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Document of The World Bank

Report No: ICR00004022

IMPLEMENTATION, COMPLETION AND RESULTS REPORT (IBRD-48140, IBRD-80440)

ON

LOANS

IN THE AMOUNT OF EURO 34.7 MILLION (US$ 44.1 MILLION EQUIVALENT)

TO

AD PRENOS NA ELEKTRICNA ENERGIJA I UPRAVUVANJE SO

ELEKTROENERGETSKIOT SISTEM, VO DRZAVNA SOPSTVENOST,

SKOPJE, (AD MEPSO, THE MACEDONIAN POWER

TRANSMISSION SYSTEM OPERATOR)

WITH THE GUARANTEE OF THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA

IN SUPPORT OF THE THIRD PHASE OF THE US$1,000 MILLION

ENERGY COMMUNITY OF SOUTH EAST EUROPE PROGRAM

January 31, 2017

Energy and Extractives Global Practice Europe West Balkans Country Unit Europe and Central Asia Region

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CURRENCY EQUIVALENTS

(Exchange Rate Effective 12/31/2016)

Currency Unit = Macedonian Denar (MKD)

MKD 1.00 = US$ 0.02

US$ 1.00 = 58.17 MKD

FISCAL YEAR

January 1 – December 31

ABBREVIATIONS AND ACRONYMS

APL Adaptable Program Loan BP Bank Procedures CAS Country Assistance Strategy DC Direct Current EBRD European Bank for Reconstruction

and Development EC Energy Community (formerly

ECSEE) ECSEE Energy Community of South East

Europe EIA Environmental Impact Assessment ELEM Macedonian Power Generation

Company EMP Environmental Management Plan EMS Energy Management System ENTSO-E European Network of Power System

Operators for Electricity ERC Energy Regulatory Commission of

Macedonia ERR Economic Rate of Return ESM Integrated Macedonian Electric

Company EU European Union EUR Euro EVN Macedonian Distribution Company,

privately owned FEAP Framework for Environmental

Assessment Procedures FM Financial Management FMIS Financial Management Information

System FYR Former Yugoslav Republic GoM Government of FYR Macedonia GWh Gigawatt hour IBRD International Bank for

Reconstruction and Development

ICR Implementation, Completion and Results Report (This report)

IFRS International Financial Reporting Standards

ISR Implementation Status and Results Report

Km kilometer kV Kilovolt kWh Kilowatt hour M&E Monitoring and Evaluation MEPSO AD MEPSO, the Macedonian Power

Transmission System Operator MK FYR Macedonia MKD Macedonian Denars MS Moderately Satisfactory MU Moderately Unsatisfactory MW Megawatt MWh Megawatt Hour NDC National Dispatch Center O&M Operation & Maintenance OHTL Overhead Transmission Line OP Operational Policies OPGW Optical Ground Wire PAD Project Appraisal Document PDO Project Development Objectives PIU Project Implementation Unit PLAO Property and Legal Affairs Office SCADA Supervisory Control And Data

Acquisition SCC Substation Control System SCS Sub-Station Control System SDH Synchronous Digital Hierarchy SEE South Eastern Europe TF Trust Fund VAT Value Added Tax WB World Bank

Senior Global Practice Director: Riccardo Puliti Practice Director: Ranjit Lamech

Project Team Leader: Peter Johansen ICR Team Leader: Peter Johansen

FYR MACEDONIA

Energy Community of South East Europe Program

CONTENTS

Datasheet

A. Basic Information ........................................................................................................................ i B. Key Dates .................................................................................................................................... i C. Ratings Summary ........................................................................................................................ i D. Sector and Theme Codes............................................................................................................ ii E. Bank Staff .................................................................................................................................. iii F. Results Framework Analysis ..................................................................................................... iii G. Ratings of Project Performance in ISRs .................................................................................. vii H. Restructuring (if any) .............................................................................................................. viii I. Disbursement Profile ................................................................................................................. ix 1. Project Context, Development Objectives and Design ............................................................... 1 2. Key Factors Affecting Implementation and Outcomes .............................................................. 6 3. Assessment of Outcomes .......................................................................................................... 15 4. Assessment of Risk to Development Outcome ......................................................................... 21 5. Assessment of Bank and Borrower Performance ..................................................................... 21 6. Lessons Learned........................................................................................................................ 24 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners........................... 25 Annex 1. Project Costs and Financing .......................................................................................... 26 Annex 2. Outputs by Component.................................................................................................. 27 Annex 3. Economic and Financial Analysis ................................................................................. 30 Annex 4. Bank Lending and Implementation Support/Supervision Processes ............................. 35 Annex 5. Beneficiary Survey Results ........................................................................................... 38 Annex 6. Stakeholder Workshop Report and Results ................................................................... 39 Annex 7. Summary of Borrower's ICR and/or Comments on Draft ICR ..................................... 40 Annex 8. Comments of Co-financiers and Other Partners/Stakeholders ...................................... 42 Annex 9. List of Supporting Documents ...................................................................................... 43 Annex 10. Map.............................................................................................................................. 44

i

Data Sheet

A. Basic Information

Country: Macedonia, former Yugoslav Republic of

Project Name: ECSEE APL 3 - FYR Macedonia

Project ID: P082337 L/C/TF Number(s): IBRD-48140, IBRD-80440

ICR Date: 01/27/2017 ICR Type: Core ICR

Lending Instrument: APL Borrower: MACEDONIAN TRANSMISSION SYSTEM OPERATOR

Original Total Commitment:

US$ 25.00M Disbursed Amount: US$ 43.51M

Revised Amount: US$ 43.38M

Environmental Category: F

Implementing Agencies:

Macedonian Transmission System Operator (MEPSO)

Cofinanciers and Other External Partners:

B. Key Dates

Process Date Process Original Date Revised / Actual Date(s)

Concept Review: 05/18/2004 Effectiveness: 05/25/2006 05/25/2006

Appraisal: 09/19/2005 Restructuring(s):

03/09/2011

03/06/2014

11/25/2015

Approval: 01/10/2006 Mid-term Review: 02/07/2010 02/01/2010

Closing: 03/31/2011 07/31/2016

C. Ratings Summary

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C.1 Performance Rating by ICR

Outcomes: Satisfactory

Risk to Development Outcome: Moderate

Bank Performance: Moderately Satisfactory

Borrower Performance: Moderately Satisfactory

C.2 Detailed Ratings of Bank and Borrower Performance (by ICR)

Bank Ratings Borrower Ratings

Quality at Entry: Moderately Satisfactory Government: Moderately Satisfactory

Quality of Supervision: Moderately Satisfactory Implementing Agency/Agencies: Satisfactory

Overall Bank Performance: Moderately Satisfactory Overall Borrower

Performance: Moderately Satisfactory

C.3 Quality at Entry and Implementation Performance Indicators

Implementation Performance Indicators QAG Assessments (if

any) Rating

Potential Problem Project at any time (Yes/No):

No Quality at Entry (QEA):

None

Problem Project at any time (Yes/No):

Yes Quality of Supervision (QSA):

None

DO rating before Closing/Inactive status:

Moderately Satisfactory

D. Sector and Theme Codes

Original Actual

Major Sector/Sector

Energy and Extractives

Energy Transmission and Distribution 100 100

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Major Theme/Theme/Sub Theme

Private Sector Development

ICT 33 33

ICT Solutions 33 33

Regional Integration 67 67

E. Bank Staff

Positions At ICR At Approval

Vice President: Cyril E Muller Shigeo Katsu

Country Director: Ellen A. Goldstein Orsalia Kalantzopoulos

Practice Manager/Manager: Ranjit J. Lamech Hinderikus Busz

Project Team Leader: Peter Johansen David Kennedy

ICR Team Leader: Peter Johansen

ICR Primary Author: James Sayle Moose

F. Results Framework Analysis Project Development Objectives (from Project Appraisal Document)

The original Loan Agreement states: "The objective of the Project is to support the implementation of the Investment Program and to improve the overall operational efficiency of AD MEPSO." The Project Appraisal Document (PAD) contained two different wordings of the PDO: (i) "The objective of the project is to strengthen transmission and dispatch and improve efficiency of AD MEPSO to support functioning of this new company in the context of the regional power market through (a) financing investments necessary to rehabilitate and upgrade the power transmission network, (b) financing investments to increase the level of interconnection with neighboring power systems, (c) strengthening the institutional capacity of AD MEPSO"; and

(ii) "The objective of the ECSEE APL 3 Project is to support the functioning of the new transmission company (AD MEPSO) in the context of the regional power market through financing investments necessary to rehabilitate and upgrade the power transmission network, increase the level of interconnection with neighboring power systems, and to strengthen the institutional capacity of MEPSO". The latter wording was repeated in the Project Paper on the Additional Loan (March 9, 2011) and is used for the purposes of this Report.

iv

Revised Project Development Objectives (as approved by original approving authority)

N/A

(a) PDO Indicator(s)

Indicator Baseline Value Original Target

Values (from approval documents)

Formally Revised

Target Values

Actual Value Achieved at Completion or

Target Years

Indicator 1 : PDO Indicator 1

Value quantitative or Qualitative)

N/A

APL3 projects are completed successfully. The Macedonian power transmission network operates reliably and efficiently.

N/A

All five components are completed successfully. The Macedonian power transmission network is (i) reliable, with no major unscheduled outages in the 12 months preceding project completion and (ii) efficient, with transmission losses under 2%.

Date achieved 05/25/2006 03/31/2011 07/31/2016

Comments (incl. % achievement)

Achieved. This project has addressed key bottlenecks for power transmission around the major cities of Skopje and Bitola as well as power transit between Bulgaria, Serbia and Greece. The achievements of reliability and efficiency are largely attributable to the project.

(b) Intermediate Outcome Indicator(s)

Indicator Baseline Value Original Target

Values (from approval documents)

Formally Revised

Target Values

Actual Value Achieved at Completion or

Target Years

Indicator 1 : Component 1: Expansion of Skopje 5 Substation. Indicator 1

Value (quantitative or Qualitative)

Nil Satisfactory completion of substation expansion

N/A

Substation expansion completed successfully

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved. Expanded substation is operational

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Indicator 2 : Component 1: Expansion of Skopje 5 substation. Indicator 2


100 kV and during peak as low as 93 kV

Voltages at Skopje 5 are within their operating limits

N/A Voltage remains in interval 110kV +/-1kV

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved. Voltages are very stable (within +/-1kV) from Skopje 5 substation, which is now providing reliable power to sections of Skopje.

Indicator 3 : Component 1: Expansion of Skopje 5 Substation, Indicator 3


Nil Incremental supply of at least 50 MW from Skopje 5

N/A Incremental supply of 64 MW

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved. In peak load situations, Skopje 5 can deliver an additional 64 MW thereby ensuring room for further demand expansion in the area.

Indicator 4 : Component 2: Rehabilitation and Construction of Interconnection and Overhead Transmission Lines. Indicator 1


Nil Satisfactory completion of subprojects

N/A All four subprojects are satisfactorily completed

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved

Indicator 5 : Component 2: Rehabilitation and Construction of interconnection and Overhead Transmission Lines. Indicator 2


Cross border trade for 2005 was 624 GWh

Increase cross border trade between FYR Macedonia and Greece by at least 20%

N/A Cross border trade FYR Macedonia-

Greece increased by 223%

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved. In 2015 the additional cross-border trade with Greece on the Bitola-Florina line was 1393 GWh. The increase since 2005 of 223% is therefore directly attributable to the Project.

Indicator 6 : Component 2: Rehabilitation and Construction and Overhead Transmission Lines. Indicator 3

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Total duration of outages in 2005 was 1480 minutes

Reduce number and amount of energy interruption due to outages of Skopje1-Tetovo line by 80%

Energy interruption due to outages on Skopje 1-Tetovo line reduced by 100%

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved. Since the line was upgraded there have been no outages. The reduction of outages is 100%



Nil Putting into operation the Nis-Stip Transmission Line

N/A Nis-Stip Transmission Line has been put into operation

Date achieved 05/25/2005 03/31/2011 07/31/2016


Achieved. This indicator was introduced in the March 9, 2011 Additional Loan Project Paper. The new line facilitates north-south power flows enabling lower cost supply of power in FYR Macedonia and increased transit Bulgaria- Greece.



Nil

Increasing transit volumes through MK Power System by 61 MW.

N/A Transit volumes through MK Power System have increased by 61 MW.

Date achieved 05/25/2006 03/31/2006 07/31/2016


Achieved. This indicator was introduced in the March 9, 2011 Additional Loan Project Paper. Due to the new line transit volumes have increased from 219 MW to 280 MW.

Indicator 9 : Component 3: Upgrade of existing EMS Systems and Planning Software


Nil

Satisfactory completion of the EMS and Planning Software expansion

N/A EMS and Planning Software expansion completed

Date achieved 05/25/2006 03/31/2011 07/31/2006


Achieved. The EMS has improved economic dispatch in the NDC and allowed for higher levels of trade. The planning software has improved the accuracy of load flow simulations and assessment of transmission system reliability.

Indicator 10 : Component 4: Upgrading and Rehabilitation of 110 kV Substations, Indicator 1

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Nil

Satisfactory completion of the component's subprojects

NA 21 substations have been upgraded

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved. Performance and efficiency of substation operation improved trough upgrading of circuit breakers and other high-voltage equipment as well as installation of Remote Terminal Units, control systems and telecommunication equipment.

Indicator 11 : Component 4: Upgrading and Rehabilitation of 110 kV Substations, Indicator 2


Nil

Reduce substations’ operating and maintenance costs by at least 25% for the unbundled substations

Reduction in substation O&M costs of 58%

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved. Due to fewer equipment failures leading to less need for component replacement and repair work substation O&M fell from EUR 227,000/year to EUR 94,000/year.

Indicator 12 : Component 5: Support for Institutional Development


Nil

Successful deployment of a Financial Management Information System (FMIS) at MEPSO

N/A FMIS is installed and operating successfully at MEPSO

Date achieved 05/25/2006 03/31/2011 07/31/2016


Achieved. FMIS has improved financial reporting (IFRS) and enhanced efficiency of financial monitoring and planning.

G. Ratings of Project Performance in ISRs

No. Date ISR

Archived DO IP

Actual Disbursements

(US$ millions)

1 12/01/2006 Satisfactory Satisfactory 2.84




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6 06/24/2010 Moderately Satisfactory Moderately Satisfactory 14.96



9 06/26/2012 Moderately Unsatisfactory Moderately Unsatisfactory 23.96

10 05/16/2013 Moderately Unsatisfactory Unsatisfactory 25.51

11 12/30/2013 Moderately Unsatisfactory Unsatisfactory 27.40







H. Restructuring (if any)

Restructuring Date(s)

Board Approved PDO

Change

ISR Ratings at Restructuring

Amount Disbursed at

Restructuring in US$ millions

Reason for Restructuring & Key Changes Made

DO IP

03/09/2011 N MS MS 16.38

Additional Financing to fund financing gap and for additional transmission line Stip-Serbian Border. Extension of the Closing Date of existing loan from March 31, 2011 to March 31, 2014

03/06/2014 N MU U 28.03 Extension of Closing Date for original and additional loan until November 30, 2015

11/25/2015 N MS MS 39.50 Extension of Closing Date for additional loan until July 31, 2016.

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I. Disbursement Profile

1

1. Project Context, Development Objectives and Design

1.1 Context at Appraisal

Regional Context. The APL3 Project in FYR Macedonia was one of a series of Adaptable Program Loans (APLs) in South Eastern Europe (SEE1) designed to liberalize the markets of the participating countries and better interconnect the grids of these countries with one another and with the European Grid. When the PAD for this project was written in 2005 most of the countries in the SEE except Turkey, were anticipating power shortages as there had been limited investment in generation in these countries over the past 10-15 years. According to the PAD “with the average age of generation capacity now in excess of thirty years….The SEE countries have acknowledged that solutions to these regional issues based on isolated national markets are neither desirable nor feasible as a means to attempt to close investment gaps and emerging demand and supply imbalances. Building upon their experience to cooperate in the power sector, in recognition of potential gains from increased trade, and as part of a wider movement to strengthen regional cooperation, the Governments of the SEE countries and the European Commission signed the “Athens Memorandum”-the Memorandum of Understanding on the Regional Energy Market in South East Europe and its Integration into the European Community Internal Energy Market-on December 8 2003 in Athens Greece, whereby they formally expressed their commitment to what was called the Energy Community of South East Europe (ECSEE).”

The treaty establishing the Energy Community was signed on October 25, 2005 and formalized the arrangements under the Athens Memorandum. The key aim of the treaty is to extend the EU internal energy market to the SEE and beyond on the basis of a legally binding framework. The treaty has as its objectives, the establishment of an integrated market in natural gas and electricity by increasing the interconnections and cooperation between the countries based on common interest and solidarity, liberalizing their energy markets and creation of a stable regulatory and market framework capable of attracting investment. FYR Macedonia as well as almost all of the other countries in the SEE signed the Energy Community Treaty as did the EU.

FYR Macedonia at the time of the Project appraisal was just starting to liberalize its market, adhering to its commitments under the Athens Memorandum. The integrated government-owned electric utility, ESM, was being unbundled into a transmission company, AD MEPSO (in the following just referred to as MEPSO), a generation company, ELEM, and a distribution company, ESM Distribution (now EVN). MEPSO was operating the transmission system and acting as a Single-Buyer for the rest of the market. It was expected that distribution would be privatized and that over time the market would be liberalized so that all customers could choose their supplier of electricity. This process would start with the larger companies. FYR Macedonia also planned to enhance its connections with other Energy Community Members and the EU by building new

1 In the context of the operation, the SEE includes the following countries: Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, Serbia and Turkey.

2

connector lines to adjacent countries to allow increased imports, exports and wheeling of electricity.

Rationale for Bank Assistance. At the time of the Project appraisal, the Bank was participating in regional efforts to promote cooperation and integration in the SEE and was an active participant in the Athens process, at the request of the European Commission. The Bank had supported individual countries of the SEE, including FYR Macedonia, in their efforts to rehabilitate and restructure their power sectors through policy dialogue, technical assistance and financing since the early 1990s (in some cases even earlier). This deep country knowledge and participation in the development of ECSEE and the Athens process, including work on a regional trade strategy, put the Bank in a strong position to provide regional lending, policy advice and technical assistance to further support the Athens process for ECSEE. The ECSEE APL program was approved by the Bank on January 27, 2005. It was a key component of the Bank's support for the Stability Pact and its working partnership with the European Commission. FYR Macedonia was one of the countries actively involved in the Athens process and therefore it participated in the APL Program.

1.2 Original Project Development Objectives (PDO) and Key Indicators (as approved)

The objective of ECSEE APL program is the development of a functioning regional electricity market in South East Europe and its integration into the internal electricity market of the European Union, through the implementation of priority investments supporting electricity market and power system operations in electricity generation, transmission and distribution and technical assistance for institutional/systems development and project preparation and implementation. Within this general objective specific project Development objectives were defined.

For the FYR Macedonia ECSEE APL3 Project, the original Loan Agreement states: “The objective of the Project is to support the implementation of the Investment Program and to improve the overall operational efficiency of AD MEPSO.”

The Project Appraisal Document (PAD) contained two differently wordings of the PDO: (i) “The objective of the project is to strengthen transmission and dispatch and improve efficiencyof AD MEPSO to support functioning of this new company in the context of the regional powermarket through (a) financing investments necessary to rehabilitate and upgrade the powertransmission network, (b) financing investments to increase the level of interconnection withneighboring power systems, (c) strengthening the institutional capacity of AD MEPSO”; and

(ii) “The objective of the ECSEE APL 3 Project is to support the functioning of the newtransmission company (AD MEPSO) in the context of the regional power market through financinginvestments necessary to rehabilitate and upgrade the power transmission network, increase thelevel of interconnection with neighboring power systems, and to strengthen the institutionalcapacity of MEPSO”. The latter wording was repeated in the Project Paper on the Additional Loan(March 9, 2011) and is used for the purposes of this Report.

The overall outcomes at appraisal were stated as:

3

- APL3 projects are completed successfully; and- The Macedonian power transmission network operates reliably and efficiently.

This was translated into component-specific key PDO indicators as follows:

- Improved voltage stability at Skopje 5 substation- Incremental supply from Skopje 5 substation- Increased cross border trade between FYR Macedonia and Greece- Reduced energy interruptions due to outages of Skopje1-Tetovo line,- Reduced operating and maintenance costs at the unbundled substations

1.3 Revised PDO (as approved by original approving authority) and Key Indicators, and reasons/justification

As a result of the Additional Financing an extra PDO indicator was added for the new Nis - Stip transmission line/interconnector (for which most of the Nis - Serbian Border portion had already been constructed by the Serbian System Operator):

- Increased transit volumes through MK Power System.

1.4 Main Beneficiaries

The primary beneficiaries of this project were not explicitly stated in the PAD, but can be inferred from the PDO and indicators as the people of FYR Macedonia who will benefit by: (i) being able to obtain electricity supplies for base load or peaking, often at lower cost and more easily from other counties; (ii) having fewer and shorter outages; (iii) having lower operating costs for the transmission system due to reduced repairs; and (iv) having increased revenue from wheeling electricity, which should help to reduce net transmission costs. MEPSO will also benefit from lower operation and management costs and improved financial management.

1.5 Original Components

There were five components in the project.

Component 1: Expansion of Skopje 5 Substation. This component consisted of the installation and commissioning of a second 400/100 kV transformer in the Skopje 5 400/110 kV substation to replace an existing, but out of operation, 220/110 kV transformer. It also includes the construction of the corresponding 400 kV bay and adaptation of the existing110 kV bay at Skopje 5.

Component 2: Rehabilitation and construction of interconnection and overhead lines. This component consisted of the following three transmission subprojects:

Construction of FYR Macedonia - Greece 400 kV interconnection line: This subproject consisted of the construction of the Macedonian section of a 400 kV transmission interconnection between FYR Macedonia (Bitola 2 substation) and Greece which upgraded the existing 150 kV interconnection between Bitola 2 substation and the Florina

4

substation in Greece. The total length of the line is 41 km of which the Macedonian section of the line is 19 km long. The subproject also included the construction of the necessary new 400 kV bay at Bitola 2 substation.

Construction of Skopje 1 - Tetovo 110 kV transmission line: This subproject consisted of the reconstruction of a 52 km 110 kV overhead transmission line between Skopje 1 and Tetovo 1 substations to replace the existing transmission line connecting the two substations. The old 110 kV transmission line was constructed in 1957 with concrete towers. Many of these had deteriorated to a level that posed a danger to the public and increased the line outage rate.

Construction of Bitola 3 - Bitola 4 110 kV transmission line: This subproject consisted of the construction of a 12 km, double circuit, 110 kV transmission line in southwest FYR Macedonia to connect Bitola 3 and Bitola 4 substations. The construction of this transmission line provided a second line connecting Bitola 3 substation to the 110 kV transmission network to fulfill the n-1 reliability criterion for network operation. Furthermore, the construction of the line relieved the heavily loaded transmission lines and low voltages in the local area surrounding Bitola.

Component 3: Upgrading of the existing EMS System and Planning Software. This component consisted of the following two subprojects:

EMS software expansion: This subproject consisted of procurement and installation of several new software applications to enhance the capability of the Energy Management System (EMS) at the National Dispatch Center (NDC); and

PSS/E software expansion: This subproject consisted of procurement of transmission planning software and applications necessary for performing transmission reliability studies and calculations of the transmission transfer capacity for both the local and regional interfaces.

Component 4: Upgrading and rehabilitation of 110kV substations. This component consisted of the following three subprojects:

Supply of substation RTUs, SCCs and DC Supply: This subproject covered the procurement, installation and commissioning of 13 RTUs (remote terminal units) and measuring transducers, 8 SCSs (substation control systems), new substation digital protection devices with all necessary additional auxiliary and communication equipment; and 21 new control houses with AC/DC supply, auxiliaries and wiring;

Supply of high voltage equipment: This subproject consisted of procurement of high voltage equipment necessary for rehabilitation of existing 110 kV substations. It included the replacement of 42 circuit breakers, 111 current transformers and 81 voltage transformers located in fourteen 110 kV substations; and

Supply of telecommunication equipment: This subproject consisted of deployment of a modern telecommunication network based on SDH technology to replace the existing telecommunications equipment with Optic Ground Wire (OPGW) cables in eastern FYR Macedonia.

Component 5: Support for institutional development. This component consisted of the following two subprojects:

5

Consulting services to support strengthening of the financial management function in MEPSO. Review of the financial function and proposal of improvements in the areas of budgeting, costing, accounting, financial reporting and internal controls. The consultant provided training to support development of MEPSO’s in-house capacity; and

Purchase of a Financial Management Information System (FMIS). The modules include: General Ledger, Accounts Payable, Receivables, Treasury/Cash Management, Fixed Assets, Inventory, Project Accounting, and Reporting.

1.6 Revised Components

One additional subproject was added to Component 2 during Additional Financing (March 2011):

Construction of the Stip – Serbian Border Line This subproject was added in 2011 when it became clear that a new Serbian line was needed fairly urgently to better connect to the European Grid. MEPSO built the line from Stip to the border with Serbia while the Serbian transmission system operator built the line from the Macedonian border to Nis where it connected to the Serbian Grid.

1.7 Other significant changes

Additional Financing. In 2011 it became clear that there was a funding gap of about EUR 3 million caused primarily by exchange rate fluctuations. The main sub-project that was not fully funded was the Skopje-Tetovo line. In addition, a line to Serbia was needed to increase FYR Macedonia’s interconnections to other SEE countries and strengthen its connection to the European Grid. Since the Serbian Electric Utility was building a line to the Macedonian border for this purpose, MEPSO needed to move ahead with their part of the connector as soon as possible and needed funding for this. As a result, on March 9, 2011 the project was restructured with additional financing of EUR 14 million (then US$19.1 million) provided, which was to fund both the existing project (EUR 3 million) and the line to the Serbian Border (EUR 11 million).

Dropping of two financial covenants. The project as originally designed had three financial covenants. With the major improvement in the financial condition of MEPSO after it ceased to be the Single-Buyer for the electricity market, only one major financial covenant was maintained in the revised Loan Agreement following the Additional Financing. This was the minimum debt service coverage ratio required if MEPSO was to take on additional loans.

Completion time. The project lasted five years and four months longer than originally planned. Due to the addition of the Stip - Serbian Border transmission line, the project was extended by three years from its original closing date of March 31, 2011 to March 31, 2014. However, due to implementation delays, primarily related to land acquisition for the Skopje-Tetovo and Bitola transmission lines, the closing date had to be extended twice, first until November 30, 2015 and finally to July 31, 2016.

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2. Key Factors Affecting Implementation and Outcomes

2.1 Project Preparation, Design and Quality at Entry

Soundness of background analysis.

The project was designed as a follow-on to the previous World Bank financed project in the electricity sector in FYR Macedonia, the Power System Improvement Project, which had provided considerable background and understanding of FYR Macedonia’s electricity infrastructure and institutions. In addition, the Bank was actively engaged in Adaptable Program Loans in several other SEE countries including Turkey and Romania and thus was very familiar with the electricity and energy situation in South Eastern Europe as well as FYR Macedonia. The APL 3 Project in FYR Macedonia drew on this background and focused in particular on investments that were needed to upgrade the country’s power transmission infrastructure and increase the connections to the grids in neighboring countries which would allow FYR Macedonia to be part of the regional power market It also aimed at upgrading the capacity of MEPSO so that it could run the Macedonian grid more easily and better connect with neighboring grids.

Key lessons learned that the project successfully incorporated were as follows:

The progressive integration of energy markets in SEE and the implementation of common security of supply policies requires close attention to be paid to operation of subsidiary electricity markets by transmission system operators such as MEPSO.

Political commitment and adequate financial support are key ingredients of successful reform programs.

Adequacy of PDO and indicators

The project’s PDO, (as outlined in the PAD) was adequate and well aligned with the planned activities. However, the PDO indicators do not sufficiently capture any outcomes related to “strengthening of the institutional capacity of MEPSO”. The component-related outcome indicators reflected that the Project supported a comprehensive investment program that sought to compensate for many years of underinvestment in transmission infrastructure so that FYR Macedonia could enter the regional market as an equal partner with its neighbors. They reflected the focus on capacity expansion (new transmission, increased transformer capacity), reliability improvement (rehabilitation of transmission line, high voltage equipment in substations), and more efficient operation (substation upgrades, SCADA, optic cable communications and financial management system).

Project design. The components to be undertaken under the loan were agreed between the Bank and MEPSO and were those most urgently needed by MEPSO and which the Bank considered to be both necessary and economically efficient. They were of proven design, similar to components that had been included in APL Projects in other SEE Countries. One difference with some of the projects in other countries, for example those in Turkey, was that the Macedonian APL3 Project

7

had an increased emphasis on interconnection lines to other countries. This was because FYR Macedonia is a small country with limited low cost sources of additional generation, which needs diversification of power supply sources. Additionally, these interconnection lines would benefit not only FYR Macedonia but also other countries in SEE particularly Bulgaria, Serbia and Greece. With the new interconnection lines, Bulgaria and Serbia could increase their exports of electricity to Greece especially in the summer and Greece, which is summer peaking, would have access to increase energy and peaking capacity during the summer months thus reducing its need for additional capacity of its own.

Government commitment

At entry, the Government of FYR Macedonia (GoM) and MEPSO were fully committed to the project and familiar with Bank procedures. The Project Implementation Unit was set up and started work already during project preparation. The first transmission line project (interconnection to Greece) started implementation before the Project was taken to the WB Board using retroactive financing.

Assessment of risks

Table 1. Risks Identified at the Appraisal of the Project and Mitigation Measures Taken during the Implementation

Risk Category Risk Rating

Risk Description Mitigation Measures and Accuracy of Risk Rating

APL Program Risks ECSEE Program

Electricity Market Liberalization in FYR Macedonia

Moderate Political or other considerations could lead to a sharp slowing or end the on-going liberalization and unbundling of the Macedonian Electricity System and Market.

The main mitigation measure was to support the ECSEE (later EC) process with technical guidance and support. Initially, FYR Macedonia did follow the timeline for market opening but political considerations have led to a slow-down of the final steps of the liberalization, i.e. the full opening of the market to residential customers. The identified risk was relevant but a rating of Significant would have been more accurate

ECSEE Program-

Integration of the Macedonian Electricity System into the ECSEE

Moderate Political or other considerations could lead to the sharp slowing or end the integration of the Macedonian Electricity System with that of other countries in South East Europe and its interconnection with the EU

The main mitigation measure was to support the ECSEE (later EC) process with technical guidance and support. The integration of FYR Macedonia into the European electricity system has been successful – largely supported by the construction of high voltage transmission lines enabling significant expansion of the regional power transfers.

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The identified risk was accurately rated a Moderate.

Project Risks Implementing Agency’s Financial Risk

Significant This risk came from MEPSO’s role as the market operator and supplier of last resort with any additional needed electricity supplies imported by MEPSO. The risk was that MEPSO would not be allowed to bill its customers the full cost of these imports and/or that the customers would not pay. These events could seriously damage its financial condition.

The main mitigation measure was careful monitoring of the financial covenants, which showed that this became a major issue in 2007-8 and the Bank was encouraging the Government and ERC to take action to relieve the financial pressure on MEPSO. The issue was eliminated when the Government restructured the market shifted the Single-Buyer risk away from MEPSO. The identified risk was accurately rated as Significant.

Implementing Agency’s lack of familiarity with Financial Management Information Systems

Low MEPSO was not familiar with the design or specification of financial management systems, which they proposed to install.

The main mitigation measure was to hire a consultant to assist MEPSO with the design and specification of financial management systems and the FMIS. The process went well. The identified risk was accurately rated as Low.

The PAD did not identify land acquisition as a risk, which was a notable omission given the fact that this became the major reason for the delayed completion of the Project. Land acquisition risk should have been identified as Significant and mitigation measures should have been built into Project design and implementation. However, this is somewhat a conclusion with the benefit of hindsight since land acquisition for the Greece interconnector, which had been done prior to Project start had been unproblematic since it was on public land and following older (simpler) regulations and therefore had not provided any indication that this would become an issue.

2.2 Implementation

Summary

The Project achieved all of its targets with some of them being overachieved. It took more than 10 years (2006-2016) from the Project approval to the Project Closing, which was over five years longer than the original duration. The extended duration was due to (i) the addition of a significant subproject (the Stip – Serbian Border transmission line) through additional financing by which three years were added, (ii) difficulties that MEPSO had in connection with land acquisition, and (iii) to a hiatus in the implementation during around 18 months in 2007-8 while a new management team dealt with MEPSO’s financial problems.

Main factors which contributed to successful implementation were:

MEPSO’s PIU members had initial strong knowledge of the Bank’s rules and procedures from the recently completed Power Sector Improvement Project;

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MEPSO’s management and technical staff were competent and, for most of the Project duration, motivated to deliver results;

The Government was willing and able to step in and remove implementation bottleneck by ensuring coordination across different Government institutions;

Readiness was high due to advanced procurement of key packages under the project using retroactive financing; and

The Bank took an active role in addressing the challenges and needs facing the Project. Due to flexibility in the project design the Bank was able to respond quickly when MEPSO requested modifications relating to the need for additional technical assistance (for instance, a Power Quality Study was included in order to pinpoint sections of the network with specific upgrading needs) or adjustment of equipment quantities.

The main challenges faced in regard to project implementation included:

Land acquisition issues. Delays in combination with land acquisition and compensation payments accounted for at least 2 years and 4 months of the 5 years and 4 months difference between original and final closing dates – with 3 years being accounted for by the addition of a major electricity interconnection with Serbia through Additional Financing. The critical delays were almost entirely in Component 2 where obtaining the right-of-way and acquisition of the necessary land for the tower footprints were critical for construction of transmission lines.

A period of grave financial distress related to MEPSO’s Single-Buyer status during 2007-2008 which diverted management’s attention and staff resources away from the project and created cash flow issues that de-facto stopped any new activities from being started during a period of 18 months. Identified as a risk in the PAD the Bank was monitoring the situation closely. When, in 2007 for political reasons, tariffs were frozen despite rapidly rising import prices of power from the neighboring countries, the Bank early on advised the Government to either allow MEPSO to charge cost-recovery tariffs to the distribution company (to be ultimately borne by retail customers such as private households) and its direct costumers (large industrial companies) or restructure the market model so that MEPSO would not have to absorb any politically motivated losses. The Government went for the latter model but it took time to implement and MEPSO was only able to resume project activities in 2009 following a market restructuring. The reasons it took so long time for MEPSO to restart activities were: (i) it took time for the GoM to realize that the market structure was unsustainable, (ii) time was needed to redesign the market structure, (iii) the reform needed to be passed in Parliament, (iv) MEPSO’s top management was replaced and new management was selected to bring MEPSO out of the financial distress. The new management lacked knowledge of the Project and did not consider it a first priority to deal with after they had taken over, since they still had to spend a lot of time on “firefighting” such as reestablishing connections with vendors that had not been paid so as to be able to undertake postponed operation and maintenance activities etc.

Skopje 5 substation, EMS, software and PMIS components

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The implementation of Components 1, 3 and 5 relating to Skopje 5 substation expansion, a new Energy Management System, improved planning software and new Financial Management Information System (FMIS) in general went well. There were some delays from the original time schedule – in particular with the design and implementation of the FMIS – but these were all of little significance and all the above components were implemented more or less as planned.

Transmission line component

As mentioned, the significant delays were related to land acquisition for transmission lines under Component 2. Since each of the four transmission lines that were financed under the Project presented MEPSO with different land related challenges they are presented separately below.

1. The Greece interconnector was constructed using retroactive financing and the land acquisition had taken place prior to the Project start. Since almost all the land was public, MEPSO did not report on any significant issues that delayed the land transfer to MEPSO ownership for tower footprints and permanent access roads as well as imposing restrictions on the needed right-of-way.

2. For the Bitola 3 – Bitola 4 transmission line there were 42 permanent land acquisitions for the 42 towers. Out of 42 towers, 19 tower positions were on land owned by the state and the rest on private land. The land acquisition process was managed by the Ministry of Finance’s Property and Legal Affairs Office (PLAO) in Bitola. The subproject suffered from four major delaying factors: (i) Late start of the activities. Due to the 2007-8 hiatus mentioned above land acquisition for this subproject did not start as planned in late 2007 but only got going in the middle of 2009 when the Single-Buyer status had changed and MEPSO’s cash flow had improved enough to allow it to contract consultants to assist in surveys and land data processing. (ii) Poor Quality of Land Acquisition Data. The next delays occurred due to poor quality of the initial land identification work done by consultants. The so-called Elaborate (a Land Acquisition Master Plan), which contains the data related to the exact locations of land that needs to be either acquired or compensated for due to right-of-way, ownership information and cross-references to Cadaster data, had to be revised twice: (i) after MEPSO performed ground checks, the first version proved to be inadequate and it turned out the consultants had based the Elaborate mostly on desk studies without checking quality of the data through field studies; (ii) after having hired new consultants a new version of the Elaborate was prepared, this time with somewhat better accuracy but when submitted to the land agency it turned out that the data were incompatible with the recently digitalized Cadaster and had to be revised yet again. By the time the Elaborate was finally accepted a year and a half had been lost and by late 2010 the land acquisition had not yet started. At that point both MEPSO and the Bank thought that the issues behind the delays had been dealt with satisfactorily and although the poor progress on land was a concern for the Bank in the decision to accept inclusion of the Stip-Nis interconnector in the Project (in March 2011) through additional financing, it was believed that the lessons learned by MEPSO thus far would make this new line easier to implement – which actually turned out to be true.

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(iii)Administrative bottlenecks. The next set of issues were of administrative nature and occurred because of the lack of capacity of the PLAO Office in Bitola combined with changes in the 2009 Construction Law governing expropriation processes and procedures with which PLAO staff were unfamiliar. The process of obtaining right of ways and land expropriation coincided with the process of establishing titles to land in Bitola, which was also led by the PLAO office and thus the work load for that office was very high. MEPSO responded to the overload situation at the PLAO office by deploying vehicles, providing legal assistants for processing documents and most importantly opening village (outreach) offices in the communities affected by the land acquisition process. Another measure taken by the Bank was to escalate the issue to the minister level causing the Minister of Finance to take personal charge of the issue and convene weekly meetings with all concerned parties to keep momentum going. In combination, these measures proved effective and the processing of MEPSO’s land acquisition was finalized in 2013. (iv) Delay of Construction Permit. Previously, construction could go ahead even when the actual amount of the compensation was being challenged in court and the Construction Permit would be issued when the legality of the expropriation had been established. However, following a ruling by the Constitutional Court a new interpretation of the Construction Law was made by which construction could not start until Developer (in this case MEPSO) had acquired all of the rights of way and had contracts for the needed land. MEPSO brought this issue to the attention of the Government and in 2013, the Construction Law was amended which solved the issue. However, because of the change of the law, new documentation was needed before Ministry of Transport could issue the Construction Permit for Bitola 3 – Bitola 4 and it became clear that the line could not be completed by the revised Completion Date of March 31, 2014. As a consequence of this, in December 2013, the Bank’s management agreed in-principle to extend the Closing Date by 20 months to November 30, 2015 provided that by January 31, 2014 Construction Permits had been issues for both the Bitola 3 – Bitola 4 and the Stip – Serbian Border line (see below). This encouragement worked and by spring 2014 construction finally started on the Bitola 3 – Bitola 4 line. Land acquisition for the line had taken six years instead of the planned 1-2 years. Construction of the line went according to plan and lasted around a year. The Bitola 3 – Bitola 4 transmission line was energized in June 2015.

3. The land acquisition for the Stip - Serbian Border transmission line/interconnector went more smoothly even though the process was managed by no less than three PLAO offices (in Sveti Nikole, Stip and Kumanovo), and contained four times as many tower footprints (namely a total of 168) as the Bitola line. The main reason was that MEPSO had learned from the Bitola experience and that the line passed through hilly areas far from the inhabited settlements where land was public (like for the Greece interconnector) and thus there was little interference with local communities. Taught by experience, MEPSO’s Board adopted generous compensation offers plus opened in a timely fashion, community offices where information was easy to obtain on the transmission line for any interested citizen of the surrounding area. In addition, the PLAO offices in these three municipalities

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were better equipped than the office in Bitola and less overwhelmed with the work establishing land titles.

The Stip - Serbian Border line suffered from some delays due to the Construction Permit issue described for the Bitola line but after the issue was solved as described above, construction could start in early 2014 – approximately two and a half year after land acquisition begun. After some initial issues related to the structural integrity of the tower design offered by the contractor, construction of the line went according to plan and lasted around a year and a half. The line was energized in November 2015.

4. In the case of the Skopje-Tetovo transmission line, 158 tower footprints needed to beacquired with around 40% on state owned land and 60% on privately owned land. Landacquisition started in 2011 after the EUR 3 million financing gap for the subproject hadbeen covered by Additional Financing. The process involved PLAO offices in themunicipalities of Cair, Karposh and Tetovo and these all experienced various degrees ofthe same issues that had characterized the cooperation with the PLAO in Bitola. It alsoturned out that the quality of the Elaborate was poor with many inaccuracies whichnecessitated a significant number of partial revisions each of which caused loss ofmomentum. In about eight places footprints were changed to avoid positioning the towersin the yards of houses or in the middle of agriculture plots.

As in the case of the Serbia line, MEPSO’s Board provided generous compensation for theland taken. However, in many cases the Cadaster data was not accurate regardingownership and who could represent absent owners (of which there are many in thisparticular region of FYR Macedonia) as recipient of the compensation. This resulted in avery slow pace of the land acquisition process, which after initially having made someprogress in 2011 and 2012 failed to move much forward during early 2013. As describedfor the Bitola line, the project resumed momentum through the combined effect of changesto the Construction Law and outreach support to PLAOs, which resulted in completion ofland acquisition and issuance of Construction Permit by August 2014.

Even though site clearances started immediately after the Construction Permit was issuedthe actual construction work did not start until May 2015 due to (i) delay in hiring ancertified independent supervising engineer, (ii) the contractor being busy with work on theStip line and not able or willing to dedicate work crews to the Tetovo line, and (iii) initialstrong resistance among certain of the affected households who often denied the landclearing crews access to the tower footprint locations due to lack of proper coordinationand dialogue on the part of the contractor. It therefore was clear that the Tetovo line couldnot be completed by the November 30, 2015 Closing Date which therefore had to beextended to July 31, 2016. The Bank team provided hands-on assistance to MEPSO andthe contractor by initiating dialogue with local communities so as to find practical solutionsto the issues of concern. These concerns included ownership disputes, requests to movetower positions, and simple misinformation about the Project. In some cases, stressing thepositive effects of the Project, such as reduction/elimination of the frequent outages, wasan important factor in changing local perceptions and making way for the Contractor to

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access the tower positions. The last hurdles were overcome in late spring and in June 2016 the work was completed and the line energized.

Upgrading and Rehabilitation of 110 kV Substation component

The 110 kV substations had become shared property of MEPSO and the private distribution company (EVN) following the unbundling of the vertically integrated ESM utility in 2004. Component 4 aimed to finalize the physical unbundling by separating control systems and bringing high voltage equipment up to international standards in the shared substations. However, for certain substations EVN and MEPSO failed to reach agreement on how to separate ownership inside the perimeter of the substations and/or how to make sure that there would be enough space for installation of the new MEPSO equipment and this issue needed to be resolved before installation could proceed. Furthermore, the procurement and installation of Optical Ground Wire was delayed due to a need to discuss ownership issues and applicable standards with Macedonian Telecom. These issues were resolved by 2013 – two years after the original completion date but three years before the Project actually closed. In the case of two out of 21 sub-stations some of the control boards could not be installed due to inadequate room in the substation leading to reconstruction work that had to be undertaken by EVN.

2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization

M&E Design

The component-specific M&E indicators selected at project appraisal were relevant to the Project Development Objectives and, overall, included a balanced combination of targets which allowed monitoring of implementation progress and of project outcomes. However, the PDO-level indicators failed to capture capacity strengthening in MEPSO. Furthermore, the PAD did not provide a baseline for the entire Macedonian power system against which improvements in reliability and efficiency could have been measured.

M&E Implementation

MEPSO was responsible for the collection of the project’s performance indicator data and analysis of the results. Progress towards the achievement of the final targets was monitored through regular reports, provided by MEPSO and the Bank’s implementation reviews and Implementation Status and Results Reports (ISRs). The quality and timeliness of the data collection and reporting from MEPSO remained satisfactory throughout the lifetime of the Project. Regular follow up by the Bank on environmental responsibility and financial sustainability issues helped ensure the timely delivery of monitoring and status reports and continuing tracking of the Project’s progress. The project was closely monitored during implementation by Bank Staff from the Washington, Skopje and Tirana Offices. While the project was delayed, the Bank was always aware of the issues and what was being done about them. Based on information obtained from the M&E the Bank encouraged the Government and MEPSO to deal with the right-of-way and land acquisition issues.

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M&E Utilization

The set of intermediate indicators were useful in timely reaction to the delays. Performance indicators were designed to ensure adequate monitoring and reporting of project implementation progress and were utilized efficiently after some adjustment. Information regarding the procurement and execution of contracts was used to follow the progress of the Project and to address the implementation issues as they were arising.2.4 Safeguard and Fiduciary Compliance.

2.4 Safeguard and Fiduciary Compliance

Environmental and social safeguards

The project was classified as Category B under the OP/BP 4.01 Environmental Assessment due to the reconstruction and construction of overhead transmission lines (OHTLs) carrying limited, predictable and short-term environmental risks typical for earth works and use of heavy machinery. The Framework for Environmental Assessment Procedures (FEAP) was prepared to address envisaged environmental issues. Potential adverse impacts of construction/reconstruction of OHTLs were successfully mitigated through implementation of Environmental Management Plans (EMP) prepared in accordance with the FEAP while other project activities were classified as C Category.

MEPSO prepared a Resettlement Policy Framework for the three transmission lines Bitola 3 - Bitola 4; Stip – Serbian Border and Skopje - Tetovo. For the transmission lines MEPSO had to obtain a 15-30 meters wide right of way corridor, which after the construction of the line the owners could use as per the original use, and small land plots for the tower footprints. In neither of the four transmission line subprojects were there any major social problems such as loss of substantial assets or livelihoods or cases of displacement of dwellings or a business.

The safeguard compliance for the overall implementation was moderately satisfactory. While no major environment related non-compliances occurred, and no accidental situations or complaints were recorded during the project implementation, there were some shortcomings in the waste management and reporting (inclusive of an ornithological report for OHTL Bitola 3 – Bitola 4 and the final EMP implementation report for Skopje – Tetovo line which were received only after the final Closing Date). Nature protection concerns, protection of geological sites as well as protection of existing infrastructure were well incorporated in the project design resulting in, amongst other things, the first project in FYR Macedonia where bird diverters were used for biodiversity preservation. Related research and optimal positioning of diverters was carried out within EIAs as well as positioning studies.

Procurement

Procurement was carried out by the same MEPSO PIU staff throughout the entire duration of the Project. This was staff that had already been trained and had gained experience with World Bank procedures during the earlier Power System Improvement Project. All the procurement processes went smoothly and were performed without significant delays on either side. Some packages were

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sent out after appraisal as advanced procurement using retroactive financing. Procurement was rated satisfactory throughout the lifetime of the Project.

Financial management

The Project’s financial management (FM) was satisfactory. The Project’s FM system provided accurate, timely information and the withdrawal procedure and funds flow arrangements were appropriate. In 2013, the Entity audit report contained qualifications related to the valuation of property, plant and equipment and the auditors recommended improvement in several areas of MEPSO internal controls framework, namely investment in securities, internal audit, provisions for impairment of financial receivables and information systems. MEPSO’s management acknowledged the findings and addressed them accordingly. The implications of the matters raised by the auditors had little or no effect on the reliability of financial arrangements for the Project and was promptly addressed by MEPSO. FM was rated satisfactory throughout the lifetime of the Project.

2.5 Post-completion Operation/Next Phase

All the transmission system assets that were financed over the Project were satisfactorily put into operation during the Project period and have a high likelihood of satisfactory operation in the future. The acquired equipment and components are of good quality fully conforming to international standards and MEPSO is a competent operating organization which conscientiously carries out the required maintenance on its equipment. MEPSO is adequately staffed and with a functioning decision making and management structure. Management is monitoring operations and making medium and long term investment plans to sustain the achievements under the APL3 Project. The investments financed by the Project helped integrating FYR Macedonia into the SEE market and increasing electricity trade from which both the country and its neighbors will continue to benefit.

MEPSO is currently profitable with a profit of MKD 817 million in 2015 and a profit margin (after tax profits over sales) of about 16%. The debt equity ratio is down to about 0.46 and it is paying dividends to its shareholder, the Government. As long as it remains profitable it should be able to finance operations, maintenance and needed investments.

There are no current plans for a World Bank financed follow-up operation. MEPSO has chosen to borrow from EBRD (without sovereign guarantee) for its most recent transmission investments including an interconnection to Kosovo.

3. Assessment of Outcomes

3.1 Relevance of Objectives, Design and Implementation Rating of Relevance: Substantial.

Relevance of Objectives

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The relevance of the Project objectives is assessed as High. The Project was consistent with the Bank’s Country Assistance Strategy at the time of Project Appraisal (CAS report No 26513 of August 14, 2003) which highlights the need for power sector investment and institutional development to support greater integration in the regional power market and to enhance security of power supply. The Project is also aligned with the strategic priorities set out in the Country Partnership Strategy 2015-2018 which includes in its Growth and Competitiveness Pillar the “better provision of clean energy through public and private investments” (since power transmission capacity is an important enabler of clean energy) and as a cross-cutting theme supports progress on the EU accession agenda to which participation in the ECSEE Energy Community is closely linked.

Regional cooperation on power generation and transmission brings large benefits to all parties in terms of improved efficiency and reliability (a country with summer peak such as Greece can rely on generation capacity in neighboring countries with winter peaks such as Bulgaria, Serbia and FYR Macedonia for imports in the summer but will be able to reverse the flow in the winter when it has surplus generation and its neighbors have deficits). Regional cooperation allows countries to meet increased demand with regional least cost generation expansion, to operate efficiently over the interconnected networks and to maximize use of low-carbon energy sources such as hydropower and nuclear. For FYR Macedonia specifically, the objective was highly relevant due to the need to upgrade and expand aging electricity transmission infrastructure in order to remove constraints for meeting a growing electricity demand and to improve reliability and efficiency. MEPSO was a new company and played a pivotal role in this development in its function as the national System Operator in a regional power market and needed strengthening its institutional capacity for technical and financial management. Expansion of interconnections to Greece and Serbia was also needed, so FYR Macedonia could be supplied with additional sources of lower cost power and increased peaking and emergency power in the winter and export cheap baseload power in the summer.

Relevance of Design and Implementation

The relevance of project design and implementation is assessed as Substantial. The project was well designed to meet the project objectives with some subprojects aimed at expanding capacity of transmission infrastructure (Skopje 5 Substation, new transmission lines) to accommodate increased consumption and trade, some to improve reliability and enable future growth through upgrading of existing transmission infrastructure (upgrading and rehabilitation of substations, rehabilitation of Skopje – Tetovo transmission line to reduce outages caused by deteriorated equipment). There were subprojects aimed at improving system efficiency through improved monitoring, control and planning (upgrading of EMS and planning software) and finally there were subprojects increasing MEPSO’s institutional capacity through training and new software tools for system planning and financial management. The project was successful in implementing and completing all of its subprojects albeit with a substantial delay, due to issues related to a period of financial distress and slower than anticipated land acquisition. The project design did not feature measures to deal with the latter, leading to delays while MEPSO and the team devised various mitigation strategies during implementation.

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3.2 Achievement of Project Development Objectives

Rating of Efficacy: High.

ECSEE APL Program. The PDO for the Program was that: “Electricity markets in South-East Europe are liberalized in accordance with the ECSEE Treaty (including derogations and subsequent modifications, if any) and a regional electricity market is functioning”.

The achievement of the overall objectives of the APL ECSEE Program have been accelerated by the project. The construction of new connector lines North and South enabled increased trans-border power sales and exchanges as movement of power across the Macedonian border increased from 3,201 GWh in 2005 to 7,341 GWh in 2015. An electricity market has developed in FYR Macedonia and is linked to electricity markets elsewhere in South Eastern Europe. The Energy Community of South Eastern Europe, in which FYR Macedonia is an active participant, links the various national electricity systems and markets with one another and with the European Electricity Grid and markets.

The institutional restructuring of the Macedonian Electricity System is largely complete. The integrated government owned company, ESM, has been split into three separate companies; ELEM for generation, MEPSO for transmission and EVN for distribution. EVN has been privatized. Private generators have entered and continue to enter the market especially in the area of renewables. There are a number of traders, buying and selling power with supply from outside and from within FYR Macedonia. A balancing electricity market has been created. There are about 60 market participants, consisting of traders, generators and large consumers and about 40% of the country’s electricity consumption passes through this market. The market opening is not yet complete since small commercial and residential consumers remain regulated and therefore outside the market. The market is expected to expand in the next couple of years as smaller customers start to use it and eventually it will be open to all customers, although experience elsewhere would indicate that households will not make much use of their right to choose an electricity provider. The Energy Regulatory Commission or ERC, has been created to oversee the sector and regulate EVN, MEPSO and ELEM’s sales to EVN. Thus a newly liberalized, competitive, partially privatized and regulated electricity structure has been created.

FYR Macedonia APL 3 Project. The PDO was “to support the functioning of MEPSO in the context of the regional power market through financing investments necessary to rehabilitate and upgrade the power transmission network, increase the level of interconnection with neighboring power systems, and to strengthen the institutional capacity of MEPSO”.

The first objective in the PDO, upgrading the power transmission network, was achieved by: (i) the rehabilitation of the 110 kV transmission line from Skopje to Tetovo and upgrading of the transmission network around the city of Bitola, (ii) improvement of infrastructure as key 110 kV substations were rehabilitated and upgraded by installation of new high voltage equipment and (iii) a new 400/110 kV transformer was installed in the Skopje 5 sub-station. The second objectivein the PDO, increasing the level of interconnection with neighboring power systems, was achievedwith the construction of connector lines south to Greece and north to Serbia. The third objective

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in the PDO, strengthening the institutional capacity of MEPSO, was achieved through upgrading the Energy Management System (EMS) in use by the dispatch center and the addition of a financial management information system, planning software and training.

All of the project development objectives have been achieved, albeit with delays (see details in Table 2 below).

Table 2. Achievement of PDO Indicator Target (Original and Revised)

PDO Indicator Expected Outcome at Project Completion – Original

Expected Outcome (for restructured Project)

Actual Achievement at Project Completion

1 Improved voltage stability at Skopje 5 substation

Voltages at Skopje 5 are within their operating limits

No change

Voltages at Skopje 5 are within their voltage limits, i.e. 110 kV (+/- 1kv)

2 Incremental supply from Skopje 5 substation

Incremental supply of at least 50 MW from Skopje 5

No change Incremental supply of 64 MW from Skopje 5

3

Increased cross-border trade between FYR Macedonia and Greece

Increase cross border trade between FYR Macedonia and Greece by at least 20%

No change

Cross border trade FYR Macedonia-Greece increased from 624 MW to 1393 MW i.e. by 223%

4

Reduced energy interruptions due to outages of Skopje1-Tetovo line

Reduce number and amount of energy interruptions due to outages of Skopje1-Tetovo line by 80%

No change

Number of energy interruptions due to outages on Skopje 1-Tetovo line reduced from 1480 to 0, i.e. by 100%

5 Increased transit volumes through MK Power System N/A

Increasing transit volumes through MK Power System by 61 MW

Transit volumes have increased from 219 to 280 MW, i.e. by 61 MW

6

Reduced operating and maintenance costs of unbundled substations

Reduce unbundled substations’ O&M costs by at least 25%

No change

Substation O&M costs have been reduced from EUR 227,000/year to EUR 94,000/year, i.e. by 58%

The benefits to FYR Macedonia are substantial. Through the regional power market integration and the strengthened interconnections to neighboring countries (and thereby to the entire European power market) FYR Macedonia is able to provide cheaper electricity to its citizens and industries by importing lower cost electricity from countries that have surplus. The Project has also reduced system losses and increased the reliability and safety of the supply, which benefits all consumers.

3.3 Efficiency

Rating of Efficiency: Substantial

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This project invested in a number of specific transmission investments and infrastructure upgrades. It is possible to estimate an Economic Rate of Return (ERR) for certain specific investments in substations and high voltage lines. The Bank's consultants initially calculated ERRs for these investments. This ICR calculates the ERRs on these same investments except for one (110 kV sub-station upgrades) where only part of the data is available. The main benefits to FYR Macedonia from these investments are:

- Reduction of energy losses. The upgrading of transmission lines and substations reducesenergy losses. Since reductions in electricity losses reduce imports by the correspondingamount these reductions are valued at the average cost of importing electricity to FYRMacedonia

- Meeting new loads. The construction or upgrading of substations and lines allows newload to be supplied.

- Reduction in energy supply interruptions. Power outages are more likely on oldtransmission lines. Outages were a particular problem on the Skopje 1- Tetovo 1transmission line. The average of 65 hours of interruptions per year on this line in 2005was high by international standards. The construction of a new line resolved this problem.

- Reduction in operation and maintenance cost. New or upgraded equipment generallyhas lower operating costs and needs less maintenance than older equipment.

- Benefits of interconnection. These are the benefits that FYR Macedonia (and the rest ofECSEE) gets from closer interconnection. These include cost reductions associated withregional merit order dispatch together with sharing of reserve capacity. Interconnectionbenefits are particularly important for the FYR Macedonia- Greece transmission line(Bitola 2 to Florina).

While ERRs could not be calculated for each investment, they were calculated for most of the major investments. The highest rates of return were for the interconnection line to Greece and the rehabilitated Skopje 5 substation. For the whole project, using the same methodology applied in the PAD, the ERR is 61% and the net present value is EUR 53.7 million discounted at 10%. Neither includes any benefits for major investments such as the upgrades of the 110 kV substations or the software and training provided. If full information on the benefits from these investments, such as cost reductions, increased efficiency and reduced outages, were available the rate of return on the project would be significantly higher.

Only benefits to FYR Macedonia were taken into account. The interconnection lines, however, also benefit Greece and to a lesser extent Serbia and Bulgaria. Most of the electricity trade on these lines consists of low-cost power from Serbia and Bulgaria being partially used in FYR Macedonia and partially transferred to Greece. Greece is a major beneficiary especially since it is summer peaking while the rest of the SEE is mostly winter peaking. Over the course of the project, Macedonian deliveries of electricity to Greece went from 794 GWh in 2005 to 2,702 GWh in 2015, in spite of a severe recession in Greece. This represents substantial benefits that are not included in the ERR calculation.

The financial rate of return on the project depends on the tariffs set by the Energy Regulatory Commission (ERC). The present rules for tariff setting related to new investments allows these to

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be included in MEPSO’s rate base earning 6.29% rate of return on equity. Annex 3 provides details on the economic and financial analyses.

Whereas efficiency in terms of costs has been High, the efficiency of implementation is considered to be only Substantial. The original loan was expected to close in March 2011 and it actually closed in November 2015 - over four and a half years later. The additional loan was supposed to close in March 2014 and it closed in July 2016, over two years later. Therefore, due to the delays and to factor in implementation efficiency, the rating for Efficiency is considered to be Substantial.

3.4 Justification of Overall Outcome Rating

Overall Rating: Satisfactory.

The Relevance of Objectives and Efficacy are rated High while Efficiency and Relevance of Design and Implementation are rated Substantial. With the Efficacy rating High and no other ratings lower than Substantial the overall outcome rating is Satisfactory.

3.5 Overarching Themes, Other Outcomes and Impacts

(a) Poverty Impacts, Gender Aspects, and Social Development

The Project did not directly target poverty or gender aspects. Indirectly, it has probably had a favorable impact on reducing poverty, since it has helped provide less expensive electricity than would have been provided otherwise by allowing FYR Macedonia to obtain electricity from other countries with lower generation costs. The Project has also reduced system losses and increased the reliability and safety of the supply, which benefits all consumers. Particularly, in the Bitola and Skopje-Tetovo corridor the Project has had a positive social impact through reduction of electricity interruptions.

(b) Institutional Change/Strengthening

MEPSO has been strengthened by providing it with IT systems and training. It now has improved monitoring, control and planning tools as well as financial management system. The project allows MEPSO to participate and cooperate more effectively in the SEE market. In the course of the project, MEPSO was relieved of its role as Single-Buyer for the electricity system and was allowed to charge cost-recovery tariffs to its direct costumers (large industrial companies), which greatly improved its financial condition so that it is now quite profitable.

(c) Other Unintended Outcomes and Impacts (positive or negative)

N/A

3.6 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops

No beneficiary surveys or stakeholder workshops were held.

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4. Assessment of Risk to Development Outcome

Rating: Moderate.

The risk to the development outcome is moderate. The technical, environmental and social risks are low due to the deployment of familiar and safe technologies. However, there are financial risks since MEPSO has to have reasonable transmission tariffs in order to maintain the infrastructure financed by the Bank. If transmission tariffs are set so as to not allow full cost recovery, there will be insufficient funds to maintain the transmission infrastructure and it will deteriorate with increasing outages and rising losses. The Energy Regulatory Commission (ERC) is responsible for setting these tariffs at cost recovery and has done so thus far. However, ERC could be subject to political pressure to keep the transmission tariff low as has been the case for the distribution tariff. There is also a small risk from natural disasters including earthquakes. There was an earthquake in the vicinity of the rebuilt Skopje-Tetovo line in the second half of 2016 but the line suffered no significant damage.

5. Assessment of Bank and Borrower Performance

5.1 Bank Performance

(a) Bank Performance in Ensuring Quality at Entry

Rating: Moderately Satisfactory.

The Bank designed, prepared and appraised the Project such that it was realistic to achieve its development objectives. In preparing the project, the Bank mobilized a team with all necessary skills, including specialists in electricity markets, utilities, engineering, procurement, environmental and social safeguards and financial management. Project design built on the success of the earlier Bank financed Power System Improvement Project in FYR Macedonia and electricity projects in other ECSEE countries including Adaptable Program Loans in other countries. The Bank also built on the excellent relationships that had been developed with the Macedonian Government and with the predecessor of MEPSO (ESM) in designing the project and ensuring quality at entry. The Project was consistent with the government’s development priorities and the Bank’s CAS. However, in two areas the quality at entry was not satisfactory: (i) the PDO formulation was different in different documents and the PAD contained two different versions one of which was used in the Additional Loan Project Paper and the PDO-level indicators failed to capture capacity strengthening in MEPSO; and (ii) the PAD failed to identify and analyze risks connected to land acquisition and the need for mitigating measures to ensure timely completion. With those shortcomings taken into account a rating of Moderately Satisfactory is appropriate.

(b) Quality of Supervision


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The Bank diligently undertook its fiduciary role in terms of: (i) ensuring regularity of supervision missions and adequate skill-mix of Bank staff; (ii) providing timely responses to project issues and involving management when called for by the complexity of the project matters; (iii) actively involving the Country Office in maintaining close working contacts with MEPSO; and (iv) applying realistic project performance ratings. The Bank proactively identified and resolved threats to the achievement of Project outcomes. The team made consistent and continuing efforts to resolve the difficulties and ensured that issues were escalated to higher level decision makers when necessary. When Project progress had ground to a halt due to the changed interpretations of the Construction Law the Bank actively intervened and brought the issue to high-level attention resulting in law amendments that not only benefitted this Project but also any future infrastructure investment where it is necessary to apply eminent domain. In the final phase, when MEPSO and its contractor encountered difficulties accessing tower positions for the Skopje – Tetovo line, the Bank actively intervened and promoted solutions based on improved information, dialogue and pragmatic solutions. Procurement and financial management were supervised efficiently and satisfactorily.

However, there were shortcomings related to the implementation of the Results Framework. The team failed to use the March 2011 Additional Financing cum Restructuring to update and streamline the PDO indicators so as to address the issues of ambiguity and to introduce an operational PDO indicator for the MEPSO capacity building. With those shortcomings taken into account a rating of Moderately Satisfactory is appropriate.

(c) Justification of Rating for Overall Bank Performance

Rating: Moderately Satisfactory

Ratings of Moderately Satisfactory for both Quality at Entry and Quality of Supervision lead to a combined rating of Moderately Satisfactory.

5.2 Borrower Performance

(a) Government Performance

Rating: Moderately Satisfactory

The Government intervened on several occasions to facilitate the implementation of the Project. The team met on a regular basis with high-level civil servants in the Ministry of Economy and the Ministry of Finance (MoF), frequently with personal attendance of the respective ministers. The Government representatives monitored Project progress and followed up on various issues that needed solutions at the Government level albeit sometimes with considerable delays. The first issue was the status of MEPSO as Single-Buyer which led to a deterioration of its balance sheet and caused an 18 month hiatus in starting up new Project components. Eventually, the Government undertook a market restructuring which gradually relieved MEPSO of its Single-Buyer liabilities and also transferred budget funds to provide the necessary liquidity for the company to go about

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its business and avoid a deterioration of its international relations due to non-payment of power imports. The second issue related to land acquisition where MoF took steps to address the lack of capacity of the PLAO Office in Bitola so as to increase its capacity to handle its work burden. The Minister of Finance took personal charge of the issue and convened weekly meetings with all concerned parties to keep momentum going until the issue was solved. The third issue related to the above-mentioned lack of implementation progress due to the changed interpretation of the Construction Law which became moot when the law was amended. Even though it can be argued that all of the mentioned issues also originated from the Government due to flawed initial market restructuring, understaffing of PLAO offices, and ambiguities in the Construction Law, the fact is that once these things were recognized it also showed willingness to address said issues, although not as rapidly as it might have. The Borrower performance is therefore rated Moderately Satisfactory.

(b) Implementing Agency or Agencies Performance

Rating: Satisfactory

The PIU in MEPSO operated very professionally and there were no notable procurement, financial management or environmental/social safeguards compliance issues. The major problems that impacted Project progress – financial distress and the land acquisition issues were largely out of its control although not entirely. As a Government controlled company, the competitive bidding process used by MEPSO to hire consultants (financed from its own funds) resulted in consultants who seemed to be financially stressed and did not do enough site visits. As a result, the routes of the transmission lines had to be constantly modified, especially for the Skopje-Tetovo Line, where the consultants discovered obstacles to their proposed routes. In retrospect, it is also clear that MEPSO should have begun to contact land owners earlier about gaining right of ways and acquiring the land needed. However, MEPSO reacted to its problems by taking those actions it could, including deploying more staff and allowing overtime work when needed for instance when processing of the many hundreds of compensation cases necessitated switching data from paper to digital version and included frequent on-site investigations to check and rectify ownership and borderline discrepancies. MEPSO also responded to the overload situation at the PLAO offices by deploying vehicles, providing legal assistants for processing documents and most importantly opening village (outreach) offices in the communities affected by the land acquisition process. On the balance it is reasonable to rate MEPSO’s performance as Satisfactory.

(c) Justification of Rating for Overall Borrower Performance


Ratings of Moderately Satisfactory for Borrower and Satisfactory for Implementing Agency’s performance lead to a combined rating of Moderately Satisfactory.

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6. Lessons Learned

The most important lessons learned from this Project were:

- The Project has functioned as an anchor for the World Bank energy dialogue in FYR Macedonia in support of energy market and instructional reforms. Financing priority transmission infrastructure and systems (such as EMS) has been essential for successful functioning and integration of the Macedonian electricity system in the SEE regional electricity market.

- The Project design benefitted from including advance procurement using retroactive financing allowing fast implementation and high disbursement at the start of the project.

- It is important to analyze the land acquisition and compensation framework already during project preparation. Risk analysis should consider delays and problems with the land acquisition process that could arise due to (i) legal framework, (ii) lack of capacity of government departments dealing with land acquisition, and (iii) need for staff resources and capacity building in the Implementing Agency;

- The Bank should ensure internal and external coordination across its Global Practices and with other Development Agencies to ensure that projects to improve governance and to introduce better land registries are informed by the need to carry out efficient and effective land acquisition for important infrastructure projects. In the case of this Project another Bank project had assisted the Cadaster with digitalizing their database and the change was implemented just as MEPSO was getting ready to submit documentation that they had already spent the best part of a year preparing using old formats that were no longer compatible with the digitalized system;

- Land acquisition process: (i) The process should start as early as possible. Since it is normally not financed from Bank funds it can be undertaken as an early action without the need to wait for Loan effectiveness; (ii) The Implementing Agency must allow sufficient time and attention to explain and engage with the communities to explain the benefits of the Project and the principles to be applied for identifying land for expropriation and determining compensation payments; (iii) Land survey consultants must spend enough time in the field to ensure that all Cadaster data are accurate or can be corrected in a timely fashion; and (iv) The implementing agency should maintain a visible presence in the project area during the entire land acquisition process. MEPSO was able to speed up the land acquisition process considerably after they established outreach offices in the Bitola suburbs where the process had gotten completely stuck; and

- Timely communication with people in affected areas is very important. Many disputes over the use of land were resolved through better communication between MEPSO, its contractor and the people affected. The ability of local stakeholders to meet MEPSO representatives face-to-face and understand what was going on, how the process worked, how compensation was calculated etc. was key to overcoming initial skepticism and creating a climate for out-of-court settlement of disputes.

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7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners

(a) Borrower/implementing agencies

(b) Cofinanciers

There were no cofinanciers

(c) Other partners and stakeholders

There were no other partners and stakeholders aside from the Macedonian People.

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Annex 1. Project Costs and Financing

(a) Project Cost by Component (in EUR million equivalent)

Components Appraisal Estimate (EUR millions)

Actual/Latest Estimate (EUR

millions)

Percentage of Appraisal

Total Baseline Cost 33.09 50.6 153%

Physical Contingencies 0

0

0

Price Contingencies 0

0

0

Total Project Costs 33.09 50.6 153%

Front-end fee PPF 0 0 0

Front-end fee IBRD 0.09 0.09 0

Total Financing Required 33.18 50.69 153%

Note: The Stip - Serbian Border OHTL was not in the appraisal and was added to the project in 2011. It cost EUR 12.4 million and is included in the actual results above. The project total includes VAT, import duties and land costs.

(b) Financing

Source of Funds Type of Cofinancing

Appraisal Estimate

(EUR million)

Actual/Latest Estimate

(EUR million)

Percentage of Appraisal

Borrower Equity 12.48 17.4 139%

International Bank for Reconstruction and Development Loan 20.7 33.3 161%

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Annex 2. Outputs by Component

Component 1: Expansion of Skopje 5 Substation This component consisted of the installation and commissioning of a second 400/110 kV transformer in the Skopje 5 400/110 kV substation to replace an existing, but out of operation, 220/110 kV transformer. The subproject also included the construction of the corresponding 400 kV bay and adaptation of the existing 110 kV bay at Skopje 5. The Skopje 5, 400/110 kV substation is one of the major substations supplying power to Skopje City in which about 27% of the Macedonian population lives. The substation included only one 400/110 kV transformer whose outage usually resulted in overloading other substations in the Skopje area. The construction of the second transformer was necessary to meet the n-1 operating criteria and to supply electricity to the planned expansion of the existing metallurgic plant connected to Skopje 5 substation. The installation of the new transformer has added 64 MW of incremental supply and significantly improve the voltage performance of the substation particularly during peak demand periods where voltage in peak periods would be as low as 93 kV, whereas now it is the required 110 kV +/- 1kV.

Component 2: Rehabilitation and construction of interconnection and overhead transmission lines

This component consisted of the following four transmission subprojects:

Construction of FYR Macedonia - Greece 400 kV interconnection line: - The Macedonian section of a 400 kV transmission interconnection between FYR

Macedonia (Bitola 2 substation) and Greece which upgrades the existing 150 kVinterconnection between Bitola 2 substation and the Florina substation in Greece. Thetotal length of the line is 41 km of which the Macedonian section of the line is 19 kmlong.

- The necessary new 400 kV bay at Bitola 2 substation.- The successful completion of the subproject has resulted in improved cross border trade

with Greece from a level of 624 GWh/year in 2005 to 1393 GWh/year in 2015.

Construction of Skopje 1 - Tetovo 110 kV transmission line: - Reconstruction of a 52 km 110 kV overhead transmission line in two sections. First

section from Skopje 1 to Jugohrom substation. Second section from Tearce to Tetovo 1substations. The old 110 kV transmission line was constructed in 1957 with concretetowers. Many of these had deteriorated to a level that posed a danger to the public andincreased the line outage rate.

- Necessary modifications of the Jugohrom substation- The successful completion of the subproject has resulted in improved security of supply

(through fulfilling n-1 requirement) as well as voltage quality and reliability in the Skopje– Tetovo area. Outages have been reduced to zero from a level of 1480 minutes in 2005.

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Construction of Bitola 3 - Bitola 4 110 kV transmission line: - Construction of a 12 km, double circuit, 110 kV transmission line in southwest FYR

Macedonia to connect Bitola 3 and Bitola 4 substations. The construction of this transmission line provides a second line connecting Bitola 3 substation to the 110 kV transmission network which fulfills the n-1 reliability criteria for network operation. Furthermore, the construction of the line relieved the heavily loaded transmission lines and low voltages in the local area surrounding Bitola.

- Necessary modification of the substations- The successful completion of the subproject has resulted in improved security of supply

(through fulfilling n-1 requirement) as well as voltage quality and reliability in the Bitola area.

Construction of the Stip-Serbian Border interconnection line. - Construction of an 82 km, double circuit 440 kV interconnection line to connect Stip

substation the Serbian border from where a transmission line constructed by the Serbiansystem operator connect the line to Nis. This line serves the purpose of facilitating powerexchange with Serbia and power transit between Serbia and Greece.

- The successful completion of the subproject has resulted in an increase in transit volumesfrom 219 MW before the Project was implemented to 280 MW at the time of Projectcompletion.

Component 3: Upgrading of the existing EMS System and Planning Software

EMS software expansion: Software applications to enhance the capability of the Energy Management System (EMS) at the National Dispatch Center (NDC). PSSIE software expansion: Transmission planning software and applications necessary for performing transmission reliability studies and calculations of the transmission transfer capacity for both the local and regional interfaces:

• Transmission Reliability Assessment software package;• MUST Module for the Power System Simulator for Engineer (PSS/E) software.The successful completion of the component has The EMS has improved economic dispatch in the National Dispatch Center. The planning software has improved the accuracy of load flow simulations and assessment of transmission system reliability.

Component 4: Upgrading and rehabilitation of 110 kV substations

Supply of substation RTUs, SCSs, DC Supply and other equipment: Procurement, installation and commissioning of a number of different types of equipment for the 110 KV substations in the Macedonian transmission system which were in need of repair or replacement. The main pieces of equipment included were remote terminal units (RTUs). Substation control systems (SCSs) and control houses with AC/DC supply. Supply of high voltage equipment: High voltage equipment necessary for rehabilitation of existing 110 kV substations. Supply of telecommunication equipment Modern telecommunication network based Optical

29

Ground Wire (OPGW) cables in eastern FYR Macedonia. The successful completion of the component has improved performance and efficiency of substation operation. Due to fewer equipment failures leading to less need for component replacement and repair work substation O&M fell from EUR 227,000/year in 2006 to EUR 94,000/year by Project completion.

Component 5: Support for institutional development

Study with recommendation on strengthening of the financial management function in MEPSO Power Quality Performance Study Financial Management Information System The successful completion of the component has improved financial reporting and enhanced efficiency of financial monitoring and planning.

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Annex 3. Economic and Financial Analysis

Economic Analysis

Benefits

This project invested in a number of specific transmission investments and infrastructure upgrades. It is possible to estimate an Economic Rate of Return (ERR) for certain specific investments in substations and high voltage lines. The Bank's consultants calculated ERRs for these investments based on the following categories of benefits. This ICR calculates the ERRs on these same investments except for one (110 kV substation upgrades) where sufficient data was not available.

- Reduction of Energy Losses The upgrading of transmission lines and substations reducesenergy losses. This is particularly important for the Skopje 5 400/110 kV transformer. Sincereductions in electricity losses reduce imports by the corresponding amount these reductions arevalued at the average cost of importing electricity to FYR Macedonia.

- Meeting New Loads The construction or upgrading of substations would allow new load tobe supplied. This is particularly true for the Skopje 5 substation expansion, which was built in partto facilitate supply to an expanded metallurgical facility and help meet power demand growth inthe Skopje area. The value associated with meeting the new load is assumed to be the differencebetween the cost of meeting the new load by installing diesel generation (around EUR 80/MWh)compared to the average cost of electricity imported to FYR Macedonia (about 45 Euro/MWh in2016 according to ERC) since virtually all new demand will have to be met by imports (in realitythe new load, a metallurgical facility, has been spasmodic, see below).

- Reduction in Energy Supply Interruptions. Power outages are more likely on oldtransmission lines. Outages were a problem on the Skopje 1- Tetovo 1 transmission line. Theaverage 65 hours of interruptions per year on this line in 2005 were high by international standards.In estimating the benefit of reducing outages, we continue to use the consultant estimated valuefor unserved energy of EUR 385/MWh minus the cost of importing the energy.

- Reduction in Operation and Maintenance Cost New or upgraded equipment generally haslower operating costs and needs less maintenance than older equipment. Maintenance costreductions associated with substation rehabilitation and upgrading were estimated based largelyon forecast reduction in required man hours with labor valued at the average MEPSO salary of EUR485 per month in the PAD. MEPSO was able to provide updated maintenance cost estimates forthe 110 kV substations.

- Benefits of interconnection. These are the benefits that FYR Macedonia (and the rest ofECSEE) gets from closer interconnections. These include cost reductions associated with regionalmerit order dispatch together with the sharing of reserve capacity. Interconnection benefits areparticularly important for the FYR Macedonia- Greece transmission line (Bitola 2 to Florina).

Specific Investments

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Skopje 5 400/110 Kv transformer and upgrade of substation. In the PAD the main benefits from this investment were the ability to supply new load and the reduction in energy losses estimated at 2.9 GWh per year. The ERR was well over 200% (i.e. extremely high), even conservatively assuming the new load is phased in over three years. (It is much higher of course if the new load were to start immediately.) This reflects the fact that the substation upgrade would allow MEPSO to meet the new load at the cost of imported electricity rather than having it met from local diesel generators.

The actual situation developed differently. The new load, which was an expansion of a steel plant, came on stream but then closed down during the global financial crisis of 2008-9. It has operated at less than full capacity ever since. If the new load were to continue to operate at 80% of capacity in the future, the ERR would be quite high at 110%. However, this seems unlikely. A more conservative assumption would be to assume the plant operates about half the time at 50% of capacity. Using this assumption, the ERR for this component is 75%, which is still very high.

FYR Macedonia-Greece Transmission line. This line produces savings estimated by ESM, PPC (Greece) and EMS (Serbia) to be worth around EUR 9 million per year (this consists of approximately EUR 3 million in operating cost savings, EUR 5 million in annualized reductions in capacity requirements and EUR 1 million from increased reliability). The savings primarily accrue to FYR Macedonia, Greece and Serbia. The Macedonian savings account for about 1/3 of the total. The ERR for this component based on the Macedonian benefits only was estimated in the PAD at about 66% and the ICR is quite similar at 71%. The ICR rate of return is somewhat higher because the construction cost of the line was less than estimated.

Reconstruction of the Skopje 1 Tetovo 110 kV transmission line. This investment results in reduced energy supply interruptions or outages. At the time of the PAD outages were about 65 hours per year or about 3.4 GWh of electricity per year. The ERR from rehabilitating the lines was estimated at about 20% in the PAD. After reconstruction finished in mid-2016 there were no outages. This is despite the fact that there was an earthquake in the vicinity of the line as well as a wildfire. If no outages are taken as the new baseline, then the ERR on this investment is 22%, again quite close to the PAD.

110 kV Substation Upgrades This component consists of upgrading equipment in 21 substations. These packages were projected by the consultant to produce benefits totaling about EUR 1.5 million per year after three years. These benefits consist of reduced energy supply interruptions (about US$0.9 million) and reduced operation and maintenance costs (about 0.6 million). The ERR on this component was estimated in the PAD as 13%. Unfortunately, it was not possible to calculate an ERR for this component in the ICR since the data to do so are not fully available. (Data on operation and maintenance cost reductions are available but not reductions in energy supply interruptions.)

Other Investments financed under the project are justified on technical grounds, meaning that they are technically needed but difficult to justify economically. These consist of: (i) the 110 kV Bitola 3 - Bitola 4 line needed to meet n-1 system security requirements in the Bitola area; (ii)

32

software to upgrade the SCADA/EMS system which should result in more efficient dispatch; and (iii) consulting services and a Financial Management Information system which will support efficient management and performance of MEPSO. The overall rate of return on the project was estimated by the Bank’s consultants as 80% in the PAD. A substantial part of this high return came from the very high return on investment in the Skopje 5 Substation which was supplying new load at a much lower price than the alternative. Since this new load is likely to operate at lower capacity levels than forecast, the ICR estimates a lower ERR on the project but still at least 61%. This excludes any contributions from investments for which the benefits could not be completely estimated such as the 110 kV station upgrades. Clearly the 110 kV station upgrades and a lot of the other investments have significant benefits and if they could be determined, the ERR for the project would be greater than 61%, which is therefore a conservative estimate and still a very acceptable real rate of return.

Costs and Economic Rates of Return by Component compared with the PAD

Component Original Cost

EUR million Actual Cost

EUR million

ERR Original Est.

%

ERR ICR Est. %

Skopje 5 Substation Upgrading and new

transformer

2.14 2.53 >200% 75%

400 kV Connector line to Greece

4.5 3.34 66% 71%

110 kV Skopje-Tetovo Line

5.4 4.56 20% 22 %

110 kV Substation Upgrades

9.1 8.17 13% N.A.2

Other Components and sub-projects

3.8 4.32 N.A. N.A.

Total Project3

24.9 22.92 80% 61%

2 MEPSO‘s estimates are that the reduction in costs for operation and maintenance of the 110 kV transformers are about 58% comparing 2015 with 2009 and about a 70% reduction comparing the average of 10 months of 2016 with the average monthly total of 2009. No information is available on the reduction in outages due solely to the upgrading of the 110 kV substations. No calculation of the benefits of this component was done since the reduction in costs are insufficient by themselves to make it economic and excluding the reduction in outages produces a misleading result

3 As defined in PAD. Costs exclude VAT and import duties.

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Financial Analysis

Since being relieved of its Single-Buyer obligations, MEPSO has been profitable and in relatively good financial condition. While it was a Single-Buyer, the company had an obligation to supply all customers with electricity. It was buying imported power since ELEM, the state generation company, could not supply all the power required by the country. This imported power was substantially more expensive than the regulated prices at which MEPSO sold the electricity. These losses were draining the company and causing it to rely on the Government. The Single-Buyer obligation was gradually removed from MEPSO over the period 2009-10. First, many of the larger customers were required to obtain their own electricity supply and not rely on MEPSO or ELEM. Second, ELEM became the supplier of last resort for smaller customers and the distribution company, EVN. As a result, by 2010 MEPSO was profitable and has remained that way. In the restructuring of the Bank Loan that took place in 2011, the Bank recognized this new and more profitable situation for MEPSO by eliminating two of the three financial covenants that were in the original loan. The remaining financial covenant is one specifying a minimum debt service coverage ratio required before any new debt can be assumed.

MEPSO Selected Financial Data 2010-15 (MKD million)

Year 2010 2011 2012 2013 2014 2015

Revenue 3,067 2,810 3,429 3,035 4,048 5,183 Operating Expenses 2,352 2,001 2,958 3,005 3,457 4,367

After Tax Profit 663 841 483 16 592 817

Long Term Debt 2,808 2,682 2,573 2,406 2,349 2,243 Equity and Reserves 3,935 3,777 4,138 4,153 4,654 4,883

Cash flow from operations 365 972 1217 475 1,149 1,362

The audited financial data above show that for 2010 and later MEPSO has been in good financial shape, except for 2013 when a tariff increase was delayed and profits dropped sharply. MEPSO is thus profitable, with reasonable cash flow and is paying its debt.

The one remaining financial covenant in the Bank Loan is that before MEPSO takes on any new debt it should have a debt service coverage ratio of greater than 1.5 in the preceding year. This is calculated by dividing a measure of cash flow “net revenue” by the highest level of expected debt service from the new debt combined with the existing debt. From 2005 to 2012 MEPSO did not take on any new debt and so met the covenant. In 2013 it received a loan of EUR 25 million from the EBRD. Net revenue in 2012, the previous year, was about 1.5 times the highest level of debt service which would occur in 2018, so it met the covenant in 2013. In 2015 MEPSO received an additional loan of EUR 37 million from the EBRD. However, since cash flow had expanded substantially in 2014 it met the covenant easily with a debt service ratio of 1.8.

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These two EBRD loans were for upgrades of existing lines (2013) and a new transmission line to Albania (2015). The second loan was accompanied by a substantial grant.

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Annex 4. Bank Lending and Implementation Support/Supervision Processes

(a) Task Team members

Names Title Responsibility/

Specialty

Lending

David Kennedy Senior Energy Economist Task Team Leader

Husam Beides Senior Energy Specialist Power engineer

James Moose Consultant Financial analysis

Devesh Mishra Senior Procurement Specialist Procurement

Olav Christensen Senior FM specialist FM

Bernhard Baratz Consultant Environment

Stan Peabody Lead Social Scientist Social

Mark Walker Lead Counsel Lawyer

Nicholay Chistyakov Senior Finance Officer Disbursement

Dejan Ostojic Senior Energy Specialist Power engineer

Zarko Bogoev Operations Officer Country aspects

Juderica Dias Program Assistant Team support

Supervision

Peter Johansen Senior Energy Specialist Task Team Leader

Husam Beides Lead Energy Specialist Task Team Leader

Zarko Bogoev Operations Officer Country aspects

Aleksandar Crnomarkovic Senior FM Specialist FM

Olav Christensen Senior FM specialist FM

Lewis Raymond Hawke Head FM

Anneliese Viorela Voinea FM Analyst FM

Devesh Mishra Senior Procurement Specialist Procurement

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Angelica A. Fernandes Procurement Analyst Procurement

Jose Martinez Senior Procurement Specialist Procurement

Gentian Keri Consultant Procurement

Antonia Vyachka Procurement Specialist Procurement

Gazmend Daci Senior Energy Specialist Power engineer

Julie Rieger Senior Counsel Lawyer

Bekim Ymeri Senior Social Development Spec Social

Stan peabody Lead Social Scientist Social

Bernhard Baratz Consultant Environment

Natasa Vetma Senior Environmental Specialist Environment

Ivana Ivicic Consultant Environment

Rozena Serrano Program Assistant Team support

Dung Kim Le Program Assistant Team support

Luan Aliu Program Assistant Team support

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(b) Staff Time and Cost

Stage of Project Cycle Staff Time and Cost (Bank Budget Only)

No. of staff weeks US$ Thousands (including travel and consultant costs)

Lending FY04 64.50

FY05 32.63

FY06 88.36

FY07 0.40

FY08 0.00

Total: 185.89

Supervision/ICR

FY04 0.00

FY05 0.00

FY06 13.25

FY07 74.39

FY08 46.79

FY09 64.61

FY10 81.08

FY11 86.29

FY12 100.02

FY13 42.86

FY14 95.79

FY15 62.41

FY16 81.61

FY17 59.78

Total: 808.88

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Annex 5. Beneficiary Survey Results

No Beneficiary Survey undertaken.

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Annex 6. Stakeholder Workshop Report and Results

No Workshop Held.

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Annex 7. Summary of Borrower's ICR and/or Comments on Draft ICR

Delays in Project Implementation and Reasons for Delays

During the project implementation process some delays have been identified, especially in the Component 2: Rehabilitation and construction of interconnection and overhead transmission lines, caused by late obtaining of the Construction Permits for the Packages 5, 6 and 16. The Contracts for these projects were signed before the obtaining of the Construction Permits. The Law on Construction at the time of signing of the Contracts strictly declared that all Land Acquisition (LA) activities, regarding the OHTL projects should be finished before the start of the civil works, no matter if it considered permanent or temporary LA. Considering the fact the LA procedure usually lasts several years, MEPSO requested the relevant Ministry to reconsider the exception in the a.m. Law for infrastructural line project of national interest. This requirement resulted in a change in the law and the work on the OHTLs could move from the dead point by MEPSO obtaining the Construction Permits which allowed proceeding with the OHTL projects implementations. World Bank Performance

World Bank has been periodically present with its own experts inspecting the project by all indicators and making MEPSO aware of its own opinion on the project performance. Cooperation with the World Bank has been very correct and fruitful. The Bank contribution in supporting of the project was permanent during the implementation phase and issues of the project, but we especially emphasize the support during the process for obtaining the additional loan financing and the efforts made for extending the Loan Closing Date, thus assisting MEPSO to achieve the project goals.

We would like to point out the very important assistance provided by the World Bank referring to the Land Acquisition process and all the efforts helping to strengthen the communication among MEPSO and relevant Municipalities for OHTL projects, which resulted in big improvement in this administrative process.

Lessons learned

The problems and difficulties that appeared during the implementation of the project imply some lessons learned for future projects:

The unbundling of ESM had tremendous impact on the implementation of Component 4. An intensified focus on the interfaces and mutual agreements related to responsibilities and obligations is mandatory when such split of the organization occurs;

Regarding the Component 2, Rehabilitation and construction of interconnection and

overhead transmission lines, the main problem identified was the obtaining of the Construction Permits which was strictly related with the progress of the Land Acquisition process. The master lesson learned is that the LA process is a time consuming issue and should be attentively planned and processed long before the Contract signing. The other

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lesson learned in this component was the importance of providing supervision on the project by certified supervisor company, which should be selected in parallel with the Contractor selection in order not to delay the implementation start of the project;

A clear definition of the technical solutions is essential before the planning and compilation of the tender documents are started. Changes or hesitation in fixing the technical solutions hamper a timely production of the tender documents since a firm basis is not established; and

The large number of domestic tenders solely depending on input/action from MEPSO has turned out to constitute a barrier to the progress. The Public Procurement process and domestic tenders mainly for construction works caused a several unpredicted delays in the projects implementation.

Conclusion

The fulfilment of the objective of ECSEE APL 3 FYR Macedonia project had been obtained by the Loan Closing Date, by improvement of the functioning of the regional electricity market in South East Europe and its integration into the internal electricity market of the European Union and through the implementation of priority investments supporting electricity market and power system operations in electricity generation, transmission and distribution and technical assistance for institutional development and project preparation and implementation

In the overall context, considering the completed projects, it can be concluded that the stability and reliability of the network have been increased, and the transmission capacity of the generated/imported/exported electricity with higher quality level is increased as well.

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Annex 8. Comments of Co-financiers and Other Partners/Stakeholders

No co-financiers or other partners/stakeholders

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Annex 9. List of Supporting Documents

1. Project Appraisal Document for APL 3 in FYR Macedonia, December 8 2005

2. Loan Agreement for APL 3 between IBRD and MEPSO, April 19, 2006

3. Guarantee Agreement of APL 3 between IBRD and Government of FYR Macedonia

4. Letter Amending Loan Agreement between IBRD and MEPSO, April 11, 2011

5. Supplemental Letter 2 between IBRD and MEPSO April 11, 2011

6. Project Paper on a Proposed Additional Loan March 9, 2011

7. MEPSO’s Audited Annual Reports 2010, 2013, 2014, 2015

8. MEPSO’s Abbreviated Annual Reports, 2011, 2012

9. Mid-term Review February 2010

10. A number of Aide Memoires, and ISRs

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Annex 10. Map