The World Bank The District Heating Energy Efficiency Project (P132741) REPORT NO.: RES48607 RESTRUCTURING PAPER ON A PROPOSED PROJECT RESTRUCTURING OF THE DISTRICT HEATING ENERGY EFFICIENCY PROJECT APPROVED ON MAY 22, 2014 TO UKRAINE ENERGY & EXTRACTIVES GLOBAL PRACTICE EUROPE AND CENTRAL ASIA REGION Regional Vice President: Anna M. Bjerde Country Director: Arup Banerji Regional Director: Charles Joseph Cormier Practice Manager: Sudeshna Ghosh Banerjee Task Team Leader(s): Sandu Ghidirim, Fabrice Bertholet The World Bank The District Heating Energy Efficiency Project (P132741) ABBREVIATIONS AND ACRONYMS CO2 Carbon dioxide CTF Clean Technology Fund CPMU Central Project Management Unit CY Calendar Year DH District Heating DHC District Heating Company FM financial management GHG greenhouse gas GWh gigawatt-hour IBRD International Bank for Reconstruction and Development LCD Loan Closing Date LLC Limited Liability Company m3 cubic meter MCTD Ministry of Communities and Territories Development (ex Minregion) MJ mega Joules MoF Ministry of Finance MWh megawatt hour PDO Project Development Objectives RPMU Regional Project Management Unit SCADA Supervisory control and data acquisition SLA Subsidiary Loan Agreement US$ US dollar The World Bank The District Heating Energy Efficiency Project (P132741) BASIC DATA Product Information Project ID Financing Instrument P132741 Investment Project Financing Original EA Category Current EA Category Partial Assessment (B) Partial Assessment (B) Approval Date Current Closing Date 22-May-2014 31-Dec-2022 Organizations Borrower Responsible Agency Ukraine Ministry of Communities and Territories of Ukraine Project Development Objective (PDO) Original PDO The project development objective is to improve the energy efficiency and quality of service of selected Ukrainian district heating(DH) companies, improve their financial viability and decrease their CO2 emissions. The global objective is to reduce greenhouse gas (GHG) emissions through avoided heat generation by improving heat generation efficiency, reducing heat losses in DH transmission and distribution systems, and reducing residential heat consumption. OPS_TABLE_PDO_CURRENTPDO Summary Status of Financing (US$, Millions) Net Ln/Cr/Tf Approval Signing Effectiveness Closing Commitment Disbursed Undisbursed IBRD-83870 22-May-2014 26-May-2014 21-Nov-2014 30-Jun-2022 155.00 115.60 39.40 TF-16327 22-May-2014 26-May-2014 21-Nov-2014 31-Dec-2022 50.00 18.24 31.76 The World Bank The District Heating Energy Efficiency Project (P132741) Policy Waiver(s) Does this restructuring trigger the need for any policy waiver(s)? No I. PROJECT STATUS AND RATIONALE FOR RESTRUCTURING 1. Five District Heating Companies (DHCs) currently participate in DHEEP. Four previous project restructurings have removed half of the original ten participating utilities, which for a variety of reasons were not able or willing to implement the Project according to the legal agreements and Bank fiduciary requirements. These restructurings have resulted in a reduction of the IBRD loan from US$332 million originally to US$155 million currently. Following the first extension of the Project’s Closing Date by one year from October 30, 2020 to October 30, 2021, project activities made significant progress for three of the participating utilities representing about 80% of total project investments. As a result of budget support provided by the municipalities, by the end of calendar year 2020, the District Heating Companies (DHCs) in Kharkiv, Ternopil, and Mykolaiv were able to meet their debt obligations to the Ministry of Finance (MoF) under the Subsidiary Loan Agreements (SLAs), thus allowing MoF to process the applications for outstanding payments to contractors and replenish the three municipalities’ designated accounts. On this basis, the major contracts showed steady implementation progress in the three cities. 2. Another positive development is the significant improvement in the contract management on the part of the participating DHCs. The most significant improvement took place in Kharkiv (largest participating DHC and beneficiary of half of the investments under the project). Since January 2021, and under the new management of Kharkiv’s DHC, decision-making processes were streamlined and the responsiveness and proactivity of the regional project management unit (RPMU) in managing contractors improved dramatically. The RPMUs in Mykolaiv and Ternopil continued to implement project activities diligently and competently. 3. As of October 15, 2021, the combined disbursement ratio for the IBRD loan and CTF loan was 15 percent and the cumulative disbursement reached 65 percent. However, despite these improvements, several issues, primarily related to insufficient allocation of loan proceeds by MoF to the Project, continued to negatively impact project implementation. a. Disbursement delays have persisted in 2021, in particular due to limited allocation of loan funds to the Project in the initial 2021 State Budget, which was insufficient to cover significantly increased disbursements compared to previous years and was already fully utilized by the end of April 2020. The Ministry of Communities and Territories Development (MCTD) managed to mitigate this problem through reallocation of funds to the Project from other projects under its control, but this process took time and payments were delayed negatively impacting the ability of contractors to carry out works in the late spring and early summer of this year. The 2021 State Budget was revised earlier this month to include an additional allocation of UAH 400 million (US$ 15 million) for the Project from the loan amount. This amount would be sufficient to process all of the outstanding payments before the end of this calendar year. The draft State Budget for 2022 which went through the first reading in the Parliament earlier this month includes a budget line of UAH 949 million for the Project. This budgetary allocation (out of the The World Bank The District Heating Energy Efficiency Project (P132741) remaining undisbursed loan amount) would be sufficient for completing all the remaining investments under the Project in calendar year 2022. b. Project implementation remained at a standstill for Kamianets and Kherson. In Kherson, as a result of significant conflict between the municipal authorities elected last October and the DHC management, the latter has delayed implementation of a major contract (boiler house reconstruction) failing to pay the contractor for supplied equipment and a completed contract. Progress has resumed since the change in DHC’s top management in June 2021. In Kamianets, while project activities are more than 90% completed and have been so for more than two years, persistent disagreements (for more than two years) between the DHC/municipality on one side, and MoF on the other with regard to DHC’s sub-loan servicing, have prevented a resumption of disbursements. 4. An implementation support mission conducted from September 27 to October 8, 2021, including a physical field trip to Kharkiv, confirmed progress in contract implementation. Several key contracts have already been completed or will be completed in the coming weeks. However, the utilities and their municipal authorities in the cities of Kharkiv, Ternopil and Mykolaiv, as well as MCTD have requested through MoF an extension of the Closing Date for an additional 8 months until June 30, 2022. This would enable completion of ongoing physical works and leave sufficient time to conduct the technical testing and pre-commissioning procedures, which can only be carried out when the heating season is in operation, as well as the legal and administrative procedures required for the formal commissioning of the new facilities and settlement of all contract obligations and processing of final retention payments. 5. The justification for the requested extension is: (i) the recent outstanding implementation progress as evidenced by the latest monthly progress reports and site visits in Kharkiv; (ii) stronger leadership and proactive engagement by MCTD’s First Deputy Minister / Project Coordinator in regular progress monitoring and dialogue with municipalities and DHC’s management; (iii) MoF’s constructive attitude and inclusion of sufficient resources in the draft 2022 State Budget to complete the project activity in the three municipalities, (iv) the potential negative impact and reputational risk of leaving boiler houses and network reconstruction work unfinished on the verge of a complex 2021/2022 heating season, aggravated significantly by historically high gas prices globally and unforeseen financial pressure on municipalities. Municipalities have been asked by the Government to freeze heat tariffs for households and financially support their utilities to cover the related deficit. This will make it highly unlikely that municipalities can rapidly mobilize financial resources to pay contractors to finish construction works and commission the installed equipment, even if the works are very advanced. 6. In the case of Kamianets, Ukrainian counterparts have agreed that it is unlikely that the dispute between the DHC and MoF can be settled rapidly. The DHC, after suing the national regulator for its failure to set heat tariffs at cost-recovery levels and winning its case, has now initiated litigation against MoF for which a speedy resolution appears unlikely. In this context, the Kamianets DHC and municipality are likely to use their own financial resources to prioritize the final payment to the contractor for the main investment under the project, which is necessary to proceed with the final commissioning of the facility, over the repayment of the subsidiary loan to MoF. This would enable to achieve the Project’s objectives in Kamianets and would be preferable to a continuation of the stalemate over the last two years. Kamianets is current on sub-loan servicing for CTF and will be able to continue the implementation of a contract for the installation of Individual Heat Substations. II. DESCRIPTION OF PROPOSED CHANGES The World Bank The District Heating Energy Efficiency Project (P132741) 7. The Ukrainian authorities have sent a formal request to restructure and extend the Project’s Closing Date in their letter dated October 26, 2022. This would be the fifth restructuring of the Project. The request includes the following: a. cancellation of US$3,410,746 million from the IBRD loan (reduction of the Unallocated category); b. Extension of the IBRD Loan’s Closing Date to June 30, 2022; and c. Extension of the Clean Technology Fund (CTF) Loan’s Closing Date to December 31, 2022. 8. As previously explained, the proposed extension would be sufficient to enable the physical completion of major ongoing works, as well as of the subsequent technical, administrative, and legal procedures (testing, formal commission, issuance of completion certificates, processing of final payments, etc.) in the participating DHCs (though as previously explained Kamianets, which has already disbursement 90% of the funds under IBRD is likely to complete its major investment by directly paying the contractor). 9. The CTF extension for an additional fourteen months (unlike the 8-month extension for the IBRD Loan) was already formally requested by the Ukrainian authorities in June 2021. This extension would allow for the completion of the SCADA investments in Kharkiv. The SCADA component in Kharkiv is strategically important due to: (i) its direct energy efficiency and emission reduction impact; and (ii) its important demonstration impact for other large DH systems in Ukraine. The generalization of SCADA technologies in DH systems is critical for the modernization of the Ukrainian heating sector and for the transition to a consumer-driven system. The SCADA investment in Kharkiv would be implemented under 4 large contracts (for which procurement has been completed) sequentially dependent on other network and boiler house investments currently being completed. As a result of the advancement of these investments, and the increased dedication of the RPMU since January 2021, the requested extension of the CTF’s Loan Closing Date, would enable a speedy completion of SCADA by the utility. The SCADA system is a cornerstone of the modernization and development strategy of the new DHC management, which benefits from the support of the municipal authorities. The SCADA investment would also fit strategically within the proposed Municipal Energy Efficiency Project currently under preparation, which will include a District Heating component incorporating the lessons learned during this Project’s implementation. In addition, the extension would also allow for the completion of ongoing works and full commissioning of the individual heat substations contracts financed under the CTF. 10. On the basis of several positive trends over the last 6 to 12 months (significant improvement in implementation performance by the RPMUs and DHCs management, strong support by municipalities, mobilization of the Deputy MCDT Minister/Project Coordinator) and of the more constructive attitude of MoF which has now taken all the required measures to ensure unimpeded disbursements in 2021 and 2022, it is expected that the proposed extension would allow project completion with satisfactory performance and achievement of the PDO. The Project has no overdue audit reports. III. SUMMARY OF CHANGES Changed Not Changed Components and Cost ✔ Loan Closing Date(s) ✔ Cancellations Proposed ✔ Reallocation between Disbursement Categories ✔ The World Bank The District Heating Energy Efficiency Project (P132741) Disbursement Estimates ✔ Implementation Schedule ✔ Implementing Agency ✔ DDO Status ✔ Project's Development Objectives ✔ Results Framework ✔ Disbursements Arrangements ✔ Overall Risk Rating ✔ Safeguard Policies Triggered ✔ EA category ✔ Legal Covenants ✔ Institutional Arrangements ✔ Financial Management ✔ Procurement ✔ Other Change(s) ✔ Economic and Financial Analysis ✔ Technical Analysis ✔ Social Analysis ✔ Environmental Analysis ✔ IV. DETAILED CHANGE(S) OPS_DETAILEDCHANGES_COMPONENTS_TABLE COMPONENTS Current Current Proposed Proposed Cost Action Component Name Component Name Cost (US$M) (US$M) Component 1: Energy Efficiency Component 1: Energy 199.50 Revised 196.09 Investments Efficiency Investments Component 2: Technical Component 2: Technical 5.50 No Change Assistance and Capacity 5.50 Assistance and Capacity Building Building TOTAL 205.00 201.59 The World Bank The District Heating Energy Efficiency Project (P132741) OPS_DETAILEDCHANGES_LOANCLOSING_TABLE LOAN CLOSING DATE(S) Original Revised Proposed Proposed Deadline Ln/Cr/Tf Status Closing Closing(s) Closing for Withdrawal Applications 30-Oct-2021, 30-Jun- IBRD-83870 Effective 30-Oct-2020 30-Jun-2022 30-Oct-2022 2022 30-Oct-2021, 31- TF-16327 Effective 30-Oct-2020 31-Dec-2022 30-Apr-2023 Dec-2022 OPS_DETAILEDCHANGES_CANCELLATIONS_TABLE CANCELLATIONS Value Reason Current Cancellation New Ln/Cr/Tf Status Currency Date of for Amount Amount Amount Cancellation Cancellation LOAN Disburs IBRD- 155,000,000.0 151,589,254.0 RESTRUCTUR ing&Re USD 3,410,746.00 26-Oct-2021 83870-001 0 0 ING, COST paying SAVINGS TF-16327- Disburs USD 50,000,000.00 0.00 50,000,000.00 001 ing OPS_DETAILEDCHANGES_REALLOCATION _TABLE REALLOCATION BETWEEN DISBURSEMENT CATEGORIES Financing % Current Allocation Actuals + Committed Proposed Allocation (Type Total) Current Proposed IBRD-83870-001 | Currency: USD iLap Category Sequence No: 1-I Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Chernihiv 0.00 0.00 0.00 100.00 100.00 iLap Category Sequence No: 1-II Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Dnipropetro 767,000.00 641,725.52 767,000.00 100.00 100.00 iLap Category Sequence No: 1-III Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Donetsk The World Bank The District Heating Energy Efficiency Project (P132741) 0.00 0.00 0.00 100.00 100.00 iLap Category Sequence No: 1-IV Current Expenditure Category: GD,CW,Non-CS,CS,IOC for IvanoFrank 0.00 0.00 0.00 100.00 100.00 iLap Category Sequence No: 1-IX Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Mykolaiv 19,340,000.00 17,016,559.37 19,340,000.00 100.00 100.00 iLap Category Sequence No: 1-V Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Kharkiv 71,645,000.00 59,527,785.35 71,645,000.00 100.00 100.00 iLap Category Sequence No: 1-VI Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Kherson 19,955,000.00 4,291,095.92 19,955,000.00 100.00 100.00 iLap Category Sequence No: 1-VII Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Kirovograd 0.00 0.00 0.00 100.00 100.00 iLap Category Sequence No: 1-VIII Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Kamyanets-P 15,830,000.00 14,239,440.82 15,830,000.00 100.00 100.00 iLap Category Sequence No: 1-X Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Vinnytsia 0.00 0.00 0.00 100.00 100.00 iLap Category Sequence No: 1-XI Current Expenditure Category: GD,CW,Non-CS,CS,IOC for Ternopil 16,491,000.00 12,637,814.29 16,491,000.00 100.00 100.00 iLap Category Sequence No: 2 Current Expenditure Category: GD,CW,Non-CS,CS,TRNG,AUD,IOC for P2 5,500,000.00 2,229,562.04 5,500,000.00 100.00 100.00 iLap Category Sequence No: 4 Current Expenditure Category: Interest Rate Cap & Collar Premium The World Bank The District Heating Energy Efficiency Project (P132741) 0.00 0.00 0.00 iLap Category Sequence No: 5 Current Expenditure Category: UNALLOCATED 4,642,000.00 0.00 1,231,254.00 Total 154,170,000.00 110,583,983.31 150,759,254.00 OPS_DETAILEDCHANGES_DISBURSEMENT_TABLE DISBURSEMENT ESTIMATES Change in Disbursement Estimates Yes Year Current Proposed 2014 0.00 0.00 2015 0.00 0.00 2016 1,840,000.00 2,018,400.00 2017 9,500,000.00 9,547,712.14 2018 15,100,000.00 15,063,435.75 2019 40,000,000.00 30,235,368.59 2020 100,000,000.00 31,486,163.53 2021 42,000,000.00 31,993,822.70 .