Public Disclosure Authorized - World Bankdocuments.worldbank.org/curated/pt/... · power generation system. * The Project documents relevant to the Kyoto Protocol framework, such

Document ofThe World Bank

For Official Use Only

Report No: 32687-BR

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED PIURCHASE OF EMISSIONS REDUCTIONS

FROM THE PROTOTYPE CARBON FUND

IN THE AMOUNT OF UP TO US$3.3 MILLION

TO THE

REPUBLIC OF BRAZIL

FOR THE

PCF SUGAR BAGASSE-COGENERATION PROJECT

June 24, 2005

Finance, Private Sector, and Infrastructure DepartmentBrazil Country Management UnitLatin America and the Caribbean Region

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

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EXCHANGE RATEFebruary 14, 2005 - R$ 2.57= US$ 1

WEIGHTS AND MEASURESMetric System

FISCAL YEARJanuary 1 - December 31

ABBREVIATIONS AND ACRONYMS

CAS Country Assistance StrategyCDM Clean Development MechanismCER Certified Emission ReductionCETESB State Environmental Licensing EntityCFB World Bank Carbon Finance BusinessC02 Carbon DioxideCPFL Companhia Paulista de Forca e LuzEA Environmental AssessmentEIC Econergy International CorporationEIRR Economic Internal Rate of ReturnER Emissions ReductionERPA Emissions Reduction Purchase AgreementFIRR Financial Internal Rate of ReturnFY Fiscal YearGHG Greenhouse GasIMCCC Inter-ministerial Commission on Climate ChangeKm KilometerLoA Letter of ApprovalMP Monitoring ProtocolMW Mega WattMWh Mega Watt hourNPV Net Present ValuePAD Project Appraisal DocumentPCF Prototype Carbon FundPDD Project Design DocumentPIN Project Idea NotePPA Power Purchase AgreementPROINFA Incentive Program for Alternative SourcesmtCO2e Metric Tons of Carbon Dioxide EquivalentUNFCCC United Nations Framework Convention on Climate Change

Vice President: Pamela CoxCountry Director: Vinod Thomas

Sector Director: Makhtar DiopTask Manager: Jari Vayrynen

BrazilPCF Sugar Bagasse Cogeneration Project

Table of Contents

Page

A: Project Development Objective .................................................................... 2

1. Project development objective: .................................................................... 22. Key performance indicators .................................................................... 3

B: Strategic Context .................................................................... 3

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project ......... 32. Main sector issues and Government strategy .................................................................. 43. Sector issues to be addressed by the project and strategic choices ................................. 6

C: Project Description Summary .................................................................... 6

1. Key policy and institutional reforms supported by the project ....................................... 72. Benefits and target population .................................................................... 73. Institutional and implementation arrangements .............................................................. 8

D: Project Rationale ................................................................... 10

1. Basis for PCF project selection ................................................................... 102. Major related projects financed by the Bank ................................................................ 113. Lessons learned and reflected in the project design ...................................................... 114. Indications of borrower commitment and ownership .......................... ......................... 125. Value added of Bank support in this project ................................................................. 12

E: Summary Project Analysis ................................................................... 12

1. Sector/economic ................................................................... 122. Financial and Economic ................................................................... 143. Technical ................................................................... 154. Social ................................................................... 185. Environmental assessment ................................................................... 196. Participatory Approach ................................................................... 217. Safeguard Policies ................................................................... 21

F: Sustainability and Risks ................................................................... 22

1. Sustainability ................................................................... 222. Critical Risks ................................................................... 223. Possible Controversial Aspects ................................................................... 23

ii

Pages

G: Main Project Conditions ............................................... 23

H: Readiness for Implementation ............................................... 23

I. Compliance with Bank Policies ............................................... 23

Annex 1: Institutional and implementation arrangements ............................................... 24

Annex 2: Financial Analysis ............................................... 28

Annex 3: Environmental Audit ............................................... 32

Annex 4: Project Processing Schedule ............................................... 40

Annex 5: Documents in the Project File ............................................... 41

Annex 6: Technical annex ............................................... 42

Annex 7: Status of Bank Group Operations ............................................... 50

Annex 8: Statement Of IFC Held And Disbursed Portfolio ............................................... 52

Annex 9: Brazil at a Glance ............................................... 54

- - : X

Project Appraisal Document

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1 Financing plan: Source Local Foreign Total

1 I'l-i\a~i. Scc~ol- tic\elol,e~-s 1i)1 t\\.o s~lbl>~-ojcct i (I iSSm: NOTE: n~111213c1- ~n 16.2 (20 .3 ) 11Y1.2 ( 2 0 . 3 ) 1 bt-a~licl.; ~ o t a l ln\~cslniclil I I' sccon~l phases oi' projects ~mplcmented) i l<c\ .cn~~e. ; I'l.olii ernls.lon I-ecluct~on crecl~ts a1 I_:SS 3 1C.03 for r\\.o I .:is (3.-73) I 5s ( 3 . 3 3 ) I - o I lo: I ! I L I I I I ~ C I . in braclitt.; ~f 1,~11-chasc o p t ~ o n s

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'Potal 16.3 ( 0 . 3 ) I S ( 7 . 3 ) 17.7s (20.0.;)

1 <'arl)on E~ilissious lie~luctior~s I)at;~ I:!,tl~i~:~tccI ~ \ r n l \ l o l i rccl~~ctioli!, (1111('02e) o\.cr 3002-20 12 purchasing ~ ~ c r ~ o c i : ca. 0 I 7.000 I ( 'Oe I S I I I ~ ~ ; ~ I C L ~ C I I I I > ~ I O I ~ S ~ c t i ~ l c ~ i o ~ i i 1 3 t . 1 ~ ~ (ITS'$ .' 1111('02e): I IS54 Estimated Disbursemen,t Schedule: FY 2006 2007 2008 2009 2010 201 1 2012 201 3

j Annual 460.000 160.000 160.000 1 60,000 160,000 1 60,000 163.000 1 Ei0.000 j Cumulative 460:000 620.000 780.000 940,000 1,100,000 1.260.000 1 ,L20,000 1 580.000 I j Expected effectiveness date: \.la! 1 . 2005 1 Expected closing date: I )ccembel- I ; 1 . 20 13

-- --

2

A: Project Development Objective

1. Project development objective:

The objective of the Project is to reduce emissions by generating energy from renewable sources.Furthermore, the project supports development of an international market mechanism for"Emission Reductions" (ER), under the framework of the Kyoto Protocol. In this particular case,the project is designed to facilitate the implementation of several subprojects in Brazil of whichtwo sugar bagasse cogeneration projects are presented for approval at this time. These projectswere prepared by an intermediary, Econergy International Corporation Brazil (EIC). The firsttwo subprojects are Gurani Cruz Alta Bagasse Cogeneration Project (Guarani) and Alta MogianaBagasse Cogeneration Project (Alta Mogiana), both located in the State of Sao Paulo.

The subprojects produce reductions of C02 emissions through substituting electricity producedby thermal plants with electricity from renewable sources using sugar cane bagasse. Thesubprojects self supply energy as well as sell it on a commercial basis and will also receiverevenue from sale of verified and certified emission reductions (ERs) - often referred as carboncredits.

In the context of the Clean Development Mechanism (CDM), those carbon credits are based onthe difference in greenhouse gas (GHG) emissions between the most likely practices in theforeseeable future (known as baseline scenario) and practice occurring due to project activities(known as project scenario). The positive difference in GHG emissions between the projectscenario and the baseline scenario is called additionality.

la. Relevance of the Project

* The first two subprojects under this Project - and other similar CDM projects being developedby other project developers - will create a show-case for best practices in combining thebenefits of the CDM with generation of renewable energy from bagasse for the national gridin Brazil. This will serve as an example to many other projects in a sector of high importanceto the Brazilian economy. The project also contributes to increased reliability of the Brazilianpower generation system.

* The Project documents relevant to the Kyoto Protocol framework, such as the Project DesignDocument, the Monitoring Protocol and the Baseline Study serve as a model for other similarprojects. The design and project documents will be disseminated to stakeholders from theGovernment and the private sector for replication.

* By virtue of the Repeater Project concept, the Project can be expanded to other potentialbagasse projects (see Section 4.e. below). Repeater cogeneration projects in the sugar bagassesector could become interesting for the World Bank's Carbon Funds in particular in the caseof complex and risky projects. In such cases the CFB could act as a "buyer of last resort", i.e.purchase ERs in case the project would have difficulty finding another buyer or act also as a"lead purchaser", opening the market for other buyers of ER. Sugar bagasse cogenerationprojects seem to be of interest to many buyers in the carbon credit market and therefore theCFB should avoid any crowding-out of the private sector.

3

2. Key performance indicators

* At full scale implementation of the two subprojects, certified ER of 917,000 metric tonsof carbon dioxide equivalent (mtCO2e) produced by the first two subprojects through2012 and a total of ca. 2,000,000 mtCO2e in 21 years (the maximum crediting periodallowed under the Kyoto Protocol for CDM projects).

Achievement of this performance indicator will be monitored based on a specific MonitoringPlan and verified by an independent third party as per the requirements of the Kyoto Protocol.

2a. Quality Assurance Mechanisms

A specialized World Bank team will supervise the Project activities to verify progress on projectimplementation. Additionally, CDM projects foresee a number of quality assurance mechanismsduring the preparation and implementation of the project, as indicated below. As the Projectsponsor is paid only after verification of annual performance, the sponsor has a genuine interestin complying with the provisions of the Emission Reduction Purchase Agreement (ERPA),signed between the project entities and the World Bank Prototype Carbon Fund (PCF):

* The Kyoto Protocol CDM project cycle requires independent validation of a detailed ProjectDesign Document, including the Baseline Study and the Monitoring Protocol. This validationprocess guarantees that the documentation and the project are prepared in compliance withthe CDM. The two subprojects are already being validated by TUV SUD, one of the leadingvalidation companies for CDM projects worldwide. Validation process is expected to becompleted by end of April for both Guarani and Alta Mogiana.

* The Project documentation is made available for public opinion for one month before theEmissions Reduction Purchase Agreement is signed. This provides another important controlmechanism for CDM projects.

* The Host Country provides a Letter of Approval (LoA) after the validation process has beenconcluded. The LoA will guarantee that the project is in compliance with the Host Country'sstrategy and sustainable development policies.

* During the implementation process, the ER achieved by the Project will be verified byanother external auditing company on an annual basis. The carbon credits will only be issuedif the project sponsor's activities are in compliance with the Kyoto Protocol requirements andthe MP.

* The annual verification reports are made available to the World Bank and only after thereceipt of the verification report, the payment to the Project sponsor will be effected

B: Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project

Document number: 27043 Date of latest CAS discussion: 9 December, 2003

The Project addresses the sustainability and competitiveness objectives outlined in the CAS. TheCAS mentions the importance of making strategic infrastructure investments in transport,energy, telecommunications and water resources to reduce bottlenecks and maximize thedevelopment potential. Mechanisms to attract the private sector for these investments arehighlighted in the CAS. Furthermore, more efficient use of sugar bagasse for energy in the sugar

4

and ethanol industry helps to increase productivity of agricultural land use in a state whereavailability of land for other productive uses, including food production, is becoming an issue.

The Project also supports the CAS objective of encouraging environmental protection withactions to (a) improve activities related to energy efficiency and use of renewable energy, (b)strengthen private sector involvement by contracting out delivery of special services to privatesector, local communities and NGOs; (c) promote laws, regulations and policies for tradablepollution and conservation permits. Furthermore, the importance of the World Bank's carbonfinance instruments is highlighted in the CAS to assist Brazil to develop its world-scale carbontrading market by further project development, capacity building, and replication of bestpractices.

l.a Global Operational Strategy/Program objective addressed by the project

The Project is supported by the Prototype Carbon Fund (PCF). The objective of the PCF is todevelop experience through a "learning-by-doing" approach, applying CDM and JointImplementation (JI) processes of the Kyoto Protocol:

High-Quality Emission Reductions: The PCF supports funding of projects that produce highquality greenhouse gas ER which could be registered with the United Nations FrameworkConvention on Climate Change (UNFCCC) for the purposes of the Kyoto Protocol.

Knowledge: By transacting the business of reducing greenhouse gas emissions, the PCF isdeveloping a knowledge base of business processes and practices to facilitate climate-friendlyinvestment and inform the ongoing UJNFCCC negotiations.

Public-Private Partnership: PCF resources are provided by both the public and private sectors.The PCF demonstrates how insights and experience from both sectors can be pooled to mobilizeadditional resources for sustainable development and address global environmental concerns.

2. Main sector issues and Government strategy

Renewable Energy

Renewable energy has traditionally played an important role in Brazil's energy supply, althoughmainly in large-scale installations and programs such as large hydropower plants or the NationalAlcohol Program (PROALCOOL). There are also several projects aiming at the electrification ofrural communities with solar home systems, wind farms, biomass power and photovoltaics, inparticular the national program for developing renewable energy services in rural areas(PRODEEM) and several state programs. The government provides specific financial, fiscal andlegal incentives for cogeneration plants and for small hydroelectric plants. Recently, theBrazilian Government launched the "Luz no Campo" program for rural electrification, using thecapacity of regional concessionaires as contractors and focusing on renewable energy especiallyin remote areas.

Following the Wind Energy Emergency Program (PROEOLICA) created by GovernmentResolution in 2001, which aimed at the implementation of 1.050 MW of grid connected windenergy by the end of 2003, the Incentive Program for Alternative Sources of Electric Energy

5

(PROINFA) was created by Law no. 10.438 in April 2002. The objective of this renewableenergy program is to increase the participation of electricity produced by independent powerproducers in the interconnected system, on the basis of wind energy, small hydropower andbiomass. The target of PROINFA is the purchase by Eletrobras of 3,300 MW of renewableenergy to be brought on line before the end of 2007. EletrobrAs will buy energy at pre-setpreferential prices and will market renewable electricity. PROINFA is expected to leverageprivate investments of around US$ 2.6 billion. Once the 3,300 MW objective has been met,PROINFA's long term objectives are to increase the share of electricity produced by renewablesources to 10% of annual consumption within 20 years.

Eletrobras estimates that in the sugar/alcohol sector, in terms of the surplus that can becommercialized, there is an economic potential for making available more than 2,820 MW ofadditional generation capacity.

Carbon Emissions of Brazil

Brazil is currently responsible for close to 3% of the carbon emissions of the world. Fossil fuel-related carbon emissions of Brazil increased by more than a third during the 1990s, mostly due toincreased usage of petroleum. Brazil emits more than I billion tons C02 annually and almosttwo third of it stems from forest clearing, which increased during recent years significantly.However, Brazil has a comparative low per-capita carbon emission, only about one-tenth that ofthe United States. A major contributing factor to the low fossil fuel based emissions is Brazil'sexceptionally high use of hydropower in the energy mix. Brazil is classified as a developingcountry under the Kyoto Protocol, and as such does not have quantitative emission limitation orreduction target. Nevertheless, GHG reductions and issues such as global warming are occupyinga central place in national environmental and, increasingly, economic debates.

Sugar and Ethanol in Brazil

Brazil is the largest producer and exporter of sugar in the world and has a significant impact onworld sugar market. It surpassed India as the world's largest producer and the industry outputincreased to 22.2 million metric tons in 2003 (17% of world production). The growth trend isexpected to continue due to the decision of the World Trade Organization against Europeanproducers depending on governmental subsidies. Brazil's largest and most efficient cane growingareas are in the centre-south region, with the State of Sao Paulo alone accounting for over 70%of the crop.

The strong growth in Brazil's sugarcane production has reflected a near doubling of areaharvested since 1980. Sugar yields have also increased with the use of improved varieties ofcane.The sugar industry has expanded their milling capacity and crop efficiency which occurredin parallel to a drastic decline of governmental subsidies.

Besides being the top sugar producer, Brazil is one of a few countries that produce significantamounts of ethanol (ethyl alcohol) from sugar cane. The production of alcohol from sugar wasboosted in 1975 with the introduction of the government support scheme, PROALCOOL, inresponse to the oil crisis. Since then the use of sugarcane for alcohol production has expandedrapidly, now representing 53% of world production. The Government also recently increased theethanol concentration required in "gasohol" from 20% to 25%.

6

3. Sector issues to be addressed by the project and strategic choices

The project activity is consistent with the World Bank and Brazilian sector policies as it supportsthe use of renewable sources of energy and the involvement of the private sector. However, thechallenging issue with carbon finance projects is still their novelty in most countries and sectors.For this reason a project by project learning approach has been implemented by the PCF and theCarbon Finance Business (CFB) more broadly, aiming to establish precedents that can bereplicated in other projects.

The two subprojects are of strategic importance as they are among the first CDM projects in thesugar bagasse industry where one of the most important renewable energy potentials in Brazillies. Brazil's sugar industry has already an attractive pipeline of renewable energy projects,several of which started as early as 2001, and a large number of there projects are underpreparation for CDM. With the success of the first sales of ERs, many more projects areexpected to be developed. The baseline determination, Project Design Document and validationreports are publicly available and can be used for the replication projects.

Another issue facing such projects is the relatively high CDM transaction costs, in particularrelevant for projects that generate a relatively small volume of Emission Reductions. To addressthis problem and to further facilitate replication by enabling inclusion of more subprojects, theproject structure with two subprojects and potential for Repeater Projects was selected tostreamline the operations. Furthermore, the World Bank Carbon Finance Business seeks to traintechnical and financial intermediates on how to develop projects for this emerging CDM market.To this end, PCF entered in an intermediary agreement with EIC.

C: Project Description Summary

The proposed Project will allow the PCF to provide funding for renewable energy subprojects.The following paragraphs contain short descriptions of the initial subprojects that are includedwith the approval of the Project.'

Table 1. Subprojects for Approval

Principal Total ERs purchased Value of PCFSubproSubpro ject financing by PCF purchased ERsName Sponsor e (US$ 2002 -2012 (us$ ERs

Sponsor millon) (mtCO2e) Usmlin

Alta Usina Alta 8.63 (+2.5 in 170,000 + an 680,000 (toogiana MS.A n third phase) option for 100,000 ot ion)

7.56 (+ 7.6 + n 900,000 (toGuarani A Sugar 75 (+7 option for 250,000 2,150,000 with

phase) option)395,00 (74,000 1,580,000 (to

Total 26.29 with options) 3,330,000 withwith options)options)

'See Annex 6 for a detailed description of the two subprojects.

7

Alta Mogiana Bagasse Cogeneration Project is hosted by Usina Alta Mogiana S.A. and locatedin the Sapucai Mirim-Grande River Basin in Sao Joaquim da Barra Municipal District, Sao PauloState. The project focuses on increasing efficiency in the cogeneration process to produce moresteam and increase the electricity output to supply the national grid. The project is implementedin three phases. In the first phase, implemented in 2002, two 21 Bar pressure boilers wererefurbished at 42 Bar and a new 25 MW turbo generator was installed. Installed capacity reached37.5 MW. In Phase 2 (2003) a new 42 Bar boiler was installed, and the installation of another 42Bar boiler is planned for 2005 as Phase 3 of the project.

Guarani Cruz Alta Bagasse Cogeneration project is hosted by Acucar Guarni S.A. (Guarani) andfocuses on installing new facilities to increase the electricity output from its cogeneration plant.The Cruz Alta Mill is located in the Turvo and Grande River Basin in Olimpia MunicipalDistrict, Sao Paulo State. In Phase 1 (2003), Guarani installed a 21.8 MW backpressure turbo-generator and a 63 Bar boiler, with total capacity reaching 29.8 MW. In Phase 2 (planned for2005/2006), a 25 MW backpressure turbo-generator will be installed, along with another 63 Barboiler. Therefore, the total installed capacity will reach 54.8 MW.

1. Key policy and institutional reforms supported by the project

The Project supports Brazilian policy of promoting private sector participation and renewableenergy sources which is in line with CAS and sector policy. In addition, it will contribute to thepromotion of the development of the market for high quality ERs in Brazil and internationally,and to the increased knowledge and understanding of the functioning of these markets.

Apart from the support from Brazil's renewable energy programs the CDM is seen as animportant contribution to overcome the barriers for such projects. The high investment costs willnot be able to be addressed directly, but the additional revenue stream from the sale of carboncredits represent an important financial contribution and can effectively reduce long termfinancial risks, especially the uncertainties related to energy sales prices. The CDM and theincreasing investment in renewable sources for energy generation using sugar bagasse andbiomass is contributing also to increased development of appropriate technology and financeopportunities from national financial institutions.

2. Benefits and target population

The Project will have environmental benefits of reduced C02 emissions of up to 917,000mtCO2e for the first two subprojects over the 2002 to 2012 period. Furthermore, in accordancewith CDM procedures the projects can continue to be credited for the emissions reductions forup to 21 years in total. In a 21 year crediting period the two subprojects will generate reductionsof ca. 2,000,000 mtCO2e. Any subproject beyond the two being considered would increasethese figures further. The project will also increase power generation capacity in Brazil and havesignificant demonstration benefits. Therefore, the Project is expected to contribute to additionalclimate improvement that may be achieved through similar projects in the future.

The generation of electricity through bagasse in Brazil has many advantages such as: (i) benefitsto the environment due to renewable source of energy, including emission reductions and limited

8

carbon sequestration; (ii) increase of energy supply to the market relatively quickly since it takeson average only 18 - 24 months to design, procure and build a cogeneration plant; (iii) increasedreliability of dry season power supply since the sugarcane harvest of the Center South regioncoincides with the dry period of this area; (iv) reduced energy loss on transmission becausemultiple cogeneration power plants can be built closer to where the energy is consumed; and (v)increased competition in the energy generation market with entrance of new players.

3. Institutional and implementation arrangements

The institutional arrangements are described in more detail in Annex 1.

3a. Prototype Carbon Fund (PCF)

The Project will receive carbon finance and project preparation/processing support from thePCF. PCF already signed sixteen ERPAs with a total value of US$74.3 million and is negotiatinganother sixteen with a total value of US$90.9 million. The Fund expects to sign all the ERPAs byDecember 2005. All emission reductions will be purchased for the PCF investors.

3b. Brazilian Institutions Involved

The Brazilian Government has created the Inter-ministerial Commission on Global ClimateChange - IMCCC which gives advice and technical support to the Government on the issuesrelated to climate change, including inter alia the CDM and the Kyoto Protocol. The IMCCCapproves every CDM project before it can be registered and credits be traded.

Figure 1. Institutional Arrangements for the PCF Project

| PCF | IntermediaryAgreement

ERPA(s! | EICl

Letters of Approval iProect

IMCCC * * Project Sponsor(s) Preparation

3c. PCF Intermediary Econergy International Corporation

PCF has entered into an Intermediary Agreement with Econergy International Corporation (EIC),a Delaware USA based consulting company, for preparation of CDM projects in Brazil and othercountries as agreed. EIC is also the fund manager for the Clean Tech Fund. The objective of the

9

Intermediary agreement is to deliver projects to the PCF generating ERs with a value of a total ofUS$ 3 million.

3d. Renewable Energy Subproject Sponsors

The PCF will enter into ERPAs with each sponsor of the eligible renewable energy subprojects.The ERPAs define the minimum amount of ERs in metric tons of carbon dioxide equivalent thatthe eligible renewable energy subprojects will deliver to the PCF. Both Guarani and AltaMogiana are financially sound companies.

3e. Process for Inclusion of Repeater Projects

The Project is set up to provide the possibility of including additional subprojects using theRepeater Project procedure of the World Bank operational policies. Repeater Projects can beused to scale up successful operations by augmenting quantity of output, extending geographicalscope and adding additional components.

With the approval of the Project, two subprojects will be processed. Additional subprojects canbe added to as they are submitted and processed. Such additional subprojects can be financed byany one of the CF instruments managed by the World Bank. The process for their inclusion is asfollows.

Project selection criteria

Consistent with the PCF project selection criteria and project cycle, additional subprojects haveto meet the following requisites:

* Be in the project category of sugar bagasse cogeneration;* The subproject passes the additionality test as provided for by the Baseline Method;* All World Bank Group Safeguards Policies have to be complied with.

Under the Repeater Project arrangement, in addition to the project selection and portfolio criteriaspecified in the relevant carbon fund's instrument, preference will be given to projects where:

* Required licenses, concessions, permits, etc, have been obtained;* Power Purchase Agreement (PPA) or equivalent off take agreement is in place;* Debt and/or equity finance for the underlying project will be in place such that financial

closure can be attained by the time the PCF ERPA is negotiated;* An Environmental Assessment (EA) has been prepared and approved by the local

environmental agency and by the World Bank;* An operational license has been issued by the local environmental agency.

Due diligence and appraisal

A Carbon Finance Document (CFD) will be prepared for each additional project and submittedto the World Bank's Carbon Fund Unit and to the relevant sector leader and task manager forreview and subsequent required approval and clearances as per the relevant Carbon Fund's

10

Instrument and by the CFD meeting. If the Task Leader finds a project suitable for repeateroperation, he should inform the country director and initiate a special review. The project shouldalso be assigned a project ID.

Once the special review establishes the benefits of scaling up, the Task Leader should prepare ashort memorandum to the country director who will decide whether to proceed with projectpreparation. For all projects, regardless of category, a new Integrated Safeguards Data Sheetshould be prepared. An Environmental Audit similar in scope and process to the one carried outfor Guarani and Alta Mogiana would be conducted if investment already took place prior toappraisal. A separate safeguard review of compliance with environmental and safeguard policiesshould be done for all Category A projects. Therefore, future cogeneration subprojects associatedwith new sugar mills or significant expansions of existing mills, particularly where there is apossibility of expanded sugar cultivation into natural habitat areas, will be submitted to QAT fora determination of whether a Category A rating is appropriate. With such subprojects, a broaderenvironmental audit or impact assessment may be required than was applied to Guarani and AltaMogiana.

After the Country Director's decision, the task team should begin simultaneous preparation oflegal agreements and a Project Appraisal Document. One streamlined project document shouldconsist of a brief PAD and projects prepared under this framework would be reported as newdeliveries and are subject to quality reviews by the Quality Assurance Group (QAG). In addition,a CDM Project Design Document and a Monitoring Plan will be prepared and independent CDMvalidation undertaken for each Repeater Project.

D: Project Rationale

1. Basis for PCF project selection

The Project fits well with the PCF portfolio strategy of achieving diversity across countries andregions and emphasizing renewable energy, in particular relatively to small project. RepeaterProject procedure provides the necessary framework for the approval of a number of subprojects,each of which would require undue administrative efforts when dealt with individually.

Additionality and baseline: The most important Kyoto Protocol requirement for CDM projectsis that "reductions in emissions are additional to any that would occur in the absence of thecertified project activity." This environmental additionality of the project is assessed against abaseline, which describes what would happen without the proposed project. For these projects,the baseline scenario is the continuation of current practice, i.e. a scenario where the bagasse isnot utilized to generate electric energy for the grid. Emission reductions result from thedisplacement of thermal and/or electric energy generated with fossil fuels.

l~ ~ ~~~~~~~~

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2. Major related projects financed by the Bank

Table 2 below lists some of the other carbon finance projects in the Central and Latin America region.Table 2: Carbon Finance Projects in Central and Latin America

~ ect9r lssuuf- Proet' .1 ~Ssi~ra'90>

,________.__:_____E__,____ (Bank-financed projects only)Implementation Development

Progress (IP) Objective(DO)

BANK-FINANCEDEnvironent, climate change Brazil NovaGerar Landfill Gas to S S

EnergyEnviromenent, Climate Change Brazil Plantar Sequestration and S S

Biomass UseEnergy, Climate Change Brazil Lages Wood Waste S S

CogenerationEnergy, Climate Change Chile Chacabuiquito Small Hydro S SEnergy, Climate Change Colombia Jepirachi Wind Farmn S sEnergy, Climate Change Costa Rica Chorotega Wind Fart S S

and Cote Small HydroEnergy, Climate Change Guatemala El Canada Small S S

IH ydro__ _ _ _ _ _ _ __ _ _ _ _ _

IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (HighlyUnsatisfactory)

3. Lessons learned and reflected in the project design

Project identification when working with an Intermediary: Using an intermediary can lowerthe direct preparation costs for the World Bank Carbon Funds, but the capacity of theintermediary to fully implement the project could be a limiting factor in terms of preparationtime and identification of most suitable projects. On the other hand, the World Bank's CarbonFinance business may not be in as good a position as a local intermediary to evaluate theviability of initial project ideas. A number of preliminary project ideas were eventually droppedpartially due to these limitations, but during the preparation of further projects both theintermnediary and the World Bank Carbon Finance Business gained valuable experience that wasthen used to identify the most appropriate projects.

Intermediary and conflicts of interest: Some conflict of interest situations may also arisewhere the internediary has an incentive to promote the interests of both the World Bank and theproject entity. To mitigate and manage this risk all work done by the intermediary was carefullyreviewed by the World Bank and most important aspects of the ERPA was negotiated by PCFdirectly with the Project Entity (the Intermediary Agreement provides that EIC would negotiatewith the project sponsor based on basic terms provided by PCF). Finally, the intermediaryagreement was revised so that the payments from the PCF go directly to the project company andnot through the accounts of the intermediary.

m - - m Hydr

12

4. Indications of borrower commitment and ownership

In the case of carbon finance projects, the project sponsor is only paid after performance. Theactual emission reductions are verified annually by an accredited independent third party and itsstatements transmitted to the PCF. Payment will be effected based on this independentverification of progress made. Therefore, the project sponsor has highest interest in fulfilling theproject objectives.

Brazil is also rapidly evolving to one of the most important markets for CDM projects. With theentry into force of the Kyoto Protocol this trend is expected to continue and be reinforced. Thereis demonstrated strong interest in both the private sector and the Government to promote furtherCDM project activities in Brazil.

5. Value added of Bank support in this project

An important World Bank Carbon Finance business objective is to pioneer ER purchasetransactions in the emerging global market for GHG ER. The Bank's involvement is perceived ascritical in terms of benchmarking quality for increasing the emission credibility for the first of-a-kind projects in one of the most important renewable energy sectors in Brazil, as well asinstitutionalizing experiences and ensuring replicability of the projects, while providingnecessary project due diligence and other fiduciary responsibilities.

The value-added of Bank support also includes the availability of in-house expertise in powersector and in managing the environmental and social dimensions of the project and the ability todraw upon expertise in GHG mitigation policy and practice.

In addition, the World Bank Carbon Finance Business involvement adds credibility to theproject. The high quality carbon asset of the project and the Bank's high standard of duediligence is attractive to other investment funds and project financiers. It is expected that theProject will open doors for other similar bagasse and other biomass projects.

E: Summary Project Analysis

1. Sector/economic

In 2001, Brazil faced a critical electricity shortage, which can be explained both by naturalcauses (insufficient rainfall in a country which depends heavily on hydropower) andunderinvestment in the electricity industry, including delays in the authorization, licensing andconstruction of new gas-fired plants. After the 2001 power shortage, the development of powerfrom sugarcane bagasse seemed to be a natural choice. However, the sugar industry needed tofeel comfortable with the stability of the regulatory system (that has undergone many changes inthe last two decades) and get adequate guarantees for secure and sufficient returns on investment,which has now partially been provided by PROINFA.

Sugar Cane Bagasse Cogeneration in Brazil

The sugarcane business had strong governmental intervention until the 1990s. The "AlcoholProgram" - created after the oil crises of the 1970s - was terminated in the early 1990s. In

13

addition, the government ceased to determine sugar prices in the internal market in 1997 and fuelalcohol prices in 1999. The transition was not always smooth and producers sought foralternatives in order to adjust to the new market conditions. Today, Brazil is the world leadingsugar cane producer and sugar exporter, as well as producer and consumer of ethanol.

Brazilian sugar and alcohol industry is projected to process 350 million tons of sugarcane thiscrop season (see Figure 1 below), corresponding to about 80 million tons of bagasse with 50%moisture content and a calorific value of approximately 9,500 kJ/kg. Therefore, the estimatedcurrent theoretical potential of cogeneration for supplying the national grid is about 4,050 MW2 .This would be 10 times those of the existing sugarcane powered cogeneration plants supplyingthe grid. Furthermore, the Brazilian sugarcane production is predicted to increase from 350million tonnes in 2004/2005 year-crop to 500 million tonnes of sugarcane in 2010/2011. It isestimated that by 2011 the theoretical potential for cogeneration supplying the grid could grow to6.000 MW3 of installed capacity or 27,000 GWh annually. Generation of energy could also beincreased if the potential for increased cogeneration in the ethanol production units was utilizedand if technological development led to the use of sugarcane residues (tops and leaves) inaddition to bagasse for energy generation.

Before the reform of the sector, there was no incentive for sugarcane mills to operate at their bestefficiency due to restriction of access to the national grid that was imposed to independent powerproducers. Therefore, inefficient equipment - such as low pressure boilers, bad steam controllers,and mechanically activated cane crushers - led to very low energy efficiency production for thesugar production.

Recently, the Brazilian regulations removed the main barriers for entry of independent energyproducers to the market. Therefore, incentives for improving boiler efficiency have been createdso that the surplus of produced energy could be sold to the energy market. In addition, themarked need of new power plants has triggered investment opportunities for many new bagassecogeneration power plants. However, the production 4 and sale of sugar and alcohol varysubstantially based on market and weather conditions of a given year. Sponsors of bagasse-basedcogeneration plants are often concerned whether they will have enough bagasse to comply withlong term energy supply contracts. As a result, carbon finance can work as an appropriateadditional incentive to sugar mills for developing cogeneration projects and for improving theenergy efficiency of cogeneration facilities already being operated.

2 This is a theoretical potential of which perhaps 25 - 50% would be a legitimate target.3No more than 25 - 50% of this should be considered as achievable in the reasonable future.4 Sugarcane productivity fluctuates from 70 to 100 tonnes/hectare.

14

Figure 1: Sugarcane production volumes in Brazil

Sugarcane Production

sc'l l "Tljil '' c"l 1 / - . . . - _ .

:ston Cii o-0 v 0_00' ' A5llll'T :.:! , i ,.

31t'~ ~~ CO ''u * ,

ton L c'k __________v -a , _ ___ _ __ 9' '. di i i ;5 l, ei ,,

nl) N LW 1!Xl,1 I!iiC ili 1 iijl kiiil lfii~~ ~~ ~~~ $i i 1 1 ,i

90/91 92/93 94/95 96/97 98/99 00/01 02/03 04/05'year-crop

2. Financial and Econoniic

The following sections present the summary of the financial and economic analyses. The riskassessments and sensitivity analysis are included in Annex 2.

Guarani Subproject

AcuIcar Guarani S/A is a financially sound company. Like any other company of the sector,A9ccar Guarani's profitability is highly dependant on the exchange rate, sugar and alcoholprices, and the Brazilian government's incentive policies for alcohol production. Regardless ofthese factors, at least for the past five fiscal years, it has been presenting positive operationalresults that are sufficient to comply with all financial and commercial commitments.

Guarani2002 2001

Revenue (Net) 283,539 227,316Net Profit 33,130 43,388Short term Debt 6,715 4,715Long Term Debt 6,381 7,525Equity 276,599 260,839

The price of energy is the main factor that can affect the project's long-term viability. AlthoughGuarani has a PPA in place, we considered in our conservative sensitivity analysis the remotepossibility that CPFL could cancel the PPA if energy prices decrease and purchase energydirectly from the market or other producers instead. Therefore, we produced a sensitivityanalysis (see annex with Sensitivity Analysis table) to assess the impact of Guarani potentiallyhaving to sell its energy at a lower price. We concluded that the project is thoroughly robust, aseven a drop of 25% in the energy price would affect the FIRR by only 4.3%, maintaining thefeasibility of the project.

6~ ll

15

The project is already operating, so there is no construction risk related to the contracted ERsunder the ERPA. It incurred investment expenditures of approximately US$7.56 million. Thesponsor, Acujcar Guarani S/A, did not use debt to finance because of constraints imposed by itsmain shareholder Tereos. The investment costs of Phase 2 are estimated at US$7.6 million.

The impact of the ERs on the project FIRR is relatively small. With the ERs revenue, theProject's FIRR increases by 0.8% from 18.8% to 19.6%. However, the dollar denominated CDMrevenue stream has importance to these kinds of projects in terms of mitigating some risks, inparticular those related to the fluctuation in energy prices and exchange rates, raising thecreditworthiness of the company. CDM can also help in improving the public environmentalimage of the company.

The economic analysis of the Guarani subproject points to a 23.1% EIRR. The small differencebetween the project's EIRR and FIRR is the result of the inclusion of the economic value of thebagasse (see annex), and the exclusion of the impact of taxes.

Alta Mogiana Subproject

Alta Mogiana is financially sound and its operations have consistently resulted in profits andenough cash to secure every financial and operational obligation. The energy price sensitivityanalysis shows that the project is thoroughly robust as even a major drop of 25% in energy priceswould affect the FIRR by only 4. 1%, maintaining the feasibility of the project.

Alta Mogiana2003 2002


Like in the Guarani project, the impact of carbon revenue on Alta Mogiana is fairly small. TheERs increase the project FIRR from 17.2% to 17.9%, and the equity FIRR from 27.2% and28.2%. The economic analysis of the Alta Mogiana subproject points to 22.9% EIRR. However,the same risk mitigation and image enhancements benefits of the ER revenue apply.

There is no construction risk related to the contracted ERs under the ERPA because the project isalready operating. The project incurred capital expenditures of US$8.63 million. The investmentscosts of Phase 3 are estimated at US$2.5 million.

3. Technical

3.1. Cogeneration

The predominant technology in all parts of the world today for generating electricity frombiomass is the steam-Rankine cycle, which consists of direct combustion of biomass in a boilerto raise steam, to be expanded through a turbine. Most steam cycle plants are located at industrialsites, where the waste heat from the steam turbine is recovered and used for meeting industrial-process heat requirements. Such combined heat and power (CHP), or cogeneration, systems

16

provide much higher levels of energy services per unit of biomass consumed than systems thatgenerate power only.

Guarani Subproject

Until 2001, the Cruz Alta Mill worked with just a sugar mill, installing a bagasse-fired power co-generation project in 2002-2004 and expanding its capacity through introducing an alcoholproduction plant.

Table 3 below gives the main technical production characteristics of this Mill before (2002/2003harvest) and after the implementation of the co-generation project and the alcohol distillery.

Table 3Data Harvest Feb/03 (*) After Expansion

Cane grinding (tons/harvest) 2,250,000 2,900,000Daily grinding (tons/day) 10,000 14,500Harvest days 225 200Sugar production (50kg. bags/harvest) 5,224,000 6,381,000Alcohol production (liters/harvest) - 0 - 48,400,000Industrial facilities area (m2 ) 432,700 516,916Constructed industrial area (total) m2 80,591 111,798Sugar-cane area (own/partners) hectares 16,095 18,600Sugar-cane area (suppliers) hectares 18,800 22,400Sugar-cane area (total) hectares 34,895 41,000Number of employees 500 522

(*) Preliminary Assessment Report August 2002

Guarani subproject is implemented in two phases. Until 2002, Cruz Alta did not commercializeelectricity. It had two 4 MW and one 2.4 MW backpressure turbo-generators installed and active,totalling 10.4 MW installed capacity. To supply steam, three 22 Bar boilers were used.

Phase 1 (2003): In Phase 1, Guarani installed a 21.8 MW backpressure turbo-generator and a 63Bar boiler in Cruz Alta, while deactivating one 2.4 MW backpressure turbo-generator andputting a 22 Bar boiler on stand-by, with total capacity reaching 29.8 MW.

Phase 2 (2005/2006): In Phase 2, the expansion and optimization of the industrial processes willcontinue. A 25 MW backpressure turbo-generator will be installed, along with another 63 Barboiler. The 22 Bar boiler put on stand by in Phase 1 will become active, and a 4 MWbackpressure turbo-generator will be put on stand by. Therefore, the total installed capacity atCruz Alta will reach 54.8 MW in Phase 2.

Guarani has a PPA signed with CPFL (Companhia Paulista de Forca e Luz, a leading electricitydistributor in Brazil), valid though 31 December 2012. The contracted capacity is 12.5MW, butthe mill can sell any extra-amount produced above that threshold to CPFL. For Phase 2, Guaraniis negotiating an addendum for the extra amount of electricity it will produce with the newfacilities.

17


Alta Mogiana project was implemented in three phases. The co-generation facilities include 2.2kilometers of transmission line, already strung, for interconnection with the CPFL powerconcessionaire. Some key figures on Alta Mogiana sugar mill are presented in Table 4 below.

Table 4:

Data Harvest 03/04Cane grinding (tons/harvest) 2,200,000Sugar production (50kg. bags/harvest) 4,480,000Alcohol production (liters/harvest) 52,700,000Sugar-cane area (own/partners) hectares 32,453Sugar-cane area (suppliers) hectares 4,950Sugar-cane area (total) hectares 37,403Number of employees 2,155

The three phases of the cogeneration project consist of the following:

* Phase 1 (2002):

Phase 1 included the refurbishment of two 21 Bar boilers to 42 Bar each and the acquisition of abackpressure turbo-generator of 25 MW capacity. Thereby, Alta Mogiana reached a totalinstalled capacity of 37.5 MW, but the two turbo-generators of 5 MW and 7.5 MW were putstand-by. Moreover, the energy consumption in the sugar process was reduced by 19% from 530kg of steam per ton of sugarcane crushed to 430 kg.

* Phase 2 (2003):

In Phase 2, a new 42 Bar boiler was installed. Furthermore, several efficiency improvementmeasures in the sugar production process also carried out enable more efficient use of the alreadyinstalled capacity and use of more steam for the grid generation.

* Phase 3 (2005):

In Phase 3, Alta Mogiana will construct a new 42 Bar boiler to increase the steam supply forelectricity generation purposes. However, the implementation of this phase depends on itsfinancial viability and experiences from the first two phases, as well as on any increase in AltaMogiana's core business of sugar production.

Alta Mogiana has a PPA signed with CPFL valid through 31 December 2012 with full contractedcapacity of 20MW. It is worth noticing that small energy projects are not dispatched by theNational Operator of the Electricity System (ONS). Therefore, Alta Mogiana is allowed tosupply the grid more energy and could do so by using the generators put on stand-by in the Phase1 of the project. Any extra amount of electricity could be sold in the Wholesale ElectricityMarket (MAE) in Brazil.

18

3.2. Baseline and Additionality in the context of the Clean Development Mechanism

These projects use a methodology to establish the baseline scenario and to demonstrate theadditionality of the project which was developed by EIC and already approved by the CDMExecutive Board (Approved Method AMOO1 5 available on www.unfccc.int/cdm). The method isapplicable to bagasse-based cogeneration power plants displacing grid electricity. Thedisplacement of fossil fuel based electricity by these project will occur at the system's margin,i.e. this CDM project will displace electricity that is produced by marginal sources (mainly fossilfueled thermal plants) which have higher electricity dispatching costs and are solicited only overthe hours that baseload sources (low-cost or must-run sources) cannot supply the grid (due tohigher marginal dispatching costs or fuel storage - in case of hydro sources - constraints). Anelectricity baseline emission factor is calculated as a combined margin (CM) approach,consisting of the combination of operating margin (OM) 5 and build margin (BM) factors. Theemission factor calculated with this method is 499 tonnes of C02/GWh. ERs generated by theProject are then derived simply by multiplying the amount of electricity produced by theemission factor.

Furthermore, the additionality test in the sugar bagasse projects will use the "additionality tool"approved by the CDM Executive Board, requiring the project to demonstrate additionality bymeans of an investment analysis and/or barriers to investment. Additionality is established in theCDM Project Design Document and validated by an independent third party.

Barrier analysis is used to demonstrate additionality in the case of Alta Mogiana and Guarani.Such barriers to investing in cogeneration for the grid include the sponsors' culture in the sugarindustry that is focused on and dependent the conditions on the commodities - sugar and ethanol- markets. Therefore, they need an extra incentive to invest in the new business area ofelectricity production. The Power Purchase Agreements (PPA) also require different negotiationskills that are not the core competence of the sugar companies. Furthermore, when signing along-term PPA, a given sugar mill has to be confident that it will produce sufficient biomass tosupply its cogeneration project. The revenue from GHG emission reductions offers a financialincentive for the sugar mills that can mitigate some of the risks and help overcome barriers.

CDM guidelines provide that projects started after I January 2000 are eligible for CDM. Forsuch projects already in operation, the additionality tool also requires a demonstration that theCDM opportunity was considered before the project implementation. Both Alta Mogiana andGuarani have provided documented evidence that CDM opportunity was considered before thestart of the projects. Therefore, these subprojects can retrospectively receive ERs from the datethe projects started operation of the first phases.

4. Social

The sugar industry in Brazil is employing more than 500,000 people. A recent UJNDP study inBrazil shows that the expansion of the ethanol program and the sugar production has positiveimpacts on job creation and quality. Adjustments in the relationship between job quality and the

' In accordance with the method, the emission factor for the OM is calculated as the generation-weightedaverage emissions per electricity unit (tCO2/MVWh) of all generating sources serving the system, separating thepower units in low-cost/must-run power sources and other power sources.

19

number of agricultural jobs can be made to fit the local labor market; new technologies make itpossible to use more skilled workers, reducing the number of workers for the same job. The trendin Brazil is irreversibly toward better technology and higher quality, but fewer jobs.

The state of Sao Paulo has the highest technology level and produces 60 per cent of Brazil'ssugar cane. Estimates indicate that every 1 million tonnes of sugar cane processed per yeargenerates 2,200 direct jobs (1,600 in agriculture, and 600 in industry). Agricultural supervisorsand skilled industrial workers account for 30 per cent; medium-skill workers (e.g., truck andtractor drivers) account for 10 per cent; and unskilled laborers (doing planting, cultivating, andharvesting, and low-level industrial work) account for the remaining 60 per cent.

Regional differences in the labor market, particularly in technology, account for differences inthe number of jobs created per unit of energy produced, differences in wages, and in the overallquality of the jobs created. For example, the competition for manpower among various sectors ofthe economy in Sao Paulo led to higher wages and better working conditions for the cane cutters;however, the number of jobs per tonne of sugar cane is much smaller than in the Northeastbecause of greater efficiency (training, equipment) and mechanization. Similarly, gradualautomation, higher rates of productivity, and conversion efficiencies lead to fewer industrial jobsin producing and processing cane.

Job quality must be assessed in the context of other employment sectors. In Sao Paulo, the jobresponsible for the largest proportion of unskilled labor (cane cutting) generated an averageincome of US$140 per month. This is higher than the average salary of 86 per cent ofagricultural workers, 49 per cent of industrial workers, and 56 per cent of workers in the servicesector in Brazil as a whole.

This numbers are representative for the two subprojects under this Project. In addition bothcompanies have a number of social programs that would increase the quality of employment,such as private medical care and educational programs; both plants also support local educationaland daycare centers and hospitals. Guarani provides 2117 (2003) jobs and promotes more than20 social programs within and outside the company. Alta Mogiana maintains 2,155 jobs. Thenumber of employees at Guarani Cruz Alta Mill is 500 and after expansion 522.

5. Environmental assessment

Environmental Category []A [x] B [] C

The project will not directly finance the construction of the cogeneration plants, but neverthelessan Environmental Assessment (EA) was carried out during the preparation of the CDM project toidentify the impacts and the most important mitigation strategies. The EAs are based onpreviously prepared environmental assessments (RAP) required by Brazilian law. To verify ifthe current operations are in accordance with Brazilian law, the World Bank's safeguard policiesand the previously prepared EAs, the World Bank requested an independent environmental audit(see Annex 3).

The environmental audit procedures consisted of the following steps: (i) analysis of the proposaldocuments submitted to the Bank, including the technical reports, the Project Concept Note, etc.;(ii) analysis of the technical documents for environmental licensing covering the co-generation

20

activities; (iii) field inspection and visit; and (iv) analysis of the documentation received duringthe technical visit, and/or as requested subsequently from the Companies.

Guarani Cruz Alta Mill

The audit analyzed the

* water intake;* transmission lines;* liquid wastes (equipment cooling liquid wastes; wastewaters; and distillate);* waste gases (sulfur furnace gasses and gasses from burning bagasse in the boilers);* solid Wastes (bagasse, fly ash from boiler, cane washing earth, filter cake, common waste

and garbage, laboratory waste, septic tank sludge, scrap and waste oils); and* Environmental Control and Management Procedures: Road Infrastructure, Green

Manuring, Reforestation activities in Permanent Preservation Areas, Introductionactivities of untreated cane harvesting and an organic sugar project.

Outstanding Environmental Matters

The main outstanding environmental matter at the Mill is the Environmental Licensing for thepower co-generation and alcohol distillation activities:

* Temporary Operating License issued for 180 days, expiring on February 27, 2005, for thepower co-generation Project with an average output of 21.8 MW.

* Lack of Operating License (LO) - Operating License for the last alcohol distillationexpansions.

Guarani argues that it has implemented all the conditions stipulated in the Installation License,including the gasses emissions reports, and is awaiting an inspection by CETESB. It is expectedthat both licensing issues will be resolved within the next months.

Alta Mogiana Mill

The audit analyzed the* water intake;* transmission lines;* liquid wastes (wastewaters; and distillate);* waste gases (not correctly monitored yet);* solid wastes (bagasse, cane washing earth, filter cake, common waste and garbage,

laboratory waste, septic tank sludge); and* Environmental Control and Management Procedures: Road Infrastructure, Green

Manuring, Reforestation activities in Permanent Preservation Areas.


The main outstanding environmental matters at this Mill are:

21

* Water Usage Permit - The Mill presented no documentary proof of these permits. Theentity in charge of this aspect is the Sao Paulo State Waters and Electricity Department(DAEE/SP).

* Environmental Licensing - The Mill did not present the Operating License covering itssugar and alcohol production activities.

* Monitoring of Gas Emissions - The gas emissions were non-compliant, and the Mill did notpresent any monitoring reports.

Alta Mogiana has applied for all required licenses and is now waiting for the response from theState environmental agencies.

6. Participatory Approach

The Environmental Assessment (RAS) required by law was discussed with local stakeholders byboth companies prior to the construction of the cogeneration plants. The environmentalassessment did not state any negative comments from stakeholders. The EnvironmentalAssessment summary for the CDM project was disclosed in January 2005 on the webpages ofthe project companies, Econergy and the World Bank Infoshop.

In addition, the environmental assessments and a project summary were sent to several localpublic authorities, environmental NGOs and to organizations that work on climate change andCDM. No negative comments were received.

In accordance with CDM procedures, the Project Design Documents are made public to receivecomments for one month separately during the validation process. Alta Mogiana PDD iscurrently open for these comments and Guarani PDD is expected to be opened for stakeholdercomments shortly. Validation process is therefore expected to be completed by end of April forboth Guarani and Alta Mogiana.

7. Safeguard Policies

Policy | Applicaility|Environmental Assessment (OP 4.01) YesNatural Habitats (OP/BP/GP 4.04) NoForestry (OP 4.36) NoPest Management (OP 4.09) NoCultural Property (OPN 11.03) NoIndigenous Peoples (OD 4.20) NoInvoluntary Resettlement (OP 4.12) NoSafety of Dams (OP 4.37) NoProjects on International Waterways (OP No7.50)Projects in Disputed Areas (OP 7.60) No

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F: Sustainability and Risks

1. Sustainability

The sustainability of the Project depends on the availability of eligible subprojects which canproduce ERs. Brazil's sugar cane private sector has shown great interest in participation in theProject and has a great potential for renewable energy generation from bagasse projects.

The sustainability of the Project and opportunities to expand it will depend on the projectedexpansion of the sugar industry. Brazil is also very much committed to expand PROINFA, whichwill be able to provide long-term energy sales on a higher price level. As Brazil's sugarcaneproduction is relatively unsubsidized, it would also most likely be a major beneficiary of anyfreeing-up of international agricultural trade.

2. Critical Risks

Eligibility of Emission Reductions. Since the baseline and monitoring methodology used wereapproved by the CDM methodology panel, the eligibility of ERs from the project baselineappears to be less of a risk and the validation of subprojects will be formally completed shortly.

Issuance of the Government's Letter of Approval (LoA). At appraisal, the Government has notyet issued the LOAs for the subprojects, which are necessary for trading the CERs. PCFIntermediary EIC will support subproject in their applications for the LOAs, and the expectationis that the subprojects will be approved by the IMCCC.

Availability and Price of Bagasse: Since the project is already running, one of the main risks isrelated to availability of bagasse. This risk is almost negligible because, in addition to thebagasse surplus, the companies can purchase this biomass from neighboring sugar companies. Arelated risk is at which price level it is more profitable to the companies to sell the biomass ratherthan produce energy. Our estimate points to a bagasse price of at least US$40/ton. This seemsvery unlikely as the bagasse peak price has never surpassed the US$ 1 0/ton level.

CPFL credit risk: The project revenue is currently based fully on CPFL's financial capacity.CPFL generation and distribution company has outstanding financial health, and healthyshareholders. If CPFL has any financial liquidity issue in the future, both Alta Mogiana andA,iccar Guarani can sign new agreements with another energy company or sell the energy on thespot market.

Standard project risks: political, technical performance or construction risks are not anticipatedto be higher than the normal for this type of projects. The applied technology is standard, andmaintenance is inexpensive and accessible.

We must note that PCF exposure is always limited since (i) there are no advance paments and(ii) ER purchases are due once generated. If the project fails for the reasons above, no PCFpayments would have been made. Hence, PCF exposure would be restricted to only thetransaction costs incurred until then.

23

3. Possible Controversial Aspects

No controversial aspects were identified

G: Main Project Conditions

1. Issuance of a Letter of Approval through the IMCCC, satisfactory to the Bank, as adisbursement condition in the ERPAs.

2. Issuance of Environmental and Operating Licenses as disbursement conditions in theERPAs.

H: Readiness for Implementation

[X] 1. a) The engineering design documents for the first year's activities are complete and readyfor the start of project implementation.

[ ]1. b) Not applicable.

[ ] 2. a) The procurement documents for the first year's activities are complete and ready for thestart of project implementation.

[X] 2. b) Not applicable

[X ] 3. The Project Implementation Plan has been appraised and found to be realistic and ofsatisfactory quality.

] 4. The following items are lacking and are discussed under loan conditions (Section G):

I. Compliance with Bank Policies

[X ]1. This project complies with all applicable Bank policies.

[ ] 2. The following exceptions to Bank policies are recommended for approval. The projectcomplies with all other applicable Bank policies

, op Vinod ThomasTask Manager ,toirector Country Director

l l l ~p3be

24

Annex 1: Institutional and implementation arrangements

la. Prototype Carbon Fund (PCF)

The Project will receive carbon finance and project preparation/processing support from thePCF, which was established for the purposes of (i) demonstrating how project-based transactionsin greenhouse gas emission reductions can contribute to the sustainable development ofdeveloping countries; (ii) sharing the knowledge gained in the course of such transactions withall interested parties; and (iii) demonstrating how the World Bank can work in partnership withthe public and private sectors to mobilize new resources for its member countries whileaddressing global environmental concerns.

PCF purchases high quality greenhouse gas ER which could be registered with the UNFCCC forthe purposes of the Kyoto Protocol. PCF enters into an Energy Reduction Purchase Agreement(ERPA) and accompanying Monitoring Verification Plan (MVP) with "project sponsors",defining the quantity, price and other delivery conditions of ER to be purchased by PCF, as wellas accompanying institutional arrangements, including the monitoring and verification systemsand methods.

The ER estimates are based on the findings of a baseline study, carried out and validated byindependent experts. The baseline study also certifies a project's "environmental additionality",as the Kyoto Protocol requires that "reductions in emissions are additional to any that wouldoccur in the absence of the certified project activity". In other words, the project is additional ifthe scenario "with project" generates fewer greenhouse gas emission than the "baselinescenario".

To increase the likelihood that ERs acquired via ERPAs will satisfy the requirements of theUNFCCC and the Kyoto Protocol, the PCF will retain the services of internationally-recognized,fully independent third parties (so called Designated Operational Entities) to: (i) provideValidation of the subproject design, subproject specific Baseline Study (test of additionalityagainst the sector-wide baseline) and MVP; as well as (iii) undertake periodic verification andcertification of the ER generated by each subproject. In the case of this Project the DesignatedOperational Entity for the Validation stage was contracted by the EIC intermediary and approvedby the PCF.

Following each verification, the PCF will require the independent third party contracted toperform the verification to issue a Verification and Certification Report that includes inter alia:(i) a statement of the amount of verified and certified ERs the subproject has generated in therelevant period, (ii) such other matters as may be required by the UNFCCC or Kyoto Protocol;and, (iii) verification of compliance with Bank Safeguard Policies. This approach ensures thecreation of an environmental commodity that will conform with the Kyoto Protocolrequirements. It is understood that these international guidelines may change, according todecisions of the Conference of the Parties to the U.NFCCC and Kyoto Protocol.

The subprojects under the Project will be carried out by private corporations and/or parastatals.Apart from the PCF support, the project does not include any World Bank or IFC financing.PCF involvement expires after the last ER purchase takes place. Accordingly, implementationperiod is limited from the commissioning of each subproject to mid 2013 (to allow for

25

Verification and payment for ERs generated through end of 2012).

Figure 2: PCF Operational Structure

PCF operations:

Companies and Governments have contributed to the PCF which uses Fund resources to supportprojects designed to produce emission reductions fully consistent with the Kyoto Protocol and theemerging framework for Joint Implementation (JI) and the Clean Development Mechanism (CDM).Contributors, or "Participants", in the PCF receive a pro rata share of the emission reductions,verified and certified in accordance with carbon purchase agreements reached with the respectivecountries "hosting" the projects.

in ~~~~inanc o

Technology finace Emission Reductions

E IT-Economies in Transition

lb. Brazilian Institutions Involved

The role of the Brazilian Government in supporting the CDM and the Kyoto Protocol acquiresvital importance for the Project. The Government of Brazil has created two importantarrangements to deal with global climate change: a) the Inter-ministerial Commission on GlobalClimate Change (IMCCC); and (b) the Brazilian Forum on Climate Changes.

The IMCCC was created by presidential decree on July 7, 1999, with representatives from eightMinistries, the Presidency and the Extraordinary Ministry of Special Projects. The head of theCommission is the Minister of Science and Technology and its attributions are to give advice andtechnical support to the Governmnent on the issues related to the national and intemnationalscenario of ongoing climate change activities, including inter alia the CDM and the KyotoProtocol.

The PCF management unit and the World Bank have liaised with and informed the Gover'nentfocal point for the UNFCCC on all major steps in the Project development. The ExecutiveSecretariat for the CDM Brazilian will be supported through a Technical Assistance Loan to the

26

Federal Government within the context of the Competitiveness Adjustment Loan.

The Federative Republic of Brazil has ratified the UNFCCC on February 28, 1994, and theKyoto Protocol (that was adopted at the Third Conference of the Parties to the UNFCCC inKyoto, Japan on December 11, 1997) on July 23, 2002.

At the end of the Project preparation, after validation, the project needs to be approved by theIMCCC. Only after the Government has provided a Letter of Approval (LoA), certifying that theCDM project is contributing effectively to sustainable development in the host country, the CERmay become valid under the Kyoto Protocol and registered at the UNFCCC. The IMCCC issuedResolution no. 1, on December 2, 2003, outlining the approval process of CDM projects inBrazil. The ICCC has 60 days to issue the approval letter after receiving a request for LoA fromthe project participants.

Figure 3. Institutional Arrangements for the PCF Project

| PCF | IntermediaryAgreement

ERPA(s) EIC

Letters of Approval Project

IMCCC 4 * Project Sponsor(s) Preparation

lc. PCF Intermediary Econergy International Corporation

PCF has entered into an Intermediary Agreement with Econergy International Corporation (EIC)for preparation of project eligible for the CDM in Brazil and other countries as agreed. EIC is aDelaware, USA, based consultancy within the carbon market, and has worked with projects inareas ranging from carbon management, renewable energy to energy efficiency. Econergy is alsothe fund manager for the Clean Tech Fund, an investment fund with funds from the Inter-American Development Bank. This Fund proposes targeting clean technology companies inLatin America, investing in small scale energy generation, energy efficiency and water supplyprojects with power purchase agreements, energy service agreements or long term watercontracts.

The objective of the Intermediary agreement is to deliver projects capable of generating ERswith a value of a total of three million Dollars (US$ 3,000,000). The projects must be offollowing types:

27

1. Renewable sources of energy2. Improved energy efficiency in industrial or domestic sector3. Cogeneration4. Transportation sector5. Environmental residue recycling and waste treatment

Under the Agreement EIC shall (i) identify and present project to the PCF and undertakeunderlying pre-feasibility or feasibility study and business plan (if necessary); (ii) prepare theBaseline Study, the Monitoring Plan, any consultant-executed studies; and (iii) cooperate withthe PCF in the risk assessment, Validation, Initial Verification, periodic Verification andCertification, the environmental and social impact review and supervision. Delivery of Projectsshall start not later than December 31, 2002, and end no later than December 31, 2004.

ld. Renewable Energy Subproject Sponsors

The PCF will enter into ERPAs with eligible renewable energy subprojects. Each ERPA covers,inter alia, institutional roles and responsibilities for subproject implementation, and monitoringand verification obligations. The ERPAs define the minimum amount of ERs in metric tons ofcarbon dioxide equivalent that the eligible renewable energy subprojects will deliver to the PCF.Generation and delivery of the ERs shall be carried out in accordance to schedule set forth in thesubproject ERPA and be completed on or prior to a date agreed upon between the PCF and eacheligible subproject.

The PCF's total purchase of ERs from the Project will not exceed US$ 3.33 million. This totalwill include project preparation expenses such as those related to baseline establishment,validation, monitoring, verification and certification. The project sponsors shall make requestsfor payment to the PCF under the ERPA. The first payment from the PCF to each eligiblerenewable energy subproject will be agreed to in the ERPA and will occur upon declaration bythe PCF that relevant conditions have been met. Thereafter, the PCF will only pay each eligiblesubproject upon successful transfer of ERs.

A9ccar Guarani S.A. and Usina Alta Mogiana S.A. are both financially sound companies. Likeany other company of the sector, their profitability is highly dependant on the exchange rate,sugar and alcohol prices, and the Brazilian government's incentive policies for alcoholproduction. Regardless of these factors, at least for the past five fiscal years, they have beenpresenting positive operational results that are sufficient to comply with all financial andcommercial commitments. Guarani and Alta Mogiana Projects have been commissioned, but theimplementation of the second phase of Guarani is still pending.

28

Annex 2: Financial Analysis

Guarani Subproject

The following table and graph show the IRRs and NPVs of the project with and without ERs.For the NPV calculation, a broad range of discount rates were adopted, adequately coveringdifferent opportunity costs and the sovereign risk in Brazil.

Table 5: Guarani Financial AnalysisNet Present Value

IRR EquityWithout Carbon With Carbon

7% 7,802 8,3599% 5,504 5,96010% 4,577 4,99213% 2,439 2,76015% 1,408 1,68217% 598 83520% (316) (122)

Figure 3: Guarani's NPV and sensitivity to Discount Rate9,000 Guarani

8,000

7,000

6,000

> 5,000

Z 4,000

3,000

2,000

1,000

07% 9% 11% 13% 15% 17% 19%

Discount Rate

The impact of the ERs on the project FIRR is small. Without the ERs, the Project's FIRR falls by0.8% only, from 19.6% to 18.8%. However, the dollar denominated CDM revenue stream hasimportance to these kinds of projects in terms of mitigating some risks, in particular those relatedto the fluctuation in energy prices and exchange rates, raising the creditworthiness of thecompany. CDM can also help in improving the public environmental image of the company.

The economic analysis of the Guarani subproject points to a 23.1% EIRR. The small differencebetween the project's EIRR and FIRR is the result of the inclusion of the economic value of thebagasse (see Annex), and the exclusion of the impact of taxes.

29

The price of energy is the main factor that can affect the project's long-term viability. Therefore,we produced a sensitivity analysis (see annex with Sensitivity Analysis table) to assess this risk.We concluded that the project is thoroughly robust, as even a drop of 25% in the energy pricewould affect the FIRR by only 4.3%, maintaining the project's feasibility.

The project is already operating, so there is no construction risk. It incurred investmentexpenditures of approximately US$7.56 million. The sponsor, A9ccar Guarani S/A, did not usedebt to finance because of constraints imposed by its main shareholder, Tereos.

Acuicar Guarani S/A is a financially sound company. Like any other company of the sector,Acuicar Guarani's profitability is highly dependant on the exchange rate, sugar and alcoholprices, and the Brazilian government's incentive policies for alcohol production. Regardless ofthese factors, at least for the past five fiscal years, it has been presenting positive operationalresults that are sufficient to comply with all financial and commercial commitments.Nevertheless, the most recent financial results presented losses due to exceptional financialexpenditures restricted to that year. Its operational ratios are presented below.

Guarani2002 2001


Table 6: Guarani Cogeneration Power Plant - Operational Ratios

Operational Ratios

Additional Capacity 19.4 MWCapacity 29.8. MWAdditional Generation 6OGWh /yeaInvestment 7.56 US$ millionInv/Cap 39.0$/kW

Alta Mogiana Power Subproject

The following table and graph show the IRRs and NPVs of the project with and without ERs.Because the sponsors financed the project with 60% equity and 40% debt, provided by BNDES(National Development Bank), we assessed the IRR of the project with and without the loan. Forthe NPV calculation, a broad range of discount rates were adopted, adequately covering differentopportunity costs and the sovereign risk.

30

Table 7: Alta Mogiana Financial AnalysisProject NPV and FIRR

IRR Equity ProjectWithout With Without WithCarbon Carbon Carbon Carbon

7% 12,191 12,955 9,586 10,3508% 10,541 11,227 7,926 8,6129% 9,121 9,740 6,497 7,11710% 7,895 8,456 5,264 5,82513% 5,099 5,526 2,458 2,88415% 3,771 4,132 1,129 1,49017% 2,740 3,049 102 41120% 1,591 1,841 (1,034) (784)25% 362 544 (2,227) (2,044)30% (367) (229) (2,906) (2,767)

Figure 4: Alta Mogiana's NPV and sensitivity to Discount Rate

Alta Mogiana

12,000

10,000

8,000 -NPV - Equity>o \ \ -NPV - ProjectZ 6,000

4,000

2,000

7% 12% 17% 22% 27%

Discount Rate

Like the Guarani project, Alta Mogiana is not greatly impacted by the carbon credits. The CERsincrease the project FIRR from 17.2% to 17.9%, and the equity FIRR from 27.2% and 28.2%.However, the dollar denominated CDM revenue stream has importance to these kinds of projectsin terms of mitigating some risks, in particular those related to the fluctuation in energy pricesand exchange rates, raising the creditworthiness of the company. CDM can also help inimproving the public environmental image of the company.

The economic analysis of the Alta Mogiana subproject points to 22.9% EIRR. The smalldifference between the project's EIRR to FIRR is a result of the inclusion of the economic valueof the bagasse (see annex), and the exclusion of the impact of taxes.

31

The price of energy is the main factor that can affect the project's long-term viability. Therefore,we produced a sensitivity analysis (see annex with Sensitivity Analysis table) to assess this risk.Nonetheless, the project is thoroughly robust, because even a major drop of 25% in energy priceswould impact the FIRR by only 4. 1%, supporting the project feasibility.

There is no construction risk because the project is already operating. The project incurredcapital expenditures of US$8.63 million.

Table 8: Alta Mogiana Operational RatiosOperational Ratios

Additional Capacity 25 MWTotal Capacity 37.5MWAdditional Generation 87.7 MWh/yeaInvestment 8.63 US$ millionInv/Cap 34.5US$/kW

Alta Mogiana is financially sound. Like any other company of the sector, Usina Alta MogianaS.A's profitability is highly dependant on the exchange rate, sugar and alcohol prices, andincentive policies to alcohol production from the Brazilian government. Nevertheless, itsoperations have consistently resulted in profits and enough cash to secure every financial andoperational obligation (see table xx in annex). Due to its solid financial health, Alta Mogiana haseasy access to credit, including from the most selective in lending banks in Brazil such asCitibank, Itau, and ABN.

Alta Mogiana2003 2002


32

Annex 3: Environmental Audit

The power co-generation projects at the Guarani and Alta Mogiana Sugar and Alcohol mills anddistilleries in Sao Paulo State underwent an environmental audit in order to analyze theconditions at these two companies, in terms of environmental licensing and compliance with thepertinent Federal and State environmental legislation.

The environmental analysis procedures consisted of the following steps: (i) analysis of theproposal documents submitted to the Bank, including the technical reports, the Project ConceptNote, etc.; (ii) analysis of the technical documents for environmental licensing covering the co-generation activities; (iii) field inspection and visit; and (iv) analysis of the documentationreceived during the technical visit, and/or as requested subsequently from the Companies.

The analysis covered the current operations of these mills and distilleries in terms of powergeneration and the production of sugar and alcohol.The findings of this analysis are presented by company, as follows: (1) technical description ofthe Mill and the co-generation plant; (2) production and discharge of solid wastes in theenvironment; (3) environmental licensing status; (4) environmental control procedures, and (5)outstanding environmental aspects.

GUARANI CRUZ ALTA MILL

Until 2001, the Cruz Alta Mill worked with just a sugar mill, installing a bagasse-fired power co-generation project in 2002-2004 and expanding its capacity through introducing an alcoholproduction plant.

Table 9 below gives the main technical production characteristics of this Mill before (2002/2003harvest) and after the implementation of the co-generation project and the alcohol distillery.

Table 9Data Harvest Feb/03 (*) After Expansion

Cane grinding (tons/harvest) 2,250,000 2,900,000Daily grinding (tons/day) 10,000 14,500Harvest days 225 200Sugar production (50kg. bags/harvest) 5,224,000 6,381,000Alcohol production (liters/harvest) - 0 - 48,400,000Industrial facilities area (mi) 432,700 516,916Constructed industrial area (total) m2 80,591 111,798Sugar-cane area (own/partners) hectares 16,095 18,600Sugar-cane area (suppliers) hectares 18,800 22,400Sugar-cane area (total) hectares 34,895 41,000Number of employees 500 522

(*) Preliminary Assessment Report August 2002

The Mill Project includes power co-generation through turbo-generators buming cane bagasse in

33

boilers. In Phase 1 (2003), Guarani installed a 21.8 MW backpressure turbo-generator and a 63Bar boiler, with total capacity reaching 29.8 MW. In Phase 2 (planned for 2005/2006), a 25 MWbackpressure turbo-generator will be installed, along with another 63 Bar boiler. Therefore, thetotal installed capacity will reach 54.8 MW. The co-generation facilities include 5.9 km oftransmission line, already strung, for interconnection with the CPFL power concessionaire.

Location

The Cruz Alta Mill is located in the Olimpia Municipal District, Sao Paulo State, alongside theRodovia Assis Chateaubriand highway at Km 155 (SP-425), which is the major highway linkingSao Jose do Rio Preto to Barretos. This region has a long-established tradition in sugar andalcohol production, with vast sugar-cane plantations and a large number of sugar mills andalcohol distilleries, including mills such as: the Usina Guarani, Usina Sao Domingos, UsinaCerradinho, Usina Catanduva, Usina Antonio Ruette and the Destilaria Vale do Rio Turvodistillery.

2This Mill is located in the Turvo and Grande River Basin, covering an area of 15,975 km with apopulation of 1,054,267 inhabitants. The water-body into which the liquid wastes are dischargedby the Mill is the Baguacu stream, which flows into the Turvo River. This stream is rated asClass 2, in compliance with Resolution N° 13/86, issued by the National Environment Council(CONAMA). There are no Conservation Units in the area around the Mill, the closest of which issome forty kilometers away, outside its area of influence.

Water Intake

The Mill has five water intake points, four of which are deep wells, and one surface water intakefacility at a small dam on the Baguacu stream.

The wells produce some 20 m3/hour, used mainly for office and household purposes. The surfaceintake produces 351 m3 /hour used for industrial processes, particularly cooling the boilers. At themoment, with the introduction of the closed-circuit cooling system, this intake has dropped to157 m3/hour.

All the water intake points are covered by licenses issued by the Water and ElectricityDepartment (DAEE), which is the State water resource management entity.

Liquid Wastes

This Mill generates three types of liquid wastes: (i) equipment cooling liquid wastes; (ii)wastewaters; and (iii) distillate.

The liquid wastes from the cooling system were previously discharged into the dam on theBaguacu stream. With the complete closure of the water cooling circuits (heat-exchanger coolingfor the generator turbines and grinding mills), the Mill ceased to discharge liquid wastes into thedam.

Domestic wastewaters are channeled to septic tanks, while wastewaters from washing floors, thesugar and alcohol plant equipment, the grinding mills and the boilers, the sugar-cane washing

34

sand-box etc., are treated in stabilization ponds, with the liquid wastes subsequently channeled tothe plantations for fertilization and irrigation purposes.

The distillate left over from the alcohol production system currently reaches some 2,700 m3/day,initially channeled to storage tanks and then used for fertilization through the irrigation system,as well as trucks and spray-heads. The fertilization and irrigation process is integrated with theagri-business activities of the sugar and alcohol sector due to the soil fertilization properties ofthe distillate, fully or partially replacing mineral fertilization of the sugar-cane crops, loweringexpenditures on fertilizers and boosting productivity.

The use of distillate is limited to at least 200 meters away from any water-bodies, and protectivesafety slopes are built downstream from the fertilization and irrigation areas in order to retainany run-off, preventing their discharge into water-bodies. The distillate usage plan is submittedannually to the State Environmental Licensing Entity (CETESB) that undertakes regularinspections. The Mill monitors the water table through piezometric wells.

Waste Gasses

The main atmospheric emission points in the process are:

* Sulfur furnace gasses - Used when white sugar is produced. This is an important source thatmay emit SO,, should the burning process be poorly regulated for absorption by the juice.

* Gasses from burning bagasse in the boilers - Incomplete burning of bagasse in the boilersgenerates particulate matter consisting basically of unbumed bagasse and mineral impuritiesfrom the fields. This also generates carbon monoxide (CO). In order to control emissions ofparticulate matter from the boilers, the Mill replaced the multi-cyclones used (dry process)by wet-processed soot traps for the current and new boilers.

A dispersal study shows CO and PM levels well below the air quality standards stipulated by theFederal and State legislation.

The last gas emissions monitoring campaign for the three cane bagasse-fired boilers wasperformed on November 7, 2004, in compliance with the CETESB standards, analyzing NOx,combustion (C02, 02 and CO) and particulate matter, while also assessing the colorimetricdensity of the smoke, demonstrating compliance with environmental legislation.

Solid Wastes

The solid wastes produced present the following characteristics and treatment/disposal routes:* Bagasse - This solid waste is reused for burning in the boilers to produce steam and

consequently energy for the industry. Its use is continuous, with the bagasse left over afterthe harvest stored for use during the inter-harvest periods.

* Fly-ash from the boiler and soot traps - The Mill works with a soot-pressing system thatreduces the moisture content to around 60%-65%, with a reduction of around 30% comparedto the current volume. The final disposal site is a landfill on property owned by the Mill.

35

* Cane washing earth - This matter is transported by tipper-trucks to renewal areas of the caneplantations. It is used sporadically to reclaim eroded areas, as well as for landfills, earth-leveling and slopes.

* Rotating vacuum filter cake - The filter cake is collected through hoppers and removed fromthe Mill by tipper-trucks that take it to planting and renewal areas on the cane plantations.

* Common garbage - The Mill has implemented a hazardous waste separation plan(fluorescent light-bulbs and batteries), in addition to selective collection of recyclablematerials. Household garbage goes to the sanitary landfill.

* Out-patient clinic and laboratory wastes - These wastes are sent to the Hospital incinerator inthe town of Olimpia.

* Septic tank sludge - These solid wastes are channeled to the stabilization ponds when theseptic tanks are cleaned.

* Ferrous and non-ferrous scrap - Both types of scrap are properly stored and sold at the end ofthe harvest to third parties that accept responsibility for removal and transportation.

* Spent lube oils - Classified as Class I (hazardous) solid wastes by the Brazilian TechnicalStandards Association (ABNT), these solid wastes are partly reused at the Mill to lubricatechains and protect metal work, with the remainder being sold.

Environmental Licensing and Permits

With regard to awarding water use rights, the Water and Electricity Department (DAEE) issuedEdict NO 1,359, dated September 9, 2003, authorizing the listed ground water and surface wateruptake activities.

With regard to environmental licensing, since 1985 the activities of the Cruz Alta Mill have beenlicensed by the State Environmental Licensing Entity (CETESB). The last expansion of this Milltook place in 2002/2003, extending the sugar production facilities, introducing power co-generation facilities and the alcohol Distillery.

The Prior License (LP N° 00627) was issued by the Sao Paulo State Environment Bureau on July22, 2003. Installation License (LI N° 40000236) was issued on May 5, 2004.The Sao Paulo State Environmental Licensing Entity (CETESB) issued two Operating Licenses(LOs), covering (i) the manufacture of liquid sugar (LO N° 40000145, dated June 23, 2004); and(ii) the manufacture of granulated sugar (LO N° 40000167, dated September 2, 2004).

Additionally, CETESB issued a Temporary Operating License - valid for 180 days as fromSeptember 2, 2004 - covering the power co-generation process with an average output of 21.8MW.

With regard to the co-generation and alcohol production facilities, although this Mill is operatingnormally with the planned expansions, it still does not have the respective Operating License(LO).

In response to a request from CETESB, on November 30, 2004 the Mill submitted an applicationfor a Joint Operating License covering its various production activities, which is currently underanalysis.

36

Environmental Control and Management Procedures

The Mill implements a series of environmental control and management procedures, including:* Road Infrastructure - The Mill has a repair, maintenance and cleaning program for blacktop

and local roads, used mainly by trucks carrying sugar-cane.

* Green Manuring - Green manuring is an age-old farming practice that is designed to upgradethe production capacity of the soil through adding non-decomposed organic matter producedfrom plants grown solely for this purpose. The Mill works with crop rotation on an area of2,000 hectares/year, using soy beans and crotalaria.

* Reforestation in Permanent Preservation Area - The Cruz Alta Mill runs a native treenursery that produces approximately 25,000 seedlings a year of several different species thatare then used to thicken the plant cover in Permanent Preservation Areas.

* Introduction of Untreated Cane Harvesting - The Usina Cruz Mill has been phasing inuntreated cane harvesting techniques in compliance with legal requirements. In Sao PauloState, the last document covering this matter is Law N° 10,547, dated May 2, 2000, regulatedby Decree N° 45,869, dated June 22, 2001, which forbids cane-straw burning in areas wheremechanical harvesting can be phased in.

* Organic Sugar Project - The purpose of this Project is to produce organic sugar incompliance with global quality standards, through growing organic/biodynamic sugar-canewith sustainable industrial processing. Initially, an area covering some 2,000 hectares ofsugar-cane is currently being converted to organic techniques, certified by the BiodynamicInstitute (IBD - Instituto Biodinamico) at Botucatu, Sao Paulo State. The conversion of theseareas began in January 2002.


The main outstanding environmental matter at the Mill is the Environmental Licensing for thepower co-generation and alcohol distillation activities:

* Temporary Operating License issued for 180 days, expiring on February 27, 2005, for thepower co-generation Project with an average output of 21.8 MW.

* Lack of Operating License (LO) - Operating License for the last alcohol distillationexpansions.

The Mill argues that it has implemented all the conditions stipulated in the Installation License,including the gasses emissions reports, and is awaiting an inspection by CETESB.

ALTA MOGIANA MILL

The Alta Mogiana Mill currently produces sugar and alcohol (ethanol), with the characteristicslisted in the Table below.

The project focuses on increasing efficiency in the cogeneration process to produce more steamand increase the electricity output to supply the national grid. The project is implemented inthree phases. In the first phase, implemented in 2002, two 21 Bar pressure boilers wererefurbished at 42 Bar and a new 25 MW turbo generator was installed. Installed capacity reached

37

37.5 MW. In Phase 2 (2003) a new 42 Bar boiler was installed, and the installation of another 42Bar boiler is planned for 2005 as Phase 3 of the project.

The co-generation facilities include 2.2 km of transmission line, already strung, forinterconnection with the CPFL power concessionaire.

Table 10

Data Harvest 03/04Cane grinding (tons/harvest) 2,200,000_Sugar production (50kg. bags/harvest) 4,480,000Alcohol production (liters/harvest) 52,700,000Sugar-cane area (own/partners) hectares 32,453Sugar-cane area (suppliers) hectares 4,950Sugar-cane area (total) hectares 37,403Number of employees 2,155

Location

The Alta Mogiana Mill is located in the Sao Joaquim da Barra Municipal District, Sao PauloState,' 96 kms from Ribeirao Preto and 400 km from the Sao Paulo State Capital.This region hasa long-established tradition in sugar and alcohol production, with vast sugar-cane plantations anda large number of sugar mills and alcohol distilleries.

The Mill is located in the Sapucai Mirim-Grande River Basin, covering 9,170 hectares with apopulation (in 2000) of 609,635 inhabitants. The Sapucai River is the main source of watersupply and is the recipient water-body for the liquid wastes discharged by the Mill. The Sapucai-Grande River Basin is covered by the Water Resource Management Unit (UGRHI 8), classifiedas 'Under Industrialization' by CETESB. The Sapucai River is rated as Class 2 by Resolution N°13/86, issued by the National Environment Council (CONAMA).

There are no Conservation Units close to the Mill.

Water Intake

The Mill has surface water uptake points for the industrial process and ground water intakefacilities (deep wells) for human consumption. The Mill does not have the respective licenses,with the entity in charge of this aspect being the Sao Paulo State Waters and ElectricityDepartment (DAEE/SP).

Liquid Wastes

The Mill generates two types of liquid wastes: (i) wastewaters; and (ii) distillate.

38

Domestic wastewaters are channeled to septic tanks, while wastewaters from washing floors, thesugar and alcohol plant equipment, the grinding mills and the boilers, the sugar-cane washingsand-box etc., are treated in the distillate tanks, with the liquid wastes subsequently channeled tothe plantations for fertilization and irrigation purposes.

The distillate is initially channeled to storage tanks and then used for fertilization through theirrigation system, as well as trucks and spray-heads. The use of distillate is limited to at least 200meters away from any water-bodies, and protective safety slopes are built downstream from thefertilization and irrigation areas in order to retain any run-off, preventing their discharge intowater-bodies.

The Mill monitors the surface water courses and the water table through piezometric wells,forwarding regular reports twice a year to CETESB.

Waste Gases

The main atmospheric emissions points in the process are the same as those at the Cruz AltaMill. During the inspection visit, it was noted that the boiler emissions were 'dark grey',demonstrating that particulate matter was being discharged, not in compliance withenvironmental legislation.

The Mill claimed that it was still encountering problems in adapting its operations, but solutionswere on the way. The Mill did not monitor its gas emissions.

Solid Wastes

The solid wastes produced present the following characteristics and treatment/disposal routes:* Bagasse - reused for burning in the boilers to produce steam and consequently energy for the

industry.

* Cane washing earth - This matter is transported by tipper-trucks to the cane plantations andrenewal areas, as well as for the reclamation of eroded areas, landfills, etc.

* Rotating vacuum filter cake - The filter cake is removed from the Mill by tipper-trucks thattake it to planting and renewal areas on the cane plantations.

* Septic tank sludge - These solid wastes are forwarded to the distillate storage tanks.

Environmental Licensing and Permits

This Mill did not present the water usage rights permit (ground water and surface water intake),issued by the Waters and Electricity Department (DAEE).

With regard to the environmental licensing, the Functioning License (LF N° 00627) was grantedby the Sao Paulo State Environment Bureau on August 28, 2002 for the power co-generationproject.

Although requested to do so, the Mill did not present the Operating License (LO) or FunctioningLicense (LF), covering its sugar and alcohol production activities.

39

Having consulted CETESB (www.cetesb.sp.gov.br), it was ascertained that the OperatingLicense application is under analysis by this entity.

According to the Alta Mogiana Mill, at the request of CETESB, it submitted an application for aJoint Operating License covering all the units at this Mill, including the power co-generationplant, in order to obtain a single Operating License for all production areas. This application wassubmitted on December 10, 2004, and it is currently under analysis.

Environmental Control and Management Procedures

The Mill implements a series of environmental control and management procedures, including:* Roads Infrastructure - The Mill has a repair, maintenance and cleaning program for blacktop

and local roads, used mainly by trucks carrying sugar-cane.

* Green Manuring - Green manuring is an age-old farming practice that is designed to upgradethe production capacity of the soil through adding non-decomposed organic matter producedfrom plants grown solely for this purpose. The Mill works with crop rotation, using soybeans and crotalaria.

* Reforestation in Permanent Preservation Area - The Alta Mogiana Mill runs a native treeseedling nursery and a reforestation and reclamation program enhancing the plant cover inPermanent Preservation Areas.

* The Mill Agricultural Director sits on the Water Resources Committee for the Sapucai RiverSub-Basin.

General Remarks

The Mill has not yet forwarded to Ecoenergy several items of information that were requestedduring the technical visit, and subsequently.


The main outstanding environmental matters at this Mill are:

* Water Usage Permit - The Mill presented no documentary proof of these permits.* Environmental Licensing - The Mill did not present the Operating License covering its

sugar and alcohol production activities.

* Monitoring of Gas Emissions - As mentioned above, the gas emissions were non-compliant, and the Mill did not present any monitoring reports.

40

Annex 4: Project Processing Schedule

Taken to prepare the project (months) __| ______18 ___l

First Bank mission (identification) October 2003Appraisal mission departure December 2004PCF Negotiations April 2005Signing August 2005 (forecast)

41

Annex 5: Documents in the Project File

Documents in Project File additional to PAD annexes:

1. PCF Project Idea Notes for each subproject2. PCF Carbon Finance Documents for each subproject3. Brazil: Country Assistance Strategy4. Subproject Environmental Impact Assessments5. Financial documents for subprojects

42

Annex 6: Technical annex

3.1. Cogeneration:

The predominant technology in all parts of the world today for generating megawatt (MW)levels of electricity from biomass is the steam-Rankine cycle, which consists of directcombustion of biomass in a boiler to raise steam, to be expanded through a turbine. Most steamcycle plants are located at industrial sites, where the waste heat from the steam turbine isrecovered and used for meeting industrial-process heat requirements. Such combined heat andpower (CHP), or cogeneration, systems provide greater levels of energy services per unit ofbiomass consumed than systems that generate power only. CHP applications typically employbackpressure turbines, wherein steam expands to a pressure that is still substantially aboveambient pressure. It leaves the turbine still as a vapor and is forwarded to satisfy industrialheating needs, where it condenses back to water.

Guarani Subproject

Guarani subproject is implemented in two phases. Until 2002, Cruz Alta did not use tocommercialize electricity. It had two 4 MW and one 2.4 MW backpressure turbo-generatorsinstalled and active, totalling 10.4 MW installed capacity. To supply steam, three 22 Bar boilerswere used.

Phase 1 (2003): In Phase 1, Guarani installed a 21.8 MW backpressure turbo-generator and a 63Bar boiler in Cruz Alta, while deactivating one 2.4 MW backpressure turbo-generator andputting a 22 Bar boiler on stand-by, with total capacity in this phase reaching 29.8 MW.

Phase 2 (2005/2006): In Phase 2, the expansion and optimization of the industrial processescontinue at Cruz Alta's unit. A 25 MW backpressure turbo-generator will be installed, alongwith another 63 Bar boiler. The 22 Bar boiler put on stand by in Phase 1 will become active, anda 4 MW backpressure turbo-generator will be put on stand by. Therefore, the total installedcapacity at Cruz Alta will reach 54.8 MW in Phase 2, and this is the maximum capacity forCABCP.

Guarani has a PPA signed with CPFL (Companhia Paulista de Forca e Luz, a leading electricitydistributor in Brazil), valid from 2003 to 2012, meaning it is contracted to supply electricity.According to this contract, Guarani has to deliver at least 51.360 MWh per year. This is aminimum required for CABCP Phase 1, but the mill can sell any extra-amount produced aboveof that threshold to CPFL, following PPA's clauses. For Phase 2, Guarani is negotiating anaddendum for the extra amount of electricity it will produce with the new facilities.

The schematics below illustrate the configuration in Phases 1 and 2.

43

Figure 1: CABCP Phase 1 scheme

PHASE 1 (2003) DISTILLATION-TOTAL INSTALLED CAPACITY: 29.8 MW -' -ACTIVE BOILERS: TWO 22 bar Itl~

ONE63bar - _

X 6~~~~~~----------------------- ----------------------/ SEVF:RINIA

/ . ~~~~~~~~~~(RI L AI;rA

SUGAR CONCENTRATE

/ 10 QOOt ~~~EXTR-ACTION__j X _ = _ X SUGARCANE JUICE EVAPORATION

SUGARCANE CROPCRISTALIZATION

BAGASSE

Figure 2: CABCP Phase 2 sche6ie 12.5 MW AVAILABLE FORCOMMERCIALjIZATION

PHASE 0 COGEN EQUIPMENT 21MW

COGENERATIONPHASE I COGEN EQUIPMENT ' 6 IV, COMMERCIALIZED

ELECTRICITY

PRO( I B() NI)DARIFS

P H A S E 2 ( 2 0 0 5 ) DISTILLATION ITOTA.L INSTALLI.ED APci'rY 54 RM W z_ A CT I VE B O IL ER S T HRE BE t23 b ar,. tI _ , r>_ETH^NOL

L ------ --- - -- - - -- - - -- - -- - - -- - -

SE\ S EEIN I\

SUGAR CONCEN rRATE

10 0001 EXTRACTION

CALDO MISTO OEVAPORATONRT

SU1GARCANE CROP

BAGASSE

-~~~~~ S S-- L S~~~ > ~~~3 3 MW AV AI L 1B LE1 I / < PG ~~~~FR COM M ERr IA A LlCOGENERATION ZATIOPHASE I COGEN EQUIPM ENT

PHASE I COGEN EQUIPM ENT .

[71 PHASE 2 TOOTH EQUIPMENT -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ FC I I

I't l R I 1s It 1 0 IJ S

44

Table below shows Cruz Alta's cogeneration infrastructure will be updated according to CABCPphases.

Table 1: Cogeneration equipment upgrades

Phase 0 (until 2002) Phase 1 (2003) Phase 2 (2005/2006)Total Installed Capacity: 10.4 MW Total Installed Capacity: 29.8 MW Total Installed Capacity: 54.8 MW

Active Active ActiveTurbo-generators: Turbo-generators: Turbo-generators:Two 4 MW backpressure One 21.8 MW backpressure One 25 MW backpressureOne 2.4 MW backpressure Two 4 MW backpressure One 21.8 MW backpressure

One 4 MW backpressure

Boilers: Boilers: Boilers:Three 22 bar One 63 bar Two 63 bar

Two 22 bar Three 22 bar

Stand By Stand byBoilers: Turbo-generators:One 22 bar One 4 MW backpressure

UninstalledTurbo-generators:One 2.4 MW backpressure

45

-- DAW | | |F |

I ____~~~~~~~~~~~~~~~~~~~~~~~~~~~~~-i_ o( -l :l lo- ,._..rl_ ----------------- ,

| F~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~----------------I II

iiI I 1-1_________

---- ---- ---- ---- ---- ---- ---- ---- ---- ---- --- ------------ - -* ~~~~~I 'CSCi ______ I

L----------------------- ---I-----+


Alta Mogiana project was implemented in three phases. The steam turbine is supplied by ABB.The boiler technology is Brazilian, as is much of the small equipment installed to work with theturbine

The three phases consist of the following:

* Phase 1 (2002):

This phase included the refurbishment of two 21 Bar boilers to 42 Bar each and the acquisitionof a backpressure turbo-generator of 25 MW capacity. Moreover, the energy consumption in thesugar process was reduced by 19% from 530 kg of steam per ton of sugarcane crushed to 430 kg.

In 2002, Alta Mogiana supplied the grid with 28.948 MWh of renewable electricity. CPFL1 isthe utility that has signed a ten-year contract with Alta Mogiana.

Even though Alta Mogiana reached a total installed capacity of 37.5 MW, the two turbo-generators of 5 MW and 7.5 MW were on stand-by as this was the first year Alta Mogianaoperated the new turbo-generator. Although in the PPA a surplus capacity of 6 MW is

'Companhia Paulista de For,ra e Luz, a leading electricity distributor in Brazil.

46

guaranteed to operate in order to generate electricity for commercialization, Alta Mogiana mightbe capable to deliver more, since it may use spare capacity as needed or wanted. It is worthnoticing that small energy projects are not dispatched by the National Operator of the ElectricitySystem (ONS), meaning that Alta Mogiana is allowed to supply the grid as much as it can and itcan sell any extra amount of electricity in the Wholesale Electricity Market (MAE) in Brazil.

* Phase 2 (2003):

During the 2003 harvest season Alta Mogiana continued the investments from 2002 to reachhigher efficiency through a number of measures in its process and also installing a new 42 Barboiler originally scheduled for Phase 3. The mill was therefore able to generate 41.700 MWh ofclean energy to supply the grid. The contracted capacity to supply the grid was 12 MW.

In this phase, the already installed capacity is better exploited thanks to the efficiency increase inthe sugar production leading to savings in steam consumption internally. Moreover, bagasseproduction is also projected to increase. Even though the two stand-by turbo-generators arepredicted not to be in use according to the PPA, they can generate electricity if there is afinancial advantage for doing it.

* Phase 3 (2005):

In this phase, Alta Mogiana will construct a new 42 Bar boiler to increase the steam supply forelectricity generation purposes. However, the implementation of this phase depends on itsfinancial viability and experiences from the first two phases.

Table below shows how Alta Mogiana's infrastructure is updated according to the project.

Table 1: ALTA MOGIANA's Cogeneration equipment upgrades

Active/Activating Stand-byTwo 42 Bar boilers Tv akrsu-refurbished 1 s~~~~~~~wo hackpressurePhase 1 refurbished tUho-generators2002 oe New5an5 on2002 backpressure turbo- one otl5 andi one

generator

Nexm 42 Bar boiler Two refurbished 42 iwo hackpleSSLrePhase 2 Bar boilers turho-generators

(2003) 25 MW ~~~~~~~~~~~~~~~ol f 5 ~alid onec(2003) backpressure turbo- on75 M generator

New 42 Bar boiler One 42 Bar boiler Two refurbished 42 1 vo hackpreSSL ePhase 3 Baonler25 MtUlrbo-generators

(2004-2005) One 25 W one of 5 and onebackpressure turbo- 7,5 ~1\Vl

generator I 5I__ ___

Schematic below provides an energy diagram for Alta Mogiana in order to provide a picture ofhow the energy is distributed through the mill and the path from biomass energy to electricpower.

~~t .Fu, I i

~~~iI~~

48

Figure 3: Alta Mogiana's Energy Balance Diagram

BALANIO DE VAPOR DIRETO -TURBINAS E CO-GERAIAO

Icwa sp TCH |..| 0311,4040 SAGASo 0 | AGA eA OP1R9TAJ2tOO | | SOWAOetAG O | 0v 48

131Isdllw 20284 43TC e1p 04006co 2270 44C 000Eu 2.21 R M-(32 2) - 11,4 l- 4eleITX t5 I bh (0. 1 1249 lOOT 0e 13,31 lb41 (1).T1,6scosar0T 1

Y.6. C~~~~~~~~~~~6.4. 11,314

I C0AID PAr s CALEHRtA r o CALEOBVAO' C 07inaS7o 7551Z_ii ] Zvntil ] ZS l ~~~~~~ ~~~~~~~~Plemo 31,4e41.4 1,40 I : 40013 Prev 7r40 94 tg' 7,58 inD0 kgtr.' 8401,0. 42.04Tanp V23 n12 C2 lemp Vajar C 7 mp V., 'C 0.840 72,t8

C_ ~ ~ ~ ~ ~ ~ ~ a E. I,5 E. O.M kWr(l Ch E,e7> Sh C. kPt C-E:.5k. C

PoJ E.1 2,(3taq PT04e p 313kGti P>I Eep tE- 2 *dt Td e 031

| tlaZll Z7Z bh | ~~~~~~~~~~~~~~(2)- (u18404 com 0005AC

f t -t- P. - PO -1 t' d t0

cE-g Po .,-cosso C.o E Ai E-Jci%e 7Ar P aeM t A I..0OMA 5,7 PIJdi IE- V _2 5{ I1 Alllzs YItX 7b NA7 7t TI- 12ti TSSt V_ 17#Z 4

CO~~~~~~~~~1. P ki ,2 gAw cm W 85 9V V SS Cam Es 7323U tPgVC Cpnp EW 73 9vv E-, 8,EZ , IPV V po Sh

11~~~~~~0401 -II I I .

I.13 I1 ISsc.trt C

I I tAPOa18kJ*ln2 | . I | ~ agrk~ VAPORE- OES 7 + NEFARCES | EEC"7l

3.2. Baseline and Additionality in the context of the Clean Development Mechanism:The most important Kyoto Protocol requirement for CDM projects is that "reductions in.emissions are additional to any that would occur in the absence of the certified project activity."This environmnental additionality of the project is assessed against a baseline, which describeswhat would happen without the proposed project.

These projects use a methodology already approved by the CDM Executive Board. Themethodology is applicable to bagasse-based cogeneration power plants displacing gridelectricity. The displacement of fossil fuel based electricity by these project will occur at thesystem's margin, i.e. this CDM project will displace electricity that is produced by marginalsources (mainly fossil fueled thermal plants) which have higher electricity dispatching costs andare solicited only over the hours that baseload sources (low-cost or must-run sources) cannotsupply the grid (due to higher marginal dispatching costs or fuel storage - in case of hydrosources - constraints). An electricity baseline emission factor is calculated as a combined margin(CM) approach, consisting of the combination of operating margin (OM) and build margin (BM)factors. ERs are then derived simply by multiplying the amount of electricity produced by theemission factor.

49

Furthermore, the additionality test in the sugar bagasse projects will use the "additionality tool"developed by the CDM Executive Board, requiring the project to demonstrate additionality bymeans of an investment analysis and/or barriers to investment. The tool also requires ademonstration that the CDM opportunity was considered before the project implementation andthat it creates a supplementary incentive to invest in such renewable energy projects, as well asdiscussion of the common practice in the relevant sector. Additionality is established in the CDMProject Design Document and validated by an independent third party.

Sugar bagasse has traditionally used by the sugar industry to produce electricity and heat forinternal use. Producing more electricity through improvement in energy efficiency of the systemand adding generation capacity with the aim of selling electricity for the grid is far less common.Because of constraints that limit the access of independent power producers to the electricutilities market, there has been no incentive for sugarcane mills to operate in a more efficientway. Low-pressure boilers, very little concern with optimal use and control of steam, crushersmechanically activated by steam, energy intensive distillation methods, are a few examples ofinefficient methods applied to the sugar industry as normal routine. 2

However, the Brazilian electric sector legislation currently recognizes the role of independentpower producers, which has triggered interest in improving boiler efficiency and increasingelectricity generation at mills, allowing the production of enough electricity not only to satisfysugar mills' needs but also a surplus amount for selling to the electricity market. Nevertheless,some barriers pose a challenge for implementation of this kind of projects. In most cases, thesponsors' culture in the sugar industry is very much influenced by the commodities - sugar andethanol - market. Therefore, they need an extra incentive to invest in electricity production dueto the fact that it is a product that can never be stored in order to speculate with price. The PowerPurchase Agreement requires different negotiation skills, which is not the core of the sugarindustry. For instance, when signing a long-term electricity contract, the PPA, a given sugar millhas to be confident that it will produce sufficient biomass to supply its cogeneration project. Therevenue from GHG emission reductions offers a financial incentive for the sugar mills.

2 Nastari, 2000.

CAS Anone Ba- B3razil

Operations Po-folo (IBRDIDA and Grania)

A. Dr Dftn 06121005Closad Projects 251

IBRODIA-Total Dhtuxod lAme) 1,561.DB

of wllh ho bo taid 300.08ToW Dised (Cbod) 27T2Q1ta

of tdhnhlrbwnnrnp 23,02.54Tow Diood lAst. . Closd) 28823.20

olfw Oh has ben nWd 24,135t22TOal Undirbsed lActi) 3,497.37Towa Ul*rind ICbed) 025Towl Uudeu (Anio , Cbsd) 31503.63

AcHUePrdetS

Difenincl- Bn EnLasi PSe Epeited and Actul !Spevnislon Rating Orlt Amount In US$ MiNions Disbu2 a tn ts

Proet ID Proea cNtm Nan.mnt !rymerntaton. Fiscl Year SRD IDA GRANT Cancel. UndIsb. Orig. FPn Red tEObbodteS PnremssP087713 BR(CRL1)Bosa Famia itaS S 2004 572.2 569.339 94.239 °P037828 BR (PR)R.POVERTY MS S 1996 175 10 26.36555 36 365553 -3.642686P043873 BRAGTECHDEV. S S 1997 60 14.70086 14.700863 14.70086 t 1nP054119 BR BAHIA DEVT (HEALTH S MU 2003 30 26.47784 11.477842 0P006449 BRCEARAWTRMGTPRCS S 2000 136 57.51926 57.519263 14.5581 rP050875 BR Ceara RuNta Poverty Ro S S 2011 37.5 1.824091 1.8240912P083013 BR Dt"se Survailano & 'S S 2004 99.5 99 -0.499979 C)P047309 BR ENERGY EFFICIENCY S S 2000 15 3.1 1.567934 4.6679341 1.640907P087711 BR Espirto Santo WVtr b Co S S 2005 36 33.82 0.42 OP006532 BRFEDHWYYOECENTR S $ 1997 300 50 44.15398 94.153975P038895 BR FEO.WTR MGT S S 1998 198 40 55.03218 95,032183 40.34468P060221 BR FORTALEZA METROP' U U 2002 85 111.4703 74.01681 0P073294 BR Fiwcal & Fin. MgmL TAL U U 2001 8.98 6.74365 5.7836504P055954 BR GotAs STATE HIGHW, S S 2002 65 26.58898 26.588978 -0.492876P006474 BRLANDMGT3(SAOPAIMS MS 1998 55 10 33.18814 43.188144 30.3032 0tPOS0772 BR LAND-BASEO POVATY S S 2001 202.1 58.1284625 165.1346 152.74385 VtP080830 BR Marantrao Integrated. ItS S 2004 30 30 52 HvP035741 BRNATLENV2 S S 2000 15 2.3185 5.610222 7.9287218 4.744544 0P050776 BRNEMItocnrioaicDevelwbS S 2000 50 21.19738 -28.e0257 0P042585 BR PARAIBA R.POVERTY S S 1998 60 4.474374 4.4743745P057910 BR PENSION REFORM LIL HS S 1998 5 0.5 1.477293 1.9772927 1.477293P050881 BR PIAUI RURAL POVERT S S 2001 22.5 4.604584 4.6045837P386525 BR PRGM. FISCAL REF -' ## 2005 658.3 658.3P039199 BR PROSANEAR 2 S S 2000 30.3 6.4 22.29198 28.691978 22.29198P05880 BR Pemambuco Rural Pov S S 2001 30.1 6.866577 6.8865774P034578 BR RGS Highway MGT MS 5 1997 70 17.29656 17.296563 2.54952P043868 BR RGS LAND MGTRPOVE S S 1997 100 1.970396 1.970396 1.970396P043421 BR RJ M.TRANSIT PRJ. S S 1998 1b6 27.7788 79.07162 106.85042 11.13849P048869 BR SALVADOR URBAN TF S MS 1999 150 32 53.9529 85.952903P043869 BR SANTA CATARINA NA- MS MU 2002 62.8 58.13853 23.460133P074085 BR Sergipe Rural Poverty R S S 2002 20.8 1.448082 -0.551918P051696 BR SAO PAULO METRO L S S 2002 209 157.6431 148.44305 -4.353531P073192 BR TA FinancialSector MS S 2002 14.46 9.300523 9.3005235P083533 BR TA-Sustain. & Equft Go S S 2005 12.12 12.12 1P060573 BR Tocan8ins Suslainable FS S 2004 60 59.4 17.4

a. Intended disbursements to date mrnus actual disbursements to date as projected at appraisal.

P043420 BR WATER S.MOD.2 S S 1998 150 125 19.32987 144.29987 7.525725P078716 BR(CRLI)Prog Growth for * # 2005 502.52 502.52P050763 BR- Funrdescola 2 MS S 1999 202.03 10.86 4.241988 15.101988P059556 BR- CEARA BASIC EDUCA U U 2001 90 61.18085 -28.81906P057653 BR- FUNDESCOLA IIIA S S 2002 160 124.4252 -99.88464P076924 BR-(Amapa) Sustainable Cc S S 2005 4.8 4.B 0.04P070827 BR-2nd APL BAHIA DEV. ES S 2003 60 32.04448 22.364478P080400 BR-AIDS & STD Control 3 5 MS 2003 100 91.88102 38.181022P076977 BR-Energy Setor TA Prole S S 2003 12.12 11.9988 5.9988P057665 BR-FAMILY HEALTH EXTE MU MU 2002 68 51.13721 45.537206P082328 BR-lnteg.Munic.Proj.-Betim S S 2005 24.075 23.95463 2.979625P074277 BR-Muncipal Pension Refof S MU 2003 5 4.9 4.9 0.4P069934 BR-PERNAMBUCO INTEG S S 2005 31.5 31.5 3.5P049265 BR-RECIFE URBAN UPGR S MS 2003 46 44.78765 10.607654P066170 BR-RGN 2ND Rural Povert S S 2002 22.5 12.14864 8.948638P058503 GEF BR Amazon Region Pt S S 2003 30 22.67856 -7.321423P070552 GEF BR PARANA BIODIVE MS S 2002 8 6.176991 5.0869908P006210 GEF BR-NArL BIODIVERE S S 1996 10 1.666873 1.6168733 1.027577Overal Resuf 5325.105 63 376.0657825 3529.463 1327.4232 148.1842

a. Intended disbursements to date rrinus actual disbursemwts to date as projected at appraisal.

a. Intended dis:bursements to dale oniss actal disbu4rseens to date as proed at appr aisal

. . , * ! * I I* ! ! ! !

52

ANNEX 8: Statement of lFC Held and Disbursed Portfolio

CAS Annex B8 (IFC) for Brazil

BrazilStatement of IFC's

Held and Disbursed PortfolioAs of 04/30/2005

(In US Dollars Millions)

Held Disbursed

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic2005 ABN AMRO REAL 7 0 0 0 7 0 0 02001 AG Concession 0 15 15 0 0 14.07 0 0

2002/05 Amaggi 30 0 0 0 15 0 0 02002 Andrade G. SA 25.67 0 10 15.15 25.67 0 10 15.152001 Apolo 7.21 0 0 0 4.71 0 0 02005 Aracruz 50 0 0 0 50 0 0 01998 Arteb 20 0 0 18.33 20 0 0 18.331999 AutoBAn 22.73 0 0 17.25 22.73 0 0 17.251998 BSC 1.33 0 0 0.55 1.26 0 0 0.551996 Banco Bradesco 0.68 0 0 1 0.68 0 0 12001 Brazil CGFund 0 20 0 0 0 2.6 0 0

1994/96 CHAPECO 1.78 0 0 5.26 1.78 0 0 5.262002/04 CN Odebrecht 25 0 0 0 25 0 0 0

2003 CPFL Energia 0 0 40 0 0 0 40 01992 CRP-Caderi 0 0.17 0 0 0 0.17 0 0

1996/97 CTBC Telecom 0 6.54 0 0 0 6.54 0 01999 Cibrasec 0 3.22 0 0 0 2.71 0 02004 Comgas 45 0 0 45 12.5 0 0 12.5

1997/00 Coteminas 0 0.18 0 0 0 0.18 0 01980/92 DENPASA 0 0.06 0 0 0 0.06 0 0

1998 DixieToga 0 10.36 0 0 0 10.36 0 01997 Duratex 3.24 0 3 2.55 3.24 0 3 2.551999 Eliane 19.2 0 13 0 19.2 0 13 01998 Empesca 5 0 10 0 5 0 10 0

2000/04 Fleury 20 0 0 0 0 0 0 01998 Fosfertil 4.55 0 0 16.7 4.55 0 0 16.71998 Fras-le 5.33 0 9.99 0 5.33 0 6.69 01994 GAVEA 0 0 5.5 0 0 0 5.5 0

GP Cptl Rstrctd 0 3.02 0 0 0 2.95 0 02001 GPC 0 0 9 0 0 0 9 01997 Guilman-Amorim 20.99 0 0 28.74 20.99 0 0 28.741998 Icatu Equity 0 5.79 0 0 0 4.42 0 01999 InnovaSA 12.5 5 0 30 12.5 5 0 30

1980/87/97 Ipiranga 23.62 0 0 39.75 23.62 0 0 39.751999 Itaberaba 0 2.28 0 0 0 2.28 0 0

2000/02 Itau-BBA 83.63 0 0 0 51.48 0 0 01999 JOSAPAR 7.57 0 7 0 2.57 0 7 01995 Lojas Americana 2 0 0 0 2 0 0 0

1992/99 MBR 12.5 0 0 0 12.5 0 0 02002 Macae 38.27 0 10 31.25 38.27 0 10 31.252002 Microinvest 0 1.25 0 0 0 0.42 0 0

!~~~ - * I " I I I I I

53

2002/05 Net Servicos 0 7.37 0 0 0 7.37 0 01994 Para Pigmentos 6.45 0 9 0 6.45 0 9 01996 Perdigao 2.19 0 0 0 2.19 0 0 0

1994/00/02 Portobello 0 1.15 0 0 0 1.15 0 02000 Puras 1.33 0 1 0 1.33 0 1 0

2003/04 Queiroz Galvao 0.6 0 0 0 0.08 0 0 0Randon Imp] Part 3.27 0 3 0 3.27 0 3 0

1997/03 SP Alpargatas 30 0 0 0 15 0 0 01997 Sadia 5.84 0 3.67 37.06 5.84 0 3.67 37.062002 Salutia 0 0.01 0 0 0 0 0 01997 Samarco 5.4 0 0 0 5.4 0 0 01998 Saraiva 3.46 2.4 0 0 3.46 2.4 0 02003 Satipel 12.86 0 10 0 12.86 0 10 02000 Sepetiba 26.68 0 5 0 11.68 0 5 01999 Sudamerica 0 7.35 0 0 0 7.35 0 02001 Synteko 15.43 0 0 0 15.43 0 0 0

1998/04 Tecon Rio Grande 8.1 0 0 8.1 0 0 0 02001/03 Tecon Salvador 0 0.56 0 0 0 0.55 0 0

2004 TriBanco 10 0 0 0 0 0 0 02002 UP Offshore 11.6 10 0 30 0 3 0 0

2002/04 Unibanco 20 0 0 0 0 0 0 0

Total Portfolio: 658.01 101.71 164.16 326.69 470.57 73.58 145.86 256.09

Approvals Pending CommitmentLoan Equity Quasi Partic

2005 ABN AMRO REAL 25 0 0 02000 BBA 10 0 0 02002 Banco Itau-BBA 0 0 0 1001999 Cibrasec 0 4.5 0 02005 Cosan SAIC 50 20 0 02005 Embraer 35 0 0 1002005 GP Capital III 0 15 0 02005 LOJAS II 35 0 0 02002 SuapeICT 6 0 0 02004 TermoFortaleza 55.5 0 7 112.5

Total Pending Commitment: 216.5 39.5 7 312.5

54

ANNEX 9: Brazil at a Glance

Brazil at a glance 4/12105

Latin Lower.POVERTY and SOCIAL America middle-

Brazil & Carib. Income Development dlamond'2003Population, mid-year (millions) 176.6 534 2,655 Life expectancyGNI per capia (Atlas method, USS) 2,720 3,260 1.480GNI (Atlas method, USS billions) 479.5 1,741 3,934

Average annual growth, 1997-03 TPopulation (%) 1.3 1.5 0.9 GsLabor force (V) 1.6 2.1 1.2 GNI Grossper primaryMost recent estimate (latest year avaIlable, 1997-03) capita enrollmentPoverty (% ofpopulation below national poverty line) 22Urban population (I% of total population) 83 77 50Life expectancy at birth (years) 69 71 69Infant mortality (per 1,000 live births) 33 28 32Child malnutrition (% of children under 5) 6 .. 11 Access to improved water sourceAccess to an improved water source (% ofpopulation) 87 86 81Illiteracy (Vo ofpopulation age 15+) 14 11 10Gross primary enrollment (% of school-age population) 148 129 112 Brazil

Male 153 131 113 --- Lower-middle-incomne groupFemale 144 126 111 il

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1983 1993 2002 2003Economic ratios'

GDP (USS billions) 203.3 438.3 460.8 492.3Gmss domestic investment/GDP 16.7 20.8 19.8 20.1Exports of goods and services/GDP 11.4 10.5 15.5 16.9 TradeGross domestic savings/GDP 19.1 22.3 21.8 23.8Gross national savings/GDP .. 20.2 18.5 20.7

Current account balance/GDP -3.4 -0.1 -1.6 0.8 DomesticInterest payments/GDP 3.9 0.6 2.9 2.7 -v ng 7'--I InvestmentTotal debt/GDP 48.5 32.9 49.6 48.0 savIngsTotal debt service/exports 54.7 24.4 70.3 65.1 IPresent value of debt/GDP .. .. 52.6Present value of debtUexports .. 329.6

Indebtedness1983-93 1993-03 2002 2003 2003-07

(average annual growth)GDP 2.4 2.3 1.9 -0.2 3.9 BrazilGDP per capita 0.6 1.0 0.7 -1.4 3.2 --- Lower-middle-income groupExports of goods and services 6.3 7.5 14.2 7.9 1.6

STRUCTURE of the ECONOMY

1983 1993 2002 2003(% of GDP)Agriculture 10.9 7.6 5.8 5.8Industry 44.0 41.6 20.6 19.1 101

Manufacturing 33 2 25.0 12.4 11.4Services 45.1 50.8 73.5 75.1 0

Privateconsumption 71.2 60.1 58.1 56.9 4sGeneral govemment consumption 9.7 17.7 20.1 19.3 GDl -GOPImportsofgoods and services 9.0 9.1 13.4 13.1 ---GDI _ GDP

1983-93 1993-03 2002 2003(average annual growth)Agriculture 2.4 3.9 5.0 5.5 20Industry 1.2 1.8 2.6 -1.0 Is

Manufacturing 0.0 1.4 1.4 2.7Services 3.0 2.5 1.6 -0.2

Private consumption 0.8 1.9 -0.4 -3.3General govemment consumption 6.4 2.0 1.0 11.6 -20Gross domestic investment 4.9 1.2 -4.3 -4.5 rEPOMSi * ImponsImports of goods and services 5.9 4.0 -12.3 -1.9

Note: 2003 data are preliminary estimates.

The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond wilbe incomplete.

l~~~~~ ~ : - _ , ,

55

Brazil

PRICES and GOVERNMENT FINANCE1983 1993 2002 2003 Inflation (%)

Domestfc prices(96 change)Consumerpnces 135.0 1,928.0 125 9.3 :o Implicit GDP deflator 140 2 1,996.6 10.2 12.8

Government ffnance(96 of GDP, indludes curment grants) 0Current revenue .. .. 23.9 23.7 sO so 00 01 02 03Current budget balance .. 2.8 3 0 -GPdol.tor - CPIOverall surplus/deficit . .. - -CP

TRADE

1983 1993 2002 2003 Export and imnport levels (USS mfil.)(USS millions)Total exports (fob) .. 38,563 60,362 73,084 0o.000

Coffee 2,466 3,049 3,456Soybeans 3,074 3,032 4,290 so.000Manufactures 25,935 33,000 39,653

Total imports (cif) 25,256 47,237 48,260 40,000Food 1,089 1,085 924 20.000 W | i i I IIIFuel and energy 2,139 6,240 6,577 1 iilllCapital goods 8,369 11,643 10,348

or iso so to to 02 03Export prce index (1995=100) 80 91 88 95Import price index (1995=100) 57 67 91 90 K Expons NImport.Terms of trade (1995=100) 140 136 97 105

BALANCE of PAYMENTS

1983 1993 2002 2003 Current account balance to GOP (%)(USS millions)Exports of goods and services 23,611 41,616 69,913 83,567 2Impoortsofgoodsandservices 19,534 31,795 61.709 63,819Resource balance 4,077 9,821 8,204 19,748 o

Net income -11,022 -12,099 -18,191 -18,552Netcurrenttransfers 108 1,686 2,390 2,867 -2

Current account balance -6,837 -592 -7,597 4,063 J

Financing items (net) 4,946 9,805 -6,003 -963Changes in net reserves 1,891 -9,213 13,600 -3,100 e

Arno:Reserves including gold (US$ millions) 4,563 32,211 37,823 49,296Conversion rate (DEC, local/USS) 2.10E-10 3 22E-2 2 9 3 1

EXTERNAL DEBT and RESOURCE FLOWS1983 1993 2002 2003

(USS millions)Total debt outstanding and disbursed 98,525 144,104 228,662 236,245 X 8,58a

IBRD 3,628 6,575 8,585 8,588 0: 22,103 C. 28,317IDA 0 0 0 0

Totaldebt service 13,304 10,883 51,636 56,793lBRD 507 1,858 1,518 2,010IDA 0 0 0 09,122

Composition of net resource flowsOfficial grants 16 59 0Official creditors 1,576 -1,033 916Private creditors 2,659 10,073 -9,541 233Foreign direct investment 1,609 1,292 0Portfdio equity 0 6,570 0 F: 155,904

World Bank programCommitments 2,067 636 1.276 1,217 A -IBRD E-Bitandt |Disbursements 1,204 471 1,384 1,291 B-.DA D- OIhrmutlat.rel F-privat|ePnncipalrepayments 270 1,279 1,063 1,633 C-IMF G-Short-termNet flows 934 -808 322 -342 1 tInterest payments 237 579 4a6 377Net transfers 698 -1,387 -134 -719

Development Economics 4/12/05