4._Attachment_2_Program_Background_and_Context_2.pdf

ATTACHMENT 2

BACKGROUND AND CONTEXT OF PROGRAM

1. Existing Situation

Kandahar, with a population of about 0.5 million is the second largest city in Afghanistan. Located in southern part of Afghanistan, the city is also the capital of Kandahar province. Currently, isolated from the two major power grids of Afghanistan, Kandahar meets its power demand from local diesel power generation and through supply of hydro power from neighbouring province. The city has a mix of residential, commercial and industrial consumers, with residential consumption accounting for ~65% of the total electricity sales. Factories and commercial establishments account for more than 20% of the sales and also contribute a significant amount of revenue for the Government (refer Figure 1.1 below for complete distribution of electricity sales and revenue from consumers in Kandahar). It is evident that uninterrupted and affordable power supply is essential not just for providing basic services and improving living conditions of the people of Kandahar but also for the economic growth and sustainable development of the Kandahar city.

Figure 1.1: Consumer wise distribution of electricity sales (kWh) and revenue in Kandahar for Year

1392 (FY 2014)

Source: DABS

In terms of power supply, the two diesel generation plants of 10 MW each located at Bag-e-Pol and Shorindam Industrial Park provide for majority of power consumption in the city. The rest of the demand is met by ~10 MW power sourced from Kajaki hydroelectric power plant located in neighbouring Helmand province (Figure 1.2 below indicates the available capacity in Kandahar).

Figure 1.2: The city of Kandahar with existing power sources indicated on the map of Afghanistan

The two diesel plants in Kandahar were funded by the U.S Department of Defence (DoD) under the ‘Kandahar Bridging Solution’ programme. In coordination with Government of the Islamic Republic of Afghanistan (GIRoA), DoD identified delivery of affordable electricity in Kandahar as a top priority for:

(i) Enabling the Afghan Public Utility (DABS), to produce electricity for Kandahar city, promoting stability and economic growth.

(ii) To demonstrate Government of Afghanistan’s capability to provide basic services and improved living conditions.

Hence the plants which otherwise would have been economically unsustainable are being operated under substantial fuel subsidy (USD 1 Mn/month) provided by the US Government, making the power cost affordable for the people in Kandahar. However, this subsidy provided by the U.S Government is slated to be withdrawn by September 2015. Figure 1.3 below indicates the declining subsidy trend as conveyed by DoD to DABS.

Figure 1.3: Declining Monthly Diesel Subsidy Until 2015

Source: SIGAR Reports

2. Context of the Programme

With the provision of electricity being at the heart of economic growth, the above development is poised to have adverse effects on the overall growth of Kandahar. Withdrawal of fuel subsidy would make cost of generation extremely uneconomical and unaffordable for the consumers. The situation appears to be grimmer considering the fact that Kandahar’s interconnection with the two major grids1 will not happen before 2018 and supply from hydro power can only meet limited demand.

Proposed Interconnection with Grid

The first two sections of the SEPS connector to

Kandahar are currently in progress. Contracts for the final 370 km line from Ghazni to Kandahar are expected to be awarded in mid to late 2015.

Completion is expected in late 2018. NEPS power is expected to arrive Kandahar post 2018.

Proposed Scaling of Kajaki Hydro Plant

Unit 2 of Kajaki hydro plant is expected to get operational not before 2016. Power from this unit

(8-10 MW after other load centres take their share) will not be sufficient to meet the shortage.

Hence there exists no reliable and sustainable power source for this strategically important city of Afghanistan in the interim period, imperilling thousands of homes and businesses (particularly the newly established industrial park at Shorindam) without access to reliable source of electricity.

1 SEPS- South East Power System; NEPS- North East Power System

Figure 2.1: Sequence of events and likely situation foreseen in Kandahar if no action is taken

Given the above backdrop, the Government of Afghanistan in coordination with the US Government is considering various options to minimize the adverse effect of withdrawal of the fuel subsidy on the cost of power to the consumers in Kandahar. USAID had commissioned a feasibility study to evaluate the viability of a solar photovoltaic project for Kandahar using Independent Power Producer business model.

A 10 MW Solar Diesel hybrid is being looked at as a key solution to provide interim relief before interconnection happens and hydro capacity is augmented. The tariff of the solar power generated from the project is expected to be significantly lower than that of diesel power, which would mitigate to a large extent, the sudden tariff shock to the power consumers in Kandahar. Successful installation of Solar PV project which is proposed to be built as IPP will not only provide interim relief by meeting the demand of Kandahar, but also act as a model that could be replicated in the other parts of Afghanistan.

Shared objective of Governments of Islamic Republic of Afghanistan and United States of America

The project is being looked at as an important development as part of a larger objective of the United States Government (USG) in coordination with the Government of the Islamic Republic of Afghanistan (GIRoA) for the development of Kandahar. The program is being accorded the topmost priority with following objectives:

1. Improving living conditions of people of Kandahar: Provision of basic services and improving the living conditions of people of Kandahar.

2. Improvement in short term supply situation: Installation of solar power plant provides interim relief to meet demand of Kandahar until the installation of Kajaki Dam Unit 2 and NEPS-SEPS interconnection.

3. Cost effective option after end of diesel fuel subsidy: Solar power being cheaper vis-à-vis diesel based generation act as a cost-effective supply option for DABS after diesel fuel subsidies are phased out.

4. Scale up opportunities – Solar and other RE: Successful installation of Solar PV project built on IPP mode provides opportunity for expanding the project in different parts of Afghanistan.

It is important to mention that this is the first time an RE project of such large capacity and scalable model is being implemented through IPP route in Afghanistan.

The proposed project is likely to result in following benefits:

Figure 2.2: Overall benefits of Solar PV and likely impact of its installation on Kandahar

In addition to the above, considering that the model has strong replication potential, the outcome of proposed program holds immense value to scale up solar initiatives in the country.

3. Solar Energy Potential in Afghanistan & Kandahar

Afghanistan is a mountainous land locked country located in Central Asia and South Asia. Geographical location lies between latitudes 290 N and 390 N and longitudes 600 E and 750 E. The annual average insolation is about 5.5kWh/m2/day, but varies nationally and is highest in the southern Afghanistan.

Located in the sub-tropical belt, Afghanistan receives abundant sunshine through most of the year, with many parts receiving 250-300 sunny days a year of sunlight. Afghanistan exhibits a strong potential for solar power (Refer figures 4.1 and 4.2) particularly in the Southern region.

Figure 3.1: Solar Energy Potential in Afghanistan

Source: NREL Website

Figure 3.2: Diagram depicting Solar Insolation in Afghanistan

Source: www.gaisma.com

Kandahar which is located in southern part of Afghanistan has a strong potential for solar energy. The energy harnessed from solar could be an important source of energy both for off grid and grid connected population in Kandahar. The average annual solar resource in Kandahar is very good with one axis tracking providing an annual average of about 5.8 kWh/m2/day (sun-hours) at latitude tilt (optimal tilt for maximum annual energy generation).

Solar energy is being considered as one of the key elements of Afghanistan’s energy security initiatives.

Solar based solutions are being implemented in various parts of the country. Donor agencies including the USAID have been actively participating and facilitating such initiative in coordination with the Government of Afghanistan. In Kandahar, Solar PV has been successfully installed at District Centers under SIKA & Street Light Programme. Further, the USAID has also helped start the solar tech programme at the Kandahar University. This additionally provides reasonable basis and experience for the Kandahar Solar Project which is at topmost priority on the agenda items of DABS.

4. Review of Existing Solar Installations in the Afghanistan

In the absence of an interconnected centralized power system, solar based installations in Afghanistan are currently limited to standalone off-grid solar systems. Such off-grid systems have been identified by the Government of Afghanistan, external donor agencies and local communities as a favorable solution to electrifying remotely located rural areas in Afghanistan. These standalone off-grid solar systems offer lower operating costs, technical simplicity, and short installation time.

Currently there are several small-scale off-grid PV projects in operation, under construction and in planning. 13 MW of solar PV systems stand as a part of decentralized generation capacity (Source: MEW 2013). A brief of some of the major solar based off-grid installations in Afghanistan is provided below:

a) Bamyan Solar PV Project (2013)

Funded by the Government of New Zealand, the Bamyan Renewable Energy Programme includes the world’s largest off-grid solar system with an output of 1 MW. The Bamyan project utilizes off-grid Solar PV technology to bring reliable renewable power to 2,500 rural households, businesses and government buildings in Bamyan. It consists of a PV generator supplemented with a diesel generator and batteries for periods of poor weather.

b) Takhar Solar Programme (2013)

Financed by the Afghan-German cooperation, the program includes two pilot solar projects in Takhar province. A 200 KW Solar PV Diesel hybrid scheme in Yakatoot district with 560 customers and a 44 KW Solar PV Diesel hybrid scheme in Khanaqa serving 363 customers. Customers include shops, schools, mosques, private business and households.

c) Sayed Karam Solar PV Diesel Hybrid (2009)

Funded by the U.S State Department, it is 100 KW PV system covering 7 villages of Sayed Karam community. Implemented by Sustainable Energy Services Afghanistan (SESA), it includes a 20 kV transmission and distribution, pre pay metering and off grid inverter, battery and diesel generator system. It serves 600 houses and small businesses. Every connection has a pre pay meter with 14 km distribution lines and 20 KV transmission line.

d) Logar Solar programme

Designed in close consultation with the Barak District Development Council in coordination with USAID, the project includes 25 solar panels distributed to households. Each solar panel generates approximately 40 watts of sustained electricity per household, enough to light four rooms with the most-commonly used 10-watt bulbs

Table 4.1: Summary table showing existing solar installations in Afghanistan

Project Location Capacity Type Coverage Investor

Bamyan Solar

PV Project

Bamyan Province

1 MW Solar PV Diesel Hybrid

2,500 rural households, businesses and government buildings

Government of New Zealand

Takhar Solar

Programme

Yakatoot and Khanaqa

200 KW and

44 KW

Solar PV Diesel Hybrid

560 and 363 customers

Afghan- German cooperation

Sayed Karam

Solar PV

Paktya Province

100 KW Solar PV Diesel Hybrid

600 houses and small businesses

U.S State Department

Logar Solar Logar 1 KW Standalone

Solar PV

N.A USAID

Source: Data available in public domain

It is important to mention that most of the above installations are direct donor contributions. The proposed programme is first attempt to install a scalable IPP based self-sustainable model that offers strong replication potential.

5) Review of Legal Issues

The Government of Afghanistan through its policy and legislation has demonstrated a strong political will to encourage private sector participation in various infrastructure projects and over the period has made efforts to improve the legal and regulatory framework. The investment in private sector by an investor (including foreigner) is a regulated activity and requires approvals, authorizations and permissions from relevant Government entities at different stages.

As of now, the legal framework in the sector includes Law on Using Electricity which is limited in its coverage. However, a new Electricity Law is in the draft stage and its enactment is awaited. It is expected to add significantly in the operational clarity of private sector, as the law deals with promotion and regulation of the generation, transmission, distribution and supply of electricity.

The consultant has reviewed the Legal, Policy & Regulatory aspects related to power sector in Afghanistan. The various legal and policy documents which were reviewed are listed below:

Box 5.1: Documents reviewed by the consultant

Civil Code 1977

Law on Managing Land Affairs 2008

Insurance Law 2008

Constitution of Islamic Republic of Afghanistan 2004

Law for Using Electricity 1986

Environment Law 2007

Corporations and Limited Liabilities Law 2007

Regulations on Evaluating Environmental Impact 2008

Draft power sector strategy for Afghanistan National

Development Strategy, dated 28 May 2007

The overall strategy on Energy for period 2007/ 8 – 2012/ 13

Electricity Sector Policy 2003

Procurement Law 2008

Law on Domestic and Foreign Private Investment 2005

Income Tax Law 2009

Commercial Contracts and Scale of Property Law 2014

Rules of Procedure for Public Procurement 2009

Procurement Policy Unit Circulars

Public Finance and Expenditure Management 2005

Some of the key findings are given below:

Current legal and regulatory regime is at a nascent stage with several gaps including lack of standard contracts and regulatory framework that governs investments.

GIRoA is inherently responsible for any enactment, amendment, modification and repeal of laws and regulations. In the absence of a stable regulatory regime, any change in the law/regulation could be perceived as a potential risk by investors.

The draft Electricity Law seeks to promote and regulate the generation, transmission, distribution, and supply of electricity, as well as regulate private sector participation. The Law envisages the establishment of the Afghanistan Electricity Regulatory Authority (AERA) as the industry regulator, and defines the electricity sector policy duties of MEW.

The constitution of the Islamic Republic of Afghanistan guarantees safety of capital investment and private enterprises, and the rights and liberties of foreign citizens. The Afghanistan Investment Support Agency (AISA) serves as a ‘one stop shop’ for foreign investors and registers/incorporates companies. Investments in infrastructure and power sector, in addition to permissions from the concerned ministry, require approval of a ministerial commission referred to as the High Commission on Investment.

The Law on Domestic and Foreign Private Investment of Afghanistan 2005 provides certain protections to investors, for example: investors may maintain bank accounts in foreign currency in and outside Afghanistan, sell or transfer all or part of its ownership interest, no restrictions on the conversion of currency or transfer of funds related to investment, freely transfer out of Afghanistan distributions and the proceeds from the sale or transfer of the entity, and freely transfer out funds for the payment of principal, interest and fees associated with a foreign loan.

As per the law, GIRoA may expropriate an investment in or an asset of a registered enterprise for the purpose of an overriding public interest and on a nondiscriminatory basis. However, adequate and effective compensation according to international law principles at the fair market value of the expropriated property is ensured under the law.

The laws in Afghanistan allow and provide for limited liability of sponsors/shareholders of entities. A corporation or a limited liability company may be incorporated/ registered in Afghanistan. Unlike a limited liability company, the capital of a corporation is divided into shares. However, the liability of the sponsors/shareholders in both is limited to their contribution in the capital.

The Constitution of Afghanistan prohibits foreign individuals from owning immovable property in Afghanistan. However, long-term leases, of up to 90 years, for the purpose of capital investment are permitted.

The procurement laws in Afghanistan apply to procurements by public funded entities (ministry, independent head departments, state owned enterprises, other budgetary unit, and also municipality, government companies and mixed companies in which State ownership exceeds twenty-five percent (25%) under the government budget.

The National Environmental Protection Agency (NEPA) provides for environmental compliance requirements. These compliances are applicable to contractors building and operating the plant.

Currently, there are no tax/custom duty exemptions particularly for the power sector. This may be a concern as power projects being capital intensive involve large scale import of equipment/machinery.

Protection may also be required for investors against political risks, changes in the tax/duty regime and against renewable energy resource variability. Further, it important to ensure convertibility of Afghanis into US Dollars at the prevailing exchange rate, remit-ability of foreign exchange to cover necessary payments related to the project, and suitable indexation of tariff components to cover the risk of exchange rate variations and inflations. All of these issues will be reviewed during the course of the assessment.

6. Credit Market Assessment

Macroeconomic stability, structural reforms, and political and security stability are needed to ensure inclusive growth. Over the past decade, Afghanistan has made significant progress in reconstruction, development and lifting per capita income. With significant reform efforts and donor support, Afghanistan has maintained macroeconomic stability, implemented important structural reforms, and policy incentives. Risks, mostly on the downside, are related to adverse domestic or regional security developments, political instability, and inadequate implementation of economic and regulatory policies.

The GDP growth is driven by private consumption on the demand side and by agriculture on the supply side. The GDP growth for 2015 is projected to be at 3.8 per cent as per the Asian Development Outlook (ADO) Report 2014, which shows a substantial improvement from past few years. This projection is based on implementation of the new government’s medium-term transition plan supported by large security grants by the North Atlantic Treaty Organization and the conference of development partners.

Inflation has come down by half a point in 2015 on slower growth, favourable global prices, and a further decline in real estate prices. The current account surpluses at 0.9% of GDP, which include very large grant inflows for 2015, is slightly lower for export balance being less favourable for this year.

The financial sector in Afghanistan is very narrow and is dominated by the Afghanistan Central Bank, Da Bank of Afghanistan (DAB). There are seventeen licensed financial institutions/banks currently operating in the Afghanistan including eleven full-fledged commercial banks, two state owned commercial banks, three foreign banks registered in Afghanistan namely Bank Alfalah Ltd., Habib Bank of Pakistan and National Bank of Pakistan and one micro finance institutions Pashtany Bank, the first micro finance bank of Afghanistan.

From a financial stability perspective, the banking system has ample liquidity (liquid assets reached 62 per cent in year 2013) and small loan portfolio was about US$ 824 million or 19 per cent of the total assets. Despite excess liquidity in Afghanistan’s banks, the primary mortgage market remains moribund.

Afghanistan’s finance-to-GDP ratio is less than one per cent compared with 50-70 per cent in developed countries and 7 per cent in India. Non-recourse project finance is virtually non-existent as a financing option. The absence of a comprehensive legal infrastructure, limited institutional capacity in the banking and legal systems, and inadequate corporate governance constrain financial sector development.

Banks tend to lend mostly in over-collateralized mortgage backed financing products, fully secured retail and corporate loans and selective public sector financing, mostly under Government guarantees.

Mortgage loans are characterized by high interest rates (i.e. 20-24 percent annually) and short loan terms (i.e. 1 to 3) years. Average loan amounts are about US$ 85,000, although there appears to be considerable variation among banks and banks prefer to stay away from project financing business because of their inabilities in assessing and pricing risk.

The non-bank financial institutions in the country consist of a rural finance company, a specialized agriculture finance institution, insurance companies and money services businesses. All banks and the non-bank financial institutions are regulated and supervised by the Ministry of Finance/ Afghanistan Central Bank.

Further detailed discussions are needed with each of these commercial banks and Afghanistan Central Bank in order to:

Understand capital provisioning and capital adequacy norms of local financing system;

Assess the local financial markets ability to participate in the project financing and working capital financing;

Understand the ability and comfort of the local banks to participate in the PPA payment security mechanism for hybrid solar projects by subscribing to the USAID sponsored credit enhancement mechanism;

Opportunities for Islamic financing in the local financial market.

7. Off-taker Assessment

This section provides a brief about the consumer mix, consumption, revenues and tariff in Kandahar city.

It also draws attention towards establishing adequate risk mitigation measures for the developer, against any possible failure of the off-taker to generate revenues and adequate funds for payment.

Since there is no separate market in Afghanistan, DABS would be the only off-taker of power generated from the proposed solar project(s) in Kandahar. The section below gives a brief overview of Kandahar’s power profile.

8. Consumer Mix and Sales

Kandahar has a population of about 0.5 million. In 2014, it consumed ~110 million units of electricity.

Kandahar has a mix of residential, commercial and industrial consumers. Other than that there are

Government organizations, holy places and NGOs which consume electricity. As of 2014, the total no. of consumers availing electricity in Kandahar were ~67,000. Residential consumption accounts for ~67% of the total electricity sales, while registered fabrics and commercial establishments account for more than 20% of the same.

Figure 8.1: Consumer Mix and Sales Distribution in Kandahar for Year 1392 (FY 2014)

Source: DABS

9. Electricity Tariff and Revenue from Sale

The current average cost of electricity is 9.31 cents/kwh (~5.38 AFS). The current tariff regime for various categories of consumers is shown in the table below:

Table 9.2: Category wise tariff

Category Tariff (Afs/unit)

Tariff USD/unit)

Government Organizations 10 0.17

Commercial Areas 10 0.17

Holy Places 10 0.17

Registered Factories and Industrial Units 6 0.10

Unregistered Factories and Industrial Units 10 0.17

NGO / INGO 10 0.17

Residential Customers

0-200 kWh 1.5 0.03

Category Tariff (Afs/unit)

Tariff USD/unit)

201-400 kWh 2.5 0.04

401-700 kWh 4.5 0.08

701-1500 kWh 6.5 0.11

1501 and above 8 0.14

(Source: DABS)

The project structuring proposed to be designed as part of the project will need to isolate the financiers and the developers from any payments or off-take risk by building in adequate risk mitigation into the contracts and project structure. Therefore, it is important to understand the financial soundness and creditworthiness of DABS as this has direct impact on the risk perception, revenue/ payout stream of the investors and entire financial viability of the project:

In addition to the above, the review will also need to assess the ability and appetite of Kandahar to bear increased tariff due to non-subsidized diesel usage (beyond the solar power that will be available from the project) that inevitably will be consumed to serve demand.

Site Location and Access to site The Proposed Project site is located in Kandahar. Land is approachable from Kandahar-Ghazni Highway.

An access Road from Highway will have to constructed up to the proposed solar plant. The land area planned/allocated is approx. 80 acres. Out of total land area, approx. 50 to 60 acres shall be used for setting up proposed 10 MW project and the balance land will be for the future expansion.

Site Location

Site Photo

Climate details for Reference and General Information Only