Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No. -UY

CARBON FINANCE ASSESSMENT MEMORANDUM

ON A

PROPOSED PURCHASE OF EMISSION REDUCTIONS BY THE SPANISH CARBON FUND

IN THE AMOUNT OF EUR 480,000

FOR THE

URUGUAY

UTE 10 MW Grid Connected wind power farm at caracoles hill

November 5, 2009

Sustainable Development DepartmentCountry Management Unit for Argentina, Chile, Paraguay and UruguayLatin America and the Caribbean Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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63541

CURRENCY EQUIVALENTS(Exchange Rate Effective August 1, 2009)

Currency Unit = Uruguay Pesos (UYU)UYU 1 = USD 0.04264 USD 1 = UYU 23.4500

FISCAL YEARJuly 1 – June 30

ABBREVIATIONS AND ACRONYMSAM Approved MethodologyADME Administrator of the Electricity Market (Administrador del Mercado Eléctrico)BP Bank Policy (of the World Bank Group)CAS Country Assistance StrategyCDM Clean Development MechanismCER Certified Emissions ReductionCF, CFU Carbon Finance, Carbon Finance Unit (at the World Bank)CO2, CO2e Carbon Dioxide, Carbon Dioxide equivalentDNA Designated National AuthorityDNETN National Directorate for Energy and Nuclear Technology DOE Designated Operational EntityEB Executive Board of the UNFCCC (see below)EIRR Economic Internal Rate of ReturnEMP Environmental Management PlanENVCF See CFUER Emissions ReductionERPA Emissions Reduction Purchase AgreementGDP Gross Domestic ProductGHG Greenhouse GasGWh Gigawatt-hourHV High VoltageIBRD International Bank for Reconstruction and Development (World Bank Group)KP Kyoto ProtocolMIEM Ministry of Industry, Energy and Mines MP Monitoring PlanMW, MWh Megawatt, Megawatt-hourNPV Net Present ValueO&M Operation and MaintenanceOP Operational Policy (of the World Bank Group)PDD Project Design Document (for CDM projects)RE Renewable EnergytCO2e Metric tons of Carbon Dioxide equivalentUCC Uruguayan DNA: National Climate Change Unit (Unidad de Cambio Climático)UNFCCC United Nations Framework Convention on Climate ChangeUTE National Administration of Electricity Generation and Transport (Administración

Nacional de Usinas y Transmisiones Eléctricas)V, kV Volt, KilovoltVER Verified Emissions Reduction WTI West Texas Intermediate

Vice President: Pamela CoxCountry Director: Pedro AlbaSector Manager: Philippe Charles Benoit

Task Team Leader Roberto Gabriel Aiello

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Uruguay

UTE 10 MW Grid Connected Wind Power Farm at Caracoles Hill

CONTENTS

A. STRATEGIC CONTEXT AND RATIONALE.......................................21. Country and sector issues....................................................................................................2

2. Rationale for Bank involvement..........................................................................................3

3. Project development objective.............................................................................................4

4. Higher level objectives to which the project contributes.....................................................4

B. PROJECT DESCRIPTION..............................................................51. Key indicators......................................................................................................................6

2. Project components..............................................................................................................6

3. Technical overview..............................................................................................................6

C. APPRAISAL...............................................................................81. Institutional and implementation arrangements...................................................................8

2. Monitoring and evaluation of outcomes/results..................................................................8

3. Economic and financial analysis.........................................................................................9

4. Safeguard policies..............................................................................................................10

5. Critical Risks and Possible Controversial Aspects............................................................12

D. ERPA terms and conditions.....................................................13

Annex 1: Economic and Financial Analysis....................................14

Annex 2: Additionality justification...............................................20

Annex 3: Project Preparation and Supervision...............................21

Annex 4: Documents in the Project File.........................................22

Annex 5: Country at Glance..........................................................23

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Uruguay

UTE 10 MW Grid Connected Wind Power Farm at Caracoles Hill

Latin America and Caribbean Region (LCR)Sustainable Development Network (SDN)

Date: November 5, 2009 Country Director: Pedro AlbaSector Manager/Director: Philippe Benoit/Laura TuckProject ID: P102341Lending Instrument: World Bank Spanish Carbon Fund

Team Leader: Roberto G. Aiello Sectors: Renewable Energy (100%)Environmental Screening Category: BThemes: Climate Change (P); Pollution management and environmental health (S)

Project Financing Data:[ ] Loan [ ] Credit [ ] Grant [ ] Guarantee [X] Other: Carbon FinanceFor Loans/Credits/Others: The project does not involve Bank financing. Total Bank Carbon Financing through the purchase of CERs for an amount of EUR 0.48 Million (approx USD 0.70 Million).

Financing Plan (USDm.)Source Local Foreign Total

Spanish Carbon Fund (SCF)UTE (Counterpart)Spanish Government (debt swap)TOTAL

18.9 1.02

10.8

0.7018.9010.80 30.40

Responsible Agency: National Administration of Electricity Generation and Transport (UTE)Estimated payments (Bank FY/EUR)The Bank plans to purchase Emissions Reductions (ERs) for an amount of EUR 0.48 Million. Indicatively, this could lead to payments as in the following schedule:

FY/EUR 2011 2012 2013 2014

Annual72,000 156,500 156,500 95,000

Cumulative 72,000 228,500 385,000 480,000

Project implementation period: 2010–2014. This period refers to the duration of the ERPA (Emissions Reduction Purchase Agreement) with the SCF. However, the project crediting period under the CDM is 7 years, renewable for another two 7 year-periods. Expected effectiveness date: December 2009Expected closing date: December 2014Does the project depart from the CAS in content or other significant respects?

○ Yes ● No

Does the project require any exceptions from Bank policies?Have these been approved by Bank management?Is approval for any policy exception sought from the Board?

○ Yes ● No○ Yes ○No○ Yes ● No

Does the project include any critical risks rated “substantial” or “high”?

○ Yes ● No

Does the project meet the Regional criteria for readiness for implementation?

● Yes ○ No

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A. STRATEGIC CONTEXT AND RATIONALE

1. Country and sector issues

1. Uruguay’s indigenous energy resources are limited to hydropower and biomass and other renewable sources; however, the former has been practically developed in its entirety and the latter entails relatively high costs. Therefore, the country is dependent on imports for a large part of its supply of modern primary energy.

2. Uruguay has a relatively modest demand for energy. Energy demand in Uruguay is relatively low on a per capita basis compared to other Latin American countries. While Argentina and Chile consume about 1,000 and 1,200 Tons of Oil Equivalent (toe) per habitant per year respectively, Uruguay’s consumption is only about 600 toe per capita per year. Electricity consumption is, however, high on a per capita basis compared to other Latin American countries. In fact, at 875 kWh per inhabitant per year, it is the highest in the region (exceeded only by Barbados). Argentina and Chile consume about 749 and 536 kWh per capita per year respectively, while the averages for the Latin American and Caribbean Region and for the Southern Cone are at 457 and 683 kWh respectively.

3. The power sector in Uruguay exhibits characteristics and issues of hydro-based generation, with 70% of installed capacity being hydro. Almost all of the country’s domestic electricity generation is produced by four hydroelectric facilities that exploit almost all of the hydro-electrical potential of the country: Terra (152 MW), Baygorria (108 MW), Palmar (333 MW), and Salto Grande (945 MW). The remainder of the installed generation capacity is mostly covered by expensive small thermal power plants (with the exception of the larger, but still fairly expensive 200 MW Punta del Tigre diesel power plant that went online in 2007) and mobile diesel generators, mostly activated during peak demand. This leaves Uruguay vulnerable to seasonal rainfall patterns, even if under normal hydrological conditions Uruguay can supply its off-peak domestic demand.

4. This is increasingly a problem, since following the crisis of 2001-2003, Uruguay has resumed a positive growth pattern (7% GDP growth in 2006, 7.4% in 2007, 10.6% in 2008 and 3% expected for 2009), leading to a higher dependency on imports from Brazil and Argentina in years of low rainfall. Electricity consumption in Uruguay is currently above 7 TWh per year, with over 2 TWh from imports in dry years. Electricity consumption is expected to increase 3% annually for the next years. There are a few hydro generation sites but with limited potential, so future electricity needs will require the installation of new thermal units. However, high and volatile international oil prices, together with uncertainties regarding natural gas supply from Argentina or Bolivia and a total absence of fossil fuel reserves in Uruguay pose barriers to an expansion of generation capacity through thermal plants.

5. At the beginning of 2004 and 2006, Uruguay underwent a prolonged period of drought, acutely reducing its generation capacity from hydro-electrical sources. In addition, since 2004, Argentina started to experience difficulties to satisfy its domestic demand for energy and natural gas, with direct repercussions on its firm delivery contracts with neighbouring countries, including Uruguay. During 2004 and 2005, Uruguay was able to obtain some back-up energy from the regional market at prices far below the costs of its own thermal

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generation, benefitting from low prices in the Argentine spot market and from hydraulic surpluses in Brazil. Furthermore, 2006 set a record with over 2,800 GWh imported from Argentina and Brazil, at average prices of US$57.9/MWh and US$63.8/MWh respectively. However, import prices increased significantly in 2008, when the average was US$146.5/MWh from Argentina and US$340.5/MWh from Brazil.

6. In 1994, Uruguay created the National Climate Change Unit (Unidad de Cambio Climático, or UCC), with the following attributions: (i) organize, manage and execute activities resulting from the UNFCCC criteria compliance, (ii) identify, create and assess policies and measures as responses to climate change, and (iii) disseminate and promote technologies, practices, and process for greenhouse gas ERs. When Uruguay ratified the Kyoto Protocol in 2001, the UCC became the Designated National Authority, thereby creating the legal framework for CDM project implementation in the country.

7. The Energy Strategy Guidelines for Uruguay were defined in 2006 by the Ministry of Industry, Energy and Mines (MIEM). This strategy includes: (i) diversifying energy sources to reduce costs and emissions, as well as increase energy security; (ii) increasing private participation in new renewable power generation1; (iii) increasing regional energy trade; and (iv) facilitating availability and acquisition of energy efficient goods and services, including efforts to raise public awareness regarding demand-side management interventions. According to the National Directorate for Energy and Nuclear Technology (DNETN), grid-connected wind power generation is one of the domestic resources with the highest potential in Uruguay for the medium and long term. The Uruguay Wind Farm Project fits perfectly within this framework by offering both renewable energy generation capacity and greenhouse gases emission reductions.

2. Rationale for Bank involvement

8. The Kyoto Protocol of the United Nations Framework Convention on Climate Change (UNFCCC) entered into force on February 2005. This international agreement commits industrialized countries to reduce their carbon emissions by an average of 5.2% below their 1990 levels during 2008-2012. The Protocol provides for two flexible mechanisms for meeting these obligations - the Clean Development Mechanism (CDM) and Joint Implementation (JI). The CDM enables industrialized countries to meet part of their obligations through the purchasing of emissions reduction from projects that generate such emission reductions in developing countries (which do not have an obligation to reduce their emissions under the Kyoto Protocol).

9. The World Bank’s Carbon Finance Unit (CFU) helps to ensure consistency between the individual projects it supports and the international dialogue on climate change, while providing the opportunity to mobilize global experts with experience in the field, technical support for project preparation, supervision capacity, and development of linkages with other sources of expertise and funding. By mobilizing the private and public sectors on an important new source of project finance, the CFU is developing an important knowledge base and is demonstrating how insights and experience from both sectors can be pooled to

1 Decree No.77/2006 was the first specific step to incorporate private electricity generation from wind, biomass and small hydroelectric plants.

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mobilize additional resources for sustainable development and address global environmental concerns.

10. The CFU currently administers 10 funds/facilities, namely: the Spanish Carbon Fund (SCF), the Prototype Carbon Fund (PCF), the Netherlands Clean Development Mechanism Facility (NCDF), the Community Development Carbon Fund (CDCF), the BioCarbon Fund (BioCF), the Italian Carbon Fund (ICF), the Netherlands European Carbon Facility (NECF), the Danish Carbon Fund (DCF), the Carbon Fund for Europe (CFE) and the Umbrella Carbon Facility (UCF).

11. The World Bank is uniquely positioned to support this project because of its extensive experience and expertise in renewable energy and climate change as well as in its capacity as Trustee of the SCF, specifically entitled to purchase emissions reductions from the project in the framework of a debt-equity swap agreement between Spain and Uruguay. The Bank is the regional leader in this field and has implemented several renewable energy and more specifically wind power projects in the region (notably La Venta II in Mexico, and Jepirachi in Colombia), under the CDM framework. Moreover, the Bank, through its internal safeguards has extensive experience in dealing with the sensitive environmental (e.g. impact of wind turbines on bats and birds) and social (e.g. benefit sharing and land tenure) issues, and its expertise will be very valuable in all project stages as this project is to be the first of its kind in Uruguay and pave the way for others.

12. In addition, even though this is a relatively small scale project compared to the World Bank threshold, Bank involvement also stems from the fact that the project takes place under the framework of an External Debt Swap Agreement between Uruguay and Spain, signed on April 15, 2003 and approved by Law No. 17, 665 on July 11, 2003. In May 2005, a second phase of the External Debt Swap Program for a total of about US$11 million was agreed. In this case, instead of repaying this portion of its debt to Spain, Uruguay agreed to sponsor this wind farm project and buy the necessary technology from Spanish companies. Conversely, Spain will get the carbon credits generated by this project through an Emission Reductions Purchase Agreement (ERPA) to be signed with the SCF2. The SCF has already included the purchase of ERs from this project in its portfolio.

3. Project development objective

13. The PDO for this project is to purchase 48,000 tons of CO2e in the period 2010-2013.

4. Higher level objectives to which the project contributes

14. The Uruguay Wind Farm Project will contribute to the sustainable development of Uruguay, most notably by increasing energy supply and the substitution of crude oil and derivatives imports. Being the first of its kind, the project is designed as a small-scale pilot, aimed at being easily replicated in case of success.

2 Agreed by a Binational Committee composed by representatives from the Ministries of Economy and Finance of Spain and Uruguay (Acta Nro 1 - 29/11/2005, Acta Nro. 2 - 27/03/2006, Acta Nro. 3 - 20/07/2006)

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15. The project will also reduce greenhouse gas emissions by grid-connected electricity generation from wind power. The emissions reduction will arise from the displacement of fossil-fuel-based electricity generation on the national grid.

B. PROJECT DESCRIPTION

16. The Wind Farm Project is located in Sierra de los Caracoles (Caracoles Hill), between national routes number 12 in the West, number 9 in the South and number 39 in the East. The hill is 303 meters over sea level. The geographical co-ordinates of the project location are 54º 57´13´´W (longitude) and 34º 37´13´´S (longitude).

17. The wind potential for Caracoles Hill was analyzed by the Faculty of Engineering (UDELAR) under an Agreement between the Faculty and the Ministry of Industry and Energy. According to the report “Analysis of the locations to install a 10 MW wind farm” The site presents average wind speeds of 9 m/s, yielding a capacity factor of 40%.

18. The wind farm has already been built and has already been fully operational since January 2009. The wind farm has a total installed capacity of 10 MW. In particular, the project involves five 2 MW wind turbines from VESTAS, model V80. With a total plant factor of about 40%, the wind farm is expected to produce about 36 GWh per year. The technology used is proven as it is most commonly employed in Europe and elsewhere.

19. The technology for connection to the grid has been provided by UTE, Uruguay's national electricity company, which has the monopoly for transmission and distribution. The interconnection to the network has been made through a 31.5 kV line of about 20 km length and a boosting transformer.

20. The project activity is expected to generate Certified Emission Reductions (CERs) and revenues through the selling of these CERs under the Kyoto Protocol CDM. The revenues obtained will contribute to the elimination of the barriers that prevent the implementation of this type of projects, among which the high cost of electricity generation from wind power due to a supply shortage in wind turbines manufacturing and irregularity of wind patterns.

21. The project had a positive impact on local employment during construction (about 39% of the total labor needed for the project was from the immediate area) in a region with high unemployment3. In addition, the project involved the improvement of 4 km of an existing dirt road leading to the top of the ridge where the wind turbines are located. This has helped those landowners living near that stretch of road—and who are not directly affected by the project—to have easier, quicker access to route 39.

22. Additionally, the emission reduction credits generated through the project activity will help Annex I countries meet their emission reduction obligations as agreed under the Kyoto Protocol.

3 The national unemployment rate in December 2008 was of 6.9%, while the rate for the Department of Maldonado, where the wind farm is located, was of 9.2% (National Statistics Institute).

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1. Key indicators

23. Performance indicators: The primary performance indicator is the timely delivery of ERs for which payments will be made by the SCF in accordance with the Emissions Reduction Purchase Agreement (ERPA).

24. The expected emission reductions generation schedule is as follows4:

i. Annual: 25,555 tCO2eii. Up to and including 2012: 76,662 tCO2eiii. Up to a period of 7 years: 178,878 tCO2eiv. Up to a period of 10 years: 255,550 tCO2ev. Up to a period of 21 years: 536,655 tCO2e

2. Project components

25. The proposed Uruguay Wind Farm Project is a small scale stand-alone carbon finance investment and therefore comprises a single component: the purchase of emission reductions from the displacement of thermal generation capacity on the Uruguayan grid by renewable energy from wind power generation.

26. There is no IBRD lending involved in this project. The SCF, administered by the IBRD as Trustee, will purchase ERs from the project and will make annual payments, according to the ERPA, upon verification of the generated ERs by an independent entity (Designated Operational Entity, or DOE).

3. Technical overview

27. As agreed in the debt swap arrangement at the origin of the Uruguay Wind Farm Project, the technology used for the construction of the wind farm has been procured from a Spanish company, EDUINTER, selected by UTE through a bidding process.

28. Each wind turbine comprises the following parts:a. The gondola: housing the machinery related to blade movement, orientation of the

turbine, generator, etc.)b. The blades: they are made with a heart of balsa wood covered with several layers of

glass fiber and carbon fiber where the tension is greater.c. The rotor: a cube on the rotation axis carrying the blades. It is connected to a gearbox

that multiplies the rotation speed transferring it to a smaller axis connected to the generator.

d. The orientation system: a mix of an anemometer (measuring wind speed), a weather vane (indicating wind direction) a rotation axis for the gondola and motors that ensure the blades are perpendicular to the direction of the wind when it is working and parallel to it (feathered) when wind speeds are too high (to avoid damaging the turbine) or too low.

e. The tower: A tubular steel tower, made from individual sections of 20-30 meters each assembled together to reach the required height, that supports the gondola and the blades.

4 According to the PDD and expecting registration in mid-2010.

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29. The equipments selected (VESTAS V80) comply with the following technical specifications:

Type Class ICut-in wind speed 4 m/sCut-out wind speed 25 m/sAxis HorizontalNominal frequency 50 HzNominal capacity 2 MWTotal number of wind turbines to be installed 5Total capacity of the wind farm 10 MWDiameter of the rotor 80 mNominal rotation speed 16.7 rpmNumber of blades 3Length of blade 40 mTower height 67 mMinimal distance between towers 240 m (corresponding to 3 rotor diameters)Generated tension 690 VNominal exit tension 31.5 kVNet capacity factor 40.8 %

30. The construction period comprised the following phases:a. Adaptation and construction of the access road to the wind farm site.b. Set up of the construction site (mortar, machinery, etc.).c. Dismantlement of the existing single wind turbine and meteorological tower on the

site.d. Construction of the wind farm and assembling of the wind turbines and

meteorological tower.e. Interconnection between the wind turbines, the meteorological tower, control center,

protection and measurement relay and the transmission line.f. Construction of the control center and the protection and measurement outlet.g. Dismantlement of the construction site and final conditioning of the land and access

roads.

31. The wind turbine technology described above is proven; similar to the ones used in other wind farms in registered UNFCCC projects around the world.

C. APPRAISAL

32. This section describes the Bank’s plans for assisting the implementation of the Uruguay Wind Farm Project, including institutional arrangements and monitoring and evaluation of project performance in line with the requirements of international environmental frameworks. The project is also assessed on a financial and economic basis.

1. Institutional and implementation arrangements

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33. The project entity is UTE, which will enter into an ERPA with the World Bank. The Bank acts as a trustee of the SCF for the purchase of GHG emissions reductions. During the first two years, project operation will be carried out with support from the contractor, Eduinter, while Vestas, the manufacturer, will be in charge of maintenance. After this initial period, UTE will assume all operation and maintenance responsibilities.

34. The World Bank’s involvement in this project, as a trustee of the SCF, allows the purchase of emissions reductions beyond 2012 using the principles of the CDM mechanism. This arrangement reduces the uncertainty regarding the value of emissions reductions beyond the period mandated by the Kyoto Protocol and enhances the financial viability of the project.

35. A Letter of Intent (LoI) was signed on December 29, 2008 between the project entity and the World Bank (as a trustee of the SCF) to purchase emission reductions from the project and a preliminary agreement was reached for an estimation of ERs, indicative prices, and payment arrangements for the contracted emission reductions resulting from the operation.

36. The rules and modalities under the Kyoto Protocol require that CDM projects be approved by the national government through the Designated National Authority (DNA) for CDM projects. In Uruguay, the DNA is the Unidad de Cambio Climático (UCC). The DNA is responsible for approving the project, and provides confirmation that the project is consistent with the country’s overall sustainable development priorities. The so-called “Letter of Approval” for the project will be requested before the signing of the ERPA.

2. Monitoring and evaluation of outcomes/results

37. Carbon Finance projects are initially evaluated on the basis of an ex-ante analysis of the emissions baseline (conventional generation and emissions that would have occurred in the absence of the project) and determination of project additionality. Project performance will then be monitored as per a Monitoring Plan included in the Project Design Document (PDD). The performance of the Uruguay Wind Farm Project will be evaluated according to achievement of the expected ERs. Monitoring and evaluation of ERs is implicit in the project as a function of the amount of renewable electric power generated and sold to the grid.

38. The monitoring of the emissions will be carried out by the project entity based on monitoring equipment output, and verified by an accredited Designated Operational Entity (DOE), as required under CDM rules. The DOE is an independent entity accountable to the supervising bodies of the CDM and will be responsible for validating the project activities and verifying the project’s anthropogenic GHG emissions reductions. This is part of the normal validation and verification processes of the emissions reductions, as required by the CDM rules.

39. The Bank will require that the DOE issues a Verification and Certification Report comprised of a statement of the amount of verified emissions reductions the project has generated during the verification period.

3. Economic and financial analysis

40. In accordance with the provisions of the Kyoto Protocol, “reduction in emissions must be additional to any that would occur in the absence of the certified project activity”. This

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constitutes the additionality criterion that determines whether an aspiring CDM project generates certified emission reductions (CERs).

41. Baseline methodology: The project will use the Approved Small-Scale AMS-I.D (version 13) Methodology for “Grid connected renewable electricity generation”.

42. As alluded in the introduction of this Memorandum, the current situation in the energy sector of Uruguay is one of slight imbalance between demand and supply and high seasonal variability. In addition, since most of the hydro potential has already been exploited, any new generation investment would be thermal. Within this context, the Uruguay Wind FarmProject will both generate emission reductions and provide a pilot to an alternative renewable path for Uruguay’s generation capacity expansion. The construction of wind farms would also increase energy security by effectively diversifying the supply mix.

43. The project has the potential to offset about 76,662 tCO2e up through 2012, and about 178,878 tCO2e over the 7 year period through 2016. The estimated total carbon revenues are about US$ 2.1 million between 2009 and 2016.

44. Financial sustainability is guaranteed by the carbon revenue stream and the terms of the debt swap arrangement between Spain and Uruguay. UTE has bought the equipment from Spanish companies, has financed the construction costs, and will cover the operation and maintenance costs with the revenues from electricity sales to the grid. The SCF will buy the carbon credits generated by the project. As it is a small scale project (below 15 MW), additionality will not be determined on the basis of investment analysis but on barrier analysis according to the simplified modalities and procedures for small-scale CDM project activities (see Annex 2).

45. Project costs and financing: Total investment, financed by the project sponsor, excluding O&M and carbon costs, was US$29.7 million, of whichUS$10.8 million correspond to the debt swap arrangement with the Spanish Government. The total investment covers machinery and equipment as well as installation costs and amounts to about US$2,900 per kW installed for the 10 MW plant.

46. ERs revenues: The project reduces GHG due to substitution of thermal generation. ER estimates will be calculated according to the emission factor of the grid and the estimated annual electricity output, while revenues depend on the terms set out in the ERPA.

47. Economic Indicators (NPV and EIRR): The impact of carbon revenues on the economic internal rate of return (EIRR) and the Net Present Value (NPV) is very limited, as shown in Annex 1. Specifically, as the sensitivity analysis for different CERs price scenarios shows, the differential EIRR (with and without CERs) is always below 1%.

48. Sponsor Financial analysis: The project will be implemented and operated by UTE, Uruguay’s public utility, which operates thermal and hydropower plants. UTE had US$844 million of revenues from energy sales in 2008 and a net loss of US$350 million for the same year. As shown in UTE’s financial statements, the net loss in 2008 is mainly due to a considerable increase in the costs of imported fuels. UTE is expected to be profitable thanks

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to increasing sales in the next 5 years. The gross revenues from energy sales and net income over the last years and a 5 year forecast are presented in the tables below:

(US$ million) 2003 2004 2005 2006 2007 2008Revenues from energy sales 554 546 644 827 989 844Net Income 154 77 119 -55 218 -350

(US$ million) 2009 2010 2011 2012 2013Revenues from energy sales (domestic) 901 931 961 1,001 1,043Net Income 112 202 105 108 95

4. Safeguard policies

49. Environment. The project has been rated as Category “B”. UTE has prepared an Environmental Assessment (EA) and an Environmental Management Plan (EMP) that were reviewed by the Bank. Although the project is in an area of mostly native grasslands (modified by livestock grazing), it has not led to any significant loss or degradation of natural habitats and no changes in land use are expected to occur from the project. Although the area is not believed to be of high risk for bird or bat collision, systematic monitoring will be implemented by an independent entity. The terms of reference for bird and bat monitoring were agreed between the Bank and UTE. Based on those terms of reference, UTE elaborated a bird and bat monitoring plan that has already been reviewed by the Bank. The only cultural property in the area is an old stone fence that has been protected during construction, apart from the necessary removal of a very small portion to widen the access road.

50. Three potential sites with high-potential wind resources were considered for the wind farm location. The criteria used for site selection included (i) quality and consistency of wind resources; (ii) proximity to high-voltage transmission lines, (iii) existing road access; and (iv) environmental considerations, including visual and bird impacts. The Sierra de Caracoles site was chosen for its superior wind resource potential and its more favorable environmental characteristics.

51. With respect to project design, the main alternative considered was to generate the same amount of electricity with a larger number of smaller turbines. This alternative was rejected because of economic criteria and because the visual impacts would have been greater. Smaller turbines would also have been riskier for resident raptors and other birds.

52. Social. For the wind farm, UTE has acquired 27 hectares, comprising a small portion of three intersecting rural landholdings. Relevant compensations are being arranged. UTE has also obtained land use easements for the 20 km power transmission line. Easements are now starting to be paid, where they have been requested. It is unlikely that these land-use changes will lead to adverse impacts on local livelihoods, since the land area available for livestock grazing and other uses will be essentially unchanged. This was confirmed through a retroactive assessment.

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53. On February 20th, 2008, a first meeting with the local stakeholders of the windmill project was organized at the Maldonado Rural and Industry Society for Development (Sociedad Fomento Rural e Industrial de Maldonado), to understand the stakeholders’ concerns about the project activity. Invitations to the meeting were sent out to the stakeholders, which included neighbours, members of the Directive Commission from the Maldonado Rural and Industry Society for Development and UTE representatives. The invitations were delivered by UTE.

54. The project was presented by UTE representatives, who gave an overall description and covered the generation aspects and the windmill’s connection to the grid (e.g. distribution issues). After the presentation, stakeholders were invited to come forward with their comments, suggestions and concerns about the project activity. The meeting was recorded and meeting minutes were published. Both materials are available for verification.

55. Two public audiences will take place in compliance with the Climate Change Unit requirements for CDM projects. These audiences are expected to happen before the end of 2009.

Safeguard Policies Triggered by the Project Yes No TBDEnvironmental Assessment (OP/BP/GP 4.01) [X] [ ] [ ]Natural Habitats (OP/BP 4.04) [X] [ ] [ ]Forests (OP/BP 4.36) [ ] [X] [ ]Pest Management (OP 4.09) [ ] [X] [ ]Physical Cultural Resources (OP/BP 4.11) [X] [] [ ]Indigenous Peoples (OP/BP 4.10) [ ] [X] [ ]Involuntary Resettlement (OP/BP 4.12) [ X] [] []Safety of Dams (OP/BP 4.37) [ ] [X] [ ]Projects on International Waterways (OP/BP/GP 7.50) [ ] [X] [ ]Projects in Disputed Areas (OP/BP/GP 7.60)* [ ] [X] [ ]

** By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas

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5. Critical Risks and Possible Controversial Aspects

Table 1. Project Risks and Mitigation MeasuresRisk Risk mitigation measure Risk rating

with mitigationBaseline risk The Clean Development Mechanism (CDM) Executive Board has approved

the baseline methodologies used in this type of project. The emission factor of the Uruguayan grid is calculated using the combined margin method with simple adjusted operating margin (OM). This emission factor is calculated ex-ante based on historical data and there is no requirement to monitor and recalculate it during the crediting period.

Low

Additionality This is a small scale project. Barrier analysis has been used for the additionality demonstration (see pages 11-13 of the PDD). Wind farms are not common practice in Uruguay, their unit cost per MW of installed capacity is higher than thermal plants and the project would effectively transfer Spanish technology to Uruguay. Carbon Finance revenue has been considered at the very beginning of the project preparation and was a critical turning point for UTE going forward with the project. However, the project has already started operations, which elevates the risk of the project not being considered as additional by the UNFCCC.

Medium

Procurement risk The procurement arrangements have already been settled. UTE bought the equipment from Spanish companies.

Low

Environmental management

An Environmental Assessment and Management Plan (EMP) have been elaborated by UTE and reviewed by the Bank. Compliance with the final version will be an obligation set forth in the ERPA. Also, UTE has extensive experience in environmental management of electricity projects.

Low

Operation and maintenance (technical)

UTE has experience in operating power plants, but no prior experience in operating wind farms. Operation and maintenance during the two first years will be under the responsibility of the contractor (Eduinter) and the manufacturer (Vestas) respectively, who will train UTE personnel so that they can take over operation and maintenance in 2011.

Medium/High

ER non-delivery risk

As the calculations of the ER are based on the plant capacity factor and the emission factor of the grid, they are unlikely to vary once the project is validated and registered.

Low

Financial risk The project does not include lending and financial risk is limited to the Bank’s preparation costs. Those costs are to be recovered through the first ER payments. Such payments are only made upon verification and delivery of the ERs, therefore limiting the risk of non-recovery of preparation costs.

Low

Social risk The project’s social risk is considered to be low. UTE has taken a proactive approach to assessing and dealing with the land acquisition needs of the wind farm and ancillary infrastructure.

Low

Reliability of the project technology

The wind turbine technology used in the project is proven. It is similar to the ones used in other wind farms in registered UNFCCC projects around the world.

Low

Project entity’s commitment tothe project’ssustainability

UTE is strongly committed to the project as it enables transfer of new technology, serves as a pilot for future wind projects and contributes to the reduction of green house gas emissions.

Low

Overall risk rating Low

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D. ERPA TERMS AND CONDITIONS

56. At this preliminary stage, a total ERPA value of Euro480,000 (approx USD 700,000) would be considered by the SCF. ERPA terms and conditions will be negotiated upon authorization by the Country Director.

Annex 1: Economic and Financial Analysis

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UTE 10 MW Grid Connected Wind Power Farm at Caracoles Hill

The Project Sponsor

Description of the Project Sponsor

57. UTE – National Administration of Power Plants and Electric Transmission is the state-owned electrical utility of Uruguay in charge of the power transmission and distribution and a part of the power generation. The rest of the power generation is ensured by the Mixed Technical Commission for the bi-national dam Salto Grande with Argentina with a total capacity of 1,890 MW, of which 945 MW are allocated to Uruguay.

58. UTE has 1,392 MW installed generation capacity of which 593 MW is hydro, 787 MW thermal (steam and gas turbines), 10 MW wind (the current project) and 2 MW Diesel-based. The total length of the HV transmission lines is 4,435 km including 771 km 500kV, 11km 230kV, 3556km 150kV and 97k m 60kV. The length of the distribution network is 71,447km.

59. In 2007, transmission losses were 3%, and distribution and commercial losses were 17.9%.Total generation in 2008 was 4569GWh, and the average retail tariff was 13.93 c/kWh.40% of electricity consumption is residential.

Description of the Project Sponsor’s Financial health

60. UTE is expected to remain profitable on the basis of growing sales of electricity. However, the company’s financial performance is sensitive to possible large increases in fuel costs for thermal generation, which may subsequently cause financial losses. This has been the case in 2006 and 2008 when fuel costs peaked at 56% of the company’s total operating costs. Increased use of thermal generation can be triggered by unfavorable hydrology affecting hydro-generation, coupled with constraints to cheaper power imports from neighboring Brazil and Argentina. During the next five years UTE is expected to remain profitable with annual fuel costs projected at about 28% of total operating costs. In this context Uruguay is focusing on developing renewable sources of energy to reduce dependence on oil imports for thermal generation. The present wind farm project supports this government effort.

Project Financing

61. Financial sustainability is guaranteed by the carbon revenue stream and terms of the debt swap arrangement between Spain and Uruguay. UTE has bought the equipment from Spanish companies, has financed the construction costs, and will cover the operation and maintenance costs with the revenues from electricity sales. The SCF will buy the carbon credits generated by the project.

62. Project costs and financing: Total investment, financed by the project sponsor, excluding O&M and carbon costs, was US$29.7 million, of whichUS$10.8 million correspond to the debt swap arrangement with the Spanish Government). Total investment covers machinery and equipment and installation costs and amounts to about US$2,900 per kW installed for the 10 MW plant.

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63. Fiscal impact: Since the World Bank is not a lender in this project there are no fiscal impacts of Bank-lending activities. However, emission reductions sales from UTE to the SCF will contribute positively to the revenue stream of UTE and will impact either the equity of the company or the fiscal position of the country positively.

Project Economic Analysis

64. The main economic benefits of the Uruguay Wind Energy project are: (i) the production of electricity; and (ii) the reduction of GHG emissions in the global atmosphere. Other economic benefits, not quantified for the purposes of this analysis but useful in evaluating the project in a qualitative manner as well, are: (i) local economic benefits of increased employment during construction, operation and maintenance of the wind power plant (in this case, mainly during construction); (ii) increased income from land where the turbines are located --without altering the use of the land; (iii) better access to agricultural land due to improved local infrastructure (i.e. access roads); (iv) building experience in the operation of large-scale wind power in Uruguay and accompanying demonstration effects; (v) avoided local pollution from fossil-fuel alternatives (NOx, SOx, etc); (vi) increased diversification in the fuel mix for electricity generation in the country.

65. Electricity Generation (benefits). The economic benefits of electricity generation are set for the purposes of this analysis at the level of the avoided cost of generating electricity using other options. The limited potential for additional hydroelectric generation and the uncertainties regarding gas supply from Argentina or Bolivia leave thermal generation from new diesel or fuel-oil plants as the only alternative to generation other than renewable sources such as wind, solar, etc. According to UTE, about 300 MW of new diesel or fuel-oil capacity would be bid out before 2012. The analysis carried out uses as a reference the generation costs of Punta del Tigre, the last thermal unit that went online (in 2007). Since this plant burns diesel, which is more expensive than the cheaper alternative (fuel-oil), and there is no clarity yet as to which will be the fuel used in the new plants expected to be built in the next few years, the generation costs of the latest fuel-oil unit added to the Batlle plant (in 1975) were also considered for the analysis5.

66. Given that generation costs have been deeply impacted by the recent volatility in oil prices, a simple analysis was carried out to map the evolution of generation costs with changing WTI (West Texas Intermediate) prices. Figures 1 and 2 below show this relationship both for the Punta del Tigre (diesel) and Batlle (fuel-oil) plants.

5 The historical generation cost data (2006-2009) were obtained from ADME (Electricity Market Administrator, Uruguay)

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Cushing, OK WTI Spot Price FOB (Dollars per Barrel) Batlle 6a (fuel oil) (US$/MWh)

Source: Energy Information Administration (USA) for WTI prices and ADME (Electricity Market Administrator, Uruguay) for generation costs

67. Three oil price scenarios, and their corresponding estimated avoided costs of thermal generation, were considered in the economic analysis. These WTI scenarios (reference, low and high) were taken from the Energy Information Administration (EIA) medium-term projections. The tables below summarize the scenarios considered both for diesel and fuel-oil (FO) generation in Uruguay.

Table Annex1.1: Oil price and cost of thermal generation scenarios used in the economic analysis.

Scenario

WTI price (US$/bb)

Costs of diesel generation (US$/MWh)

Cost of FO generation (US$/MWh)

Low 50 200 100Reference 110 400 225High 160 550 300

68. Reductions of GHG emissions (benefits). The economic benefit of reducing emissions of GHG is an issue of environmental externalities. The economic value of reducing such emissions is subject to complex factors, for which current knowledge is far from certain. The Kyoto Protocol is indirectly creating a market value for such emissions reductions. However, the nature of the Kyoto Protocol agreement and the fact that not all countries are participating in the market created by the CDM suggest that prices reflect only part of the actual economic value of GHG emissions reductions. For the purposes of this economic analysis the agreed values and terms between UTE and the SCF are used, but this could be a low estimate of actual economic benefits.

69. Project Economic Costs. The main economic costs of the wind energy project are: (i) the investment necessary for the construction of the project; and, (ii) the costs of operation and maintenance (O&M). For the economic analysis all taxes (transfer payments) and debt service costs would be ignored6. However, this particular project is not subject to either taxes or debt service payments. The investment necessary for the construction of the project is known since the project has already been commissioned and is in operation. Operation and

6 See “Handbook on Economic Analysis of Investment Operations”, chapter. 5, Belli P. et al, World Bank, January 26,1998.

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maintenance costs for the first two years (2009 and 2010) are also known since they were part of the contract awarded to the Spanish contractor (Eduinter). However, since these costs are below regional and international averages (0.014 to 0.018 USD/kWh in Germany, Spain, Denmark and UK; and 2-3% of initial investment annually or 15-20% of annual electricity sales in Argentina)7, the estimates from 2011 onwards were revised upwards.

70. A summary of the main assumptions used for the economic analysis is available in the table below:

Table Annex 1.2: Key assumptions for the economic analysis

Key parameters Value UnitRated Plant Capacity 10 MWPerformance factor 48 %Wind farm availability 85 %Net Capacity Factor 40.8 %Project Lifetime 21 YearsCapital Cost 2,900 US$/kWDiscount rate (1) 10 %Annual Electricity Produced 35,741 MWh/yrOperation & Maintenance (O&M) Costs (09-10) 6.43 US$/MWhOperation & Maintenance (O&M) Costs (11-29) (2) 10.20 US$/MWhEmission factor 0.715 tCO2e/MWhEmissions Reductions (tCO2e/yr) 26 tCO2e/yrExchange rate (EUR:US$) 1.4  Emissions Reductions Sales Period (3) 19.5 YearsEmissions Reductions Price (09-12) 9.00 Euro/tCO2eEmissions Reductions Price (13-29) 9.00 Euro/tCO2eTotal Carbon transaction costs 90,000 US$Total Carbon monitoring and verification 11,000 US$/yr(1) Source: UTE(2) O&M = 0.4*2.5%(investment)+0.6*(17US$/MWh*Generation(MWh))Source: MIEM-DNETN. Oct-08(3) Assuming registration as CDM in mid-2010 and assuming that all the CERs generated by the project until 2029 are sold at the reference price

71. The project is economically beneficial as the NPV exceeds zero and the economic internal rate of return (EIRR) exceeds the opportunity cost of capital in Uruguay, taken to be 10% The project may remain economically beneficial for values of avoided thermal generation (imports) exceeding 10.2 c/kWh. Changes in revenue from emissions reduction affect the EIRR within a range less than 1%.

Table Annex 1.2.1

Discount rate NPV ($) EIRR (%) Switching value of avoided cost of thermal generation (imports) (c/kWh)

10% 83,623,101 48.4 10.2

7 See “Economic and financial analysis: 10 MW Wind Farm Project. Ministry of Energy and Mines, October 2008.

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72. Based on the above assumptions, the following results are obtained for a range of discount rates in the reference scenario for oil prices:

Table Annex 1.3.1: Economic Net Present Values considering avoided costs of diesel thermal generation at 40c/kWh

Discount Rate Economic NPV with ERs Economic NPV without ERs8% $102,855,733 $100,374,366 9% $92,632,643 $90,375,952

10% $83,623,101 $81,564,205 11% $75,654,972 $73,770,818 12% $68,583,643 $66,854,395

Table Annex 1.3.2: Economic Net Present Values considering avoided costs of fuel-oil thermal generation at 22.5 c/kWh

Discount Rate Economic NPV with ERs Economic NPV without ERs8% $44,845,087 $42,363,720 9% $39,311,873 $37,055,182

10% $34,446,311 $32,387,414 11% $30,153,478 $28,269,324 12% $26,353,636 $24,624,387

Table Annex 1.3.3: Sensitivity Analysis of NPV at 10% discount rate in relation to Electricity Costs for diesel thermal generation in the three oil prices scenarios

Electricity generation opportunity costs (US$cents/kWh)

Economic NPV with ERs Economic NPV without ERs (electricity benefits only)

Low: 20 $27,421,055 $25,362,159 Reference: 40 $83,623,101 $81,564,205 High: 55 $125,774,636 $123,715,739

Table Annex 1.3.4: Sensitivity Analysis of NPV at 10% discount rate in relation to Electricity Costs for fuel-oil thermal generation in the three oil price scenarios

Electricity generation opportunity costs (US$cents/kWh)

Economic NPV with ERsEconomic NPV without ERs (electricity benefits only)

Low: 10 ($679,968) ($2,738,864)Reference: 22.5 $34,446,311 $32,387,414

High: 30 $55,522,078 $53,463,182

73. A sensitivity analysis to CERs prices was also performed for the reference scenario. The following results were obtained:

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Table Annex 1.4: Sensitivity Analysis of Economic Rates of Return in relation to price of CERs

Incremental EIRR (%) - Integrating Carbon Finance

CER Price(Euro/tCO2e)

Purchase Period (years)5 7 10 14 21

€ 8 0.432% 0.483% 0.513% 0.523% 0.526% € 9 0.491% 0.548% 0.581% 0.593% 0.595% € 10 0.549% 0.613% 0.649% 0.662% 0.665% € 12 0.666% 0.742% 0.786% 0.801% 0.805%

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Annex 2: Additionality justification

URUGUAY: UTE 10 MW Grid Connected Wind Power Farm at Caracoles Hill

1. Additionality for this project has been demonstrated using a barrier analysis8, which shows that the project faced both investment and technological barriers.

2. Investment barriers. The implementation of the project activity faces high investment costs (USD 2900 /kW in this case for Caracoles Wind Farm) in comparison with the prevailing practice, fossil fueled generation plants (USD 350-1000 /kW). In addition, wind energy is not subject to special tariffs and since investment cost is higher, it is harder to repay the project.

3. UTE contributed two-thirds of the total investment. The debt swap with the Government of Spain contributes approximately a third of the total investment. The development of this investment as a CDM project and the revenue from sale of CERs were considered since the beginning of the process of approval of the debt swap agreement. Representatives from the Government of Spain, the Government of Uruguay, UTE and the World Bank participated in the discussions leading to the approval of this CDM and debt-swap project. As a result, the present PDD was developed and will be presented for the project activity.

4. According to the resolution R 06.-250, UTE capital contribution to implement the project activity corresponds to a profitable generation investment from the company’s point of view. The contribution of the debt swap (USD 10,800,571.99) thus reduces UTE’s investment costs in this project to the levels of other alternative energy generation projects (i.e. fossil-fuel generation plants).

5. Technological barriers. As previously mentioned, Uruguay had no experience with wind technology until the implementation of this project activity and another private project (Nuevo Manantial), developed during the same period of time. In particular: (i) there was no skilled, trained labor to install, operate and maintain the wind farms in Uruguay, which lead to additional risks of inadequate equipment installation, disrepair and malfunctioning; (ii) there is a lack of infrastructure to build the wind farm, in particular special cranes, which are only available abroad. In addition, roads had to be built to transport the towers and wind farm equipment to Caracoles Hill; and (iii) there are uncertainties regarding the behavior of the wind farm connected to the grid. As wind power fluctuates, there are concerns about the power quality and dispatch management.

6. Moreover, from the utility’s (UTE) perspective, a thermal generation plant presents the distinct advantage of being controlled, unlike intermittent wind generation. This means that the project activity does not contribute to system security as much as the alternative. All recent additions in power generation by UTE have been thermal power plants either gas powered or diesel powered. Renewable energy power plants have been undertaken by the private sector, and only one uses wind technology.

8 From PDD

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Annex 3: Project Preparation and Supervision

URUGUAY: UTE 10 MW Grid Connected Wind Power Farm at Caracoles Hill

The project preparation for the Wind Farm Project is outlined below.

  Planned Actual

Concept review (Virtual) 01/26/2009 02/05/2009Initial PID to Infoshop 01/26/2009 03/03/2009Initial ISDS to Infoshop 01/26/2009 03/03/2009Appraisal 04/14/2009 08/25/2009Negotiations 11/15/2009 11/16/2009Sign ERPA 12/15/2009

Bank staff and consultants who worked on the project are listed below.

  Title UnitRoberto G. Aiello TTL (Senior Energy Specialist) LCSEGAlmudena Mateos Co-TTL (Energy Specialist, Consultant) LCSEGClaudia Croce Deal Manager ENVCFGeorge Ledec Environmental Specialist (Lead Ecologist) LCSENFrancis Fragano Environmental Specialist LCSENKennan Rapp Social Development Specialist LCSDEFlavia Rosembuj Senior Legal Counsel LEGCFMonali Ranade Carbon Finance Specialist ENVCFNikolay Nikolov Operations Officer ECSSDSebastien Pascual Junior Professional Associate LCSEGAlma Domenech Program Assistant LCSEG

Alejandro Deeb Peer Reviewer (Senior Environmental Specialist, Consultant) LCSEN

Eduardo Zolezzi Peer Reviewer (Senior Energy Specialist, Consultant) LCSEG

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Annex 4: Documents in the Project File

URUGUAY: UTE 10 MW Grid Connected Wind Power Farm at Caracoles Hill

1. Strengthening Energy Security in Uruguay, ESMAP Technical Paper 116/07. May 2007.

2. Energy Strategy Guidelines (Lineamientos de Estrategia Energética). Uruguay 2006. Ministry of Energy and Mines, August 2006.

3. Environmental Impact Assessment. 10MW Wind Farm, Sierra de los Caracoles. UTE, May 2009.

4. Birds and Bats Monitoring Plan – June 2009 (Diagnóstico de las Aves y mamíferos voladores que habitan en el entorno de la Sierra de los Caracoles y el Diseño de un Plan de Monitoreo)

5. Expropriation and easements procedures – August 2009 (Procedimientos de expropiación y servidumbres y su aplicación al proyecto de UTE)

6. Economic and financial analysis.10 MW Wind Farm Project. Ministry of Energy and Mines, October 2008.

7. Wind Power Program Proposal for Uruguay. Analysis of potential sites for a 10 MW wind farm. Ministry of Energy and Mines - UDELAR, December 2005.

8. PDD. UTE 10 MW Grid Connected Wind Power Farm at Caracoles Hill

9. Consolidated and Audited Financial Statements. UTE, 2008 - 2007.

10. Consolidated and Audited Financial Statements. UTE, 2007 - 2006.

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Annex 5: Country at Glance

URUGUAY: UTE 10 MW Grid Connected Wind Power Farm at Caracoles Hill

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Annex 5: Uruguay: Country at a Glance (continued)

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