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1 Document of The World Bank Report No.: PROJECT PERFORMANCE ASSESSMENT REPORT EQUATORIAL GUINEA SECOND PETROLEUM TECHNICAL ASSISTANCE PROJECT (CREDIT 2408-EG) July 1, 2002 Sector and Thematic Evaluation Group Operations Evaluation Department

2 Currency Equivalents (annual averages) Currency Unit = CFA Franc (FCFA) Exchange Rate at Project Appraisal (March 1992): US$1= FCFA 275 Exchange Rate at Completion (January 1997): US$1 = FCFA 520 Exchange Rate as of March 2002: USS1 = FCFA 710 Abbreviations and Acronyms Bbl Bcf Bpd DH ES FDI FPSO FPU FSO GEPSA GE-Total KgOE LPG Mmb Mmcf Mmcfd Mmcm MME MMH MOP PSC Tcf Barrel Billion cubic feet Barrels per day Directorate of Hydrocarbons Evaluation Sunimary Foreign direct investment Floating production, storage, and offloading Floating production unit Floating storage and offloading unit Guinea-Espanola de Petroleo S.A. Guinea Ecuatonal-Total Kilogram of oil equivalent Liquefied petroleum gas Million barrels of oil Million of cubic feet Million cubic feet per day Million of cubic meters Ministry of Mines and Energy (formerly Ministry of Mines and Hydrocarbons) Ministry of Mines and Hydrocarbons Memorandum of the President Production Sharing Contract Trillion cubic feet Measures and Equivalents One barrel One cubic foot One cubic meter about 0.16 cubic meter cubic meter 37.3 cubic feet Fiscal Year Government: January 1 to December 31 Director-General. Operations Evaluation Mr. Robert Picciotto Director, Operations Evaluation Department : Mr. Gregory Ingram Manager, Sector and Thematic Evaluation : Mr. Alain Barbu Task Manager : Mr. Andres Liebenthal

3 The World Bank Washington, D.C U.S.A Office of the Director-General Operations Evaluation July 1, 2002 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Assessment Report on Equatorial Guinea Second Petroleum Technical Assistance Project (Credit 2408 EG) Attached is the Performance Assessment Report prepared by the Operations Evaluation Department on the above project. The Credit of SDR 1.8 million was approved in FY93, closed in FY97, and was fully disbursed. The project objectives were to: (a) ensure that the Borrower received maximum and sustainable revenues from the production of the Alba gas and condensate field; (b) identify the most cost effective methods to utilize the associated gas from Alba; (c) minimize the risks for the environment of Alba's operations; (d) improve the efficiency of energy sector institutions; and (e) strengthen the capacity of the Ministry of Mines and Hydrocarbons to monitor the activities of oil companies, and to evaluate the supply and pricing systems for petroleum products. The project's outcome is rated as moderately satisfactory, on account of progress made since project completion in 1997 towards meeting project objectives in a number of areas that were and are still considered as highly relevant and were supported under the project: the 1981 Hydrocarbon Law was amended in 1998, subsequent contract renegotiations took place, which improved the Government' s share; and imports and distribution of petroleum products were privatized and liberalized. Although the changes differed on some points from the proposals prepared under the project, Project efficacy is rated as modest. Furthermore, since 2000, associated with the resumption of Government dialogue with the IMF and the Bank, there has also been progress towards better accounting of oil revenues and systematic audits of oil companies financial accounts, which were advocated under the project. Project efficiency has further improved as there have been further considerable increases in oil revenues: objectives related to the Alba field were met substantially beyond appraisal expectations, and considerable additional revenues accrued from the much larger Zafiro field, the supervision and monitoring of which received considerable attention from the project. Consequently, with relevance rated high, efficiency substantial, and efficacy rated as modest the outcome is now rated as Moderately Satisfactory. However, sector institutional capacity, albeit improved, remains weak. Sustainability has been rated as Likely. The project contributed to the adoption of sound long-term development plans in the development of the oil sector. Benefits from current oil activities are expected to be sustained at least for the next fifteen years and further oil field findings are likely. Equatorial Guinea is now an attractive FDI destination in Africa. There are, however, still uncertainties regarding the Government's commitment or ability to manage oil wealth well and ensure long-term institutional, environmental, economic and social sustainability of oil development. Both Bank and Borrower performances are rated as unsatisfactory. Despite the moderately satisfactory outcome, Borrower performance during the project implementation period is rated unsatisfactory (though marginally so) principally on account of poor project

4 2 management and lack of transparency. Bank performance was unsatisfactory because, while the Bank insisted that existing exploration contracts were too favorable and should be re-negotiated, it ignored the dilemna this posed to the Govemment and failed to engage in a more constructive and balanced dialogue with the Government on this issue. Furthermore, supervision was very limited and the Bank failed to react strongly to overdue audits, inadequate project accounting, and failure by the Govemment to comply with the covenant requiring transparency in budgeting of oil revenues. Institutional Development Impact is rated as modest. The experience from this project confirms a number of OED lessons: * As soon as significant discovenes are made, important issues arise associated with the impact and distribution of oil wealth, which need to be addressed rapidly through the Bank-country dialogue to ensure long-term sustainability. These include the fundamental issues of national and sectoral environmental regulations and their enforcement capacity, budget transparency and allocation, strategies for public expenditures, pace of new licensing and development, savings mechanisms. and distribution of oil proceeds between the various levels of government. In the case of Equatorial Guinea, the Bank raised these issues in 1998, but only after the project was completed, and at a time of tense relations. * If the country is facing strong macro-economic constraints in the early stages of oil development, the Bank might consider supporting the adoption of policies and strategies leading to the proper management of oil wealth through adjustment or sector loans. * If the government must give especially favorable terms to attract the first investors to explore new territory for oil and gas, negotiated contracts need to incorporate time and geographical limits on those terms. * Whenever the implementing agency does not have the capability to manage the project (including accounting and reporting), efficient implementation requires that appropriate provisions to contract outside expertise for that purpose be incorporated in project design Attachment

5 OED Mission: Enhancing development effectiveness through excellence and independence in evaluation. About this Report The Operations Evaluation Department assesses the programs and activities of the World Bank for two purposes: first, to ensure the integrty of the Bank's self-evaluation process and to verify that the Bank's work is producing the expected results, and second, to help develop improved directions, policies, and procedures through the dissemination of lessons drawn from experience. As part of this work, OED annually assesses about 25 percent of the Bank's lending operations. In selecting operations for assessment, preference is given to those that are innovative, large, or complex; those that are relevant to upcoming studies or country evaluations; those for which Executive Directors or Bank management have requested assessments; and those that are likely to generate important lessons. The projects, topics, and analytical approaches selected for assessment support larger evaluation studies. A Project Performance Assessment Report (PPAR) is based on a review of the Implementation Completion Report (a self-evaluation by the responsible Bank department) and fieldwork conducted by OED. To prepare PPARs, OED staff examine project files and other documents, interview operational staff, and in most cases visit the borrowing country for onsite discussions with project staff and beneficiaries. The PPAR thereby seeks to validate and augment the information provided in the ICR, as well as examine issues of special interest to broader OED studies. Each PPAR is subject to a peer review process and OED management approval. Once cleared internally, the PPAR is reviewed by the responsible Bank department and amended as necessary. The completed PPAR is then sent to the borrower for review; the borrowers' comments are attached to the document that is sent to the Bank's Board of Executive Directors. After an assessment report has been sent to the Board, it is disclosed to the public. About the OED Rating System The time-tested evaluation methods used by OED are suited to the broad range of the World Bank's work. The methods offer both rigor and a necessary level of flexibility to adapt to lending instrument, project design, or sectoral approach. OED evaluators all apply the same basic method to arrive at their project ratings. Following is the definition and rating scale used for each evaluation criterion (more information is available on the OED website: Relevance of Objectives: The extent to which the project's objectives are consistent with the country's current development priorities and with current Bank country and sectoral assistance strategies and corporate goals (expressed in Poverty Reduction Strategy Papers, Country Assistance Strategies, Sector Strategy Papers, Operational Policies). Possible ratings: High, Substantial, Modest, Negligible. Efficacy: The extent to which the project's objectives were achieved, or expected to be achieved, taking into account their relative importance. Possible ratings: High, Substantial, Modest, Negligible. Efficiency: The extent to which the project achieved, or is expected to achieve, a return higher than the opportunity cost of capital and benefits at least cost compared to alternatives. Possible ratings: High, Substantial, Modest, Negligible. This rating is not generally applied to adjustment operations. Sustainability: The resilience to risk of net benefits flows over time. Possible ratings: Highly Likely, Likely, Unlikely, Highly Unlikely, Not Evaluable. Institutional Development Impact: The extent to which a project improves the ability of a country or region to make more efficient, equitable and sustainable use of its human, financial, and natural resources through: (a) better definition, stability, transparency, enforceability, and predictability of institutional arrangements and/or (b) better alignment of the mission and capacity of an organization with its mandate, which derives from these institutional arrangements. Institutional Development Impact includes both intended and unintended effects of a project. Possible ratings: High, Substantial, Modest, Negligible. Outcome: The extent to which the project's major relevant objectives were achieved, or are expected to be achieved, efficiently. Possible ratings: Highly Satisfactory, Satisfactory, Moderately Satisfactory, Moderately Unsatisfactory, Unsatisfactory, Highly Unsatisfactory. Bank Performance: The extent to which services provided by the Bank ensured quality at entry and supported implementation through appropriate supervision (including ensuring adequate transition arrangements for regular operation of the project). Possible ratings: Highly Satisfactory, Satisfactory, Unsatisfactory, Highly Unsatisfactory. Borrower Performance: The extent to which the borrower assumed ownership and responsibility to ensure quality of preparation and implementation, and complied with covenants and agreements, towards the achievement of development objectives and sustainability. Possible ratings: Highly Satisfactory, Satisfactory, Unsatisfactory, Highly Unsatisfactory.

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7 Contents Principal Ratings... Key Staff Responsible... Preface... v v vii Background... 1 Objectives and Design... 2 Implementation... 3 Outcome... 4 Ratings... 4 Relevance: High... 4 Efficacy: Modest... 5 Efficiency: Substantial... 6 Institutional Development Impact: Modest... 8 Sustainability: Likely... 8 Bank Performance: Unsatisfactory... 9 Borrower Performance: Unsatisfactory Lessons Annex A. Basic Data Sheet Annex B. Historical Development of Gas and Oil Exploration and Production Annex C. Table of Objectives and Components This report was prepared under the supervision of Andres Liebenthal (task manager) by Dominique Babelon and Charles Dahan (consultants), who assessed the project in March The report was edited by William Hurlbut and Soon-Won Pak provided admrnistrative support.

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9 Principal Ratings ICR* ES* PPAR Outcome Unsatisfactory Marginally Unsatisfactory Moderately Satisfactory Sustainability Likely Uncertain Likely Institubonal Partial Modest Modest Development Impact Bank Performance Satisfactory for preparation, Unsatisfactory Unsatisfactory otherwise Deficient Borrower Performance Satisfactory for preparation, Unsatisfactory Unsatisfactory otherwise Deficient * The Implementation Completion Report (ICR) is a self-evaluation by the responsible operational division of the Bank. The Evaluation Summary (ES) is an intermediate OED product that seeks to independently verify the findings of the ICR. Key Staff Responsible Project Country Director Division Chiefl Task Sector Director Manager/Leader Appraisal Michael Gillette lain T. Christie Han Bhat Completion Serge Michailof Mark Tomlinson Angel Baide

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11 vii Preface This is a Project Performance Assessment Report (PPAR) on the Equatorial Guinea Second Petroleum Technical Assistance Project, for which IDA approved a credit (Credit 2408-EG) for SDR 1.8 million, US$2.622 million equivalent, on July 2, The credit closed as scheduled on June 30, This report is based on the Implementation Completion Report (ICR) prepared by the Africa Region (Report no , June 5, 1998), the Memorandum and Recommendation of the President (Report no. P5808, June 10, 1992), the Credit Agreement, project files, economic reports from the Region and other organizations, and discussion with Bank staff. An Operations Evaluation Department (OED) mission visited Equatorial Guinea in March 2002 to review the long-term impact of the project and discuss the project results and effectiveness of the Bank's assistance with representatives of the govemment, oil companies, donors, and local authorities. The cooperation and assistance of current and former govemment officials in the Ministries of Planning and Economic Development, Mines and Energy, and Health, are gratefully acknowledged. Five years after project completion, this PPAR seeks to validate previous ratings of the project in light of events since completion and to assess the longer-term economic, social, institutional, and environmental sustainability and impact of the activities supported by the project. More specifically, the PPAR seeks to assess whether the project (a) contributed to the efficient development of the country's oil and gas resources and helped attract private sector investments; (b) contributed to improved govemance and transparency in the accounting and distribution of oil rents and in the management of the energy sector (including petroleum product imports); (c) contributed to a fair distribution of oil benefits and costs between the govemment and oil companies; (d) had significant environmental and social impacts; and (e) complied with the Bank's safeguard policies. Following standard OED procedures, this draft PPAR was sent to the borrower for comments before the final version is sent to the Board. But, none were received.

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13 BACKGROUND 1. Equatorial Guinea is a small, sparsely populated country, spread over several islands (the largest being Bioko island, with the capital city, Malabo) and mainland territories (Rio Muni) located between Gabon and Cameroon. Total population in 2002 was estimated at about 475,000. Equatorial Guinea gained its independence in During the following eleven years, until 1979, the country was ruled by a harsh military dictator who brought the country into substantial decline. The educated elite fled the country or was killed. In 1980, EG was a very poor rural economy having lost competitive advantage in export crop and in complete need for economic rehabilitation. The generally poor educational level and training of the generation currently accounting for most of the labor force is still a serious constraint to development. There is a widespread lack of institutional capacity and competence in all sectors, and therefore high dependency on outside technical assistance and on donors. 2. The World Bank became involved in Equatorial Guinea's oil sector 12 years before the signing of the project's Credit Agreement. In 1980, the government sought technical assistance from UNDP and the Bank to attract the oil industry in the exploration for petroleum of the country's sedimentary basins. In July 1981 and July 1983, UJNDP granted two technical assistance credits, which were executed by the Bank, and which resulted in the preparation and enacting of a Hydrocarbon Law and model Production Sharing Contract (PSC) in These grants were complemented by an IDA credit for the first Petroleum Technical Assistance Project (Credit 1304-EG, of SDR 2.3 million), which was approved on November 30, That project aimed to promote petroleum exploration, strengthen the government's technical capability to monitor exploration activities carried out by oil companies, help the government in its negotiations with oil companies, and help prepare an energy database. 3. In 1983, GEPSA (a joint venture company between Hispanoil, later-on renamed REPSOL, and the Government), discovered the Alba gas and condensate field offshore from Bioko, but the operator considered the field marginal and lost its rights to the field in February Other contractors had also drilled unsuccessfully in other areas. In an attempt to salvage the development of the Alba field, IDA introduced representatives of the govemment to a few independent oil companies. These contacts resulted in a new exploration/production contract in May 1990 with an independent producer. It became apparent soon after that the terms of the 1981 Hydrocarbons Law, and the PSC were excessively generous to the operator and might lead to inefficient development. Low-cost field development started in January 1992, aiming at recovery of condensates only, with all associated natural gas being flared. 4. The Second Petroleum Technical Assistance Project was approved shortly after, in July Given (a) disappointing results of past exploration efforts, (b) what was identified at appraisal as wasteful use by the operator of Alba's limited resources, and (c) the resulting negative impact on the environment, the second project focused on optimizing the use of Alba gas and on domestic energy use. It also included some essential sector-wide technical assistance and institution building components and conditions to ensure that the government would get its fair share of production in future exploration findings and properly account for revenues. 5. Major developments in the oil sector started three years later in 1995, well into project implementation. UMC/Exxon-Mobil discovered the Zafiro-Topacio oil field in Block B under a PSC signed in 1992 with terms similar to those of Alba. Developments further accelerated since 1999, with important new oil discoveries offshore from Rio Muni (Ceiba field) since More is also expected elsewhere, as a number of other licenses have been granted since Total production of oil and condensates in the country has increased, from 3,000 bpd in 1992, to 6,500

14 2 in 1996, and 221,000 in 2000,' and production is expected to further increase to over 270,000 bpd in 2002, and be sustained at 300, ,000 bpd over the next 15 years. Proven oil reserve estimates have gone up from less than 400 million barrels in 1997 to levels conservatively estimated in 2001 at close to one billion barrels. Gas reserves at Alba have increased, from 535 billion cubic feet in 1992 to an estimated 8 trillion cubic feet in The historical development of production and reserves is presented in Annex B. 6. Developments since 1996 have had a major impact on Equatorial Guinea's economy. GDP increased from US$ 152 million in 1993 to USS498 million in 1997 and to US$ 1.4 billion in GDP per capita has increased from US$407 in 1993 to US$950 in 1997 and an estimated US$2,100 in The oil sector, which accounted for 11 percent of GDP in 1993, increased to 66 percent of GDP in 1997 and 86 percent of GDP in Oil revenues accruing to the government grew from about US$3 million per year in 1993 to US$50 million in 1997 and an estimated US$212 million in 2000 (they may reach US$725 million by 2003). This recent boom has resulted in visible infrastructure improvements, increased migration to the capital city, Malabo (straining available infrastructure and social services), and very fast growth of activities related to oil activities. Given very serious capacity constraints, the challenge for the govemment remains how to effectively collect its due share of oil revenues and manage these resources so that they benefit the majority of the population as well as future generations. OBJECTIVES AND DESIGN 7. The project objectives were to: (a) ensure that the borrower received maximum and sustainable revenues from the production of the Alba field; (b) identify the most cost-effective methods to utilize the associated gas from Alba; (c) minimize the nsks for the environment of Alba's operations; (d) improve the efficiency of energy sector institutions; and (e) strengthen the capacity of the Ministry of Mines and Hydrocarbons (later the Ministry of Mines and Energy, or MME) to monitor the activities of oil companies, and to evaluate the supply and pncing systems for petroleum products. 8. To achieve these objectives, the project included studies, technical assistance, training, and rehabilitation of the ministry building and acquisition of field vehicles. Annex C presents the project objectives, detailed associated components, together with achievements, outputs, and outcomes. Technical assistance for the revision of the petroleum exploration and production framework, and for negotiating new contracts or renewal of existing contracts with the oil industry, were among the important components of the project. 9. The project design included the following main actions as covenants in the Credit Agreement: * The government would, starting 1993, enter all revenues derived from the exploitation of the Alba field or other hydrocarbon accumulations into its annual budget. * By November 30, 1992, the government would agree with IDA on an action plan, based on the recommendations of studies, to develop a program for the use of Alba gas. * The borrower would carry out an Environmental Impact Study for Alba operations and agree with IDA on an action plan. 10. The somewhat different formulation of the project objectives in the Memorandum of the President (MOP), its Technical Annex, and the Credit Agreement, creates some confusion about 1. Excluding 19,000 bpd of methanol

15 3 the relative importance of the various objectives. 2 Nevertheless, while in retrospect project objectives appear to have a narrow focus on resolving Alba issues, project design also provided means and opportunities to address wider sector issues, as well as those arising from exploration and operation of additional fields. Therefore project design was satisfactory overall. IMPLEMENTATION 11. The project closed as scheduled on June 30, Project funds were fully utilized. Technical assistance was provided to assist the Government to monitor activities of oil companies, review development plans proposed by them, audit their financial accounts, review the petroleum legislation and prepare detailed regulations, negotiate new contracts, renegotiate existing contracts and establish a data filing and statistical system. Training was provided to MME staff, mainly in technical aspects of petroleum exploration, drilling and production. A number of studies were prepared (optimal depletion strategy for the Alba field reservoir; gas utilization study for Alba; energy sector reorganization; petroleum products supply and distribution; and rehabilitation and expansion of the electrical system). Finally, an environmental impact assessment of Alba's facilities was carried out. Additional details on these activities is provided in Annex B. 11. Project implementation was affected by the following events: * The macroeconomic situation of the country during implementation was not good, leading the government to default often on its debt payment obligations to the Bank. This led to suspensions of disbursements. Furthermore, Bank-country relations were tense, because of general poor performance of most ongoing Bank projects, perceived weak governance, and lack of transparency. * Equivocal agreement on project objectives between the government and the Bank resulted in misunderstanding and friction. According to the ICR, the Bank understood that an implicit objective of the project was to renegotiate the Alba contract. This turned out not to be an immediate priority for the government, which rightly viewed renegotiation of signed contracts as legally difficult, untimely, and risky (it would undermine investors' confidence and drive away potential new partners in the sector). In need of immediate resources, the government preferred in the short term to negotiate financial advances on future revenues with the operators of Alba and Zafiro. * The project emphasis shifted after 1995, owing to rapid increase in oil sector activities following the discovery of oil in the Zafiro field, which considerably increased demands on government institutions for review and negotiations of annual production plans and supervision of exploration and production operations. * The Alba field operator changed in 1995, owing to pressure on the original operator to implement measures recommended by the environmental impact assessment and the gas utilization study. Walter International sold all its rights to CMS-NOMECO, which adopted a much longer-term development strategy and invested heavily in field development, minimization of gas flaring through downstream use of gas (processing into LPG, methanol, and power generation), and re-injection. Early in 2002, CMS/NOMECO in turn sold all its rights to Marathon, the main partner and operator of the methanol plant. 2. The PAR, like the ICR, adopted the objectives and components as stated in the Credit Agreement.

16 4 OUTCOME 13. Project objectives related to the optimization of Alba's field development and gas utilization were substantially achieved and efficiently so. The contract was eventually renegotiated to conform to the 1998 Amendment to the Hydrocarbon Law (referred to below), and subsequent developments in the field and downstream (which were recommended under the project) surpassed appraisal expectations, resulting in much higher absolute benefits to the country. However, the objectives related to the Alba field became less relevant during implementation (after discovery of the Zafiro field) and after completion, as other much larger fields were discovered (Ceiba field, offshore Rio Muni). 14. During implementation, as new licenses were granted and substantial discoveries were made, the project's institutional and sector policy objectives gained considerable more importance and urgency. Achieving these objectives required the Govemment to take a series of actions in line with the recommendations of the studies and technical assistance financed under the project. These actions included enacting changes to improve the legal and contractual framework; issuing environmental and other detailed regulations; auditing oil companies accounts and recoverable costs on a systematic basis; further building up MME's capacity to effectively monitor a growing number of oil companies; reorganizing the energy sector; and liberalizing petroleum product imports and distribution. By completion, however, most of these objectives had not been achieved. Furthermore, the Government was not in compliance with the budget transparency covenant. The project outcome was therefore rated unsatisfactory in the ICR. 15. Subsequently, there were advances in the institutional framework, in particular, the 1981 Hydrocarbon Law was amended in 1998; contract renegotiations took place, which improved the govemment's share; and imports and distribution of petroleum products were privatized and liberalized. Although the changes differed on some points from the proposals prepared under the project, these actions justify an upgrading of the efficacy rating from negligible to modest. With relevance still rated high, efficiency substantial, and efficacy now rated modest, outcome is now rated moderately satisfactory, although the case for this upgrading is marginal. RATINGS Relevance: High 16. Given the rapid development of the oil sector since 1995 and its overwhelming importance in the economy and government revenues today, the project objectives were and are still highly relevant and consistent with government priorities and Bank objectives. 3 While the various project objectives did not change during implementation, their relative importance did, with those associated with the optimization of the Alba field losing importance when the Zafiro field and other discoveries were made. Sector-wide objectives, including institutional strengthening, policy framework, environment and safety, and transparency objectives become more urgent to achieve. This change in prionties was recognized, and the project allocated funds for additional technical assistance to negotiate and supervise annual exploration and production 3. Equatorial Guinea currently has no Country Assistance Strategy, but in 1998, the Bank prepared an economic strategy note ("The Challenge of Sudden Wealth," Economic Strategy Note, February 6, 1999) that was discussed with the authorities and incorporated their comments. This strategy, which is still valid, highlights the critical importance of the oil sector to Equatorial Guinea's economy and emphasizes the need for the government to show a concrete commitment to improved financial management, especially greater transparency in the accounting, recording, and allocation of oil resources and their use for poverty alleviation

17 5 programs with the Zafiro contractor; prepare amendments to the Hydrocarbon law, model of PSC's and detailed regulations; and for additional capacity building in MME. Efficacy: Modest 17. Five years after completion, it appears that, with respect to the Alba field, project objectives were substantially achieved, but those for sector policy were only partially achieved. 18. The objectives of improvement of operations in Alba field were substantially achieved: (i) gas flaring from Alba was practically eliminated through conversion into LPG, methanol, and power generation, and through reinjection; (ii) environmental objectives were substantially achieved (see Box 1); (iii) the objective of ensuring maximum revenues from the field to the Govemment was also substantially achieved as a result of increases in production of condensates much above appraisal estimates; additional revenues generated from downstream processing of gas; and readjustment of contractual terms after amendment of the Hydrocarbon Law in The project contributed to the beneficial change of operator in 1995, leading to sound long-term field development and to a considerable expansion of Alba gas reserves and production. These achievements are expected to be further enhanced with another change of operator in The objectives of transparency and institutional development (i.e. capacity building and sector institutional strengthening) were only partially achieved. During project implementation, when, in 1996/97, the Zafiro-Topacio complex was developed in a record time, an important achievement of the project was the provision of critical assistance for the Govemment to perform its monitoring and control functions. Since completion, there have been positive developments, which can be credited to the project, at least in part. Eventually, the technical assistance financed under the project provided inputs into the govemment successful renegotiation of the PSC for Zafiro-Topacio in March 1998, and subsequently of other contracts, including that of Alba, and to the amendment of the Hydrocarbon Law and model PSC in November In fact, the govemment chose to retain one of the technical assistance firms financed under the project as official technical adviser to the MIME, to provide ongoing assistance m exploration and production matters. In line with the recommendations of the study carried out under the project, the framework for petroleum product import, storage, and distribution was liberalized after project completion and the facilities were privatized. Draft environmental regulations prepared on the basis of recommendations by the project consultants have been submitted by MME to the Ministry of Environment. 20. Despite these achievements, efficacy overall remains modest, particularly on the most relevant objectives. First, the Hydrocarbon Law and model PSC were amended, but the improved contractual framework still remains generous to operators compared to Equatorial Guinea's neighbors 4. Second, detailed regulations have still not been enacted. Third, draft environmental regulations were submitted to the Ministry of the Environment, but these have yet to be reviewed and enacted, and the ministry lacks capacity to enforce them when enacted. Fourth, the transparency covenant, that all revenues derived from the exploitation of the Alba field or other hydrocarbon accumulations should be entered into the annual budget, had not been met by the closing date. Fifth, staff training and technical assistance did significantly improve MME's capacity and efficiency in promoting and monitoring oil exploration and production activities, but not to the extent required to keep up with the subsequent rapid increase in petroleum activities. 4. A Bank Economic Strategy Note for Natural Resource Management ("The Challenge of Sudden Wealth"), dated February 26, 1999, reviewed the contractual framework and concluded that total govemment take was still substantially below levels in neighboring countries.

18 6 Large salary differentials between the civil service and oil companies 5 and the private sector, combined with promotions of qualified staff to other positions in the government, have also further exacerbated shortages of trained personnel. Sixth, the training program financed under the project was not carried out on the basis of a systematic needs assessment: it tended to emphasize immediate needs for training in technical aspects of exploration and production, but gave much less attention to the equally important aspects of business negotiations, regulations, economics, accounting, financial auditing of oil companies' accounts, and financial and strategic planning. Despite the quality of consultants and financial auditors contracted under the project to address these aspects, there is still limited capacity in the government to plan, supervise, and challenge the findings and recommendations of outside consultants. The project thus failed to establish an adequate institutional capacity in many of these areas. Efficiency: Substantial 21. At appraisal (1992), production at Alba was estimated to increase from 2,500-3,000 barrels per day (bpd) to 5,000-6,000 bpd by 1993, and production of gas was to increase from 35 million cubic feet per day (mmcfd) to 80 mnmcfd. By completion (end of 1997), these targets were fully met (6,700 bpd of condensates and 80 mmcfd of gas), and, subsequently, were considerably exceeded: by the end of 2001, production of condensates at Alba reached 10,000 bpd and they are soon to increase to 30,000 bpd (five times the original estimate), and gas production increased to over 195 mmcfd (more than twice original estimates). Gas reserves are now estimated at 8 tcf, more than 15 times reserves at appraisal. In line with the recommendations of the gas utilization and environmental impact studies financed under the project, practically all gas is processed dovwnstream into LPG (2,300 bpd, soon to increase to 10,000 bpd), methanol (19,000 bpd), and power (1OMW), or re-injected, almost eliminating gas flaring and associated pollution. 22. It is not possible to quantify the extent to which the project contributed to collection of oil revenues (through expertise provided to evaluate and approve production plans and monitor the oil companies). At appraisal, the government share of oil revenues from Alba was projected to increase from about US$3 million per year to US$ 10.5 million by 1995 and to about USS19.0 million by 1996/97. Actual government oil revenues from Alba are likely to be substantially above these levels, as a result of production increases, downstream developments, increases in international oil prices since appraisal, and revised contractual terms. Revenues from the Zafiro field, on which much of the project technical assistance focussed, are considerably above those of Alba. No data on the breakdown of oil revenues is available, but overall they increased very substantially (to about US$200 million in year 2000). 23. Although returns are likely to be considerably above appraisal estimates, efficiency is rated only substantial, due to uncertainty regarding their level and the lack of transparency (it is not clear that all revenues due were actually collected). 5. Salaries offered by oil companies are regulated by law and are a multiple of those in the government. The establishment of a public company (GE-Petrol) able to offer competitive saiaries is viewed by some government officials as a way to retain qualified staff without having to address the issue of civil service salaries.

19 7 Box 1. Environmental Aspects Alba Gas and Condensate Field The Alba gas and condensate field was developed in 1991 by an independent operator, Walter Intemational, at very low investment cost. At appraisal, the field was flaring about 35 mmcfd of gas, for a production of 3,000 bpd of gas condensate. In addition, safety and environmental control in offshore and inland facilities were very hlmited. Addressing these issues was considered an important objective in project design. Uses of associated gas - Studies to identify the most cost-effective method to use Alba's associated gas were carned out during project preparation and early during project implementation, and their recommendations were implemented In early 2002, the power plant was being operated by Marathon (with further plans to expand), the LPG plant was in operation and its capacity was expected to increase from 2,300 bpd to 10,000 bpd before 2004, a 19,000 bpd methanol plant had been operated since mid-2001, and most remaining gas was being re-injected, minimizing gas flaring. The downstream methanol plant was built according to international environmental and safety standards and Environment Monitoring, Emergency and Safety Plans were developed with the assistance of specialized international companies. Also, the plant has an on-site environmental division and is implementing an Environmental Management System. Recently, Marathon, the main owner and operator of the new methanol plant, acquired all CMS Energy interests in Equatorial Guinea, including Alba. This acquisition should further contribute to optimize Alba production and integrated use and commercialization of associated gas. Environmental and Safety Risks - A 1994 environmental impact study identified a number of safety and environmental risks due to deficiencies in production facilities and made recommendations for improvements. Government pressure to implement the recommendations of this impact study as well as of the gas utilization study also carried out under the project accelerated the change of operator in May The new operator gradually implemented the recommended measures such as improved lighting of the production tower, installation of lightning protection and fire prevention systems, and construction of new tanks (old storage tanks with leaks are now stopped). Oil Production Fields The Zafiro complex is equipped for the use of up to 90 mmcfd of associated gas for re-injection and gas lift, reducing the amount of gas flared. However, the need to limit gas flaring will be a bottleneck to future production increase. The Ceiba field, offshore from Rio Muni, does not have a problem of excess associated gas. In fact, the expansion plan to 160,000 bpd includes facilities to inject water to maintain field pressure. Petroleum Products Import, Storage, and Distribution Facilities The issue of the poor environmental and safety conditions of the storage and distribution facilities was recognized during appraisal but not directly addressed by the project. As expected at appraisal, the revamping of the petroleum products storage and distnbution facilities was financed (USS3 million) by the French Caisse Centrale de Cooperation and implemented under the control of the technical department of Total (at that time these facilities were govemment owned and operated by Total). Since 1998, after liberalization of petroleum product distribution, the government sold the facilities to Total, which built new tanks and fire protection systems in Bata and Malabo. Environmental Framework The Alba environmental impact assessment also recommended that an environmental and safety law for the mining and oil sectors be enacted. Instead, an environmental section was established within the Ministry of Mines and Energy (MME) in 1995, and environmental provisions have been included in PSCs, but these arrangements remain insufficient. The environmental provisions in the contracts are general obligations to protect the environment, but the MME recognizes that new contracts should have environmental obligations spelled out, including mitigation measures. Finally, the Ministry of Forest and Environment has already prepared a draft national environmental law, including petroleum environmental regulations that were submitted by the MME. The national environmental law is expected to be enacted in 2002 after having been discussed with the sector ministries. The objectives of transparency and institutional development (i.e. capacity building and sector institutional strengthening) were only partially achieved. There have been positive developments since, which can be credited to the project, at least in part. Technical assistance provided under the project laid the basis for the govemment successful renegotiation of the PSC for Zafiro-Topacio in March 1998, and subsequently of other contracts, including the one for Alba, and to the amendment of the Hydrocarbon Law and model PSC in November In fact, the govemment has chosen to retain one of the technical assistance firms financed under the project as official technical adviser to the MME, to provide ongoing assistance in exploration and production matters. In line with the recommendation of the study carried out under the project, the framework for petroleum product import, storage, and distribution was liberalized after project completion and the facilities were privatized. Draft environmental regulations prepared on the basis of the regulations prepared by the project consultants have been submitted by MME to the Ministry of Environment.

20 8 Institutional Development Impact: Modest 24. The sector institutional capacity has improved but remains weak. Improvements came from staff training and technical assistance, which built up MME's capacity and efficiency. Some limited improvements in the energy sector organizational structure took place, including shifting the responsibility for the power sector from the Ministry of Industry to the Ministry of Mines and Hydrocarbons, which then became the MME. An environmental section was established within MME. Petroleum product import and distribution were liberalized and facilities privatized. Finally, the regulatory and contractual frameworks for exploration and production have improved. 25. However, the rapid increase in petroleum activities, the creation of GE-Petrol, promotions with transfers of trained personnel to other agencies, and salary differentials with the private sector, have again strained the available capacity. The regulatory and contractual framework is still very favorable to oil companies. Environmental and other detailed regulations have still not been enacted. Finally, lack of transparency with respect to the collection, management, and disposition of oil revenues continues to be a senrous issue (although some progress has been reported recently). Sustainability: Likely 26. Overall sustainability is rated as likely despite some serious uncertainties regarding the government's commitment or ability to address long-term institutional, environmental, economic, and social issues. 27. Technical and financial resilience of project benefits is high. The project helped to ensure the adoption of sound long-term development plans in the development of the oil sector. Benefits from current oil activities are expected to be sustained at least for the next 15 years, and further findings are likely. Equatorial Guinea is now a major FDI destination in Africa. 28. Environmental sustainability of operations at Alba is likely. The operator has implemented the recommendations of the environmental impact study and the study on downstream use of gas. Gas flaring at Alba is now minimal. The downstream methanol plant was constructed and is operated using intemational standards. In other areas, contractors also endeavor to minimize gas flaring through reinjection and to deal with other environmental concerns (including safe disposal of waste, muds, and chemicals), and all contractors have environmental teams working in the country. With respect to import, storage, and distribution of petroleum products, the issue of poor environmental and safety conditions in the govemmentowned facilities identified at appraisal was resolved with financing from Caisse Centrale de Cooperation Economique in Since then, the facilities were sold to the concessionaire, which has built new tanks and fire protection systems. General environmental protection obligations are included in PSCs. Nevertheless, the lack of environmental regulations and of institutional capacity to monitor environmental performance and impacts is an area of concern. 29. Sustainability of institutional achievements will continue to depend on outside technical assistance, until sufficient local capacity is developed. The ability to establish and maintain local capacity within the Government, however, may be seriously eroded if the Government continues to lose qualified personnel by paying them salaries much below those offered by oil companies.

21 9 30. Given the dominance of the oil sector in the economy, the resilience of economic benefits to the country, i.e., maintaining the level of overall economic development in the long termn after the depletion of reserves, will depend on the ability of the government to manage the oil boom well and to create the conditions for the pnvate sector to develop other sectors of the economy. While direct employment creation in the oil sector is limited, indirect employment may be higher. On the other hand, there is a danger that the oil boom will further depress the traditional sectors. Avoiding adverse effects will depend on a firm govemment commitment to a development strategy that ensures sustainable development after oil depletion (avoiding the so-called "Dutch disease"effect). It will also require considerable institutional strengthening throughout the government, much improved governance and transparency, and a clear development strategy. There have been positive signs since 2002 that the government is committed to these goals. The recent government request for FIAS assistance for investment promotion in the non-oil sectors is an indicator of this positive change, as is renewed government interest in IMF and Bank assistance after several years of absence. 31. Resilience of economic benefits will also depend on social and political stability, which in turn are subject to how the govemment ensures that the benefits of oil discovery and exploitation benefit the mass of the population. If oil revenues are perceived to benefit only an elite, and regional and income disparities are exacerbated, political and social turmoil may jeopardize economic development. The country's social indicators in , during project implementation, were among the worst in Africa. There are no consistent, updated data showing these indicators today, but they are unlikely to have changed significantly, as the major revenues from the oil boom started flowing only after There have been some visible investments in infrastructure (roads, ports), but investments in social services so far appear to have been very limited. There are large capacity constraints in all sectors, for planning, project preparation, procurement, implementation, and control. Bank Performance: Unsatisfactory 32. In general, project design was sufficiently broad and flexible to adapt to changed priorities during implementation, except that objectives and components were not consistent in their presentation the MOP, the Technical Annex, and the Credit Agreement, leading to confusion about their relative importance and interpretation. In particular, Bank staff perceived that renegotiation of the existing contract was important in achieving the project objective of maximizing revenues from the Alba field. Yet, renegotiation is mentioned only in the MOP and not in the Credit Agreement or in the Technical Annex to the MOP. Also, project design should have from the start more clearly and comprehensively identified the need for capacity building to monitor and control all aspects of the performance of oil companies, including skills required for projecting accrued oil revenues, monitoring their effective collection, monitoring and auditing companies financial accounts and reports, and to review eligibility of recovered operating costs and investments. This should have required more attention to the establishment of appropriate structures, systems, and procedures as well as the design of a training program based on a comprehensive needs assessment. 33. Throughout design and implementation, up to project completion, there was a fundamental difference of perception between the Bank and the Government with respect to the need and timing for renegotiation of signed contracts. Both the Alba and Zafiro contracts, which were signed, respectively, in April 1990 and June 1992, were in line with the 1981 Hydrocarbon Law and PSC model prepared under an earlier Bank/UNDP technical assistance operation. Both contracts were negotiated and signed without Bank assistance (the Zafiro contract was signed shortly before the project's Board approval, without Bank knowledge). During appraisal, however, Bank missions assessed that contract terms were excessively favorable to operators,