials were adjusted accordingly (e.g., for annual crops installation and erection activities were made during off-season period for vegetation).

GOVERNMENT

The guarantor shall ensure that (i) it remains committed to the implementation of the State Program on the Development of the Fuel and Energy Sector in Azerbaijan (2005-2015); (ii) it fully implements its medium term tariff policy which incorporates transition to full cost recovery for utility service providers by 2010; (iii) distribution companies are required to make timely payment for 100% of the power received from the Borrower; (iv) it provides financial support, as and when needed, to the Borrower to enable it to fulfill its obligations under this Loan Agreement; (v) it causes Borrower to make available all counterpart funding and facilities for timely implementation of the Project; and (vi) its cabinet of ministers coordinates the work between MED, MENR, MIE, MOF, and other government ministries/agencies for expeditious resolution of the issues and timely implementation of the Project.

Schedule 5, para. 10

Partly complied with. (i) State Program on the development of the Fuel Energy Sector in Azerbaijan (2005–2015) was implemented. (ii) Medium term tariff policy was not implemented. (iii) In 2007, collection rate reached 65%, 75% in 2008, 83% in 2009, 95% in 2010, 90% in 2011, 89% in 2012, 91% in 2013, and 88% in 2014. (iv) Complied with. (v) Complied with. (vi) Complied with.

ANTICORRUPTION

The Borrower and Guarantor (i) shall comply with ADB’s Anticorruption Policy (1998, as amended to date); (ii) acknowledge that ADB, consistent with its commitment to good governance, accountability and transparency, reserves the right to investigate


Complied with.

28 Appendix 6

directly, or through its agents, any alleged corrupt, fraudulent, collusive or coercive practice related to the Project; and (iii) shall cooperate with any such investigation and extend all necessary assistance including access to all relevant books and records, and for engagement of independent experts who may be needed for satisfactory completion of such investigation.

The Borrower shall ensure that (i) the anticorruption provisions acceptable to ADB are included in all bidding documents and contracts, including provisions specifying the right of ADB to audit and examine the records and accounts of the executing agencies and all contracts, suppliers, consultants, and other service providers as they relate to the Project; (ii) all contracts, in addition to the Project accounts and financial statements, are audited by an independent external auditor; (iii) decisions on all procurement-related matters are taken by the tendering committee, which will comprise representatives of the MED, MIE, MOF, and the State Procurement Agency; (iv) contractors’ payment claims are verified by the supervision consultant in accordance with contract specifications; (v) the information on selection of consultants and contractors is disclosed through local newspapers in a timely manner; and (vi) status of procurements and awards of contracts is disclosed on Borrower’s website in accordance with ADB’s Procurement Guidelines.


Complied with.

CHANGE IN OWNERSHIP AND OPERATION

In the event that the Borrower proposes to make (i) any change in ownership of the Project, (ii) any sale, transfer, or assignment or interest or control in the Project, or (iii) a lease or contract out or otherwise materially modify its functions and authority over implementation and operation of the Project, the Borrower shall, at least six (6) months prior to the implementation of such a proposal, consult with ADB and obtain its consent.


Complied with.

In the event that the Guarantor proposes to make any change in the ownership of the Borrower, the Guarantor shall consult with ADB to ensure that it does not affect the implementation of the Project or the terms of this Loan Agreement.


Complied with.

Appendix 6 29

REPORTING

The Borrower shall prepare and submit to ADB quarterly progress reports, which will include (i) a narrative description of progress made during the reporting period, (ii) changes, if any, in the implementation schedule, (iii) problems or difficulties encountered, and (iv) activities and actions to be undertaken in the next reporting period.


Complied with.

PERFORMANCE MONITORING AND EVALUATION

The borrower shall (i) by the end of the year 2008, engage Project implementation consultants for monitoring and evaluation of the Project; (ii) collect additional data from relevant agencies, including local governments and statistics bureaus for compiling the performance indicators; and (iii) measure the performance indicators at the inception, Project completion, and also three (3) years after Project completion.


Partly complied with. The contract with project implementation consultant, (MWW Decon, Germany) was signed on 27 May 2008. Data on progress of implementation was collected and recorded, however, performance indicators on project benefits were not developed or data collected.

PROJECT REVIEW

ADB and the Borrower shall meet regularly as necessary, and at least every six (6) months, to review the progress under the Project. In addition, the Guarantor, Borrower, and ADB shall jointly undertake a midterm review in year 2009, which will focus on (i) Project impacts; (ii) implementation progress; (iii) sector reform and performance; (iv) performance consultants and contractors; (v) status of compliance with the covenants stipulated in the Loan Agreement; and (vi) the need for any changes in the scope or schedule of the Project to ensure full achievement of its objectives.


Complied with. ADB and Azerenergy met regularly to review the progress of the Project. a) Borrower to Manila: June 2009. ADB missions: (b) Review 1: 26 August–4 September 2009, (c) Review 2: 15–19 March 2010, (d) Review 3: 28 March–1 April 2011, (e) Midterm Review: 13–20 September 2011, (f) Review 5: 27–30 April 2012, (g) Review 6: 13–19 November 2012. (h) Project Completion Review: 14–24 April 2015.

The Borrower will: (i) maintain separate accounts for the Project; (ii) have accounts and related financial statements audited annually, in accordance with appropriate auditing standards consistently applied,

Article IV, Section 4.05(a)

(i) Complied with. (ii) Complied with. (iii) Complied with delay. Only the 2009 audited

30 Appendix 6

by independent auditors whose qualifications, experience and terms of reference are acceptable to ADB; (iii) furnish to ADB, as soon as it is available or not later than six (6) months after the end of each related fiscal year, certified copies of such audited accounts and financial statements and the report of the auditors relating thereto (including the auditors opinion on the use of the loan proceeds and compliance with financial covenants of this Loan Agreement, as well on the use of the procedures for Imprest Account and Statement of Expenditures, all in English language; and (iv) furnish to ADB such other information concerning such accounts and financial statements and the audit thereof.

project financial statement (APFS) was received on 28 June 2010. Others were received after the annual due date of 30 June: a) 2010 on 12 July 2011, b) 2011on 20 July 2012, c) 2012 on 8 July 2013, and d) combined audited project financial statements for financial year 2013 and June 2014 on 22 October 2014. (iv) Complied with. Actual project costs were consistent with the APFS. The APFS for FYs 2009, 2010, and 2011 were without management letters. The management letters of APFS for 2012, 2013–2014 concluded there were no significant internal control weaknesses requiring immediate management action. The unqualified audit opinions on the APFS were acceptable to ADB.

The Borrower shall enable ADB, upon ADB’s request, discuss the Borrower’s financial statements for the Project and its financial affairs related to the Project from time to time with the auditors appointed by the Borrower pursuant to Section 4.05(a) here above, and shall authorize and require any representative of such auditors to participate in any such discussions requested by ADB, provided that any such discussion shall be conducted only in the presence of an authorized officer of the Borrower shall otherwise agree.

Article IV, Section 4.05(b)

Complied with.

The Borrower shall enable ADB’s representatives to inspect the Project, the goods and works financed out of the proceeds of the loan, any relevant records and documents.

Article IV, Section 4.07

Complied with. All information were made available to ADB review missions.

Appendix 6 31

The Borrower shall ensure that the Project facilities are operated, maintained and repaired in accordance with sound administrative, financial, engineering, and environmental, maintenance and operational practices.

Article IV, Section 4.07

Complied with.

32 Appendix 7

CONTRACTS AND DISBURSEMENTS FINANCED BY THE ASIAN DEVELOPMENT BANK

Table A7.1: Contract Amounts by Year

($ million) Year Number of Contracts Contract Amounts Disbursement

2009

1

96.202

a

96.075

2010 1 58.951 57.986

Total 155.153 154.061 a

Contract amount includes a $9.209 million variation (approved in 2010) to the original contract amount of $87.033 million (awarded in 2009). Source: Asian Development Bank Loan Financial Information System.

Table A7.2: Contract Amounts by Category ($ million)

Category Number of Contracts Contract Amounts

Disbursement

01A 220 kV substation “Agdash” 01B 220 kV transmission line 01C Substation “Absheron” upgrading 01D Additional 220 kV Transmission Line Shimal-Dres Absheron 01E Additional 220 kV Transmission Line Shimal-Dres Absheron 02A 220 kV substation “Agdash”

1

1

96.202

58.951

12.442 56.105 12.269

17.489

25.154 6.566

02B 220 kV transmission line 5.081 02C Substation “Absheron” upgrading 02D Dismantling Work and local transportation

3.298

0.314 02E Additional 220 kV Transmission Line Shimal-Dres Absheron

7.123

02F Additional Substations 8.321

Total 2 155.153 154.061 Source: Asian Development Bank Loan Financial Information System.

Table A7.3: Contract Amounts by Procurement Method ($ million)

Method Number of Contracts Contract Amounts

Disbursement

International competitive bidding

2

155.153

154.061

Total 2 155.153 154.061 Source: Asian Development Bank Loan Financial Information System.

Appendix 8 33

ECONOMIC ANALYSIS 1. The economic internal rate of return (EIRR) was calculated to compare economic benefits with economic costs in real terms. The EIRR was calculated on the basis of constant 2015 prices, in dollar terms, with border price as numeraire. Financial project benefits and costs were converted to economic values by deducting taxes, duties and financing charges. Non-tradable items were adjusted using a standard conversion factor of .8. All equipment and materials used in the project were tradable. The labor component in project capital costs comprised skilled local labor (non-tradable) with wages reflecting economic opportunity costs.1 The economic value of the land used by the project was assumed to be nil because the land had no alternative uses (salinity made the land unproductive). The economic life of the project was assumed to be 50 years. 2. Economic benefits were based on resource cost savings from a reduction in the electricity imports, increase in hydropower output at the Mingechevir hydropower plant, and reduction of system losses. The project also reduced operating and maintenance costs associated with the transmission network, but these were small and difficult to quantify. Environmental benefits from the increase in hydropower and system loss reduction from the project were included in the analysis. The value of the benefit from reduction in system losses and increase in hydropower output was based on reduction in generation from natural gas; the resultant reduction in carbon dioxide production was valued at $37 per ton. Details of the EIRR and economic net present value calculation are in Table A8.1. 3. The EIRR for the project was calculated at 15.4% in real terms and is above the critical value of 12%. The corresponding economic net present value was calculated to be $37.9 million. Therefore, the project is deemed viable from an economic perspective.

1 The shadow wage rate factor of 1.0 for project labor was based on the fact that project labor was skilled. Because

this kind of labor was fully used in the economy (no unemployment), primarily in the oil and gas sector, the wage rate fairly reflected the alternate use of this labor. There is unemployment in Azerbaijan, but this unemployed labor is essentially unskilled, at least it was not the kind of labor the project needed.

Appendix 8 34

Table A8.1: Economic Internal Rate of Return Calculation for the Power Transmission Enhancement Project

($ million)

Year

Economic Costs Economic Benefits Net Economic

Benefit Capital O&M Total

Import Savings

Increase in Hydropower

Energy Loss Savings

Environmental Benefits

Total

2009 9.8 9.8 (9.8) 2010 19.8 19.8 4.9 1.0 7.0 (13.9) 2011 47.1 47.1 4.8 1.0 7.0 (41.3) 2012 58.2 58.2 5.7 1.3 18.6 (51.3) 2013 6.4 6.4 5.7 1.3 18.4 0.7 2014 19.3 12.6 31.9 11.2 6.0 1.4 49.5 (13.3) 2015 12.6 12.6 11.0 6.0 1.4 49.5 5.7 2016 16.6 16.6 11.0 25.2 6.0 7.3 49.5 32.9 2017 16.6 16.6 11.0 25.2 6.0 7.3 49.5 32.9 2018 16.6 16.6 11.0 25.2 6.0 7.3 49.5 32.9 2019 16.6 16.6 11.0 25.2 6.0 7.3 49.5 32.9 2020 16.6 16.6 11.0 25.2 6.0 7.3 49.5 32.9

׃ ׃

׃ ׃

׃ ׃

׃ ׃

׃ ׃

׃ ׃

: ׃

: ׃

: ׃

׃ ׃

2060 16.6 16.6 11.0 25.2 6.0 7.3 49.5 32.9 2065 16.6 16.6 11.0 25.2 6.0 7.3 49.5 32.9 ENPV= $37.9

EIRR= 15.4%

( ) = negative, EIRR = economic internal rate of return, ENPV = economic net present value, GWh = gigawatt-hours, O&M = operation

and maintenance. Source: Asian Development Bank.

Appendix 9 35

FINANCIAL ASSESSMENT OF PROJECT AND EXECUTING AGENCY A. Project Financial Internal Rates of Return 1. The weighted average cost of capital (WACC) for the project was estimated at 4.3% in real terms. This was based on a nominal cost of equity capital of 8%, a corporate income tax rate of 20%, nominal cost of debt capital of 4%, and a long-term dollar inflation rate of 2%. Table A9.1 provides the details of the weighted average cost of capital calculation.

Table A9.1: Weighted Average Cost of Capital for Azerenergy Equity Debt

Total Azerenergy ADB

Amount ($ million) 30.6 154.1 184.7 Weighting 16.6% 83.4% 100.0% Nominal cost

8.0% 0.5%

Corporate income tax rate 20.0% Tax adjusted nominal cost 8.0% 0.4% Long-term dollar inflation rate 2.0% 2.0% Real cost 5.9% –1.6% Minimum rate test

a 5.9% 4.0%

Weighted components 1.0% 3.3% 4.3% ADB = Asian Development Bank. a The minimum rate test requires that cost of debt or equity be not less than 4% in real terms.

Source: Asian Development Bank.

2. The financial internal rate of return (FIRR) recalculation: (i) assumed the life of the project is 50 years, and converted all monetary values for costs and benefits into constant 2015 prices; (ii) based investment costs on actual costs incurred during implementation, and increased these at the inflation rate to bring them to 2015 prices; (iii) based operation and maintenance costs of the transmission lines and substations on an incremental fixed cost of $10,000 per year, and a maintenance cost of $0.1 per kilowatt-hour (kWh); (iv) assumed the cost of imported electricity from Russia to be $0.055 per kWh; (v) based the financial benefits of the project on costs saved from reduced electricity imports, system loss reduction in terms of avoided fuel expenditures, and increased hydropower output; and (vi) used a corporate income tax rate for Azerenergy of 20%.

3. Recalculation of the project FIRR resulted in a FIRR of 2.6% and a financial net present value (FNPV) of –$48.5 million, discounted at the WACC (details are in Table A9.2). The FIRR is lower than the rate of 11.7% estimated at appraisal and lower than the WACC of 4.3%, meaning the project is not financially viable. However, the WACC and FNPV are based on ADB’s minimum rate test that requires a minimum of 4% return on debt or equity capital. Without application of the minimum rate test, the FIRR is above a WACC of –0.3% in real terms, the FNPV is positive, and the project could be deemed financially viable.

36 Appendix 9

Table A9.2: Financial Internal Rate of Return Calculation

for the Power Transmission Enhancement Project ($ million)

Year

Financial Costs Financial Benefits Net Financial Benefit

Capital O&M Total Import

Savings Increase in

Hydropower Energy Loss

Savings Total

2009 11.3 11.3 (11.3) 2010 21.6 21.6 1.8 1.8 (19.9) 2011 59.1 59.1 1.7 1.7 (57.4) 2012 73.9 73.9 2.1 2.1 (71.8) 2013 6.6 6.6 2.1 2.1 (4.5) 2014 25.1 11.0 36.1 11.2 2.2 13.4 (22.7) 2015 11.0 11.0 11.0 2.2 13.2 2.2 2016 15.0 15.0 11.0 9.2 2.2 22.4 7.4 2017 15.0 15.0 11.0 9.2 2.2 22.4 7.4 2018 15.0 15.0 11.0 9.2 2.2 22.4 7.4 2019 15.0 15.0 11.0 9.2 2.2 22.4 7.4 2020 15.0 15.0 11.0 9.2 2.2 22.4 7.4

׃ ׃

׃ ׃

׃ ׃

׃ ׃

׃ ׃

׃ ׃

: ׃

: ׃

׃ ׃

2060 15.0 15.0 11.0 9.2 2.2 22.4 7.4 2065 15.0 15.0 11.0 9.2 2.2 22.4 7.4 FNPV= (48.5)

FIRR= 2.6%

( ) = negative, FIRR = financial internal rate of return, FNPV = financial net present value, GWh = gigawatt-hours, O&M = operating and maintenance. Source: Asian Development Bank.

B. Financial Performance of Azerenergy 4. The review of Azerenergy’s financial performance covers 2010–2014. Azerenergy was profitable during 2011–2014 (Table A9.3). However, profitability in 2014 was achieved only through foreign exchange gains. Without these, Azerenergy would have incurred a loss of AZN52.2 million (assuming no income tax is payable). An increase in the price of natural gas from AZN50 to AZN80 per thousand cubic meters in 2014 without a corresponding increase in the electricity tariff affected Azerenergy’s profitability. Fuel accounted for about 42% of Azerenergy’s expenses in 2014. The rate of return on total assets has been low and declining during 2010–2014. The operating ratio rose above the 100% mark in 2014 for the first time in 5 years.

Table A9.3: Azerenergy Income Statements for 2010–2014 (AZN‘000s)

Year 2010 2011 2012 2013 2014

Revenue Electricity sales 591,941 646,107 716,319 717,176 777,216 Electricity connection fees 12,793 21,085 27,715 18,461 45,503 Other sales 2,958 5,282 5,963 7,615 7,986 Total revenue 607,692 672,474 749,997 743,252 830,705 Expenses Fuel 166,239 189,847 217,129 224,314 358,322 Purchased power 732 4,605 2,552 2,621 2,873 Staff costs 73,861 92,359 91,464 94,834 94,745 Repairs, maintenance 52,002 51,964 62,904 61,571 54,832 Materials, supplies 9,885 15,123 4,703 14,016 12,253

Appendix 9 37

Other taxes 23,635 22,570 22,920 22,900 44,115 Changes in loans and receivables 59,942 19,310 61,393 24,138 48,647 Other expenses 20,516 8,717 14,602 10,427 13,174 Depreciation 190,217 191,900 182,988 196,321 220,670 Total expenses 597,029 596,395 660,655 651,142 849,631 Operating income 10,663 76,079 89,342 92,110 (18,926) Financing costs (40,150) (22,724) (19,856) (8,934) (33,316) Foreign exchange gains (net) 54,430 19,061 28,623 47,431 107,620 Other income 945,923

a 158,851

b 22,429

Income tax (73,647) (38,796) 38,012 (46,018) (35,784) Net income 897,219 192,471 158,550 84,589 19,594 Operating ratio

c 98.2%

88.7%

88.1% 87.6% 102.3%

Rate of return on net assetsd

(0.0)%e 1.5%

f 3.4% 1.8% 0.9%

( ) = negative a

2010 figure includes an extraordinary item of AZN939.525 million in settlement of debts owed to SOCAR. b

2011 figure includes an extraordinary item of AZN138.015 million in settlement of debts owed to SOCAR. c

Operating ratio = total expenses/total revenue. d Rate of return on net assets = (net income + financing costs) ÷ total assets.

e Excludes extraordinary item of AZN939.525 million.

f Excludes extraordinary item of AZN138.015 million.

Source: Azerenergy audited financial statements.

5. Azerenergy’s total assets grew at a modest rate of 4.3% per year during 2010–2014 (Table A9.4), while total liabilities fell over the same period at about 3% per year. The modest growth in assets was financed by equity increases, which grew at a rate of 14.4% per year.

38 Appendix 9

Table A9.4: Azerenergy Balance Sheets for 2010–2014 (AZN’000s)

Year 2010 2011 2012 2013 2014

Assets Current assets Inventory 49,910 45,879 54,921 58,435 54,974 Loans and receivables 42,643 34,093 25,154 34,711 55,682 Recoverable VAT 256,565 263,722 304,259 349,256 387,650 Prepayments 17,160 15,179 6,455 23,300 46,333 Cash and cash equivalents 58,327 53,966 51,694 32,964 50,332 Total current assets 424,605 412,839 442,483 498,666 594,971 Non-current assets Property, plant and equipment 3,793,764 4,189,931 4,430,133 4,802,898 4,745,965 Advances for property and plant 374,876 130,449 150,222 Deferred tax assets 86,546 86,330 88,415 Other non-current assets 498,593

a 389,646

a 596 568 485

Total non-current assets 4,292,357 4,579,577 4,892,151 5,020,245 4,985,087 Total assets 4,716,962 4,992,416 5,334,634 5,518,911 5,580,058 Liabilities and equity Current liabilities Current loans, borrowings 373,406 298,750 279,804 329,958 609,962 Trade and other payables 235,887 289,186 407,038 482,545 628,832 Prepayments received 18,591 27,371 2,627 1,178 1,224 Current income tax liability 410,567 453,806 282,566 328,170 364,163 Other taxes payable 551,370 332,158 414,049 415,780 415,901 Total current liabilities 1,589,821 1,401,271 1,386,084 1,557,631 2,020,082 Non-current liabilities Non-current loans, borrowings 1,700,762 1,747,688 1,545,320 1,399,123 900,898 Government grants 106,794 97,634 88,631 Deferred tax liabilities 236,345 226,923 215,336 Decommissioning liability 36,747 33,472 38,571 Trade and other payables 74,329 68,476 2,941 2,548 2,619 Total long-term liabilities 1,775,091 1,816,164 1,928,147 1,759,700 1,246,055 Equity Share capital 111,777 1,560,035 1,760,495 1,760,495 1,760,495 Additional paid-in capital 991,729 200,460 120,022 216,610 309,357 Retained earnings 248,544 14,486 139,886 224,475 244,069 Total equity 1,352,050 1,774,981 2,020,403 2,201,580 2,313,921 Total liabilities and equity 4,716,962 4,992,416 5,334,634 5,518,911 5,580,058 Current ratio

b 0.3 0.3 0.3 0.3 0.3

Debt-equity ratioc

actual 125.8% 98.5% 76.5% 63.6% 38.9% required n/a n/a 70% 70% 70% ( ) = negative, n/a = not applicable, VAT = value-added tax. a Includes advances for property and plant and deferred tax assets.

b Current ratio = current assets ÷ current liabilities.

c Debt–equity ratio = non-current loans and borrowings ÷ total equity.


6. The current ratio has been low but steady at 0.3, meaning Azerenergy does not have sufficient resources on hand to pay its current liabilities when they become due during the year. However, much of the current liabilities are taxes owed to the government (about AZN780

Appendix 9 39

million in 2014), which allows for some flexibility in payment. The debt–equity ratio fell from 126% in 2010 to 38.9% in 2014, and Azerenergy was consequently able to meet the gearing ratio covenant of 70% in 2013 and 2014. However, in 2014, a substantial portion of long-term debt was transferred to current debt to achieve the 38.9% gearing ratio. 7. Cash generated from operations has been declining since 2011 because of falling net income and rising interest payments (Table A9.5). Consequently, Azerenergy has not been able to meet the debt service coverage ratio from 2012. ADB provided a waiver of the covenant in 2012 and 2013, but no waiver was granted in 2014, when the debt service coverage ratio fell to 0.7.

Table A9.5: Azerenergy Funds Flow Statements for 2010–2014 (AZN‘000s)

Year 2010 2011 2012 2013 2014

Cash Flow from Operations Net income before income tax 970,866 231,267 120,538 130,607 55,378 Adjustments for: Depreciation 190,217 191,900 182,988 196,321 220,670 Loss on disposal of property 2,751 (333) 647 234 749 Decommissioning liabilities (728) (281) (314) Foreign exchange gains (54,430) (19,061) (28,623) (47,431) (107,620) Net financing costs 37,064 18,109 19,856 8,934 33,316 Other adjustments (897,651) (147,042) 8,504 6,592 4,846 Changes in working capital (168,236) (30,271) (12,814) (44,580) (3,415) Income tax paid (1,610) (68) (303) (4,393) Interest paid (34,460) (19,571) (20,746) (12,312) (31,272) Net cash generated from operations 46,121 222,660 270,001 237,748 168,259 Cash Flow from Investing Interest received 3,949 4,042 979 Principal repayments received 27,757 19,828 39,343 49,889 31,496 Acquisition of property and plant (372,507) (443,508) (368,645) (313,620) (119,138) Other non-current assets acquired 853 (25,769) (31) (235) (1038) Net cash used in investing (343,897) (445,500) (325,291) (262,987) (87,750) Cash Flow from Financing Proceeds from borrowing 365,808 198,476 121,130 66,012 42,927 Repayment of borrowings (160,561) (206,136) (187,527) (155,089) (196,770) Shareholder contributions 130,045 230,460 120,022 96,588 92,747 Net cash generated from financing 335,292 222,800 53,625 7,511 (61,096) Net Increase/Decrease in Cash 37,516 (40) (1,665) (17,728) 19,413 Debt service coverage ratio

a

-actual 0.2 1.0 1.3 1.4 0.7b

-required n/a n/a 1.5 1.5 1.5 ( ) = negative, n/a = not applicable. a Debt service coverage ratio = net cash generated from operations ÷ (principal repayments + interest expense).

b Interest expense for 2014 was not available; interest paid was used instead.


40 Appendix 10

QUANTITATIVE ASSESSMENT OF OVERALL PROJECT PERFORMANCE

Criteria Assessment Rating (0-3)

Weight (%)

Weighted Rating

Relevance Relevant 2 25 0.50

Effectiveness Effective 2 25 0.50

Efficiency Efficient 2 25 0.50

Sustainability Less than likely 1 25 0.25

Overall Rating1 Successful 1.75 1

Based on the following ranges: (a) Highly Successful > or = 2.7 (b) Successful > or = 1.6 and < 2.7 (c) Partially Successful > or = 0.8 and < 1.6 (d) Unsuccessful < 0.8

Source: Asian Development Bank.

Appendix 11 41

CONTRIBUTION TO THE ADB RESULTS FRAMEWORK

No.

Level 2 Results Framework Indicators

Original Targets

Revised Targets

Achieved

1 Transmission lines installed or upgraded (km)

220 kV: 280 km 220 kV: 397 km 220 kV: 344 km; and 110 kV: 170 km

2 Greenhouse gas emission reduction (t CO2 equivalent/year

1.3 million t per year

Not specified 0.06 million t per year

CO2 = carbon dioxide, kV = kilovolt, km = kilometer, t = tons. Source: Asian Development Bank.

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