FOR OFFICIAL USE ONLY KENYA

Transcription

1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No KE Public Disclosure Authorized STAFF APPRAISAL REPORT KENYA Public Disclosure Authorized THE KENYA POWER COMPANY LIMITED OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Public Disclosure Authorized Energy Division Eastern Africa Regional Office January 14, 1983 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Currency Equivalents - Currency Unit - Shilling (Sh) Kenya Cents KSh 1 US$1.0 - KSh 10.6 (March 1982) Abbreviations and Acronyms CDC Commonwealth Development Corporation CIDA Canadian International Development Agency EAP&L The East African Power & Lighting Co. Ltd EIB European Investment Bank GENZL Geothermal Energy of New Zealand Government Government of Kenya GWh Gigawatt hour = 1,000,000 kilowatt hours KPC The Kenya Power Company Ltd kv Kilovolt = 1,000 volts KW Kilowatt = 1,000 watts KWh Kilowatt hour = 1,000 watt hours MVA Megavolt ampere = 1,000 kilovolt amperes MW Megawatt = 1,000 kilowatts SIDA Swedish International Development Authority TARDA The Tana and Athi Rivers Development Authority TRDC The Tana River Development Company Limited UEB The Uganda Electricity Board Kenya Fiscal Year: July 1 - June 30 KPC Fiscal Year : January 1 - December 31

3 FOR OFFICIAL USE ONLY KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. I. ENERGY SECTOR BACKGROUND... 1 Local Energy Resources... 1 Hydroelectric Resources... 1 Geothermal Resources... 1 Wood Resources... 2 Other Resources... 2 Imported Energy... 2 Relative Energy Pricing... 4 Energy Assessment... 5 II. POWER SECTOR BACKGROUND... 6 General... 6 The Power Supply Entities... 6 Historical Demand for Power and Energy... 6 Supply of Power and Energy... 8 Long-term Development Plan... 8 Rural Electrification Previous Bank Lending in the Power Sector Bank Strategy in the Power Sector Government Strategy in the Power Sector III. THE PROJECT Background Objectives Detailed Description Environmental Considerations IV. PROJECT COSTS AND FINANCING Cost Estimates Basis for Estimates Financing Plan Status of Engineering and Construction Schedule Procurement Disbursements Accounts and Audit This report was prepared by C.H.A. Killoran (mission leader), J. Shaukat and F. Sylla and is based on information obtained during a mission to Kenya in March This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

4 - ii - Page No. V. COST RECOVERY AND FINANCIAL ASPECTS Introduction Past Operations and Present Financial Position EAP&L's Tariffs Construction Program Proposed Financing Plan Future Earnings Debt Limitation VI. ORGANIZATION AND IMPLEMENTATION Structure of the Electricity Supply Industry Organization-and Management Staff Existing Facilities Works in Progress Training Insurance Project Monitoring System VII. PROJECT JUSTIFICATION AND RISKS.34 The Power Market.34 Requirement for the Project.34 Comparison of Alternatives.34 Economic Rate of Return.35 Project Risks.36 VIII. AGREEMENTS TO BE REACHED AND RECOMMENDATION.37

5 - iii - List of Annexes 1. Typical Daily Load Curve 2. Forecast of Production Capability and Demand for Average and Dry Water Years (Tables) 3. Actual and Forecast Demand - Generating Capability in an Average Water Year (Graph) 4. Forecast Demand - Generating Capability in a Dry Year (Graph) 5. Description of Project 6. Financing Plan 7. Implementation Program 8. Steam Production 9. Disbursement Schedule 10. Kenya Power Company Ltd - Balance Sheet as of December 31, Kenya Power Company Ltd - Income Statement for the Years Kenya Power Company Ltd - Funds Statement for the Years Kenya Power Company Ltd - Tana River Development Company Ltd - East African Power and Lighting Co. Ltd. - Combined Balance Sheet as of December 31, Kenya Power Co. Ltd - Tana River Development Company Ltd - East African Power & Lighting Co. Ltd. - Combined Income Statement for the Years Kenya Power Co. Ltd - Tana River Development Co. Ltd - East African Power & Lighting Co. Ltd - Combined Funds Statements for the Years Notes and Assumptions for Financial Statements 17. Electricity Tariff Structure 18. Loan Capital and Security Arrangements of EAP&L, KPC and TRDC 19. History of the Power Companies 20. Existing Generating Plant 21. Project Monitoring System 22. Diesel Alternative 23. Least-Cost Solution 24. Return on Investment 25. Related Documents and Data Available in Project File MAP IBRD No R - Olkaria Geothermal Power Expansion Project

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7 I. ENERGY SECTOR BACKGROUND Local Energy Resources 1.01 The greatest known indigenous resource of commercial energy in Kenya is the hydroelectric potential of its rivers and, although the potential for geothermal power has been recognized for some time, it was not until 1978 that the comparative cost of imported oil and the growth in demand made it attractive enough to warrant development. In spite of continuing search, there has been no success in locating reserves of oil in Kenya, although relatively small amounts of gas have been found. In rural areas particularly, firewood and charcoal are used extensively for energy needs while bagasse is used as a source of fuel in the sugar industry. There are no known coal reserves although coal deposits have been found in neighboring Tanzania. Hydroelectric Resources 1.02 The hydro power potential of Kenya has been estimated to be about 6,000 MW (30,000 GWh per year), although half of this lies in small rivers and is uneconomic to develop. Most of the remaining potential is on the Tana River and of this, it is only economically feasible to develop about 800 MW or 4,000 to 5,000 GWh per year (1,500,000 tons of oil equivalent per annum), about 350 MW of which is already developed (para. 6.12). The National Power Development Plan, , funded by the Bank under Loan 1147-KE (para. 2.10), was prepared by Merz & McLellan (M&M) and Sir Alexander Gibb & Partners (Gibb) of the UK, consultants to the East African Power & Lighting Company Limited (EAP&L), and their 1978 report lists the following potential sites on the Tana River in order of priority: Kiambere MW, Mutonga - 70 MW, Grand Falls - 88 MW. The only other significant hydro power potential is on the Turkwel River, and the Norconsult report, dated July 1979, indicates that a multi-purpose project could provide 120 MW of electric power to the system. Geothermal Resources 1.03 Geothermal areas in Kenya are located in the Rift Valley which runs from the Kenya - Tanzania border in the south to Ethiopia in the north. There are three major areas of geothermal activity: Olkaria, which is utider development, and Eburru and Lake Bogoria, which are currently being explored. The most attractive potential is at Olkaria, in the Rift Valley near Lake Naivasha, about 100 kim from Nairobi. Exploration began over 20 years ago, and investigations funded since then by UNDP and EAP&L indicated that the site should be capable of supporting power generation of at least 100 MW and possibly more than 200 MW. Prior to appraisal of the proposed project, completed wells were producing steam capable of generating 37 MW of electricity with a further estimated 5 MW from 3 completed but untested wells. Two steam turbine driven electric generators each rated at 15 MW have been installed - the first in operation since August 1981, and the second was placed in operation in December 1982 (para. 2.22). Two drilling rigs that have been operating in the field, will continue drilling additional wells.

8 The UNDP with a grant of about US$2.9 million is now planning a project to investigate further sources of geothermal power at Eburru and Lake Bogoria, to begin early in The Kenyan Government would provide an additional KSh. 130 million (about US$12 million). It is estimated that there could be as much as 1,700 MW of electricity generated from active volcanic centers, with a further 200 MW from non-volcanic areas where hot springs occur. Not all of this potential is economically exploitable. Hlowever, it is expected that with further search and investigation, geothermal power could contribute significantly toward meeting Kenya's electric power needs. Wood Resources 1.05 The majority of rural Kenyans use firewood, charcoal, or in some cases agricultural waste, as their principal source of energy for cooking and heating, and, as a result, many areas of the country have experienced severe deforestation. The usage has been estimated to be at least twice and possibly as much as four times the replenishment rate. A third forestry project was approved in February 1982 with total project costs of US$74 million, to which IBRD will provide US$21.5 million (LN 2098) and IDA US$16 million (CR 1213). The project is aimed at improving the Forestry Department's management performance and providing funds for new plantings and rural afforestation. Other forestry projects, now underway, are being financed by Sweden, Denmark, Finland, Belgium and the European Economic Community, and it is hoped that these projects will provide the needed fuel for the rural population before the deforestation becomes widespread througlhout the country. Other Resources 1.06 With Kenya's location on the equator, solar radiation is quite high, and could provide an attractive alternative to a portion of the high cost imported energy. However, solar energy for water heating and crop drying provides only a small fraction of the total requirements of the country, and the Ministry of Energy is actively providing information and encouraging its greater use. In addition, the Ministry is evaluating the possibility of using more wind-driven pumps for irrigation to replace diesel-driven pumps presently in use Kenya has constructed two ethanol plants based on the use of molasses, and may construct a third. However, the high capital and operating cost of the first two plants indicates that there is no justification to proceed with another plant at this time. Imported Energy 1.08 The principal source of energy for Kenya is from imported oil and petroleum products. Small amounts of coal and electricity are also imported. The consumption of imported energy as a percentage of total commercial energy has varied during the past decade as follows: %; %; %. Except for minor amounts of speciality oils and greases, most of the imported crude oil is processed at the refinery at Mombasa. In 1979, about 3.0 million tons of crude oil were refined; of this total about 1.5 million tons were used domestically, while the

9 remainder was exported to neighboring countries. During the period , the value of net imports of crude oil and petroleum products averaged about 13V of the value of Kenya's imports, whereas in 1981, mainly as a result of the steep rise in petroleum prices, imports of petroleum products represented about 30% of all imports The [aajor user of imported coal is the Bamburi cement plant in Mombasa. Electricity is imported from Uganda and fed into East Africa Power and Lighting's (EAP&L's) system by the Kenya Power Company (KPC) and distributed by EAP&L (paras and 2.09). The following table contains a summary of the growth in commercial energy consumption in Kenya: Tons of Oil Equivalent -- thousands % 1977 % 1979 % Imported Energy: Coal and Coke Imports Oil Consumption 1, , , Electricity a/ Domestically Produced Energy: Hydro Generated Electricity a/ Total Energy Consumption 1,583 1,914 1,925 a/i GWh = 250 equivalent tons of petroleum It should be noted that oil consumption decreased after the commissioning of the Gitaru Hydroelectric Project in 1978 (para. 2.20) and has been reduced further upon the commissioning of the units at Olkaria Geothermal Power Project (para. 2.22) The effects of the sharp increases in international oil prices on the country's economic growth is clearly demonstrated by the growth rates. Over the period , a growth rate of GDP 6.5% per annum was achieved in Kenya, but this dropped very sharply after 1973, and the average for the years was 3.4%, while the growth in was about 4%. The dramatic rise in petroleum prices is seen from the average price of crude oil which increased as follows: KSh. 116 per ton; KSh. 478 per ton; KSh. 786 per ton; and KSh per ton. Before 1973, in monetary terms Kenya was virtually in balance in its imports and exports of petroleum products. The receipts earned in Kenya from exports of petroleum products were almost sufficient to pay for the counitry's own petroleum needs. However, the price of imported crude oil has increased mauch faster than the price of exported refined petroleum products, and this had led to Kenya now having an adverse balance on its petroleum trade. Compounding the problem has been the border closure between Kenya and Tanzania and the break-up of the East African Community which has meant a loss of markets and stagnation in shipments of refined petroleum In 1975 the Bank provided part of the funds, US$20 million, under Loan 1133-KE for the construction of a 14-inch 452 km long oil pipeline, pumping stations, and related facilities to transport white products from

10 Mombasa to Nairobi. Since it was placed in operation in 1978, the cost of transporting fuel to Nairobi, Uganda and other neighboring countries has been substantially reduced. Preliminary studies have been carried out to determine the justification of extending the pipeline westwards to serve Eldoret and the neighboring countries, but no action has been taken to date. The East African Development Bank and the Kenya Pipeline Company are presently seeking funds for a detailed feasibility study of the proposed extension The Govearnment has thus realised that for as long as oil remains the major source of primary energy, and substantial amounts of foreign exchange are expended in paying for crude oil imports, Kenya's economy is very vulnerable. Thus, the Government's strategy, as specified in the Development Plan , is to rationalize the use of itmported petroleum and to develop and utilize domestic hydro and geothermal power resources to obtain some alleviation of the country's dependence on imported oil Kenya is not very rich in its remaining indigenous energy resources, now that the low cost hydro stations have been developed on the Tana River. However, the neighboring countries have interesting projects with great potential, and cooperation in their development would be to Kenya's advantage. Relative Energy Pricing 1.15 The price of many essential commodities, including electricity and fuel, is regulated by the Government of Kenya. The electricity tariff structure does not take account of differences in costs of supply to consumers in all parts of the country even though certain isolated areas are supplied with expensive diesel-generated electricity. Although this policy may be justified as far as income redistribution efforts to help the development of poorer regions is concerned, it could lead to imnportant diseconomies by attracting energy intensive activities to these high energy cost areas. Usually, prices of petroleum products vary regionally and, in general, reflect the cost of transportation. There are no duties or sales taxes on fuel oil and diesel oil. The structure of domestic demand for petroleum products does not match the pattern of yield from the Mombasa refinery. There is a substantial surplus production of residual fuel oil from the Mombasa refinery over market demand, and therefore it is proper that fuel oil should not be taxed. The surplus is presently being exported at lower prices than the cost of imported crude oil. This situation is expected to degenerate over the next few years as domestic demand for fuel oil becomes weaker with conversion of major users, such as cement plants, to coal. In contrast, the demand for diesel oil is disproportionately high relative to the refinery yield pattern. The high premium on the retail price of gasoline compared to the price of diesel oil (para. 1.16), due mainly to the high tax on gasoline and zero tax on diesel oil, is sending the wrong price signal to users by encouraging the consumption of diesel oil.

11 The relative cost of energy in Kenya is illustrated in the following table: Price per unit in Nairobi (March 1982) Cost per Kilocalories/Unit (K Shillings) Kilocalories x 106 Gasoline (Reg) x 10 6 /ton 10, Fuel Oil 9.9 x 10 6 /ton 1, Diesel Oil 10.2 x 10 6 /ton 3, Kerosene 10.3 x 10 6 /ton 4, Firewood 3 x 10 6 /ton Charcoal 6.9 x 10 6 /ton 1, Electricity 860/kWh The selling price of diesel oil in its relatively low place in the above price structure, is encouraging an increased demand for diesel oil and will create further problems in matching the yield of the Mombasa refinery to market demand. With the existing refinery yield pattern, the proportion of diesel to total production is significantly less than the proportion of market demand for diesel to total demand for petroleum products. This situation would improve if the refinery were to be modified to increase the yield of middle distillates from refined crude oil, and the Bank is now giving consideration to funding an engineering loan to study the various options for the conversion of the refinery to improve the yield of products most in demand. Energy Assessment 1.18 In May 1982, the Bank published Report No KE entitled "Kenya: Issues and Options in the Energy Sector", which contains the findings of a mission to Kenya, and a number of recommendations to improve Kenya's energy sector. Kenya has, in general, followed appropriate energy sector policies, and has, for example, consistently passed energy price increases along to consumers, and maintains appropriate levels of taxation. The two major energy problems are the cost of imported petroleum which is becoming a significant drain on the foreign exchange resources of Kenya, and the deforestation, which while not serious in some areas, is deteriorating because wood fuel is being consumed at about four times the annual rate of replenishment. The recommendations include the encouragement of a more economic mix of petroleum product imports and exports, a more realistic and less ambitious fuel alcohol investment program, replacing oil-fired thermal plant power generation through the further development of hydroelectric and geothermal resources, and in the longer term, the development of regional hydroelectric power projects. Other recommendations include the change-over of oil-fired, heating equipment in industries to coal, ensuring that energy is used more efficiently, a more vigorous search for possible petroleum within the country, and improvement in the reforestation programs. The final recommendation was that the Government develop an overall long term strategy for the energy sector. Under the Second Structural Adjustment Operation (Loan No KE/Credit No KE; Report No. P-3322-KE) the Government has undertaken, inter alia, to develop a comprehensive energy

12 investment program providing for both production and conservation in the modern and traditional sector to be prepared on the basis of the studies now underway and to be discussed with Bank staff. II. POWER SECTOR BACKGROUND General 2.01 The availability of power to consumers in Kenya is, in general, limited to the more densely populated narrow strip running across the southern part of the country from Mombasa through Nairobi to Lake Victoria (Map IBRD 16389R) in parallel with the railway, and along the coast. The northern and eastern parts of the country are arid, and because of the scattered population, consumers do not have easy access to electricity. Of the estimated 15 million inhabitants in Kenya, 90% live in rural areas. Only 6%1/ of the total population has access to electricity, and the average estimated per capita consumption of electrical energy of this small percentage of the population was about 1800 KWh in The Power Supply Entities 2.02 Public electricity in Kenya is now produced by four companies: the East African Power & Lighting Company Limited (EAP&L), the Kenya Power Company Limited (KPC), the Tana River Development Company Limited (TRDC) and the Tana and Athi Rivers Development Authority (TARDA). EAP&L coordinates all sources of power, purchases in bulk from the other three companies, and is the sole distributor. Background information and a description of the four companies is given in paras and Annex 19. Historical Demand for Power and Energy 2.03 In the preparation of the National Power Development Plan, (para. 1.02), the consultants, Merz & McLellan (M&M) examined the requirements of the consumers in each of the five administrative districts: Nairobi, Mount Kenya, Coast, Rift and Western, and by class of consumer - domestic, off-peak 2 /, industrial, commercial, street lighting and small consumer - for the period 1972 to By analysing the past rates of growth, projecting them into the future, and adjusting these forecasts by known factors which may influence the result (i.e. new industry, load shedding, extension of services etc.) the consultants derived the growth rates for as shown below. The actual growth rates are also shown: 1/ Percentages of population with access to electricity in other East African countries are as follows: Lesotho 3.5%; Malawi 2%; Sudan 8%; Tanzania 7%; and Zaire 2%. 2/ Off-peak - Energy purchased under this category is interruptible so that EAP&L may reduce demand when conditions warrant. EAP&L proposes to raise the cost of this energy from 1/2 the regular tariff to 2/3 the regular tariff (para. 5.08).

13 - 7 - Estimated and Actual Electrical Energy Growth Rates Forecast in Percentage Base Period M&M Report Actual of Sales District Percent Nairobi Coast Western Rift Valley Mount Kenya Total Country Although the forecast growth in the demand for energy since the preparation of the report in 1977 was achieved for Nairobi and the Western district, growth in demand in the other parts of the country was well below expectations. The high rate of growth forecast for the districts outside Nairobi reflected the Government's desire to expand industrial areas away from Nairobi, and this has been achieved only in the Western District The actual and forecast growth in demand for electric power and energy during for the total country is shown in the tabulation below: Demand for Power and Energy Forecast in M & M Report Actual Recorded System System Increase System System Increase Peak Energy in Energy Peak Energy in Energy (MW) (GWh) (%)) (MW) (GWh) (%)) Average From the above it is evident that the actual maximum demand for power coincided with forecast demand, but the energy requirements are somewhat less than expected, because of the unrealized industrial construction program (para. 2.04). During the period the load factor on the system fell from 72% in 1976 to 68% in The low growth in 1980 over 1979 was due to the need to restrict supplies of electricity from February 16, 1980 to April 21, 1980 because of low flow of the Tana River, and the outage of a 30-MW steam driven generator in Mombasa. Sales of about 40 GWh were lost when load shedding was imposed during the period Most of the demand for energy is from industry where much of the sales increase is expected to originate. There are 10 consumers who average more than 1 GWh per month, the largest being the Bamburi Portland Cement Company at 8.2 GWh per month and a demand of 15.7 MW. Twenty-two

14 - 8 - organisations consume more than 0.5 GWh while there are 93 who consume between 0.1 and 0.5 GWh per month. A demand curve and the source of generation for a typical day is shown in Annex 1. Supply of Power and Energy 2.08 The demand for power has been met by the existing generating plant, and by importation from Uganda, and the firm capacity in 1982 is estimated to be about 60 MW above the expected peak demand. The energy situation, however, is quite different. In 1980, although the Uganda Electricity Board (UEB) provided about 60 GWh above the contracted amount, it was necessary to shed about 40 GWh from the system. A combination of the driest year on record, and failure of supplies from Uganda could have caused an energy shortfall of about 300 GWh. The addition of 15 MW (about 100 GWh) at Olkaria in 1981 and again in 1982 (para. 3.01) will alleviate the dry year shortfall to some extent. However, it is evident that Kenya requires the installation of additional firm generating facilities (para. 7.01). The actual and forecast sales of electricity from 1976 to 1990 are shown in Annex 2. The forecasts of the generating capability in an average water year, and in a dry year are shown in graph form in Annexes 3 and Kenya has an agreement extending to year 2005 to purchase 30 MW (estimated 252 GWh annually at a 96% load factor) from Uganda. KPC has requested UEB to increase the power exported to Kenya, but UEB has been reluctant to provide more than the 30 MW now contracted. Due to inadequate plant maintenance in Uganda, UEB's inability at times to supply even the 30 MW, and the growing electricity demand in Uganda, EAP&L now does not expect that additional power would be provided by UEB in the immediate future. However, there is potential for supplying Kenya with electric power by the mid 1990s from new hydro projects now being considered by Uganda. For some time, there has been a suggestion that a bulk transfer of power from the Kidatu project in Tanzania may be available for use in Kenya. This would not happen in the immediate future, but in the long-term, improved relations between the two countries may make the transfer of power an attractive possibility. The Bank group should use every opportunity to encourage such links between neighboring countries to enable the most economical source of generation in the region to be developed for the benefit of all participants. Long-term Development Plan 2.10 During the preparation of the Gitaru Loan (1147-KE), it was foreseen that generation of geothermal power at Olkaria was becoming attractive, and to investigate its feasibility and to place it in a long-term perspective funds were included for two separate studies. As a result, Merz & McLellan (M&M) of the United Kingdom and the Virkir Consulting Group Limited of Iceland submitted a report on geothermal development at Olkaria, in which it was concluded that development of the Olkaria site was economically justifiable and would be part of the least cost program for meeting the growing power demand. The report also concluded that geothermal power would be required by The results of this study were incorporated into M&M's and Gibb's National Power Development Plan, , completed in Several alternative scenarios to meet the expected load growth were considered, beginning with

15 - 9 - the Olkaria project and taking into account the potential for development of both hydro and thermal schemes The National Power Development Plan (para. 2.03) contains a forecast of growth in demand which necessitates further development of power supplies by Funds for a feasibility study to determine whether a hydro, geothermal, or other conventional thermal projects should be undertaken were included as part of the Olkaria Geothermal Power Project (LN 1799-KE in 1980, para. 3.01). The study recommended construction of the Kiambere hydroelectric project to be completed in However, this project has been delayed while new engineering studies are being completed. The processing of the financial and other arrangements are now expected to start within the next few months, and the commissioning of the station is now expected to take place by about December The Olkaria Geothermal Power Expansion Project has been proposed as a result of the delay (para. 3.02). A feasibility study of a hydroelectric power project on the Turkwel River is now underway, and some preliminary results have been received. Based on information presently available, the Bank believes that this project could not be completed until about Kenya's future electric energy needs will be met by further development of geothermal and hydro resources, or by thermal stations using imported coal. While there has been an increase in the use of bagasse as a source of energy in other countries, there has been little development of its use in Kenya either for direct production of steam, or for the generation of electricity. In the long term, some of Kenya's electrical energy may be provided from neighboring countries. A recent updating of the long range plan prepared by EAP&L resulted in the following plant program. Tentative Plant Program (Based on 7% Load Growth) Capacity Commissioning Name Type (MW) Date Olkaria Geothermal 15 Dec Kiambere Hydro 140 Dec Turkwel Hydro 120 June 1987 Olkaria Geothermal 40 Dec Sondu Hydrc 60 Dec Athi Hydro 60 Dec Mombasa Coal 60 Dec Geothermal 40 Dec Mombasa Coal 60 Dec Grand Falls Hydro 120 Dec Grand Falls Hydro 60 Dec Geothermal 40 Dec Mombasa Coal 60 Dec This plant program is not optimized and is already out of date. In fact, preparation of a master plan should be a continuous process involving periodic revisions. It is evident that overallt planning of the needs of the electric power sector requires improvement. There should

16 be greater coordination between the various parties involved in this aspect, i.e. Ministry of Finance, Ministry of Energy, Ministry of Science, Technology, and Regional Development, and other public and private bodies closely related to energy production, distribution and consumption such as EAP&L, TRDC, KPC, TARDA, and very large consumers, petroleum companies etc. To this end, during negotiations, general discussions were held with the Government concering the interrelationships of each of the foregoing bodies, and the Bank urged that the most efficient arrangements be made so as to enable them to work together for the benefit of Kenya, not only for the power sector but for the energy sector as a whole. Rural Electrification 2.14 A Rural Electrification Fund was established by the Government in 1973 with a contribution of KSh. 9,980,260, and a Swedish bridging grant of KSh. 8,760,640. It is administered by the Electricity Development Committee, which is comprised of representatives of the Ministries of Finance, Energy, Economic Planning & Communications, and EAP&L. Rural electrification schemes are managed and operated by EAP&L, which receives revenue from the consumers and presents statements of revenue and cost to the committee. Funds provided from the interest differential between the soft terms of a Swedish International Development Agency (SIDA) credit to the Government for the Kamburu project and the Government's harder onlending terms to TRDC, are used to finance the rural electrification program. Annual accrual to the fund is KSh. 4,431,920 from the SIDA Credit, and the interest in the investment of the Rural Electrification Fund of KSh. 4 million in the Sugar Finance Corporation of KSh. 250,682. Total disbursement of the fund was KSh million at the end of A Swedish team, comprising a planning engineer and two construction foremen, were seconded to EAP&L to assist in the implementation of the program In February 1980, the Canadian International Development Agency (CIDA) made a grant of C$550,000 (US$460,000), and in June 1981, CIDA made another direct grant of C$2.75 million (US$2.3 million) to the rural electrification program. The grant provides two technical staff members, one attached to EAP&L to assist in carrying out the extension of the distribution system in the rural areas, and the other attached to the Ministry of Energy to assist in the socio-economic analysis of projects intended to be included in the program. In addition, of the funds from the interest differential between the soft terms of a CIDA loan to the Government, and the harder onlending terms to EAP&L for the Mombasa-Kamburu transmission line (para. 6.16) amounting to about US$7 million in 1983 and 1984, about US$4 million will be spent on rural electrification, and the remainder on other unspecified energy related projects in Kenya In a separate rural electrification program, EAP&L spent about US$800,000 per annum on 22 schemes during the period. EAP&L normally apportions 1% of its gross sales revenue (about US$900,000 in 1981) to develop additional schemes, but in recent years the funds serve mainly to cover the losses of the earlier schemes. The major problem encountered with rural electrification programs in Kenya is the consumers' inability to pay. Demand is low because the cost limits most rural

17 households to the use of electricity for lighting and not for other domestic or productive purposes. The contractors, mainly concentrated in urban areas, are unwilling to undertake minor jobs in the rural areas, and EAP&L has only a small construction staff for this type of work. The training of construction workers was included in the training component of the Olkaria Geothermal Power Project LN1799-KE 1980, and it is anticipated t'hat the additional trained staff would alleviate this problem to some extent. The geography of the country adds to the problem in that there are few village concentrations, and the scattered households make the distribution costly Although the rural electrification programs appear to be not financially self-sustaining, the Government has continued to encourage the expansion of the programs by providing funds through the interest differentials (paras and 2.15), in the belief that improvement of the social, commercial and industrial activities in small communities will tend to reduce migration to the larger urban centers. The Government recognizes that these rural schemes are subsidized to some extent by the urban consumers, and has allowed EAP&L to adjust its tariffs to enable this cross-subsidization to take place, while encouraging the least unprofitable schemes to be chosen. Although none of the schemes undertaken to date are financially viable, they do not represent an undue burden on the sector and most could become remunerative in time. Meanwhile, the social and economic well-being of the rural community is gradually being improved. Previous Bank Lending in the Power Sector 2.18 The proposed loan would be the fifth bank lending operation for power in Kenya. Two previous loans - US$23 million for the Kamburu Hlydroelectric Project (LN 745-KE of 1971) and US$63 million for the Gitaru Hydroelectric Project (LN 1147-KE of 1975) - were made to TRDC, and two to KPC - US$9 million for the Olkaria Geothermal Engineering Project (LN S-12-KE of 1978), which was absorbed into a US$40 million Loan 1799-KE in 1980 for the Olkaria Geothermal Power Project The Kamburu project was the second phase of the Seven Forks Hydroelectric development on the Tana River (the first was a hydroelectric power station at Kindaruma). The project was designed to meet the demand for power in Nairobi and the coastal areas around Mombasa, where most of the industrial and commercial activities of Kenya are concentrated. The project consisted of: a) a rock fill dam on the Tana River; b) an underground power station; c) three 30 MW units; and d) the associated transmission line facilities connecting the power station with Nairobi and the Kindaruma hydroelectric power station further downstream.

18 The project was completed in 1974 about five months behind schedule with a cost overrun of about 7%. The delays were not unusual for a construction program of this nature, and the cost overrun was unavoidable as it was largely due to currency fluctuations. The Project Performance Audit Report No. 1230, dated July 14, 1976, based on the Project Completion Report, stated that the construction of the dam, powerhouse and transmission lines posed no unusual problems, and that the project was completed as planned with only minor start-up problems. It was noted that EAP&L would have to rely on the technical expertise of expatriates for some years to come, and that an appropriate training program was available for all levels of personnel. The sales and maximum demand forecasts were exceeded to such an extent that with a tariff increase in 1974, the rate of return for the project was 21% as compared with the appraisal estimate of 16% The Gitaru project was the last phase of the development of the hydro potential at the Seven Forks of the Tana River. It is situated between the Kamburu and Kindaruma power stations, and the three stations operate in cascade. The project consisted of: a) a powerhouse with two 72-MW units with provision for a third similar unit; b) a 30 meter high dam, 580 meters long; c) a 900 meter supply tunnel and a 4,700 meter tailrace tunnel; d) switching station; e) a 111-km transmission line to the Juja Road substation in Nairobi; and f) three studies: Geothermal Development at Olkaria (para. 2.11); the National Power Development Plan (para. 2.03); and a Management and Accounting Consultancy Study (para. 6.06) The Project Performance Audit Report No dated June 24, 1981 states that the project was completed within the dates established by the contracts, due to having good control and supervision by competent consultants. It was also noted that the use of bonuses for the completion of certain tasks by key dates provided the incentive for contractors to cooperate with each other and to complete their portion of the work on schedule The Olkaria Geothermal Power Project consisted of: a) a powerhouse; b) two 15-MW steam turbines and generators, with all auxiliaries; c) a system to bring steam from the wells to the powerhouse; d) roads;

19 e) housing; f) switchyard; g) a transmission line to join the existing Uganda - Nairobi transmission line; h) training component; i) detailed studies of the geothermal field; and j) a feasibility study of the proposed Kiambere hydroelectric project The first unit was placed into commercial service in August 1981, and the second in December 1982, some three months ahead of schedule. A project completion report will be prepared in FY1984. Bank Strategy in the Power Sector 2.24 The Olkaria project was the first development of geothermal power in Africa, and is, hopefully, the beginning of a series of such projects. During the past few years the requirements for energy have taxed the resources of Governments with the rapidly rising cost of oil, and the Rift Valley has shown great potential for supplying much needed energy at a reasonably attractive price. The Bank is keeping abreast of geothermal activities by closely following the studies being made in other countries, particularly in Ethiopia, where the UNDP has recently funded a large investigation program similar to that of the initial phases of the Olkaria project The Bank has also assisted in meeting the projected shortage of energy in rural Kenya through a forestry project (para. 1.05) which included fuelwood development on both private and Government land. On January 29, 1982, Loan 2065 (US$4.0 million), the Petroleum Exploration Project (total cost US$5.3 million) became effective, and although the search for domestic oil has been unsuccessful in the past, the Government is hopeful of success in this new project. Aspects of the overall energy sector are being reviewed under the Structural Adjustment Loan P3322-KE. The Bank's continued lending in the sector would assist in funding Kenya's requirements for energy, for technical assistance, for the development of Kenyan personnel to fill middle and senior management positions now held by expatriate staff, and for studies on the justification and manner that existing resources may be developed to meet the needs of the country. Without this assistance, growth in the industrial sector would stagnate, and retard the major objective of the Fourth Five-Year Development Plan, aimed at alleviation of poverty through the creation of income-earning opportunities and the provision of social services to meet the basic needs of the population. In previous loans the Bank has included funds for continued updating of the needs for the development of new electrical generating facilities, and this proposed project contains a component to cover continued studies (paras and 3.06).

20 The present long range planning for electric power is now out of date, and it is part of the Bank's lending strategy to provide funds for two studies: future geothermal development, and for the determination of the least cost investment program (Annex 5). Government Strategy in the Power Sector 2.27 The Government continues to give high priority to the development of the power sector in view of its importance for the overall economic development of Kenya. Moreover, the need to formulate a comprehensive national energy development plan has become generally recognized by the Government since the energy crisis. Thus, to meet the development objectives for the energy sector as defined in the Development Plan , investment by the Government over the Plan period in generation expansion, transmission and distribution is estimated at US$226 million, of which US$59 million has been allocated for the geothermal program. The large allocation (about 21% of total capital expenditure in the power sector over the P?lan period) reflects the Government's emphasis on power development. III. THE PROJECT Background 3.01 The Olkaria geothermal field is located south of Lake Naivasha and is about 100 km northwest of Nairobi. Initial exploration indicated that Olkaria had excellent potential for development (para. 1.03). Thus, in 1970 with UNDP assistance, extensive investigations and surveys were initiated in order to determine the feasibility of developing power from the available steam. As a result of the studies, UNDP provided more funds to cover part of the costs of a further drilling program for six deep wells between 1973 and Following this, the Bank financed additional feasibility studies for this geothermal project from proceeds of the Gitaru Hydroelectric Project (LN 1147-KE) (para. 2.20). The studies were completed in October 1977 and indicated that the generation of electric power using geothermal steam as a primary source was feasible. KPC thus reactivated drilling operations in March 1978, and sought Bank assistance for the power project. An engineering loan (S-12-KE) for US$9 million which provided foreign funds for part of the cost of the preparatory works estimated to total US$15.5 million, became effective on April 30, The volume of steam output, temperature, and pressure from each well could vary considerably at different locations in the geothermal field. Thus, funds from the engineering loan were used to drill production wells for the proposed generating station, and 80% of the steam requirements for the first unit were proven before the Bank proceeded with appraisal. The Olkaria Geothermal Power Project (para. 2.22) was approved on January 21, The first unit was placed in service in August 1981 and the second unit in December As a result of the delays encountered in the development of the Kiambere project due to a revision in the manner in which the site would be developed, KPC has requested the Bank to give consideration to providing

21 part of the funds necessary to construct a third 15-MW generating unit at the Olkaria site. A mission visited Kenya in February and March 1982 to appraise the proposed project. Objectives 3.03 The primary objectives of the project are to assure the availability of a firm source of power and energy within the country to meet the growth in demand which could exceed the capacity of the existing facilities in 1984 (Annex 4) and, as stated in the Government's Fourth Development Plan , to reduce the country's heavy dependence on imported oil. It is important that electric power industry provide a reasonably reliable source to meet the growing demand for electricity needed for economic growth and for the social well-being of the Kenyan people. The proposed project is the least costly means of adding to the existing generating facilities to achieve this objective. Funds for studies have been included to ensure that the needs of the electricity consumers will continue to be satisfied. A further objective is to strengthen the power industry in Kenya by maintaining the power industry's financial viability through sound management and tariff policies. Detailed Description 3.04 The project consists of the construction of an extension to the existing electric generating station (para. 2.22), comprising the addition of one 15-MW turbine and generator with its associated auxiliaries and other necessary civil works. In summary, the project is as follows: a) An extension of the existing powerhouse to house a third 15-MW unit, complete with all auxiliaries and ancillary electrical and mechanical equipment; b) a system to bring steam from the wells now being drilled under LN 1799-KE; c) a new cooling tower, and other works associated with the cooling water system; d) an extension to the existing switchyard; e) a new hard-surfaced road; f) an augmentation of the water supply to the site and to the drilling operations; g) additional housing for an increase in operating staff; h) detailed studies of the geothermal potential of the site; j) studies for future projects; k) consulting engineering.

22 A conventional powerhouse has been constructed to contain the first two 15-MW steam turbine-driven generators, together with all auxiliary equipment and controls, and the proposed third unit would be similar to the original two units. Since the generating capability of each production well varies from 2 MW to about 6 MW, steam from a large number of wells has been gathered through surface piping and taken to the powerhouse. Additional piping would be required for this unit. A new tower to cool the water which is used to condense the steam as it leaves the turbines, is required because the existing cooling tower was designed to operate with only the first two units. As at present, the power from the new generator would be stepped up to 132 kv by a transformer in an adjacent switching station and carried to the load centers by an existing 22-km transmission line which is connected to the 132-kV Kenya-Uganda transmission line. The existing access road which crosses three private properties, is in a poor state of repair and requires frequent maintenance particularly during rainy weather. Thus, in order to reduce maintenance both on the road and on the operating staff's vehicles, and for security, a component of the project would be the construction of a new private road from the operators' houses to the power site, thereby shortening the distance travelled from 16 km to 9 km. The cost of road improvement was not included in the original loan, but better access is justified, now that there is proven generating capability at the site In addition, the project would include two studies to be carried out by suitably qualified and experienced consultants selected on the basis of terms of reference agreed with the Bank: (a) A study covering an indepth review of the present Olkaria site, and the potential for further geothermal electric power generation. KPC would hire consultants by June 1, 1983 and the report would be completed by December 31, (b) Funds have also been included for a second study, which would be prepared in two phases. The first phase would be the preparation of a revised medium to long term generating plant and transmission line program indicating the least-cost program to meet the growing electric power needs of Kenya. The various alternative prime sources of power-hydro, geothermal, coal, oil and bagasse would be considered as well as the possibility of developing regional needs for the benefit of Kenya. EAP&L would recommend to the Ministry of Energy that a Steering Committee be convened under its auspices in order to ensure proper review of said study. It is proposed that the Steering Committee be composed of the chief executives of all the power producing companies and the regional development authorities active in the power sector, and high ranking officials of the Ministries of Energy, Planning, Finance, and Regional Development, Science and Technology. EAP&L would act as secretariat for the Steering Committee and would carry out the day-to-day management of the study. The second phase would be a detailed feasibility study of the recommended power project. EAP&L would hire consultants by September 1, 1983 and the report would be completed by October 30, 1984.

23 Environmental Considerations 3.07 There are no inhabitants in the immediate area of the power station, the vegetation is sparse, and except for a few zebra, there is little wild life. Thus, the disposal of gases in the air, particularly the hydrogen sulphide, has little effect on human or animal life. Special attention has been given to the problem of hydrogen sulphide in the design of the station so as to eliminate unventilated areas and deep pits or trenches where the gas may accumulate. Disposal of gases from the three units would be through a 50-foot high chimney which has been designed to provide adequate dispersion and dilution so as to conform with internationally accepted criteria. Periodically, it would be necessary to blow off steam for pressure stabilization and well maintenance, but suitable silencers reduce the noise to acceptable limits for the operators. Housing for the operating staff is 9 km away, so that objectionable gases would never reach the area and there would be no noise problem. Waste water, containing quantities of salts, is piped to nearby depressions where the water seeps into the ground. The underground flow in this area is away from Lake Naivasha, so there is no possibility of contaminating the lake. There has been no problem at the existing installation but, if this effluent were to reappear on the surface, proper measures would be taken to dispose of it. Cost Estimates IV. PROJECT COSTS AND FINANCING 4.01 The total project cost is estimated to be US$37.7 million equivalent; the net cost excluding duties and taxes is estimated to be US$31.3 million. The project's foreign exchange component is estimated to be US$22.5 million equivalent, about 60% of total project costs. The total external financing, including 33% of the interest during construction, is estimated to be US$29.8 million. The estimated costs of the principal features of the project are shown in the table on the following page. Basis for Estimates 4.02 Project cost estimates were prepared by the consultant on the basis of the cost of the first two units which are now being completed, and upon being reviewed by the Bank, were found to be reasonable. The Bank subsequently adjusted the costs to reflect June 30, 1982 prices. The Bank found that only about 50% of the local costs to be disbursed for the various contracts (except engineering, studies, and taxes) could be considered truly local costs, and the remainder were indirect foreign costs attributable to the purchase locally, of fuel and equipment for the construction of the project. Therefore, the remaining 50% of local costs for each item have been included in the tabulation of the estimated project costs as indirect foreign costs. No contingencies were applied to the lump sum costs of the two studies. Physical contingencies of 10% were used on all other items. Foreign price contingencies of 8.0% in 1982 and 1983, and 7.5% in 1984 and local price contingencies of 13% for 1982, and 9% for 1983, and 8% for 1984 were applied to the base cost and physical contingencies of each project component.

24 Estimate of Project Costs Foreign as % of Local Foreign Total ldcal Foreign Total Total =KSh millions -US$ millions- Mechanical & Electrical Equipment Substation Civil Works Road Water Supply Housing Engineering Studies: Geothermal Future Projects Base Cost (June 30, 1982 Prices) Contingencies: Fhysical Price TOTAL PIUJECT COST INTEREST DURITM CONSTRUJCrION (Financed by CDC and KPC) _ Subtotal Front End Fees on Loans a/ TOTAL FINANCIN, REQJIRED Note: 1) No contingencies assumed on studies; Physical contingencies on all other items assumed to be 10%/; Price contingencies were added to the base cost plus physical contingencies as follows: Local costs : %; %; % Foreign costs : 1982 and %; % 2) Identifiable duties and taxes are estimated to be about KSh million (US$6.4 million) and the total project cost, net of taxes, is KSh million (US$31.3 million) a/ Bank Loan assumed to be US$12.0 million CDC Loan assumed to be US$9.0 million

25 Financing Plan 4.03 The proposed Bank loan of US$12.0 million would finance 32% of the estimated project cost (US$37.7 million) and 53% of the estimated foreign component of the project (US$22.5 million), in both cases excluding interest during construction. It would be used to finance: a) 50% of the total expenditures for the mechanical and electrical equipment, less taxes; b) 50% of the total expenditures for the civil works for road construction, less taxes; c) 100% of the foreign expenditures for the geothermal studies, and the studies for future projects; and e) 100% of the front-end fee on Bank loan A proposed loan of US$9.0 million equivalent from the Commonwealth Development Corporation (CDC) would be used as follows: a) 25% of the total expenditures for the mechanical and electrical equipment, less taxes; b) 100% of the total expenditures for the consulting engineering services for the project; and c) 100% of the foreign expenditure for interest during construction on the CDC loan; 4.05 A proposed loan of US$8.8 million (equivalent) from the European Investment Bank (EIB) would be used as follows: a) 22% of the total expenditures for the mechanical and electrical equipment, less taxes. b) 100% of the total expenditures for the civil works, less taxes; and c) 100% of the total expenditures for the additional housing, less taxes.

26 KPC would provide the remaining funds to cover: a) 3% of the total expenditures for the mechanical and electrical equipment, less taxes; b) 50% of the total expenditures for the road, less taxes; c) 100% of the total expenditures for the water supply, less taxes; d) 100% of local cost of the two studies; e) 100% of the total expenditures for interest during construction on the Bank and EIB loans; and f) 100% of the total expenditures for duties and taxes The total external financing would be about US$29.8 million, about 85% of the estimated cost including interest during construction and less duties and taxes. This is in line with the level of external financing that the Bank normally uses in Kenya. The Bank loan to KPC would be for 17 years including a 4-year grace period, at the standard variable interest rate. A front end fee of 1.5% of the loan amount would be due on or before the effective date, and has been included in the loan amount. A condition of effectiveness would be the effectiveness of the CDC and EIB loans. The CDC loan to KPC would be at an interest rate of 10.5% for 15 years, including a 5-year grace period. A fee of Stg 53,000 (US$85,000) to cover the cost of negotiations would be due 30 days after loan signature. The EIB loan to KPC would be for 15 years with a 4-year grace period at an interest rate of 8%. The costs borne by KPC would be financed by a Development Surcharge (para. 5.10) on the electric power sold by KPC to EAP&L (from internal cash generation). A summary of the financing plan as detailed in Annex 6, follows: Financing Plan - Summary Local Foreign Total % US$ millions----- Proposed IBRD Loan Proposed CDC Loan Proposed EIB Loan KPC Funds TOTAL

27 Status of Engineering and Construction Schedule 4.08 The construction schedule is based on full commercial operation of the proposed third unit by March 31, KPC is anxious that this schedule be maintained because of the power shortages which occur whenever the output of the hydro plants is reduced during dry years. Details of the construction schedule are given in Annex The project is being designed by Merz & McLellan (M&M) of the UK in association with Virkir of Iceland, both of whom are acceptable to the Bank. It is estimated that of the total of about 500 man-months which would be required by the consultants for the design and supervision of this project, approximately 130 man-months would be expended in Kenya, and the remainder in the consultants' offices in England and Iceland. The total cost of the engineering contract is estimated to be US$3.3 million of which US$2.3 would be foreign exchange. The average cost per man-month is estimated to be US$6,600. Geothermal Energy of New Zealand (GENZL) has been contracted to provide key staff for the operation and maintenance of the drilling equipment and to train local staff in its operation. Since the drilling program was re-activated in early 1978, three of the six wells drilled in have been successfully rehabilitated. Subsequently, fifteen more wells have been drilled. Annex 8 gives a tabulation of the steam flow from the wells The production wells, drilled to a depth of 900 to 2,500 meters, require two to three months for completion, including moving and setup times as well as delays due to equipment failures. The first drill was purchased for the program when the first 6 production wells are completed. Since the project was reactivited in 1978, the drill has been frequently out of service for maintenance. The second drill (funded under LN S-12-KE) was put into operation in August Staff of KPC, under the supervision of a team of drillers from Geothermal Energy of New Zealand (GENZL), have completed 15 wells since the program was reactivited. The steam from the 21 wells completed to date is estimated to be capable of generating about 42 MW (Annex 8). The original drill will continue to sink wells around the powerhouse until completion of well No. 26, at which time it is expected that there would be a proven supply of about 52 MW (i.e. a 15% surplus) for the 45 MW installation. Recently, the new drill rig was moved to a location about 4 km away to begin exploration for the development of further power production facilities. Procurement 4.11 Procurement for work and material to be financed under the Bank loan would be in accordance with Bank guidelines for international competitive bidding. The Bank would finance the mechanical and electrical contracts jointly with CDC, EIB and KPC, and the road and studies with KPC. EIB would provide parallel financing for the substations, civil works and housing, and CDC would provide parallel financing for engineering services. Only the civil works, water supply, roads and housing contracts would be open to local contractors bids because the very specialized nature of the generating and substation equipment and associated control facilities would exclude local interest. If there are contracts of less than about US$100,000 for miscellaneous equipment and supplies, they would

28 be awarded on the basis of the limited international or local competitive bidding procedures or price solicitation from at least three suppliers. Procurement procedures for small contracts was discussed with the Borrower during negotiations and the procedures to be used were approved by the Bank. The maximum expenditure that would be incurred under these procedures should not exceed US$500,000. Disbursements 4.12 The proceeds of the loan would be disbursed over three years on the following basis: 50% of the total expenditure for mechanical and electrical equipment, 50% of the total expenditure for the civil works of the road, and 100% of the foreign expenditure for the studies for further geothermal production wells, and for the future projects. The remaining costs would be disbursed from CDC, EIB and KPC funds (paras ). All disbursements would be fully documented by KPC. The closing date for the loan would be March 31, 1986, and any savings which may accrue due to lower purchase prices, or if all of the contingency funds are not needed, would be cancelled. A disbursement schedule may be found in Annex 9. This schedule differs from the average power project and Kenya project disbursement profiles, because the project is an addition to an existing generating station, and some items of work normally associated with a power project, have already been provided. Also, Bank funds would be used only on the mechanical and electrical equipment, road and studies. Accounts and Audit 4.13 KPC, TRDC and EAP&L prepare their accounts in accordance with sound commercial and public utility accounting practices. The accounts of the three companies are currently audited by Gill and Johnson, whose performance has been generally satisfactory, and they are acceptable to the Bank. EAP&L also prepares combined annual accounts of KPC and TRDC as well as combined annual accounts of KPC, TRDC and EAP&L. During negotiations agreement was reached that the requirements of the Bank for earlier Bank loans (745-KE, 1147-KE and 1799-KE) relating to submission of annual accounts of the three companies within six months of the end of financial year, certified by independent auditors acceptable to the Bank, and submission of consolidated accounts of the two bulk supply companies and all three companies would be repeated for the proposed loan. Introduction V. COST RECOVERY AND FINANCIAL ASPECTS 5.01 The activities of the three companies comprising the-public power supply in Kenya are closely connected through common management and staff. The financial position of the borrower, KPC, should not therefore be evaluated in isolation but jointly with that of TRDC and EAP&L. Financial statements of KPC and consolidated statements for all the three companies combined, covering the period 1979 through 1981 (actual) and 1982 through 1986 (estimated), are presented in Annexes 10 to 15. Assumptions made in these statements are given in Annex 16 together with explanatory notes which include increases in operating expenses in keeping with the planned expansion in the volume of operations, and in both capital and operating expenditures, increases to reflect the effect of estimated price escalations.

29 The revenues of the two bulk supply companies, KPC and TRDC are determined on the basis of "ascertained cost as defined in their respective bulk-supply agreements. Ascertained cost (Annex 16), described briefly, comprises operation and administration costs, interest and redemption payments for debt, income and other taxes and an amount to meet abnormal expenses and a part of the development expenses. The two bulk supply companies, while separate legal entitites, should for all practical purposes, be considered a single unit since they are both wholly owned by the Government, have similar nature of operations, and sell the entire energy purchased or generated by them to a single entity, EAP&L. Past Operations and Present Financial Position 5.03 As can be seen from Annex 10, net assets (fixed assets, investments and working capital) of KPC amounted to KSh. 683 million at the end of About 49% of these assets were financed by borrowing, most of which is repayable in foreign exchange. Net gain from the realignment of currencies from time to time since 1967 is reflected as a part of equity. The debt equity ratio at the end of 1981 was 49/51. By the end of 1984, after completion of the project, net assets are expected to be about KSh 1,582 million and the debt equity ratio 57/43, which is satisfactory. However, it is more significant to consider the financial position of KPC on a combined basis with the other two companies (para. 5.05) The combined revenue and operating expenses of the three companies, EAP&L, KPC and TRDC for the year 1979 through 1981 are summarized below. The combined rate of return earned by them during these years was 7.9%, 6.4% and 11.6% respectively. The financial covenants of IBRD Loans 1147 to TRDC and 1799-KE to KPC required a minimum rate of return of 8.5%, 6% and 7% respectively on average net fixed assets revalued annually. The rate of return earned in 1979, therefore, was lower than required by loan covenants but higher in 1980 and The operations of the three companies were satisfactory and they substantially met their working capital and rate of return requirements. Combined Revenue and Operating Expenses - Summarized Units sold (million KWh) Average price per KWh (KSh) KSh million Revenues Operating Expenses Operating Income Rate of return based on revalued average net fixed assets (%) The combined balance sheet contained in Annex 13 shows that, at the end of 1981, the total net assets of the three companies amount to KSh. 4,321 million and the debt equity ratio 43/57. It is apparent,

30 therefore, that on a combined basis, the three companies are conservatively capitalized The currency rate fluctuations in the past few years have had significant adverse effect on the foreign currency debt of the three companies, as the official rate of exchange of the Kenya shilling has declined about 40% since The rate of return covenant (para. 5.15) for this loan is proposed to repeat the provision for the annual revaluation of assets on a price index, agreed between EAP&L and the Bank, which takes into account the increases in the replacement cost of fixed assets due to currency rate fluctuations as well as inflation Annex 13 indicates that the three companies have adequate working capital and satisfactory cash positions. There has been good control of debtors; accounts receivable amounted to only a little more than two months' billing at the end of Net income of the three companies for the years 1979, 1980 and 1981 (Annex 14), expressed in million KSh, was 114,148 and 145 as against the estimates (prepared during the appraisal of the Geothermal Project in 1978) of 66, 114 and 179 respectively, and shows a satisfactory position. EAP&L's Tariffs 5.08 On the basis of a power tariff study completed by the Bank in 1977, a tariff structure, taking into consideration long-term marginal costs, was introduced throughout the country in January A fuel oil surcharge is added to the tariff to allow EAP&L to recover from its consumers the bulk of any increase in the cost of fuel used in power generation. The electricity tariff structure is described in Annex 17. The present tariff is estimated to produce an average revenue of 62 Kenya cents or 6 US cents per KWh 3 /. EAP&L has, in the past, made timely adjustments to its tariffs through fuel cost adjustments in an effort to meet agreed rate of return requirements and has indicated its intention to make appropriate tariff increases in the future. With the commissioning by TARDA of the Masinga Dam Hydroelectric Station in 1981 (Annex 19), strengthening of transmission interconnection between the coast area and central and eastern parts of Kenya in 1983 and the likelihood of commissioning new hydro and geothermal capacity in the 1980's, the power system generation characteristics will be substantially altered from the characteristics in 1979 when the last tariff study was prepared. In particular, marginal cost of energy will no longer vary with time of day, and therefore there will not be justification for allowing substantial tariff discounts for off-peak consumption. EAP&L has recently carried out a new power tariff study based on long-run marginal costs and has submitted proposals to Government for appropriate revision to the tariff structure. 3/ Electricity tariffs for some other East African countries converted at official exchange rates into US cents per KWh are: Botswana 12.4, Malawi 5.3, Sudan 10, Swaziland 3.9.

31 Construction Program The construction program of the three power companies for the period includes major strengthening of Kenya's power transmission system. Additionally, construction of two major hydroelectric stations: the Kiambere project (140 MW) and Turkwel project (120 MW) is included in Kenya's power development program, the former project is proposed to be implemented by TARDA. Proposed Financing Plan 5.10 The financing plan includes a 13% increase in EAP&L's tariffs from January, 1983 and further increases by an average of 6%, 3% and 9% from January, 1984, 1985 and 19864/ respectively, and continuation of the development surcharge (Annex 16) payable by EAP&L to the bulk supply companies. To help finance TRDC's and KPC's development projects, EAP&L has in the past paid annually a development surcharge which provided the two bulk supply companies, TRDC and KPC, with local currency funds requirements additional to those met by loan and equity contributions. EAP&L intends to continue to pay the development surcharge to help finance the proposed project at a rate of 2 Kenya cents per KWh of energy supplied to EAP&L by the two bulk supply companies. However, as the requirement of funds would vary from year to year depending on the pattern of disbursements and other factors, should this amount not prove adequate to provide the local currency funds needed for the proposed project in any particular year, EAP&L would provide additional funds required up to an amount which would make the rate of return of the two bulk supply companies in respect of any year equal to 8% of their average revalued net fixed assets in operation, and agreement on this was reached during negotiations. Thus, the costs of the project are proposed to be provided by continuation of the development surcharge and by the IBRD, EIB and the CDC loans (paras and 5.14) KPC's sources and application of funds for the period 1979 to 1981 (actual) and 1982 to 1986 (estimated) are presented in Annex 12. The financing plan of KPC for the project construction period , along with that of the three companies combined, follows: 4/ Assuming annual price escalation rates of between 13% and 8% during the period 1982 to 1986, tariffs in real terms would decline from the 1981 levels even after the proposed tariff increases during that period.

32 KPC KPC/TRDC/EAP&L KSh KSh US$ Financing Plan million % million million % Requirements Construction (including Capitalized Interest) KPC - The Proposed Projecta/ Other TRDC EAP&L - including 220 kv Line Subtotal Increase in Working Capital Increase in Reserve and Equalization Fund (see Annex 16, para. 4) Total Requirements Source of Funds Net Cash Generation Less: Debt Service Dividends Net Internal Cash Generation Loans Project - Proposed IBRD b/ Proposed EIB Proposed CDC Loans for Other Development - Programs Total Borrowings Total Sources of Funds a/ With expenditure of KSh. 10 million in 1982 and 1986, respectively, the total estimated cost of the project is KSh. 442 million (US$42 million); b/ Additional drawdowns estimated for 1986 of KSh. I million would make the IBRD loan total KSh. 127 million (US$12 million).

33 It is appropriate to consider the financing plan on the basis of the combined sources and requirements of the three companies, eliminating inter-company transactions as though they were merged into one company. The combined requirements and sources of funds on this basis, of KPC, TRDC and EAP&L for the period , are presented in Annex 15. The summarized financing plan of the three companies, given in the preceding table, shows that of the total construction requirements of the three companies for , 49% would be financed by net internal cash generation after providing for debt service and dividends, and the balance by borrowings: 7% by the proposed IBRD loan, 5% by a loan from EIB and 5% by a loan from CDC, 35% by other loans which are available to KPC and EAP&L for the development program of the power companies. Completion of co-financing arrangements for the proposed project which are already well advanced is a condition of effectiveness of the proposed loan. As indicated in Annex 15, the internal cash generation covers the annual debt service requirements by an ample margin, ranging from an estimated 2.1 times in 1983 to about 1.8 times in 1985, which is adequate During negotiations agreement was reached that, if additional funds are required to complete the project, the Government would provide the additional financing requirement in accordance with arrangements satisfactory to the Bank. Future Earnings 5.14 Forecasts of revenues and expenses of KPC and for the three companies combined are summarized below and attached as Annexes 11 and 14 respectively. The development surcharge has been calculated to provide KPC with funds required for its capital development program and EAP&L's tariffs adjusted to provide for the three companies, on a combined basis, a minimum rate of return on average revalued net fixed assets in operation of 8% from 1983, as well as the local funds required for operations, debt service, local capital expenditure and working capital requirements of the three companies.

34 KPC - Revenue and Operating Expense Estimates - Summarized (KSh million) Revenues Operating Expenses Operating Income Combined Revenue and Operating Expense Estimates - Summarized Units sold (million KWh) 1,722 1,841 1,955 2,074 2,178 Average price per KWh (Ksh) (KSh million) Revenues 1,059 1,278 1,435 1,580 1,801 Operating Expenses ,003 1,097 1,278 Operating Income Rate of return based on revalued average net fixed assets (%) The financial projections indicate that the 7% rate of return required for 1982 under the earlier Bank Loan 1799-KE will be met; and in subsequent years with small tariff increases (para. 5.10), the rate of return at a minimum of 8% will be maintained. To help provide the two bulk supply companies and EAPL with adequate funds for their development programs (paras. 5.04, 5.10 and 5.14) as well as for their operating, debt service and working capital needs, therefore, EAPL would be required to continue to take all necessary steps to ensure that the combined net operating income of the three companies, KPC, TRDC and EAPL would not be less than 8% of their combined average revalued net fixed assets in operation from 1983, as required under the Bank Loan 1799-KE. This level is adequate to provide funds required for the proposed project, the three companies' ongoing construction program and the related debt service and working capital requirement. During negotiations agreement was reached that the Government would take or cause to be taken all actions necessary to permit EAP&L to obtain revenues sufficient to yield this rate of return. Debt Limitation 5.16 Debt service coverage is relevant only in relation to the combined position of the three companies, particularly because of the rate of return requirements for KPC/TRDC and EAP&L (para. 5.15) and the debt service of the bulk supply companies, KPC/TRDC, being payable by EAP&L as a part of ascertained cost (para. 5.02). In line with the requirements of IBRD Loan 1799-KE for the Geothermal Project, no long-term indebtedness may be incurred by EAP&L, KPC and TRDC (or any associated EAP&L-managed company which may be established in the future as a bulk licensee selling power to EAP&L) without Bank approval, unless cash earnings before provision for depreciation are at least 1.5 times the maximum debt service for any

35 succeeding fiscal year, on all debt including the debt to be incurred. This test is made on the basis of combined revenue accounts and debt service after eliminating inter-company payments. The debt service coverage of the three companies is expected to be well above 1.5 and during negotiations agreement was reached that a similar covenant be repeated for the proposed IBRD loan. Annex 18 describes the security arrangements for the loan capital of EAP&L, KPC and TRDC. VI. ORGANIZATION AND IMPLEMENTATION Structure of the Electricity Supply Industry 6.01 The East African Power & Lighting Co. Ltd (EAP&L), which is the sole distributor of electricity in Kenya, was founded in 1922 by the amalgamation of two private companies which had supplied Nairobi and Mombasa since 1907 and Both the Kenya Power Co. Ltd (KPC) and the Tana River Development Co. Ltd (TRDC) were established by EAP&L, the former in 1955 principally to finance the interconnection with Uganda and sell imported power to EAP&L, and the latter in 1964 to develop the potential of the Tana River. At the time these companies were formed, the stock of EAP&L was privately owned by a large number of shareholders. Almost all of the capital raised for KPC and TRDC was loan capital. EAP&L shared the ownership of the nominal equity with a private financing company and the Government, which became the owner of one third of KPC's equity capital and one quarter of TRDC's. In 1969 the Government decided to obtain control of EAP&L by purchasing the available shares on the London stock register, and became in July 1979, the majority shareholder in the company. The Government had acquired the total equity of KPC and TRDC in February Since establishment, both companies have been managed and staffed by EAP&L under a management agreement. A brief description of the history of the power companies is in Annex Government recognizes that rationalization of the structure of the power industry could best be achieved by integrating all three companies, which already operate for all practical purposes as one company. EIowever, this cannot be achieved immediately because the income of TRDC and KPC is exempt from corporation tax whereas EAP&L's income is taxable and the arrangement serves as a mechanism for providing, from power industry's earnings, development funds which are tax-exempt. However, it would be desirable to merge TRDC and KPC into a single company and during negotiations the Government informed the Bank that a review of the structure of the power industry was being carried out by a Government committee. This review would include the issue of merger, and the recommendations would be sent to IDA for comment. In the case of EAP&L, the Government and its associated institutions, which together hold about 60% of the equity, are continuing to buy up shares on the Nairobi register as and when these become available. The present complicated arrangement is operating efficiently and it is not significant whether the merger be achieved in the short term. However, in September 1982 the 5.5% CDC debentures were fully repaid and a merger will be possible.

36 EAP&L purchases the entire output of KPC and TRDC at what is called the "ascertained cost" (see Annex 16 for definition) and is the only company allowed to earn surplus. The funds required to enable the proposed borrower to cover its operating expenses, pay its debt service and meet the local currency costs of the project must therefore come from EAP&L, and appropriate arrangements are necessary to assure KPC's revenues. During negotiations agreement on the continuation of the development surcharge to meet the needs of KPC's development program was obtained (para. 5.10) EAP&L manages and staffs the Masinga hydroelectric project owned by the Tana and Athi Rivers Development Authority (TARDA) and purchases the energy on the basis of an agreed formula based on the price of equivalent energy supplied by imported oil. Organization and Management 6.05 EAP&L is a well-managed utility and is operated in accordance with sound commercial principles. The Chief Executive, a Kenyan, is a competent administrator. The Board of Directors consists of 11 members including the Chief Executive and General Manager of the company and two government representatives; the remaining members are leading Kenyan businessmen In January 1978, the Montreal Engineering Company Limited submitted a report entitled "Management and Accounting Consultancy Study" which contained comments and recommended changes to the structure of the organization, the accounting functions, and the management reporting systems of EAP&L. In general, the report found that the company was reasonably well organised but suggested that certain activities might be better handled if assigned to other departments. The introduction of many of the recommendations, including a restructuring of the company by the creation of six functional divisions to replace nine departments, took place on July 1, Staff 6.07 The staff of EAP&L at December 31, 1981, inclusive of staff attached to KPC and TRDC, numbered 5,004. There has been a significant reduction in expatriate staff as evidenced by the fact that in 1970 there were 189 expatriate professional staff, 120 in 1974, and 72 in The number of metered connections in 1981 was 167,724 and there were about 33 consumers per employee. This compares favorably with some of the other East African companies 5 / and is reasonable considering the number of installations (some 24 power stations spread over Kenya), the distances involved, the amount of construction work carried out by the company, and staff training needs Maintaining the establishment at full strength as well as avoiding a deterioration in the quality of staff are continuing problems. Departing expatriate staff have generally been replaced with qualified 5/ Mauritius 74; Tanzania 22; and Madagascar 38.

37 local staff, but there are a number of vacancies which EAP&L is having difficulty in filling with suitable candidates either locally or from abroad. The standard of management of the companies has been maintained at a satisfactory level since the appraisal of the Olkaria Geothermal Power Project in EAP&L will have to rely on expatriates for some years but the problem is decreasing and eventually will be solved as Kenyans are trained to replace them (para. 6.18) The present staff are competent to operate the companies, to carry out the project with the assistance of consultants, and to carry out other works covered by the EAP&L development program. During negotiations EAP&L provided assurances that it would continue to employ consultants satisfactory to the Bank to carry out the project. Existing Facilities 6.10 Most of the electricity sold by EAP&L is distributed through an interconnected system covering five major areas of Kenya: Nairobi, Mount Kenya, Coast, Rift and Western Districts, which are shown on the attached Map IBRD 16389R. In addition, power is supplied to some centers in outlying areas by isolated diesel stations. Although there are numerous small privately operated generators, mostly isolated and some used for standby purposes, in this report no consideration has been given to the effect of these on the power supply system in Kenya. The existing generating plant owned by the four companies (Annex 20) together with those privately owned are shown in the following table: Summary Table of Existing Generating Plant Public Interconnected System Isolated Stations Private Hydro MW 2.6 MW Steam MW MW Diesel 31.5 MW 2.2 MW 15.0 MW Gas Turbine 30.0 MW Total MW 2.2 MW 39.6 MW 6.11 This generating plant is augmented by a 30-MW bulk supply from UEB, giving a total capacity of 552 MW on the interconnected system. However, the effective capability is reduced to about 490 MW due to derating some of the older diesel and gas turbine plant because of their age. The dates of plant retirements will depend to some extent on available river flows, and for the purposes of this report, it has been assumed that no plant would be retired until after the commissioning of the next hydroelectric generating station scheduled for December The three largest hydroelectric power stations (Kindaruma - 44 MW, Gitaru MW, and Kamburu MW located on the Tana River some 70 miles to the east of Nairobi), are owned by TRDC and the Masinga - 40

38 MW, also on the Tana River is owned by TARDA. Two smaller hydroelectric developments, Tana (14.4 MW) and Wainjii (7.4 MW), are owned by KPC. The 98-MW Kipevu steam station located at Mombasa, the remaining four very small hydroelectric installations (6.2 MW in total) together with eight diesel-electric stations, and the Nairobi South gas turbine plant, are owned by EAP&L. All of these generating stations are interconnected by means of 132-kV and 33-kV transmission and subtransmission lines. This system is linked to Uganda by a 132-kV double-circuit transmisssion line for the transfer of 30-MW bulk power. One of the 132-kV transmission lines between Kamburu and Nairobi is constructed for operation at 275 kv but will be operated at 220 kv upon completion of the Mombasa-Kamburu transmission line in June The distribution voltages are 11 kv and 415/240 kv. EAP&L also operates four isolated diesel-electric power stations aggregating 2.2 MW in the northern and eastern part of the country. However, they have not been included in this report because of their isolation and size The power installations at the Masinga dam, owned by TARDA, but operated by EAP&L, consist of two 20-MW units which began operation in August These units cannot be considered as a source of firm power supply because, at the time of greatest need, i.e. during the dry season, the reservoir wil:l generally be drawn down to such an extent that the reduced head on the plant will result in the total output being decreased to about 9 MW. However, they serve as a valuable source of less expensive energy, replacing fuel-generated energy, during periods when the head on the plant is suitable for power production. The output of the Masinga powerhouse will average about 200 GWh per year, and the additional energy output of the downstream hydro plants, (i.e. Kamburu, Gitaru, and Kindaruma) will average about 150 GWh annually over that available prior to completion of the dam. As irrigation water is abstracted from the river in the future, the increased energy available from the downstream plants will fall to about 75 GWh annually EAP&L's operating and maintenance practices are such that the electricity consumers in Kenya enjoy a reasonably reliable supply of power. The losses in the system amount to about 15%, which appear to be reasonable, when age and the condition of the equipment is taken into account. The completion of the Mombasa-Kamburu 220 kv transmission line (para. 6.16) should reduce these losses. Works in Progress 6.15 Construction of the first two units at Olkaria is virtually complete, with the first unit in operation since August 1981, and the second unit commissioned before December Para contains a description of this project financed under LN 1799-KE Two factors - the major load centers of Mombasa and Nairobi separated by 500 km, and the diverse types of power generation (hydro, steam turbine, diesel, gas turbine)- made it prudent to construct a new 220-kV transmission line from Mombasa to the Kamburu hydroelectric generating station in order to augment the transmission capabilities. Upon its completion, forecast for June 1983, it will be possible to transmit additiona:l amounts of low cost hydro power to the Coast Region,

39 during periods of high river flow, and higher cost steam-generated power to Nairobi and the Western regions, during annual low flow periods. The new transmission line will permit the transfer of about 100 MW, and the existing transmission line will be disconnected near its midpoint and used to distribute power westwards from Mombasa and eastwards from Nairobi. The Canadian International Development Agency (CIDA) has provided C$79 million (US$63 million) for this important link which is estimated to cost KSh 864 million (US$81.5 million) The foregoing loan from CIDA is also financing the strengthening of the transmission system in the Western District by overlaying a 132-kV system on the existing 33-kV system and bringing electric power from the Lessos substation (on the Nairobi-Uganda transmission line) to serve Kisumu and Eldoret and Kericho. In addition, work will commence soon on a 132-kV extension from Masinga to serve Nyeri and Nanyuki in the Mount Kenya District. Financing for this line is from a CIDA loan of C$4 million (US$3.4 million) which became effective in 1981, and a supply credit from Best Crompion, India, in the amount of KSh. 5.2 million (US$0.5 million). The work under construction is shown on IBRD Map 16389R. Training 6.18 EAP&L has several training programs designed to produce qualified staff to meet the company's normal growth and to compensate for the frequent loss of employees to other sectors of the economy because of salary differentials. The cost of training in 1981 was KSh. 16 million for 490 trainees. Of these, there were 31 students at university and 9 graduate apprentices primarily in mechanical and electrical engineering. There are 187 trainees in the Technicians Training Program, sponsored by EAP&L at polytechnic schools in Nairobi and Mombasa. Two hundred and fourteen candidates who did not meet the requirements for training as technicians were apprenticed as linesmen, mechanical and electrical fitters, welders, etc. Twelve of the middle and senior managers attended management courses conducted abroad, and 12 more attended courses by the Kenya Institute of Administration and the East African Management Institute. The immediate training requirements are being fulfilled under the loan for the first two units (LN 1799-KE). Insurance 6.19 The three power companies maintain sufficient coverage against loss through fire, machinery breakdown, special perils (such as earthquakes) as well as against consequential loss, in addition to coverage for such things as their motor vehicle fleet, workmen's compensation, personal accidents, third party liability, etc., and the arrangements are satisfactory to the Bank. Project Monitoring System 6.20 The project will be monitored through a reporting system based on critical items of implementation and financial criteria given in Annex 21. During negotiations EAP&L agreed to the project monitoring system and to the standard requirements of a completion report.

40 VII. PROJECT JUSTIFICATION AND RISKS The Power Market 7.OL Although Kenya's Fourth Development Plan was based on a targeted economic growth of 6.3% per annum the growth in GDP averaged 4.2% per year, and recent forecasts indicate that the growth will not exceed an annual average of about 4%. Growth is then expected to improve to about 5% per annum in the period when it is expected that the country's terms of trade should stabilize and the growth of external debt should decelerate. The average growth in demand for electricity was 8% (para. 2.03) during which the growth in GDP averaged about 4.7%. EAP&L have now reduced their expected rate of growth from 8% per annum in the National Power Development Plan (paras and 2.10), to the following: %; %; %; % and 1986 onwards - 6%. The mission reviewed the available data, and based on the anticipated additional loads from new industry, agreed in general with EAP&L's revised growth assumption (Annex 2). Requirement for the Project 7.02 Electricity is supplied to consumers from several hydro and thermal generating stations (para and Annex 20), and although the installed capacity is sufficient to meet the instantaneous peak demand, the existing facilities cannot continuously meet the demand for electrical energy during years when the river flows are below average, and the supply from Uganda is not available. Now that the Kiambere hydroelectric project has been delayed (para. 2.11), there is a possibility of a repetition of the 1980 problems (para. 2.08) when it was necessary to provide electricity to only half of the consumers (except heavy industry) from 7:00 AM until 1:00 PM, and to the other half from 1:00 PM until 7:00 PM from February 16 through April 21. Based on 30 years of record, it is estimated that should the driest year be repeated,there is a potential deficiency of about 80 GWh in 1985 and over 200 GWh in This potential shortfall increases each year until the next generating station is commissioned. The installation of a third generating unit at Olkaria will add the equivalent of less than one year's expected growth in demand for energy, so that even after the unit is commissioned there a possibility that the generating facilities would not be capable of meeting the energy demand for 1985 onwards, and EAP&L would like to reduce this probability to a minimum During the years when the river flows are average or above average, the third unit would not be needed to meet the demand. Nevertheless, it would be operated at full capacity so as to reduce the need to generate electricity with expensive fuel oil at the Kipevu generating station in Mombasa, resulting in an annual saving of about US$7 million. Comparison of Alternatives 7.04 A report on the feasibility of constructing the Kiambere hydroelectric generating station, prepared by Engineering & Power Development Consultants Limited of the United Kingdom, dated April 1980,

41 contained a recommendation that the station should be in operation by 1985 to meet the expected demand for energy. However, the earliest that power could be made available would be December Necessary energy in the interim period could be provided from new geothermal, diesel or gas turbine installations. The study of the alternative hydro project at the Turkwel site has not been completed, and consideration of a coal-fired plant with the necessary coal handling facilities as an alternative to this project would not be reasonable because of the length of time required for construction At the time of appraisal, the fuel cost to generate 1 GWh was as follows: steam plant fuel - KSh. 620,000, diesel fuel - KSh. 1,100,000 and gas turbine fuel - KSh. 2,100,000. In view of the extremely high gas turbine fuel costs, and the length of time required to construct a conventional steam plant, the best alternative to the geothermal plant for providing an equivalent amount of power by the end of 1984 is a diesel plant. Therefore the installation of additional generating capacity at Olkaria was compared to the equivalent installation of diesel generating equipment (15 MW) using the estimated cost of the diesel alternative shown in Annex 22. The comparison was carried out on the following basis: a) Interest during construction, price escalation, and duties and taxes were not included; b) The production equivalent of the proposed plant's output in the case of the diesel alternative would be provided as follows: 80% from the Kipevu steam plant in Mombasa and 20% from diesel generating plant located close to the demand, and therefore additional transmission facilities would not be required; c) Cost of steam plant fuel at KSh. 620,000 and diesel fuel at at KSh. 1,100,000 per GWh; and d) Shadow prices were used for foreign exchange 6 / The least-cost solution was found to be the geothermal project, at discount rates up to 78%, which is much higher than the opportunity cost of capital in Kenya, estimated to be 12%. Sensitivity tests have been carried out to determine the effect of a 10% increase in estimated capital costs for the geothermal project together with a 10% reduction in capital and operating costs for the diesel alternative, and the geothermal alternative remains the least-cost solution at discount rates up to about 74% (Annex 23). Economic Rate of Return 7.07 The economic rate of return, relating the economic project capital and operating costs to the savings and revenues expected from it, were calculated by taking into account the following assumptions. During 6/ Shadow foreign exchange rate KSh = US$1.00 compared to March 1982 rate of KSh = US$1.00.

42 most of the year, the existing generating plant is capable of meeting the demand for energy, and for the next few years energy from Olkaria would be needed to meet the requirements of the system only during the periods of low river flow. Therefore, although the sale of energy from the third unit at Olkaria is expected to begin April 1, 1985, for the computation of the benefits it has been assumed that energy from the third geothermal unit would be sold for only 20% of the year in the first year of operation. During the remaining 80% of the year, the output from the third unit at Olkaria would be used to substitute generation of expensive energy in the Kipevu oil-fired steam plant, thus reducing the annual operating costs by the equivalent fuel savings. It was also assumed that the amount of energy sold from Olkaria would increase by 20% annually and the savings in fuel oil correspondingly decrease by 20%, so that by 1989 the station was assumed to be 100% revenue producing. Shadow prices were used for the foreign exchange component. However, shadow price were not applied to unskilled labor because their application would have little effect on the rate of return. The revenue was determined by multiplying the rated output of the project, which was reduced by the estimated losses in the transmission and distribution system, by EAP&L's average tariff yield per KWh sold of KSh per KWh. The internal economic rate of return is about 15.5%. When the sensitivity of the rate of return was tested, it was found that an increase in the capital cost of the project by 10% and a decrease in benefits of 10% reduces the economic rate of return to about 14.0% The cost and benefit streams, and the assumptions used to determine the rate of return on investment are detailed in Annex 24. Project Risks 7.09 Risks of varying degree are normally associated with the implementation of a project of this kind. First, an institutional risk relating to EAP&L and KPC's capability to properly administer the contracts under this project and the other projects in their development program. The Bank's previous four loans to the power sector (para ) have all been successful, and the projects have been completed virtually on schedule, and without significant cost overruns. There is little doubt, therefore, as to KPC's capability in this regard, and this risk is minimal One physical risk, however, lies in the assessment of the geothermal reservoir and in the volume and characteristics of the steam which may be recovered to drive the steam turbines. In the loan for the first two units (para. 2.22), the Bank included a covenant that at least 80% of the steam requirements should be proven before the generating equipment could be ordered. In this project, the existence of steam capable of generating 37 MW (82%) has already been proven, and three wells, as yet untested, have an additional estimated output of 5 MW. There remains, therefore, the risk that the total 45 MW may not be found, or that a decline in the output from the wells may occur after a period of time. It is expected that calcite and silica will be precipitated when the hot water flashes into steam, resulting in a retardation of steam flow. Thus, in the cost of operation, it has been assumed that two new wells would be drilled every three years to make up for any diminuation of flow. The Olkaria site could be subject to earthquake shocks of an intensity, ranging

43 from VIII to IX on the modified Mercali Scale, which means that there would be moderate to severe damage to buildings not specifically designed to withstand such forces. Therefore, the buildings and equipment for the project would be designed to withstand these forces without incurring failure or distortion, in accordance with the Kenya Code of Practice for the Design and Construction of Buildings and Other Structures in Relation to Earthquakes. In so far as it can, this risk has been minimized by the employment of GENZL and Virkir who have had extensive experience in the development of similar geothermal projects in New Zealand and Iceland Another physical risk relates to the operation of the plant and the suitability of the design of the proposed project. For example, although a minor defect has occurred in the civil works causing the leakage of some steam condensate, electricity continues to be supplied while suitable corrective measures are being taken. Over a year's experience has been gained so far in the operation of the first unit, and to date the mechanical and electrical equipment has performed efficiently and as expected. In fact, for several months the equipment produced an average of 15.3 MW continuously which is above the nameplate rating. An indirect safeguard against the risk of failure of equipment or structures is the employment of Merz & McLellan who have had extensive experience in the design and development of conventional thermal power plants The financial risk of the proposed project and the ability of KPC to repay the borrowed funds is considered negligible. The electric power industry in Kenya has successfully provided electrical energy to its consumers for many years. In the past, the Government has allowed EAP&L to adjust its tariffs so that the company has remained in a sound financial position. The rate of return covenant proposed for this project (para. 5.15) would help to ensure that EAP&L and KPC would continue to be in a sound financial position in the future. VIII. AGREEMENTS TO BE REACHED AND RECOMMENDATION Agreements to be Reached 8.01 During negotiations, agreement was reached by the Bank, the Government, EAP&L and KPC that: a) KPC would retain consultants to carry out a study of the geothermal potential and complete their report by December 31, 1983, and EAP&L would retain consultants to plan a least cost investment program, and complete their report by October 30, 1984 (para. 3.06). b) EAP&L would continue to employ auditors satisfactory to the Bank and submit to the Bank copies of annual accounts of KPC, TRDC and EAP&L (para. 4.13); c) Fixed assets of the three companies would continue to be revalued for the purpose of determining rate of return (para. 5.06);

44 d) EAP&L would pay a development surcharge to KPC during the construction period of the proposed project to provide a part of KPC's requirements of local currency funds for the project (para. 5.10); e) The Governmeint would provide additional funds, if required, to complete the proposed project (para. 5.13); f) Minimum annual rate of return of 8% is to be earned by the three power companies on a combined basis; timely tariff adjustments are to be made to achieve this rate (para. 5.15); g) Debt limitation covenant of Loan 1799-KE would be repeated (para. 5.16); h) A program for the merging of KPC and TRDC into a single company would be made (para. 6.02); and i) EAP&L would continue to employ consultants satsfactory to the Bank to carry out the project (para. 6.09) The completion of co-financing arrangements is a condition of effectiveness of the loan (para. 5.13). Recommendation 8.03 With the above agreements, the project would be suitable for a Bank loan of US$12.0 million equivalent (including US$0.2 million capitalized front-end fee) for a term of seventeen years including a grace period of four years.

45 ANNEX 1 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Typical Daily Load Curve - Thursday January 28, PEAK 303 MW o DAILY AVERAGE MW H / ENERGY DEMAND 5,887,850 Kwh LOAD FACTOR -81% ' _ HYDRO PLANTS - AVERAGE MW - 3,869,510 Kwh. O izoo 80 S LC v KIPEVU STEAM PLANT -AVERAGE 44.2 MVV- 1,060,700 Gwh. 20 IMPORT FROM UEB -AVERAGE 24.5 MW -587,730 Kwh. GEOTHERMAL - AVERAGE 15.3 MW - 368,000 Kwh. O I II I I World Bank-23813

46 ANNEK 2 KENY-A OIKARIA GEOThERMAL POWER EXPANSION PRECr Forecast of Production Capability and Demnand for Average and Dry Water Years Productive Capability (GWh) Generated Maxinm InstaLled Effective Units % and Demand Capacity capacity Average Year- Dry Year-- Year Sold Increase Purchasea (M1) (N1) (144) ilydro Thernal UEB Total Hydro Thermal Ibtal Actual Forecast Assumeci In-Sevice Dates December x 15 1W unit (geothermal) June 19b3 - Kamturu-lynobasa trarsmission line December I x 15 M1 unit (geothermal) December x 70 Mi units at Kiambere (hydro) December nd Kmburu-_ii transmission line. December x 601W units at Turkwel (hydro) March 25, 1982

47 ANNEX 3 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT ACTUAL AND FORECAST DEMAND Generating Capability in an Average Water Year 4,000-3,800-3,600 ACTUAL - FORECAST - - 3,400 <3,200 w, 3,000 AVERAGE WATER YEAR wu PRODUCTION CAPABILITY 2,800 2,600 < 5 2,400 Lii o 2, Z 2, o1,800 1,600 D ('W1,400 w 1,200 1, Deeme M... ui goteml GENERATION SOURCE: D~ DTHERMAL HYDRO ~GEOTHERMAL ElUEB Assumed in-service Dates Decemnber x 15MW unit (geothermnal) June Karnburu-Mombasa transmission line Decemnber x 15 MW unit (geothermnal) December x 70 MW units at Kiambere (hydro) Decemnber nd Kamburu-Mombasa transmission line Decemnber x 60 MW units at Turkvvel (hydro) World Bank-23811

48 ANNEX 4 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT FORECAST DEMAND Generating Capability in a Dry Year 4,000 3,800-3,600-3,400-3,200 GENERATION CAPABILITY 3,000 2,800,u 2,400 2,200 /$ ''' / 2,000 Z7 / / //! %/ 1, // // / 1,00 6, '< / Assumed In-service [)ates December x 15 MW unit (geothermal) June Kamburu-Mombasa transmission line December x 15 MW unit (geothermal) December x 70 MW units at Kiambere (hydro) December nd Kamburu-Mombasa transmission line December x 60 MIVW units at Turkwel (hydro) World Bank-23812

49 ANNEX 5 Page 1 of 3 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Description of Project Characteristics of the Geothermal Field 1. Although the Olkaria geothermal field extends over an area exceeding 50 km 2, the area of the reservoir now being developed is some 12 km 2. Under this region, circulating ground water is heated by the hot rock to a temperature up to C and is almost wholly contained by a nearly impervious caprock about 700 meters below grade. Some steam escapes through fissures and fractures in the rock and appears at the ground surface in scattered locations. The volume of escaping steam is replaced by water from Lake Naivasha seeping down through porous sections of the bedrock. At depth, the water is saline and contains fluoride, calcium, mragnesium and the sulphate salts. The steam contains non-condensable gases, the most dominant being carbon dioxide, but hydrogen, hydrogen-sulphide and methane are also present. Scaling of silica and calcite can be expected when the pressure is reduced and the water flashes into steam. Long-term tests at the existing well-heads have been conducted to determine the appropriate operating pressures to minimise scaling. Previous Work 2. Between 1970 and 1976 approximately US$5.6 million were expended in studies and in drilling six production wells and associated works, and since 1978 about US$18 million has been expended in drilling 15 additional production wells. The cost of drilling these wells, a new drilling rig, and associated equipment and materials sufficient to operate until the end of 1984 was included in the Olkaria Geothermal Power Project Loan 1799-KE. Each production well is 22" in diameter at the top and reduces in several steps to 8-3/4" in diameter 900 to 2,500 meters below ground level. As a well is drilled, a steel liner is concreted in place, beginning with an 18-1/2" O.D. casing at the top. The lower end of the well contains a slotted 7" O.D. diameter casing which is not concreted, allowing the steam to flow into the casing. A tabulation of the capability of each completed well is shown in Annex 8. Well-head Equipment and Steam Gathering System 3. The equipment at the top of each well consists mainly of a steam and water separator, and exhaust silencer, control valves, testing and measuring devices. The steam is conveyed to the powerhouse through a system of insulated pipelines, and designed to take advantage of the topography, and allow for expansion and contraction.

50 ANNEX 5 Page 2 of 3 Powerhouse and Equipment 4. The equipment for this expansion would consist of an extension to a steel building structure with minor civil works. The structure to house the turbine and generator, associated control equipment of Units 1 and 2 and a small workshop has been completed. The proposed 15-MW turbo-generator would be designed using materials specially selected to withstand the corrosive and erosive characteristics of the steam emitted from the production wells. The site is about 7 km from Lake Naivasha, too far to be used as a source for cooling water, and therefore a system with a forced draft cooling tower was the most economical solution to meet the cooling requirements. This tower would be extended for the proposed third unit. Electrical Installation 5. Cost savings in switching and transformers were achieved by connecting the first two 15-MW units to a single 36-MVA transformer, and stepping the voltage up to 132 kv. A new 18 MVA transformer would be required for the third unit. Suitable circuit breakers at Olkaria and the substation at Naivasha allow for convenient maintenance and adequate fault protection. Transmission Line 6. The existing 132 kv transmission line has sufficient capacity to carry the output of the third 15-MW unit. The line was constructed from material salvaged from part of a 275-kV line which required removal because of the flooding of the Masinga Dam Reservoir. The shortest route for the transmission line from Olkaria to Naivasha, where it joins the Nairobi to Uganda transmission line, is through Hell's Gate Gorge, a distance of 20 km. However, by a short diversion of about 2 km, the line bypasses this frequently visited tourist attraction and leaves it in its natural state. Studies 7. Funds have been provided for two studies to be carried out as components of the project. The first is a review of the geothermal reservoir. In December 1980, all of the data collected to date on the Olkaria site was reviewed by a group of consultants and recommendations were made on further geothermal exploration to be carried out. Considerable more data is now available as a result of the drilling which has taken place in 1981 and 1982 and funds have been included to review this additional information. The characteristics of the reservoir are becoming better defined, and it is hoped that the results of another scientific review meeting would result in a more judicious location of the production wells, so as to produce a greater amount of steam. The cost to perform these studies is estimated to be about US$400,000, covering 40 man-months at about US$10,000 per man-month, plus local expenses estimated

51 ANNEX 5 Page 3 of 3 to be about US$200,000 to cover the cost of developing additional data and information. 8. The second study would be the preparation of a long range planning program including a feasibility study of the next power project, and the justification for its selection. The terms of reference for such a study would include various alternative scenarios of project' implementation, and would cover several prime sources of energy - hydro, geothermal, coal and oil. Infrastructure for a coal-fired generating station i.e land, roads, water and harbor facilities is a priority study area if it is found to be economically feasible to use coal at the end of the decade. This in-depth review of historic data on the use of electrical energy, and the several alternative methods of meeting the expected load growth and the related cost, is expected to require foreign funds amounting to about US$1.5 million (based on 150 man-months at US$10,000 per man-month). In addition, local costs of US$500,000 are expected to be required to cover additional detailed topographic and geotechnical surveys.

52 ANNEX 6 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Financing Plan (US$ millions) IBRD CDC EIB KPC TOTAL L F L F L F L F L F TOTAL Mechanical Electrical Substations Civil Road Water Supply Housing Engineering Studies: Geothermal Future Projects Taxes IDC Subtotal Source Total Front End Negotiation Fee 0.2 1/ / 0.3 TOTAL / Front end fee (1.5%) on Bank loan would be capitalized. 2/ Negotiation fee on CDC loan Stg 53,000 (US$85,000) would be due 30 days after signing.

53 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Implementation Program CONTRACT F AM JNIJ IN II J JA D0 N D J MECHANICAL ELECTRICAL * T - - SUBSTATIONS *, - - CIVIL WORKS 0 ROAD U S v - WATERSUPPLY U * HOUSING U _ - v ENGINEERING STUDIES GEOTHERMAL RESERVOIRZ FUTURE PROJECTS -- LEGEND * TENDER DOCUMENTS ISSUED IN SERVICE * RECEIPT OF TENDERS VWORK IN PROGRESS v CONTRACT SIGNATURE World Bank

54 ANNEX 8 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Steam Production (tons per hour) Wellhead Pressure Bar Absolute Power Production at 6 Bars (MW) Well No _ _ _ Proven Resources March 1982 Subtotal Estimated Output Subtotal TOTAL

55 ANNEX 9 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Disbursement Schedule (US$ millions) IBRD Fiscal Year Quarterly Cumulative Disbursements Quarter Ending Disbursement at end of Quarter 1983 June 30, September 30, December 31, March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31, March 31,

56 ANNEX 10 KENYA - OIKARIA CEOHAAL EOWER EXPANSION PRDJECT THE KENYA POWER C(MPANY LIMITED BALANCE SHEETS AS OF DECEMBER 31, (KSH MILLION) ~---Actual~ Lstimated ASSETS PLANT IN OPERATION 1/ LESS: DEPRECIATION T/ NET PLANT WRK IN PROGBESS INVESTMENS CURRENT ASSETS -CASH AND BANKS INVENTORIES EAEL OTHER TOIAL TUTAL LIABILITIES EQUITY -CAPITAL RETANED EARNINS EXCH EQJAL RESERVE CAPEITAL RESERVE SINKINI FUND RESERVE REVALUATION RESER TOTAL LON, TER4 DEBT CIJR'NT LIABILITIES -ACODUNTS PAYABLE EATh TOTAL TUIAL DEBT/DEBT & EQJITY DEBT/E(QJITY Plant in Operation and Depreciation are based on historical cost for years 1979 and 1980 and on revaluation for years 1981 to 1986.

57 ANNEX 11 KENYA - OLKARIA GEOTHERMAL EXPANSION PROJECT THE KENYA POWER COMPANY LIMITED INCOME STATEMENT FOR THE YEARS ENDING DECEMBER 31, (KSII MILLION) --- Actual Estimated OPERATING REVENUES 1/ OPN & ADM INTEREST DEBT AMORT R&E FUND PURCH EGY TOTAL SALES REV DEV SURCHARGE 2/ TOTAL OPERATING EXPENSES OPN & ADM PURCHASED ENERGY DEPRECIATION TAXES 3/ TOTAL OPERATING INCOME OTHER INCOME NET NET INCOME BEF TNT INT CHARGED OP NET INCOME / See Annex 16, para. 4 2/ See Annex 16, para. 5 3/ See Annex 16, para. 10

58 ANNK 12 KENYA - OIKARIA GEEEHRMAL POWER EXPANSION PROJECT TRE KENYA POlR 0OMPANY LIMITED EUNDSTAaD1ENT FOR THE YEARS EM)IDU EECEMBER 31, (KSY MILLION) Actual Estimat IOTAL INTEAL SOURCES -NET INX1 B3F IN DEPRECIATION GAIN/IOSS ON ExaQ INVESTMENTS R9TAL OPERATIONCL REQ,IREN -Ji)14Ml CAPITAL INCREASE DEBT SERVICE TOTAL NET AVAILABIE FFtM OPERATIO (DNSTR UCrICN RQJIREMENIS -0NGOINS WORKS RD UNIT R & E INVESTMENTS TDTAL BALANCE 1D FINANCE FINANCED BY: -CDC 1 & 2 UNTrS IBRD 1 & 2 UNITS STDBK 1 & 2 UNITS IBRD 3RD UNIT EIB 3RD UNIT {DC 3RD UNIT SJBIOTAL BHRRDWIN EQJITY TOTAL DEHE SERVICE OWER

59 ANNEX 13 KENYA - OIKARIA GEYTHE1MAL IOER EXPANSION PRDJECI THE KENYA POWER CDMPANY LIMITED TANA RIVER DEVELOEENIT 0MPANY LIMITED THE EAST AFRICAN FO1ER AND LINHW, (DMPANY LIMITED (XI]BINED BAANCE SHEET AS OF DEC42ER 31, (KSH MCION) -Actual - Estinmted ASSETS RANT IN OPERATION 1/ LESS: DEPRECIATION 1/ NET PLANT WRK. IN P)GRESS IINVESI1M CJRRET ASSETS -CASH AND BANKS AXOOUNTIS REC INVENIORIES OIHER TOTAL TOTAL LIABILITIES EQUITY -CAPITAL RET&INID EARNI&S % EXU EqJAL RESERVE CAPITAL RESERVE O`HER RESERVES REVALUATION RESER TOTAL % LOW, TERE DEBT CJR'NT LIABILITIES -AC011NTS PAYABLE DIVIDEND TAXATION TUrAI DEBT/DEBT & EQJITY DEBT/EQJITY CURRET RATIO RECEIVABIES/REV % RECEIVABlES-DAYS / Plant in Operation and Depreciation are based on historical cost for years 1979 and 1980 and on revaluation for years 1981 to 1986.

60 ANNEX 14 KENYA - OIKARIA GEUIHERMAL OWER EXPANSION PRaJECT TRE KENYA lolwer 0DMPANY LDIMTED TAM RIVER DEVEILNRT ICOMPANY LIMITED THE EAST AFRICAN R)IER AND L=IGT (M1PANY LIMJITED COMBINED INO)WE STAITMENT FOR THE YEARS ENDNL IECEMIER 31, SALES IN GWH - Actual EstinEtal A DOJFSTIC B LIGHT/EPWER C INDUSTRIAL D OFF-PEAK E STREET LIGHT F STAFF TOm REVENUE/K SOLO A DLOWSTIC B LIGHT RER C INDUSTRIAL 0.3C D OFF PEAK E STREET LIGHT F STAFF AVE REV/KWH SOLD FUEL SUCHARGE/KWH OPERATIK, IEVENJES (KSh MILLION) A WFESTIC B LIGHT/80(ER C INDUSTRIAL D OFF-PEAK E STREET LIGHT F STAFF FUEL SJRtHARiE TOTAL SAIES REV OTdER TARIFF INCREASE TOTAL OPERATI EIPENSES OP & ADM FUEL PURaASED ENE80Y DEPRECIATION TAXES iotal OPERATININCOtE OTIER INCDFE NET 1/ NET ilde IEF INT INr GIARGED OP NET INCOME RATE OF REIURN / The- minus anoxnt KSh million in 1981 ccomprises foreign exchange losses KSh 168 million, unproductlve geotl-enml wells writtenroff KSh 32 million and miscellaneous income KSh 27 million.

61 ANNEX 15 KENYA - OIKARIA GEOTHER1AL FOWER EXPANSION PRUJECr THE KENYA POWER CDMPANY LIMITED TANA RIVER IEVELORINT ClMPANY LIMITED THE EAST AFRICAN POWER AND LIQITIND C)!MPANY LIMITED COMBINED STATEMENT OF SOURCES AND APPLICATION OF FUNDS (KSh MILLION) Actual Lstimat TDTAL INTERNAL 9DURfES -NrT TINOM BEF IN DEPRECIATION PLANT DISPOSALS EXKH DIFF INVESTMENTS TDTAL OPERATIONAL REQIRNETS -W0RKIN CAPITAL INCREASE DEBT SERVICE DIVIDENDS TDTAL NET AVAILABLE FRDM OPERATIONS JNSTRUCTION REIKQM0FENTS -ONGOING WORKS PIDPOSED PIDJECT KV MIMBASA-KAMBURU TRANSMISSION INVESTMENTS TOTAL BALANCE T3 FINANCE BDRFDWINES EQJITY TOTAL DEBT SEWICE COVER

62 ANNEX 16 Page 1 of 5 Sales and Revenues KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Notes and Assumptions for Financial Statements 1. EAP&L's energy sales and revenue for each customer category appear in Annex 14. Revenues from 1982 onwards are based on a tariff increase of 18% effective on January 1, 1983, and further increases of 6% and 240 on January 1, 1984 and January 1, 1985 respectively. 2. A consumption tax of 1 cent per kwh is levied on all energy sales. 3. The revenues of KPC and TRDC are their respective ascertained costs, the amount payable by EAP&L for electricity purchased from both companies, is described in para. 4. The ascertained costs of both companies include a development surcharge as described in para. 5 below. Ascertained Cost 4. The bulk supply licenses of KPC and TRDC define ascertained cost (on the basis of which their revenues are determined) as the actual audited cost each year for the following items: (a) Operations and administration. This also includes the cost of purchasing power from Uganda and from TARDA; (b) Interest and redemption payments for debt; (c) Income or other taxes; and (d) Such other charges as the Government shall consider proper to be allowed. Under this authority a development surcharge (described later in this annex) has been added, starting 1971 for TRDC and 1979 for KPC, as part of their respective ascertained cost. In addition, ascertained cost includes small annual appropriations to a Reserve and Equalization Fund which, with the interest on the securities in which it is invested, is available for future capital expenditure or to cover deficiencies in income and to pay for abnormal expenses. Development Surcharge 5. Development surcharge, being paid by EAP&L to TRDC and KPC, was principally designed to provide the latter two companies with a part of the funds required to pay the local currency costs of their development projects. The surcharge has been paid by EAP&L since 1971, as part of the cost of electricity it purchases from TRDC and KPC, and is determined each year in relation to their respective development activities.

63 ANNEX 16 Page 2 of 5 The payment of surcharge has provided to TRDC funds for part of the local currency requirements of the Gitaru project, and to KPC for the Geothermal project. It has also reduced the income tax burden of the power sector during the construction period of the project by increasing KPC and TRDC's income which is exempt from income tax and by reducing EAP&L's taxable income. Through the development surcharge EAP&L is expected to continue to provide part of the local financing requirements of the proposed geothermal project. Fuel Cost and Purchased Energy 6. Fuel use for operating EAP&L plants is assumed to decrease with the commissioning of the two 15-MW geothermal units expected at the end of FY82 and FY84 and to increase with the load growth in FY86. A provision for price escalation of 8%, 8%, 7.5%, 7.5% and 6% respectively for the years FY82 to FY86 has been made. 7. KPC's annual purchases from UEB are assumed to be constant at 252 GWh and KSh 15.9 million from 1982 onward under the existing contract. TRDC is assumed to purchase 167 GWh during FY82-84, 170 GWh in FY85 and 185 GWh in FY86 from TARDA's Masinga dam power station. The estimated cost of this energy is based on the agreement for electricity purchase by TRDC from TARDA. Operating and Administration Expenses 8. Increases in volume of operations are reflected in these expenses: for TRDC an average of 7%; for KPC, due to the addition of two geothermal units in 1982 and 1984 respectively, the expenses are expected to increase on average by KSh 1.9 million for each unit. EAP&L's distribution cost is expected to increase by 1% annually. In addition, provision for price escalations of 13%, 9%, 8%, 8% and 8% respectively for 1982 to 1986 has been made. Depreciation 9. Depreciation is charged as a percentage of the revalued fixed asset at the beginning of each year - EAP&L 3.7%, KPC 2.6%, and TRDC 2.2%. This is consistent with past experience. The depreciation for the years 1979 to 1981 is computed on the historical cost of fixed assets, whereas for the period after 1981, it has been calculated on revalued fixed assets. Taxes 10. TRDC and KPC's incomes are exempt from income tax. EAP&L's income is subject to tax at present at the rate of 45%. Dividends 11. Dividends on 4% and 7% preferred stock are KSh 1.9 million per year. Dividends on common stock of EAP&L are assumed to continue at the 1981 level of 12% per year.

64 ANNEX 16 Page 3 of 5 Rate of Return - Financial 12. The rate of return has been calculated on the average revalued net fixed assets in operation. Depreciation allowance used for calculation of operating income is on the basis of revalued fixed assets. Rate of Return - Statutory 13. Under the Electric Power Act of Kenya (Section 47), a power company's tariffs would be subject to reduction to the extent of five-sixths of the amount by which operating income before income tax for any year exceeds 12-1/2% of the "capital expended on the undertaking" as of the end of the year. This statutory assets base is taken as the total of fixed assets at cost, including work in progress and inventories at the end of each year. The financial projections show that the operating income before income tax exceeds 12-1/2% of this statutory rate base in many of the years from 1982 to 1986; however, the rate of return covenants of IBRD loans 1147-KE, 1799-KE and the proposed loan would ensure that tariffs aremaintained at adequate levels. Fixed Assets 14. Fixed assets and depreciation for the years 1978 to 1980 are at cost as shown in audited accounts. In 1981, fixed assets and accumulated depreciation have been increased to reflect estimated replacement values and in 1982 and subsequent years by 10%, 8.4%, 7.7%, 7.4% and 6.8% respectively to reflect estimated price escalations in those years. Accounts Receivable 15. EAP&L's accounts receivables are assumed to be 18% of total revenues in accordance with recent past experience. Inventories 16. On the basis of 1981 figures, EAP&L inventories are assumed to be 13% of gross revalued plant in operation while those of KPC and TRDC are assumed to be constant. Long-Term Debt 17. A statement showing the composition of foreign exchange and local currency loans of KPC appears on the following page.

65 ANNEX 16 Page 4 of 5 KENYA: OLKARIA GEOTHERMAL POWER EXPANSION PROJECT THE KENYA POWER COMPANY, LIMITED DEBT STATEMENT FOR THE YEARS ENDED DECEMBER 31, (KSh Million) CDC 5.5% -Amortization Interest IBRD 7.95% (Geothermal lst and 2nd Units) -Borrowings Amortization Balance Interest Commitment Chge IDC-% IDC CDC 8.5% (Geothermal lst and 2nd Units) -Borrowings Amortization Balance Interest IDC-% IDC STD BNK 15.5% (Geothermal lst and 2nd Units) -Borrowings Amortization Balance Interest Proposed IBRD 11.43% (Geothermnal 3rd Unit) -Borrowings Balance Interest

66 ANNEX 16 Page 5 of 5 Proposed EIB 8% (Geothermal 3rd Unit) -Borrowings Amortization Balance Interest IDC-% IDC Proposed CDC 1255 (Geothermal 3rd Unit) -Borrowings Balance Interest Commitment Chge IDC-% IDC DEBT SUMMARY -Borrowings Repayments Balance Commitment Fees Interest Interest & CF Debt Service IDC TOTAL OPENING

67 KENYA ANNEX 17 Page 1 of 2 OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Electricity Tariff Structure 1. EAP&L's new tariff structure was developed in consultation with the Bank. It took effect on January 1, 1979 and comprises the following six categories: Method A: covers consumers whose monthly usage does not exceed 7,000 KWh. Method B: is applicable to consumers with monthly usage ranging from 7,001 to 100,000 KWh. Method C: covers consumers whose monthly usage exceeds 100,000 units. Method D: Off-peak supplies. Method E: Public Lighting. Method F: Company staff. 2. In addition, there is provision for the introduction of a fuel oil cost adjustment with the approval of the Ministry of Power and Communications. This is a surcharge designed to allow EAP&L to recover part of any additional fuel costs from electricity consumers based on the difference between actual fuel cost and a "basic price". EAP&L has added surcharge at rates of 13.9 Kenya cents per KWh from August 1980 and 21.2 cents from July 1981 on all energy sales. 3. Details of the tariffs are presented in the attached table.

68 KENYA: OLKARIA GEOTHERMAL POWER EXPANSION PROJECT Projected Average Charge per kwh (Based Demand charge per Revenue per on monthly consumption Fixed charge per month KVA per month kwh in Method A Monthly consumption 0 to 30 kwh : KSh / not exceeding 7,000 kwl Over 30 kwh : KSh 0.50 KSh 15 KSh Method B Monthly consumption ranging 415/240 V : KSh 0.27/kWh 415/240 V : KSh /240 V Kgh 50 from 7,001 to 100,000 kwh llkv/33 kv : KSh 0.25/kWh llkv/33kv ; KSh 360 llkv/33kv KSh 45 KSh kv/132kv : KSh 0.23/kWh 66kv/132kv; KSh 1,640 66kv/132kv KSh 40 Method C Monthly consumption in Peak Hours (8 AM-10 PM excess of 100,000 kwh Mon-Fri) 415/240 v : KSh /240 V : KSh /240 V : KSh 50 llkv/33kv KSh 0.25 llkv/33kv : KSh 360 llkv/33kv : KSh 45 KSh kv/132kv : KSh kv/132kv: KSh 1,640 66kv/132kv KSh 40 Off-peak hours 415/240 V : KSh 0.16/kWh llkv/33kv : KSh 0.15/kWh 66kv/132kv KSh 0.14/kWh 1/ Method D Off-Peak Supplies KSh 0.16/kWh KSh KSh Method E Public Lighting 2/ KSh 0.45/kWh KSh 32,50 per KSh supply terminal Method F Company Sta ff KSh 0.15/kWh KSh o 1/ If Method A is used in conjunction with Method D at the same supply terminals, the combined fixed charge will be KSh 35. 2/ Supplies available for a minimum period of 11 hours per night for public lamps.

69 ANNEX 18 Page 1 of 3 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT KENYA POWER COMPANY LIMITED Loan Capital and Security Arrangements of EAP&L, KPC and TRDC 1. This annex describes the loan capital of power companies of Kenya and the arrangements securing this loan capital. The amounts stated represent the total amount of the loans contracted and not the amounts outstanding, which are given in Annex 16. Unless indicated otherwise, all references to are references to Sterling. EAP&L 2. EAP&L's loan capital comprises loans from Commonwealth Development Corporation (CDC), (KSh. 7 million, KSh million and KSh. 30 million), and from Glyn, Mills and Company syndicate (KSh million, KSh million, KSh million and KSh. 4.8 million). The CDC loan of 350,000 was secured by (i) EAP&L.s 8½% Debentures ; and (ii) a Trust Deed dated November 1, 1968, which provided for a first legal charge on specified leasehold properties of EAP&L. The KSh million CDC loan and the KSh loan from the Glyn, Mills and Company syndicate were respectively secured by Debenture Stock and respectively, as well as a Trust Deed dated May 16, This Trust Deed created mortgages and charges on certain of EAP&L's properties and assets and also stipulated that EAP&L was not to create any mortgage or charge ranking in priority to or pari passu with that mortgage or charge. The KSh. 30 million CDC loan and Glyn syndicate loans of KSh million and KSh. 4.8 million were secured by Debenture Stock , and respectively, as well as a supplemental Trust Deed dated August 29, 1974 which made these loans to rank pari passu with the loans secured by the Trust Deed dated May 16, By the end of 1978 EAP&L had also taken up KSh million at 8% on an unsecured basis from a KSh. 15 million given by the Britis Government to the Government of Kenya and a further KSh million on similar terms from a loan of KSh. 20 million made to the Government of Kenya by the Finnish Government. KPC 3. In 1955 KPC floated a 7,500,000 loan by the issue of a ' 7,500,000 5½% Debenture Stock 1975/85. 3,500,000 of this loan was subscribed by CDC, and the balance was underwritten for public sale. The Debenture Stock was secured by a Trust Deed Dated June 27, 1956, which among other things, created a first legal charge and a floating charge in respect of KPC's property and assets and stipulated that KPC was not to create any further charges or incumbrances upon its undertakings and assets ranking in priority to or pari passu with the charges created under the Trust Deed

70 ANNEX 18 Page 2 of 3 except in special stated circumstances. The Trust Deed also provived that any scheme for the reconstruction should require an extraordinary resolution of the stockholders which means in effect the consent of three-fourths of the stockholders. KPC also took up in 1977 an unsecured 9% loan from EAP&L, in the amount of KSh million, repayable in 10 years commencing from the commissioning of the first geothermal plant as well as KSh million of an 8.5% unsecured loan from TRDC totalling KSh. 2.9 million (balance taken up in 1978) and repayable from 1979 to the year Both of these loans were repaid in In 1980, KPC contracted with IBRD to borrow US$40 million at 7.95% annual interest and repayable during , and with CDC to borrow 9.25 million at 8.5% annual interest and repayable during for installing the first two units of the Olkaria power project. TRDC 4. TRDC's loan capital in 1978 came from CDC, the Glyn, Mills and Company syndicate (now Williams & Glyn's Bank Ltd.), EAP&L, IBRD, the Government of Kenya, from a SIDA credit to the Government of Kenya, and from the Standard Bank Limited and export suppliers credits. A Trust Deed dated May 26, 1966 modified and extended by three Supplemental Trust Deeds dated December 5, 1968, December 16, 1971 and March 10, 1976, secures the following loans: b) Sh. 9,240,500 and Sh. 5,380,000 B Debenture Stock ; c) Sh. 6,040,000 C Debenture Stock ; d) Sh. 81,300,000 E Debenture Stock ; e) US$23,000,000 and US$63,000,000 IBRD loans; f) 2,000,000 Debenture Stock ; g) KSh. 2,000,000 loan from EAP&L; and h) KSh. 1,890,000 loan from the Government of Kenya. The Trust Deed provided for the creation of a floating charge of TRDC's undertakings, property and assets and also required TRDC (i) not to (A) create without the Trustee's consent any mortgage or charge ranking in priority to a pari passu with the floating charge of (B) create any specific mortgage or charge over any of its immovable property or other assets without prior written consent of the Trustee or have any subsidiary, except with the prior written consent of the Trustee. The Trust Deed also provides for the creation and issue in specified circumstances of additional stock to rank pari passu in point of security with the original stock created under the Trust Deed. These circumstances include the need to secure any loan TRDC would need to finance later stages of the Seven Forks Hydroelectric Project.

71 ANNEX 18 Page 3 of 3 5. In addition, TRDC has issued promissory notes in the amounts of Dm 22,553,000 and US$217,000 to cover part of the export suppliers credits while DM 32,459,000 financed by Kreditanstalt fur Wiederaufbau is covered by a guarantee from the West German Government. The loan from the Standard Bank Limited was unsecured and repaid in 1978.

72 ANNEX 19 Page 1 of 2 KENYA OLKARIA GEOTHERMAL POWER EXPANSION PROJECT History of the Power Companies 1. The Kenya Electric Supply Industry is presently comprised of four organizations: a) The East African Power & Lighting Co. Ltd (EAP&L); b) The Kenya Power Co. Ltd (KPC); c) Tana River Development Co. Ltd (TRDC); and d) Tana and Athi Rivers Development Authority (TARDA) The East African Power & Lighting Co. Ltd (EAP&L) 2. EAP&L, which is the sole distribution company, was incorporated in 1922 by the amalgamation of two undertakings which had supplied Nairobi and Mombasa since 1907 and 1909, respectively. It is a local private company with authorised share capital of KSh. 250 million, of which KSh million is issued. In addition, loan capital amounting to KSh million was outstanding as at the end of Although formerly operating throughout Kenya, Uganda and Tanzania, its activities have been confined to Kenya since 1964 due to purchase of the Uganda and Tanzania undertakings by the respective Governments. The company is primarily concerned with the commercial distribution of electricity throughout Kenya. At present, it also generates the entire power requirements of the coast system covering Mombasa, Malindi and Kwale, provides the necessary thermal back-up for the main grid system, and operates generating stations in centers not connected to the grid. It also coordinates all sources of power, and staffs and manages KPC and TRDC, and since August 1981, staffs and manages the Masinga Dam powerhouse. 3. In 1970, the Government acquired a controlling interest in EAP&L when it made a successful bid for all the shares on the London Register. Since then the Government has been purchasing shares as they come on the East African market, and its total holding together with that of government-controlled agencies is now over. The Kenya Power Co. Ltd (KPC) 4. In 1955, EAP&L was faced with the problem of financing the construction of a 132-kV transmission line to interconnect the power systems of Uganda and Kenya as well as other expansion requirements. The company did not consider it practicable to raise the required finances through new equity issues because of conservative dividend policies due to political pressures and the need for increased self-financing. There was also revived political pressure for nationalization. The company concluded

73 ANNEX 19 Page 2 of 2 it was inevitable and desirable to increase public ownership and direct government participation in the power industry. Accordingly, it was decided to form a new company, KPC, in 1955 with an issued nominal capital of KSh held equally by EAP&L, the Government and a UK finance house. KPC's function was to construct the transmission line and to take over the ownership of the two hydroelectric stations belonging to EAP&L on the Tana River. KPC financed its requirements through issuance of KSh. 7.5 million of debenture stock, the payment of the debt service on which was guaranteed by EAP&L's understanding to purchase KPC's entire production at "ascertained cost". 5. In accordance with its policy of increasing its participation in the electricity supply industry, the Government acquired 100% of KPC's issued share capital by buying out EAP&L's and Power Securities Corporation Ltd. in Subsequently, in 1980, KPC increased its share capital to KSh. 60 million and contracted IBRD and CDC loans of US$40 million and stg million respectively to finance construction of the first two 15-MW units of the Olkaria Geothermal Power Project. Tana River Development Co. LTD (TRDC) 6. A forecast of load growth after Kenya's achievement of independence in December 1963 indicated that it would be necessary to commission further major generating capacity by , and a reappraisal of the Seven Forks Scheme (the harnessing of the hydro potential of the Upper Tana) established Kindaruma as the most economical first stage development. TRDC was formed in 1964 to finance the Kindaruma hydroelectric development for much the same reasons as led to the formation of KPC. The share capital of TRDC is KSh. 120 million, all of which is held by the Government. CDC supplied KSh. 3.5 million of a total of about KSh. 6 million of loan capital which was arranged for the Kindaruma project. Kamburu Stage 1, comprising the first two generating units, was commissioned in July 1974 and the third unit in Gitaru, the last of the Seven Forks hydroelectric projects, was commissioned in Like KPC, TRDC sells its entire output to EAP&L at ascertained cost. Tana and Athi Rivers Development Authority (TARDA) 7. The fourth company, Tana and Athi Rivers Development Authority, has constructed the Masinga Dam on the Tana River primarily for irrigation purposes. Advantage of the dam has been taken by EAP&L to complete arrangements with TARDA to include a powerhouse and related structures and equipment at the site. EAP&L pays a fixed charge of KSh. 36 million per year to TARDA from the date the reservoir was first filled to the maximum operating level. This charge has been adjusted in relation to the cost of fuel that this powerhouse displaces at the time of commissioning. All costs in excess of KSh. 4.9 for operation and maintenance of the powerhouse and other direct power-producing facilities, not including the dam, will be paid by TARDA.