Peru - Fifth Power Project

Report No. 904a-PE Appraisal of the FILE COPY Fifth Power Project Peru February 11, 1976 Power and Telecommunications Division Latin America & Caribbean Regional Office FOR OFFICIAL USE ONLY International Bank for Reconstruction and Development International Development Association This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Equivalents lUS$ = 45.0o iS/ US$0.02222222 1,000 Si US$22.22 1,000,000 S, = US$22222.22 1,000 US$ SI 4 5,000 1,000,000 US$ S-/ 45,000,000 Units and Measures GWi = Gigawatt hbur =1 million kAh kWh = kilowatt hour ton metric ton = 1,000 kg bbl barrel = 42 US gallons km kilometer = 0.62 file kW = kilowatt MW = Megawatt = 1,000 kW kVA = kilovolt - ampere MVA = Megavolt - ampere = 1,000 kVA kV = kilovolt V volt m = meter = 3.28 feet m3 = cubic meter m3/sec = cubic meters per second Abbreviations and AcronEB COFIDE = Corporacion Financiera de Desarrollo DGE = Direccion General de Electricidad Electrolima = Electricidad de Lima Electroperu Electricidad del Peru Hidrandina Energia Hidroelectrica Andina, S.A. IDC Interest during construction INIE Instituto Nacional de Investigaciones Energeticas y Servicios de Ingenieria Electrica MEM = Ministerio de Energia y Minas Fiscal Year Fiscal Year ends December 31  rUK UPINrtAL U5Z V uLI APPRAISAL OF FIFTH POWER PROJECT - PERU Table of Contents Page No. Summary and Conclusions i 1. Introduction 1 2. The Sector 2 Energy resources 2 Sector organization 2 Regulation and tariffs 3 Electricity consumption and service to rural communities and "pueblos jovenes" 3 Sector development 4 3. The Project 6 The E1ectrolima program and project component 6 Technical assistance for the government 7 Estimated cost and financing 7 Engineering 9 Project execution 9 Procurement and disbursement 9 Project risks 10 4. Justification of the Project 11 Sector objectives 11 Project objectives 11 Demand and generation forecast 11 Size of the project 11 Type of facilities 12 Return on investment 12 5. The Beneficiary 14 Organization, management and staff 14 Market 14 Management information systems and audit 15 Performance indicators 15 6. Finance 16 Summary 16 Tariff levels 16 Financing plan 16 Security 18 Debt service coverage 18 7. Recommendations 19 This report has been prepared by Messrs. John E. Graves. Rafael A. Moscote and Philip Owusu. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  List of Annexes 1. Previous Bank Lending to Electrolima 2. Organization of the Electric Power Sector 3. Electricity Regulation and Tariffs in Peru 4. Installed Generating Capacity, Electric Energy Generation and Consumption 5. Brief Description of Some Power Projects Being Considered in Peru 6. Detailed List of Project Components and Costs 7. Estimated Project Implementation Schedule 8. Estimated Loan Disbursement Schedule 9. Electrolimas system Power and Energy Requirements 10. Rate of Return 11. Electrolimats Organization Chart 12. Performance Indicators 13. Financial History and Projections Map 11797 - Peru Interconnected System Map 11798 - Metropolitan Lima Transmission and Distribution Network  APPRAISAL OF FIFTH POWER PROJECT - PERU Summary and Conclusions i. This report appraises the fifth power project in Peru, for which the government has requested financial assistance from the Bank. ii. Since 1960 the Bank has provided major financial assistance to Peruvian power development through four loans to Electrolima, the utility serving metropolitan Lima, totalling US$66.5 million. All four projects have been successfully completed. However, Electrolima's financial per- formance deteriorated in 1972-74, which led to delays in Bank processing of its next loan application (see paragraph ix). iii. The fifth project's principal component would be Electrolima's 1975-78 distribution expansion program, for Which the government would on- lend most of the proposed loan. This expansion program is needed to meet increased demands on the utility's system, including the demands of a large influx of lower-income population living in new communities (pueblos jovenes) in Lima's outskirts. With Bank assistance, Electrolima would triple the number of service connections in the pueblos jovenes by 1979 and increase the percentage of Lima's population served to about 85%; almost 3C% of Electrolima's total number of customers then would be residents of the new communities. The project's estimated total and foreign financing requirements are Us$147.2 and US$T.O million respectively, including a US$2.1 million tech- nical assistance component (see paragraph v). iv. Before 1972 Peru's electric power sector was highly fragmented consisting of many government, municipal and private utilities serving distinct concession zones. Bank assistance to the sector was limited to loans to Electro- lima, the largest utility, because of inter alia insufficient technical and economic justification of other utilities' projects. v. With the formation of a central government utility - Electricidad del Peru (Electroperu) - in late 1972, the government took initial steps to consolidate the sector. It has continued this process by acquiring control of all private utilities, including Electrolima, formerly known as Empresas Electricas Asociadas. However, serious managerial and planning problems re- main among the government's power agencies, and Bank assistance in resolving them is provided in a US$2.1 million component of the proposed loan. This technical assistance component would help the government improve division of responsibilities and coordination among its agencies, establish a master plan for future sector development, identify training needs of sector personnel and complete tariff studies. vi. The proposed US$36 million loan would cover all but US$3 million of -.he project's foreign financing requirement. ElectrolimaIs total financing re- quirements cLuring the project's construction period would amount to US$221.2 million. About g% of this total financing requirement would be covered by Electrolima's net internal cash generation, customers' connection fees and contributions from developers. The balance of Electrolima's financing require- ments would be provided by the proposed loan and by US$55.8 million equivalent in loans from the government development corporation and equity contributions by the government via Electroperu.  - ii - vii. Consultants acceptable to the Bank would be engaged to: assist Electrolima in improving its planning and maintenance and in engineering for its communication and control systems, and provide specialized training to Electrolima staff; and to undertake the studies comprising the technical assistance component for the government. Electrolima's staff will engineer all other works included in the project and supervise their installation, which will be performed by local contractors. It has ample experience with similar works and is fully capable of successful project execution. viii. Procurement of Bank-financed items would be through international competitive bidding in accordance with the Bank's guidelines. Because of the need to meet the system's requirements, Electrolima might contract for cer- tain items of equipment prior to loan signing; retroactive financing of US$1.1 million is recommended for initial payments on these contracts. ix. The Bank appraised a previous version of Electrolima's expansion program in early 1973. However, further loan processing was delayed until 1975 to permit resolution of the company's financial problems (principally its need for higher tariffs and re-financing a large amount of short-term debt). With substantial re-financing in 1974 and tariff increases totalling about 38% in the first half of 1975, the government has taken appropriate steps to resolve the problems. Provisions in the proposed loan agreements requiring asset revaluations, adjustment of tariff levels to produce cash contributions to construction expenditures of at least 30% in 1976 and 45% in each year thereafter, and limitations on Electrolima's future indebtedness would provide the mechanism for further improvements in the company's financial situation. Assuming that these provisions are complied with, Electrolima's financial performance is expected to be satisfactory. x. Based on average tariff levels which would result from implementation of the financial covenants (paragraph ix), the rate of return on project in- vestment would be between 8% and 14%, depending on assumptions concerning the incremental cost of electricity to the system. This broad range results from the uncertainty regarding the future generation program which does not allow an exact determination of the incremental cost of generating electricity. xi. The project would form a suitable basis for a US$36 million loan with a term of 20 years including three years of grace. The loan would be made to the Republic of Peru; US$33 9 would be onlent to Electrolima for its distribution expansion program (paragraph iii).  APPRAISAL OF FIFTH POWER PROJECT - PERU 1. Introduction 1.01 This report appraises the fifth power project in Peru, for which the government has sought Bank assistance. Electrolima, the concessionaire for the metropolitan Lima area, (a Peruvian corporation, formerly known as Empresas Electrica Asociadas, whose control recently passed to the government) and the main beneficiary of the proposed loan, has received four previous Bank loans totalling US$66.5 million, as detailed in annex 1; all four projects have been successf'ully completed. 1.02 The project's principal component in monetary terms is Electrolima's 1975-78 distribution expansion program. The Bank originally appraised a pre- vious version (Electrolima's 1973-77 program) in March 1973. However, further loan processing was postponed until 1975 to permit resolution of Electrolima's financial problems (principally its need for higher tariffs and re-financing of a large amount of short-term debt). Electrolima's current expansion pro- gram is necessary to meet increased system demand, including that caused by a large influx of low-income population residing in new localities (pueblos jovenes) in Lima's outskirts. The total and foreign financing reauirements of the project are US$147.2 and US$39.0 million respectively. The proposed US$36 million loan would finance all but US$3 million of Eiectrolimals foreign exchange needs (see paragraph 3.05) and would include a US$2.1 million technical assistance component (see paragraph 1.04). 1.03 Future power lending to Peru would probably be to the principal utility - Electricidad del Peru (Electroperu) - where the needs for Bank financial and technical assistance will be greater than in Electrolima. The Bank has not previously been able to assist in sector development other than through its loans to Electrolima because of insufficient technical and economic justification of other utilities' projects. By creating the national electric utility - Electroperu - in 1972, the government has begun the process of sector consolidation. However, basic planning and managerial problems re- main, and Bank assistance in resolving them is included in the proposed loan. 1.04 As summarized in paragraphs 2.04-06, the division of responsibility between Electroperu and the Direccion General de Electricidad (DGE;) of the Ministry of Energy and Mines (MEM) is unusual and the coordination between them, inadequate. The proposed loan includes a US$2.1 million technical assist- ance component as a first step to help the government improve sector organi- zation, establish a master plan for future power sector development, identify the training needs of sector personnel, provide funds for part of the recom- mended training and carry out tariff studies. While the technical assistance component of the proposed loan would initiate the resolution of sector prob- lems, continued effort will be necessary if the various government agencies which have responsibility for the sector are to achieve necessary improvements in technical and managerial standards. 1.05 This report is based on a feasibility study of Electrolima's 1975-78 expansion program prepared by the utility, on discussions between various Bank, MEM, DGE, Electroperu and Electrolima officials and staff members in 1973-75 and on the findings of an appraisal mission composed of Messrs. John E. Graves, Rafael A. Moscote and Philip Owusu, which visited Peru in July 1975.  - 2 - 2. The Sector Energy resources 2.01 The main source of commercial energy is petroleum, which accounted for 77% of all commercial sources in 1972. Peru now produces about 67% of its needs, mostly in the coast and adjacent offshore sites. As new fields in the Amazon basin are developed, this situation is likely to change. Even though discoveries in the area have been less than expected previously and several foreign oil companies have terminated their drilling operations, the government still hopes that the country will become self-sufficient by 1977 and a net exporter by 1978, when an 850 km pipeline to the port of Bayovar is expected to be finished. 2.02 Preliminary investigations have revealed the existence of important coal deposits in the north. Kopex, a Polish consulting firm, has estimated an economic reserve of 270 million metric tons of coal in Alto Chicama. Of these, about 60 million tons are considered by Kopex as proven reserves. On the basis of these investigations, the government has engaged the same con- sultants for further investigations leading to determining the feasibility of installing a coal-fired thermal station in the early 1980s. 2.03 Peru is well-endowed with hydroelectric resources. In 1972, the latest year for which complete data are available, about 18% of all energy used in the country and about 72% of all electric energy generation had this origin. The government has stated a policy of substitution for petroleum products in the generation of electric energy and expects to increase the hydroelectric generation by implementing several hydro projects (see para- graphs 2.14-15). Sector organization 2.0o The power sector is undergoing a major transformation, as detailed in annex 2. Before 1972, it consisted of a number of private, municipal and State-owned utilities, the largest of which was Electrolima, serving distinct concession zones and regulated by State agencies. No national sector plan- ning or coordination existed. Captive plants serving large mining and industrial installations were not interconnected with public-service systems. The Normative Electricity Law of 1972 provided for State control of the sector by creating a single State enterprise - Electroperu - and increasing State participation in and control of all other utilities. The draft general electricity law anticipates that all utilities will be consolidated into Electroperu at an unspecified future date. 2.05 At present, an inefficient distribution of responsibilities between the several State entities, a lack of coordination between them, and a lack of experience and/or qualifications among personnel responsible for sector planning may lead to uneconomic sector development. The most unusual feature of the arrangement is DGE's assumption of responsibility for sector planning and project selection without significant participation by Electroperu,leav- ing to Electroperu only the execution and operation of the selectecd projects. This is contrary to accepted utility practice. An operating agency is by its nature in a better position than a ministry to plan its future development  -3- because of its more direct contact with the market, its more thorough know- ledge of field and operating conditions, and its greater familiarity with the capability of its own system and personnel. Both DGE and Electroperu have prepared their own market forecasts and lists of future projects. Neither of their efforts provides a satisfactory master plan because their market forecasts are unreliable (see paragraph 2.13), the comparability of the pro- jects is doubtful and there is no adequate overall survey of the country's hydro resources to serve as a basis for selecting the priority of future projects. 2.o6 As a first step in resolving the situation, the loan includes funds for consultants to study the sector's organization, establish a master plan of future works and identify the sector's training needs (see paragraph 3.04). The government has agreed to engage such consultants by March 30, 1977. Regulation and tariffs 2.07 As described in annex 3, electric utilities are effectively regu- lated by DGE following the guidelines set forth in the draft general electri- city law, even though the 1955 regulatory law (Ley de la Industria Electrica No. 12378) is supposed to be applicable until the general law is put into effect. In contrast to the early 1970s, when Electrolima's tariff increases were insufficient, regulatory treatment in 1975 with regard to overall tariff levels has been satisfactory (see paragraph 6.01). 2.08 Electrolima's tariff structure, however, deserves further analysis. TWhile its tariffs (summarized in annex 3) include some exemplary features, such as discounts to encourage acceptance of service at higher vo-Ltage and off-peak and lower rates for basic consumption of lower-income residents of pueblos jovenes, they also include other features which may not stimulate efficient energy consumption patterns. Principal among these are low resi- dential and industrial rates, high commercial and general-use rates and high connection fees and customer contributions. Because Electrolima's tariff structure exemplifies the approach which DGE intends for nationwide applica- tion, the proposed loan includes funds for studies to determine the incre- mental cost of providing service to various customer classes and to propose an alternative tariff structure which reflects marginal costs, assuming that it is shown that the present one does not. The government has agreed to submit proposed terms of reference for the study by June 30, 1976, to engage consul- tants by January 31, 1977, and to discuss the study with the Bank prom.tly upon its conclusion. e Electricity consumption and service to rural communities and "'pueblos jovenes" 2.09 The larger cities and towns have public-service electric systems which account for about 60% of all electric energy used in the country, the remainder being captive generation for mining and industrial purposes (details are shown in annex 4). Access to electricity is limited in the urban poor areas known as pueblos jovenes as well as in smaller villages and isolated rural communities but it appears that a policy on access to service has yet to be defined.  -4 - 2.10 As summarized below, Peru's electricity market is predominantly for mining and industrial purposes. This illustrates the importance of the power sector to the economy, as these key sectors represent about 30% of GDP. Actual 1973 GWh Residential 1067 18 Commercial 505 8 Industrial and mining 049 67 Other 375 7 Total $9976 100 2.11 In metropolitan Lima, about 478,000 or 81% of the households had public-service electricity supply in 1974. About 25% of the Lima households are in the pueblos jovenes, of which in 1974 only some 55,000 households or about 40% of the total had electric service. It is expected that by 1978, about 18050r households in the pueblos jovenes will have electric service and that the total estimated residential customers will be 653,000 or 85% of the projected population. 2.12 About 47% of the population of the country is rural. In 1971, the year before its incorporation into Electroperu, Servicios Electricos Nacionales operated about 250 power plants with an average capacity of about 200 kW and distributed about 120 GW. Electroperu has assumed responsibility for all rural electrification and intends to electrify a number of new comnunities in the next five years. However, it has yet to define the policies or goals of an overall rural electrification program. According to the draft general law, DGE will be given the responsibility for planning the rural electrification program, but the draft does not specify the extent of coordination between DGE and Electroperu. Sector development 2.13 Peru has planned several mining and industrial projects with large power and energy needs. This will undoubtedly have as a consequence major demands on the power sector. According to the stated policy, Electroperu has to provide for these requirements but in its planning efforts and those of MEM, there is at present no distinction between the program that the sector should carry out to meet its normal growth plus the firm power and energy requirements of specific large industrial or mining projects, and the possible requirements of other projects for which definite commitments have yet to be made. As a result, there is no consensus as to what are the real requirements of the sec- tor. Because of the physical separation of the planning function from the operating entity (paragraph 2.05), the generation and transmission planning and the priorities assigned to the different projects and to the required studies are not always relevant, nor is the information obtained from the dif- ferent sources reliable. Thus, the installation program changes very often. As an example, at the beginning of 1975 sector authorities were convinced of the need to install a 400 MW thermal station in the Central Region by 1977 or 1978 so as to avoid power shortages. Such a need had disappeared completely by mid-1975.  - 5 - 2.14 Several other generating projects have been identified by Electroperu and MEM for possible development to meet projected power demands in the Central and Northern regions which include Lima and are the most important, with 76% of the country's population and 87% of its energy generation (annex 4). The MEM has developed a list of projects in which installation dates for these projects have been proposed. However, there is no evidence that their proposed order has been determined from a general study of several alternative projects and realistic economic comparisons between them which would lead to a list of priorities based upon economic and social consideration with due regard to the power system's operating constraints. 2.15 The present total installation program envisages adding about 2,300 MW to the north and central regions and about 700 MW in the rest of the country, by 1984. The most advanced new projects, in terms of availability of data and preliminary studies, to be in service in the north and central regions after the expansion of the Mantaro hydro station from its present 342 MW to its ultimate 798 MW, appear to be: Project Type Size (MW) Restitucion hydro 200 Sheque hydro 600 Chicama coal-fired 240 A brief description of these projects is included as annex 5.  - 6 - 3. The Project The Electrolima program and project component 3.01 Electrolima serves its concession area with 220 kV and 60 kV double- circuit transmission systems and 10, 30 and 60 kV distribution systems and a 220 V low-voltage system. The 30 kV voltage is being phased out. The project includes the estimated requirements for the expansion of these systems from 1975 to 1978. 3.02 The Electrolima component of the project includes the following major elements, described in detail in annex 6. a. Transmission and subtransmission: i. 26 circuit-km of 220 kV and 125 circuit-km of 60 kV line extensions; ii. construction, expansion and/or improvement of six 220/60 kV substations and of seventeen 60/10 kV substations. b. Distribution: i. installation of about 2,300 transformers, 10,000/220 V, with an aggregate capacity of about 233 MVA; ii. installation of about 1,000 circuit-km of 10 kV lines; iii. installation of 200,000 meters. c. Auxiliary services: i. expansion of the existing communications and control center; ii. auxiliary equipment for the data processing center; iii. laboratory, shop, transportation and maintenance equipmnent. d. Consultant services and training: (25 man-months) i. consultant services for the expansion of the communications and control center, for a review of distribution planning standards and for hot-line maintenance of overhead distri- bution and transmission lines; and ii. training of Electrolima personnel in hot-line maintenance of overhead distribution and transmission lines. 3.03 Electrolima will continue expanding its system as required after the project is completed. The most important future work is to close a 220 kV loop towards which it has worked for a number of years and which will limit the extent to which 60 kV is used as a transmission voltage. 60 kV will in the future be used mostly for distribution. The project's 220 kV components would form part of that loop (see map 11798).  - 7 - Technical assistance for the government 3.04 The problems of sector coordination are serious (paragraph 2.05). The project therefore includes intensive technical assistance to the govern- ment (see annex 6 for details). The technical assistance component consists of: a. a power sector organization study to be conducted under terms of reference shown in the attachment to annex 6 and which would attempt to suggest ways of improving the division of responsibi:Lities and coordination between sector entities and identify sector training requirements (25 man-months of consultants' effort); b. the preparation of a master plan for future generation and trans- mission additions in the north-central interconnected system of the country which would follow generally accepted practices and would distinguish between firm and possible power requirements and for which terms of reference are also shown in the attachment to annex 6 (160 man-months); c. training of sector personnel in operation, planning and administra- tion of large public utility enterprises; and d. tariff structure studies (10 man-months) Estimated cost and financing 3.05 The project's estimated cost is US$137.32 million with a US$35.27 million foreign component. Total financing requirements, including interest during construction (IDC) are US$147.]8 and US$39.Qmillion respectively. The pronosed loan would cover all the project's foreign financing requirements exc^ent US$3 million of urgerntly-needed imported equioment which Electrolima has contracted using procurement procedures not in accordance with the Bank's g,uidelines . 3.06 The costs for the Electrolima component of the project were estimated by Electrolima's technical p3rsonnel, based on information from recent bids and quotations and were found to be reasonable by the Bank. The costs for the technical assistance to the government were estimated by Bank staff. The costs are detailed in annex 6 and summarized below:  -8 - Sc x 106 US$ x 106 LocaL Foreign Total Local Foreign Total A. EEA system expansion Transmission and sub- transmission (220 and 60 kV) 776.3 472.5 1248.8 17.25 13.50 27.75 Distribution (10 kV and below 2214.2 380.3 2594.5 49.21 8.45 57.66 Auxiliary services 352.5 333.0 685.5 7.83 7.40 15.23 Consulting services and training 1.0 11.7 12.7 0.02 0.26 0.28 Total direct costs 3344.0 1197.5 454 741 26.61 100.9 Physical contingencies 217.4 78.8 296,2 4.83 1.75 6.58 Price contingencies 1023.7 225.4 1249.1 22.75 5.01 27.76 Total - Part A 45851 1501.7 6h86 8101.89 33.37 135_26 _ = B. Technical assistance to the government: Studies and training 5.0 62.5 67.5 0.11 1.39 1.50 Physical contingencies 0.5 8.6 9.1 0l 0.19 0.20 Price contingencies 1.9 14.4 16.3 04 0.32 D.36 Total - Part B 7.4 . 92.9 -7-.1U T7?9 2.06 Total project cost 4592.7 '587.2 61797 102 07 35.27 1T37.3 Interest during construc- tion (IDC): Part A 275.9 159.3 435.2 6.13 3,54 9.67 Part B - 8.6 8.6 - 0.19 0.19 Total interest 275.9 167.9 -4431.8 6._1_ 3 3.73 -- Total financing require- ments 4868.4 1755.1 6623.5 108.18 39.00 147.18 3.07 A physical contingency allowance of 5% was assumed for aLl 220 and 60 kV components and of 10% for all remaining components. This was considered sufficient because no major civil works are involved and finaldesigns are well advanced for most project components. 3.o8 The base cost estimates shown in paragraph 3.06 are based on the price levels prevailing at the beginning of 1976. Local and foreign price contingencies estimated using the following annual inflation percentages have been added: International Local 1976 10 12 1977 8 10 1978 8 9 1979 7 8 The percentagesused to calculate price contingencies for the local components of the project are lower than the forecast general inflation rates for Peru due to the fact that EEA has received informal quotations for most of the equipment and services to be obtained that indicate that the lower percentages are appropriate.  -9- Engineering 3.09 Electrolima's own staff will carry out the engineering necessary for execution of most parts of the project. This is acceptable as Electro- lima has proven experience in similar works. Electrolima would agree to engage consultants acceptable to the Bank for the purposes described in paragraph 3.02 (d)(i). Project execution 3.10 The execution of the project will be carried out as follows: a. Electrolima will request bids for materials and equipment and will contract for the construction of all 60 and 220 kV lines and substations. Electrolima's own personnel will commission all lines and substations; b. the government should agree to engage consultants for the technical assistance component of the project under terms of reference acceptable to the Bank. A project implementation schedule, which envisages completion of the project by June 30, 1979, has been agreed upon and would be used to monitor project execution (see annex 7). Procurement and disbursement 3.11 The government would agree to follow the Bank policies and pro- cedures for the utilization of consultants for the technical assistance components of the project. All purchases by Electrolima for Bank-financed equipment would be made following international competitive bidding (ICB) in accordance with the Bank's Guidelines for Procurement. Peruvian regulations and high import duties (60-100%) effectively prevent ICB for equipment manu- factured in Peru. About one-third of the project's cost represents locally- manufactured equipment - distribution (10 kV and below) cables and transformers and substation structures and accessory equipment. Similar imported equipment would cost about 30% less than such non-competitive locally-manufactured equip- ment, so that reserved procurement of these items has the effect of increasing the project cost by about 10%. Purchase of locally-supplied equipment and materials, not financed by the Bank, of over US$80,000 would be made after local competitive bidding procedures; those under US$80,000 would be placed directly with the supplier after a comparison of prices with at least two other sources. This arrangement is satisfactory. While this equipment in- cludes a small foreign exchange component (about h%), the latter has been shown as local costs in paragraph 37)6 for clarity of presentation. 3.12 Disbursements from the loan account would be made for: a. the CIF cost of imported equipment and materials; b. the cost of consultant studies; and  - 10 - c. financial charges on the Bank loan through October 14, 1979, the day before the semi-annual repayment date preceding the estimated closing date of the loan. Estimated loan disbursements are shown in annex 8. Because of the ongoing nature of transmission/distribution improvements, any unused loan balance could be applied to system extensions similar to those included in the project after consultation with the Bank. 3.13 In order to avoid delays in project execution, Electrolima would purchase equipment and materials, such as cables and meters, prior to the date of loan signing, to be financed by the proposed loan. Therefore, re- troactive financing of up to US$1.1 million for payments made after July 1, 1975 has been agreed. Environment 3.14 Electrolima has carried out its previous projects with due regard to ecological and environmental factors and expects to do so with this project. Most of its distribution system is underground because of, inter alia, aesthetic reasons. As detailed in paragraph 4.05, there is some question as to whether the aesthetic benefits and reduction in congestion offset the higher costs associated with underground systems, so that the project provides means whereby Electrolima may in due course decrease the proportion of underground lines, with eventual resultant savings. The company intends to route its overhead lines so as to minimize their visual impact. Project risks 3.15 While the price contingencies assumed ap-;'ar L- be sufficient, further local inflation could result in cost increases beyond those fore- cast. As noted in paragraph 6.04, Electrolima's financing plan includes some cash build-up, which would cushion the impact of such further inflation.  - 11 - 4. Justification of the Project Sector objectives 4.01 The Bank's objectives in lending for electric power development in Peru are: a. to stimulate the government to organize the electric power sector in the most efficient manner and define its financial policy towards the sector in order to provide the necessary institutional foundation for effective public utility operations; and b. to provide for the training of key administrative, operative and planning personnel in the sector in order to help Electroperu in becoming an effective enterprise. Project objectives 4.02 Besides assisting the government to formulate a progra-n to meet the above goals and serve as a basis for further assistance, the project would provide facilities to expand Lima's distribution system and thus meet future demands for electricity in that city (which accounts for 35% of the national market) without a reduction in the quality of service and would assist Electro- lima in its planning and maintenance operations and its tariffs. The project would be instrumental in making available public-service electricity to the pueblos jovenes as Electrolima would build distribution facilities in them, in- cluding the necessary substations and transmission lines. It is estimated that the households in the pueblos jovenes with public-service electricity would in- crease by about 230% by the end of 1978. Demand and generation forecast 4.03 The average gro-th in the past 10 years has been 9.5% p a. However, the rate of growth has decreased to about 8.5% p.a. in the last five years. Annex 9 gives details of both historical and forecast energy sales and maximum demand for the Electrolima system. The projection, which assumes an average 8.3% p.a. rate of increase in sales of electric energy and in maximum demand, is conservative and reasonable. Generation capacity appears to be adequate to supply the projected growth, although there are unresolved problems regarding future sector development (paragraphs2.13-2.15). Size of the project 4.04 The project is of an adequate size to provide Electrolima with the transmission and distribution facilities in Lima to enable it to satisfy the expected increase in power and energy requirements without reduction in the quality of service or investment in idle facilities. It will increase total installed capacity in 220 and 60 kV transformers from 2 times the maximum demand in 1974 to 2.2 times the maximum expected demand in 1979. The exist- ing ratio has allowed Electrolima to provide satisfactory service but the ratio will increase as 60 kV transmission is gradually replaced by 220 kV transmission and 60 kV distribution. Electrolima has kept a relatively low 1.18 ratio of the total installed capacity in 10 kV transformer to peak demand.  - 12 - At the end of the project, the ratio will have decreased to about 1.12 due to expected increases in services at 60 kV. Type of facilities 4.05 In most areas of the world, overhead transmission/distribution systems are usually lower-cost than underground, although new materials and advances in underground construction methods have decreased the differ- ential in recent years. Consideration of the non-quantifiable costs of increased urban and suburban congestion and the detrimental aesthetic effects associated with overhead systems has in many cases, however, resulted in a preference for underground facilities. Because of Lima's unique climatic situation - extremely dusty conditions caused by an almost total absence of rain and a salt-laden atmosphere, combined with extremely high hurnidity - Electrolima has demonstrated that the higher maintenance cost of overhead facilities reduces their cost advantage and has opted for continuation of a basically underground 10 kV distribution system with some overhead lines on the outskirts of the city in the 1975-78 program. The project already in- cludes a larger percentage of overhead lines than previous expansion programs and the inclusion of consultant services for a review of the planling pro- cess and of the weight given to the non-economic advantages of underground lines and of training in hot-line maintenance of overhead lines as part of the project, should eventually reduce the cost of maintaining the overhead systems, reduce Electrolima's staff opposition to them and prepare the way for future projects to have an increasing proportion of overhead lines, thus reducing capital requirements and resulting in eventual savings. h.o6 For most of the equipment included in the project, such as meters or communication equipment, no reasonable alternative exists. Where alterna- tives do exist, e.g. in routing of lines and location of substations, Electro- lima has selected the least-cost solution which is compatible with safety and aesthetic considerations. Return on investment 4.07 It is difficult to determine the economic value of Electrolima's incremental energy needs as Electroperu has not priced its sales to Electro- lima on the basis of its costs to expand and operate the Mantaro plant, from which these sales will be made. The uncertainty regarding the future pro- gram (paragraphs 2.13-2.15) does not allow a reasonable calculation for the cost of generating the required incremental energy at the other plants in- cluded in the program. It is, however, possible to establish a range of costs and from it determine a range of economic rates of return of the project. 4.08 The rate of return of the project as calculated on the basis of the present purchase price of energy by Electrolima from Electroperu and the re- commended Electrolima tariff is about 8.4%, while that obtained with the present Electrolima tariff is about -2.2%. As shown in detail on annex 10, the rate of return is quite sensitive to the cost of the incremental energy obtained by Electrolima. As indicated below, the present purchase price is higher than the probable incremental cost of electricity and therefore represents the maximum economic value of this energy and hence, results the lowest rate of return.  - 13 - If, for example, the purchase price is substituted by the incremental cost of an alternative fuel-fired plant the rate of return rises to about 4.7% at the present tariffs and to about 12.8% at the recommended tariff level. At the estimated costs of the most probable next generation addition to the system, the Restitucion project, the rates of return are about 6.8% and 14.4% respectively. 4.09 The rate of return of the project is less sensitive to variations in the cost of the project, as also shown in detail in annex 10. An increase of 20% in the project's costs would lower the rate of return to -)X.3% at the present tariff level and to about 5.4% at the recommended level. A decrease of the same magnitude in the project's costs would increase the rate of re- turn to about 0.8% and 13% respectively. 4.10 The range of rates of return (8.4 to 14.4%) obtained at the recom- mended average Electrolima tariff for sales to the public comrpares favorably with the opportunity cost of capital for Peru. The above range is based on efficiency prices, which in this case differ from market prices only by the amount of import duties estimated at 10% of total costs, but use of market prices would not effect the results materially.  - 14 - 5. The Beneficiary 5.01 The beneficiary of most of the loan would be Electrolima, the public-service concessionaire for Lima and its environs. Electrolima was formerly a privately-owned, Swiss-controlled company. The government established control over it in 1973 by assuming ownership of the public- domain assets managed by the company (annex 2). It has reached agreement to acquire the holdings of the foreign interests which previously owned 21% of Electrolima's shares and has also finalized agreements with the local holders of 25% of the shares. It now owns almost all of the company's shares, mostly in Electroperu's name. 5.02 The government has also reached agreement with the Swiss interests which controlled Energia Hidroelectrica Andina SA (Hidrandina), a company formed in 1946 to provide bulk electricity to the Electrolima system. In addition to the Moyopampa and Huampani hydro plants, all of TAhose generation Electrolima purchases, Hidrandina also operates a separate concession north of Lima. Organization, management and staff 5.03 Electrolima is well organized (annex 11 shows the organization chart), and its management and staff are competent to execute the project and operate the system. The composition of the 15-man board of directors reflects the change in Electrolima's control; all members are government representatives, The board and the executive president (a new po3ition created by the government-controlled board) control policy matters to a much greater degree than previously, when a particularly forceful general manager effectively controlled all aspects of the company. The inevitable transitional problems associated with the change in control have not signi- ficantly interfered with management's administration of day-to-day operations, which reflects its capability. Most of the top management positions formerly held by Europeans are now filled by Peruvians. The company's policy of promotion from within, the depth of its middle management and supervisory personnel, and its training program have served to provide sufficient manage- ment continuity. 5.04 At the end of 1974, staff numbered 2,407 which represented 227 cus- tomers/employee, up from 120 in 1964 and 180 in 1970. These ratios are indica- tive of a high degree of efficiency. Several unions represent Electrolima's employees; while competion among them has contributed to some differences of opinion between management and the unions, the company has been able to re- solve the issues without negative effect on the quality of service. The ef- fect of the workers' community to be established by the general electricity law (paragraph 15 of annex 2) cannot be determined at this time. Market 5.05 WThile industrial consumption forms a smaller portion of Electrolima's market than of electricity consumption in the entire country (paragraph 2.10), it is still the largest factor in Electrolima's market. The relative market shares of different consumer classifications are not expected to change signi- ficantly during the project execution period, as summarized below:  - 15 - Actual Projected 1973 1974 1978 GWh 7 GWh GWhi Residential 709 31 785 32 1088 32 Commercial 370 16 383 15 501 1l Industrial and mining 1020 44 1099 44 1513 44 Other 200 9 222 9 326 10 Total 2299 100 100 70 100 5.o6 In 1974 Electrolima served 545,000 customers, 55,ooo of which were in pueblos jovenes. In 1979 the total number of customers is expected to in- crease to 770,000, and those in pueblos jovenes, to quadruple. Eiectrolima's quality of service has been good and is expected to continue so. Management information systems and audit 5.07 Electrolima's internal management information system is good: operating and financial reports are prepared accurately and promptly; and customer records and accounting systems have been computerized. ]:ts financial statements are audited by Moreno, Patifio y Asociados, which has a working re- lationship with Price Waterhouse & Co. The proposed project agreement would require audited financial statements and the auditors' report to be transmitted to the Bank within six months of the end of Elpctrolima's fiscal year. Electrolima has generally complied with this covenant in the nast. Performance indicators 5.o8 Annex 12 shows a representative selection of indicators of Electro- lima's marketing, operating and financial performance through the year follow- ing project completion. Performance as measured by these indicators would be monitored during project execution.  - 16 - 6. Finance Summary 6.01 As detailed in annex 13, Peruvian regulatory authorities have increased Electrolima's tariff levels sufficiently to enable the company to achieve satisfactory financial results in 1975, in contrast to its unsatis- factory performance in 1972-74. To assure that Electrolima's financial per- formance continues to improve, it is provided in agreements related to the proposed loan that the company would earn sufficient revenues to contribute, from internal resourcesnot less than 3:% in 1976 and 45% in each year sub- sequently, to its investment program. Attachment 1 to annex 13 contains projections of Electrolima's key financial indicators, which are expected to improve as a result of the utility's higher earnings and reduced dependence on borrowing. Tariff levels 6.02 Prior loan agreements with Electrolima have not included specific covenants relating to tariff levels because the 1955 regulatory law and its application were satisfactory. Because of the effective suspension of that law (with respect to tariffs) and the lack of clarity of the normative and draft general laws (annex 3), such covenants are provided in agreements re- lated to the proposed loan. It is provided that Electrolima will apply for, and the government will grant, tariff adjustments sufficient to enable Electro- lima to contribute, from internal sources, to its expansion requirements at least 30% in 1976 and 45% p.a. in subsequent years. To meet these covenants, Electrolima will require increases of 11, 16, 10, 7 and 4% in its overall tariff levels in each of the years 1976 through 1980. It has already applied for 1976 increases of about 16%; subsequent increases would be handled on a year- by-year basis 6.03 Although more specific, the above provision is consistent with the draft general law, which provides that the utility's rate of return (to be determined by MEM - see paragraph 4 of annex 3) will enable it to contribute to an expansion fund. To establish a reasonable value for application of the still-undetermined rate of return, MEM increased the value of Electro- lima's rate base by 40% in 1975, thereby offsetting deficiencies in this regard since 1968. Agreements related to the proposed loan provide for annual revaluations of Electrolima's rate base. Financing plan 6.04 Assuming that Electrolima and the government comply with the pro- visions proposed above, Electrolima's project financing plan would be accept- able. Net internal cash generation would amount to 28% of the company's finan- cing requirements (44 % if connection fees are considered as internal cash generation), which include substantial working-capital increases to pay off remaining short-term debt and provide some cushion for higher-than-expected requirements. Borrowings from the Bank and Peru's Corporacion Financiera de Desarrollo (COFIDE) would provide 3C%, and contributions from the government and developers (see attachment 7 to annex 13), 26%. To assure that earnings above the legal dividend requirement are reinvested in utility assets, the proposed oroject agreement limits Electrolima's dividends to o.5% p.a. of the value of shares entitled to dividends. Electrolima's funds forecast is sum- marized below and detailed in attachment 3 to annex 13:  - 17 - Financing plan 1975-79 - - - millions - -- Soles US$ _ Requirements of funds Construction program incl. IDC (see note): The project 6,131 136.2 Future works 1,601 35.6 Developers' construction 1,54o 34.2 Total construction 9,272 206.0 93 TWorking capital increase 684 15.2 7 Total requirements 9 956 221.2 100 Sources of funds Net operating income plus provisions 9,h11 220.2 Less debt service, dividends and income taxes 7,147 158.8 Net internal cash generation (exclud- ing connection fees) 2,764 61.4 28 Connection fees 1,612 35.8 16 Proposed borrowings: IBRD 1 34.o COFIDE 1,450 32.2 Total borrowings 2,980 30 Contributions: Government 1,060 23.6 Developers 1,54 3.2 Total contributions 26oo T57.8 26 Total sources 221.2 100 Note: The total project amount of S,/6,,131 'i$36.24)million reflects Electro- lima's policy of capitalizing IDC for the construction period of each project component and is therefore higher than the project cost of S/6,087 million shown in paragraph 3 D6, but lower than Electrolima's financing requirements. 6."5 The proposed US$36 million Bank loan would be made to the Republic of Peru for a term of 20 years including three years of grace at the current Bank interest rate, assumed to be 8.5% p.a. The government would relend UE$33.9 million of the loan to Electrolima on the same terms. As noted in paragraph 3.06, US$2.1 million of the loan woul(d be for technical assistance to the government. This portion is not included in the above financing plan or in the more detailed financial projections attached to annex 13. 6.06 COFIDE has approved a S/40o million loan to Electrolima of which S/lqO million was disbursed in 1975. COFIDE has also indicated its agreement, in principle, to provide an additional S/850 million to Electrolima over the period 1976-78. Eletrolima would, nresumably, ma;e arrangements with uorIDE to obtain bne S/ .60u million n,eded to iieet its fin.ncinb require:cents in 1979 and 1980. COFIDEts current terms are nine years including two years of grmce, 11% annual interest.  - 18 - Security 6.07 In past lending operations Electrolima has issued bonds to the Bank under an open-ended indenture written in 1957 between Electrolima and Schr5der Trust Company; use of this indenture has been necessary to prevent private bondholders from having a prior claim on Electrolima's assets. Repetition of this requirement is not necessary because the proposed loan would be made directly to the Republic of Peru. Debt service coverage 6.o8 The Bank has previously relied on financial tests included in the 1957 indenture which provide that: a. Electrolimals net income before interest and taxes should equal at least 150% of its interest on funded indebtedness; and b. Electrolima's net tangible assets should be at least 150% of its total funded indebtedness. These tests did not prevent Electrolima from amassing very large amounts (over US$20 million) of short- and medium-term debt in 1968-73, which were re- financed only with governmental assistance in 1974, and a portion of which (S/535 million in overdrafts at year-end 1975) remains to be liquidated. To give the Bank an opportunity for closer review of Electrolimals financial situa- tion, the proposed project agreement provides th-t Electrolima will not incur long-term debt without the Bank's approval unless its most recent 12-month internal cash generation is at least 1.5 times its maximum debt service re- quirement (including the debt service on the proposed loan as well as exist- ing ones) for any succeeding fiscal year. Because Electrolimals debt service is expected to be high throughout the project period, Bank approval of future borrowing is expected to be necessary. To prevent Electrolima from undue re- liance on short-term debt, the proposed project agreement also provides tPat Electrolima's maximum short-term indebtedness at any date is to be limited to one-sixth of its operating, maintenance and administrative expenses (exclusive of depreciation and other non-cash provisions) during the preceding twelve- month period.  -19 7. Agreements Reached and Recommendations 7.01 In the proposed loan agreement, the government would agree to: a. execution by acceptable consultants of the studies comprising the technical assistance component of the project (paragreph 2.06). 7.02 In the proposed project agreement Electrolima would agree to the following matters: a. use of consultants for the project (paragraph 3.09); b. submission of audited financial statements (paragraph 5.07); c. maintenance of tariff levels so as to provide sufficient fuids for an adequate contribution-to-expansion (paragraph 6.02); d. dividend limitations (paragraph 6.04); and e. limitations on Electrolimals long-term and short-term inidebtedness (paragraph 6.08). 7.03 Prior to declaring the loan effective, the Bank should receive notification that the subsidiary loan agreement between Electrolirma and the government has been signed. 7.04 The project constitutes a suitable basis for a Bank loan of US$36 million for a term of 20 years with a three-year grace period. February 11,1976   Annex 1 APPRAISAL OF FIFTH POWER PROJECT - PERU Previous Bank Lending to Electrolima Loan Loan Loan amount (in Project Principal number date US$ millions) name project component 260-PE 1960 24 Huinco Construction of -the Huinco hydro station with two units of 60 NW each 365-PE 1963 15 Huinco 11 Expansion of the Huinco sta- tion to install two additional units of 60 MW each to bring total installed capacity to 240 KW 464-PE 1966 10 Power Distribution Expansion of the transmission and distribution system 1966-68 511-PE 1967 17.5 Matucana Construction of the Matucana hydro station, with two units of 60 MW each September 1975  Annex 2 Page 1 of 4 pages APPRAISAL OF FIFTH POWER PROJECT - PERU Organization of the Electric Power Sector 1972 restructuring 1. Prior to 1972, the public-service portion of the sector was composed of distinct private, municipal and state entities serving concession zones or regions; no national sector planning or coordination existed. Captive plants serving large mining and industrial installations, which account for about 4C0 of total electricity generation, were generally not interconnected with public service systems. Decree law no. 19521, the Normative Electricity Law of Sept- ember 1972, made the State the primary factor in the sector by reserving for it the responsibility for public-service electricity supply, creating a cen- tral State-owned enterprise (Electroperu); providing for State participation in existing private utilities (by far the largest of which is Electrolima); and pro- viding for interconnection of power systems (see paragraph 5). 2. The normative law gave Electroperu primary responsibility for plan- ning, studying, engineering, construction, construction supervision, and operation of all new generating facilities larger than 10 MW and for the trans- mission/distribution functions of State electric utilities. To accomplish the necessary sector and project feasibility studies, engineering, and construc- tion supervision, the law created the Instituto de Investigaciones Energeticas y Servicios de Ingenieria Electrica (INIE), which was to report directly to Electroperu's executive president and thus be independent of Electroperu's operating division. As detailed in paragraphs 6 and 9 it consolidated all then-independent State-owned electricity agencies into Electroperu and pro- vided for incorporation of municipally-owned utilities within two years and for Electroperu to represent the State in the management of other electric utilities. 3. State participation in the other utilities was accomplished by means of capitalizing public-domain assets. Prior to 1972 those assets, which are primary and secondary distribution facilities paid for by third parties (prin- cipally by the developers of new communities, existing customers through tariffs and new customers who would recieve the service) and located in public streets (in Electrolimals case, outside its original concession zone) but maintained by the utilities were not classified as assets of the utilities. The normative law declared the State to be the owner of the public-domain assets and provided that the State contribute such assets to the appropriate utility, receiving therefor shares equivalent to their value; such shares are not entitled to dividends. 4. Increased State participation in the private utilities is assured by other sections of the law which provide that the State is to be the ex- clusive buyer of all new shares issued by utilities and of all shares cur- rently held by non-Peruvians.  Annex 2 Page 2 of 4 pages 5. Other sections of the normative law oblige non-State utilities and captive plants to intercoimect their systems with Electroperu's when the State enterprise deems such interconnection necessary. The law's provisions were extended in the M4arch 1974 Electrical Interconnection Law no. 20560, which gives Electroperu responsibility for load dispatching and the Direccion General de Electricidad (DGE) responsibility for establishing interconnection tariffs. Present situation 6. The State-owned electric utilities which were combined to form Electroperu were: a. Corporacion de Energia Electrica del Mantaro, whose principal facilities are a 342 MW hydro station, with an ultimate capacity of 798 MW and transmission facilities to supply electricity from Mantaro to Lima, Ica and Independencia (see map 11797); b. Corporacion Peruana del Santa, which operated the 100 MW Canon del Pato hydro plant and 82 MW of gas turbines to serve the Chimbote- Trujillo region; c. installations run by agencies reporting to the Sistema Nacional de Apoyo a la Movilizacion Social, which include several hydraulic and thermal generating plants, generally less than 50 MW each, in various regions; and d. Servicios Electricos Nacionales, which operated about 250 small isolated thermal installations. 7. Electroperu has divided the country into the following five opera- ting regions (with principal cities in each region): North-central interconnected - Lima, Chimbote, Trujillo North - Bayovar, Piura, Talara South-west - Tacna, Arequipa, Puno South-east - Cuzco East - Iquitos, Pucallpa The north-central region is by far the largest electricity market with electricity generation amounting to 87% of the country's total. 8. Electroperu's operating results leave room for improvement. Its 1973 operating losses exceeded SI 300 million (tariff increases and increased energy sales from its largest installation - the Mantaro hydroelectric develop- ment - are expected to improve these results). Its control over operations, particularly over the 250 isolated plants for which it is responsible, is limited. Completion of a major 220 kV transmission line to link the Chimbote- Trujillo region with the central region (see map 11797) will be seriously de- layed because of difficulties in arranging financing to pay for expected cost overruns.  Annex 2 Page 3 of 4 pages 9. Electroperu's participation in the management of other utilities is not being carried out as provided in the normative law. No representative of Electroperu sits on Electrolima's board of directors or otherwisewparticipates in the company's management. 10. INIE has been separated from Electroperu, presumably to report to MEM. Its basic laws remain unwritten, however, and the failure of the draft general law to recognize its existence (see paragraph 17) leaves its future status in doubt. 11. With respect to Electrolima, the go7rernment has concluded negotiations - acquire the 21% interest in the company held by foreign shareholders. The govern- ment has proposed the terms of acquisition for the 25% of Electrolimats shares currently in private Peruvian hands; the governmentts proposal was approved at a shareholders' meeting in October. The shareholders will receive bonds in ex- change for their shares; terms of the bonds are detailed in attachment 7 to Annex 12. Once this process is completed, state agencies, principally Electro- peru, will be the exclusive owners of Electrolima's shares. Present organizational problems 12. Despite the provisions of the normative law which gave Electroperu overall sector responsibility (paragraph 3), DGE has assumed responsibility for sector planning and selection of future generating and transmission works, citing its own organic law as authority for doing so. This arrangement, which leaves to Electroperu only the execution and operation of the selected works, is very unusual. In most electric power systems, the agency responsible for planning, designing and executing works to meet expected growth in demand is the operating agency, subject to governmental review only for policy and/or budgetary purposes. The reasons for this are threefold: the operating agency has more direct contact with the market for electricity - distribution com- panies and/or retail consumers - and hence is in a better position to fore- cast future requirements and coordinate its installation program with present or prospective customers' needs; it has a more thorough knowledge of field and operating conditions, which allows it to take into consideratiorn the capa- bilities and limitations of its system to handle the expected loads; and it is in a better position to accept all the responsibilities connected with plan- ning decisions related to quality of service, such as amount of reserve, out- age expectancy, etc. 13. The results of the unique arrangement found in Peru are not en- couraging. Both DGE and Electroperu have prepared their own market forecasts and formulated a list of projects to meet the expected demand. The validity of their demand forecasts, however, is questionable because the forecasts are based on assumptions of industrial expansion which may not reflect the current situation. There is no adequate hydro survey of the country; instead, indi- vidual surveys of Peru's major river basins have been prepared by various foreign consultants and local agencies. While pre-feasibility and feasibility studies of certain hydroelectric developments (e.g., the Restitucion plant downstream from the Mantaro plant, the Sheque plant upstream from Electrolima's existing H-uinco plant and the Chorro plant upstream from Electroperu's existing  Annex 2 Pag of 4 pages Canon del Pato plant) exist, they may not be comparable because non-coincident and uncoordinated study preparation may have resulted in the use of incom- patible assumptions. 14. To improve this situation, the proposed loan includes US$2 million to assist the government in improving coordination among its power sector agencies, establish a "master plan" of future generating and transmission works, identify the training needs of sector personnel (including but not limited to Electroperu's) and propose means of meeting those needs. The master plan would include reliable projections of energy requirements for the period 1977-96, a nationwide hydro survey, pre-feasibility-level cost estimates for the most promising hydroelectric sites identified in the survey., and the resultant least-cost scheme to meet the forecasted requirements. The Government has agreed to the proposed terms of reference for this study (see the attachment to annex 6). Future developments 1. Most foreseeable future developments concerning the power sector's organization are embodied in the draft general electricity law which MEM published in late 1974. The noteworthy features of the draft are that it: a. confirms the division of responsibility for sector planning, selection, execution and operation of works advocated by DGE (paragraph 12); b. provides for incorporation of all utilities into Electroperu at an unspecified future (iate; c. fails to mention INIE; d. provides for a unified national tariff (see annex 3); e. establishes two funds, the electric development fund (fondo de desarrollo electrico) and the network improvement fund (fondo de ampliaciones de redes) to provide for financing of system expansion. The former is to be funded by a portion of the rate of return to be determined by DGE and the latter, by contributions from developers and consumers to pay for the distribution works now known as public- domain assets (paragraph 3); and f. creates a workers' community (comunidad de electricidad) to participate in the management of electric utilities and in their earnings and financing through a complex financing scheme detailed in annex 12. September 1975  Annex 3 Page 1 of 3 pages APPRAISAL OF FIFTH POWER PROJECT - PERU Electricity Regulation and Tariffs in Peru Regulation 1. Electricity tariffs in Peru are regulated by the Direccion General de Electricidad (DGE), which has already begun to take steps to implement the features included in the draft general electricity law (annex 2). Among the more noteworthy features are: a. the creation of a tariff system which provides for the eventual implementation of a unified national tariff (under which standard service classifications, demand charges and block energy rates would be established for nationwide application regardless of location or sources of electricity); b. bi-annual review of tariff levels; and c. determination of the allowable rate of return every four years. 2. Implementation of the unified national tariff would be gradual. As an interim step the draft general law provides for the implementation of regional tariff systems. The draft law also establishes a compensation fund (fondo de compensacion tarifario) into which utilities whose revenues exceed revenue requirements would contribute and from which those wihose requirements exceed revenues would draw. DGE personnel have already drafted proposals re- lating the tariff levels to be charged various customer classifications to the overall average tariff levels. These relationships would be similar to those inherent in Electrolimats tariffs (see paras. 8-10) and would be determined more by political than by technical or economic factors. Under this system, commercial and general-use tariffs are extremely high; governmental-use (ex- clusive of water pumping, which is off-peak), about average; and residential and industrial, quite low, 3. While the draft law provides for tariff-level reviews every two years, the underlying philosophy apparently does not prevent more frequent tariff adjustments to compensate for inflation rates higher than expected in the original biennial determination. Electrolimals 1975 tariff increases provide evidence of this pragmatic approach: after having received an overall 30% tariff increase in February 1975, a further increase of about 7% was put into effect in July. 4. Under the draft law the utility's revenue requirements are to be its cost of doing business (broadly defined as purchases of goods and ser- vices and personnel costs - presumably related to operations and maintenance - taxes and provisions for depreciation using average useful lives determined by DGE) plus an appropriate rate of return to be determined every four years by MEM. This rate of return is designed to cover, in order of priority:  Annex 3 Page 2 of 3 pages a. the utility's financial charges; b. 70% of its contribution to the workerst community (paragraph l5f of annex 2); and c. a contribution to the electric development fund (paragraph l5e of annex 2) to be determined by DGE. Any excess profits (excedente economico) after deducting these charges would be applied to the remaining 30% contribution to the workers' community and other uses to be determined. 5. As an interim measure (presumably until their consolidation into Electroperu), the draft law would allow private or mixed utilities to include an 8.5% return on shares entitled to dividends in their rate of return. 6. The draft law's lack of specificity (e.g. with regard to the manner in which contributions to the development fund are determined, what constitute "financial charges" and whether tariff adjustments will be awarded more fre- quently than bi-annually in case of high inflation) gives DGE a greater degree of latitude in determining the self-financing capability of utilities than is common in many other countries' regulatory laws or in Peru's existing Electric Industry Law No. 12378 of 1955 (which, although nominally the regulatory law until the general law has been made effective, has effectively been superseded by the provisions of the draft general law). In 1975, when arrangements for the government to acquire private shareholders' remaining interests are ex- pected to be completed, regulatory attitudes towards the financing needs of utilities in general and in particular have become more favorable than in previous years, as indicated by the following: a. DGE officials have indicated their intention to allow Peruvian utilities to self-finance 20-30% of their expansion programs; and b. Electrolima has received two tariff adjustments through July 1975, which will enable it to achieve satisfactory financial performance for the first time in four years (see chapter 6). Because of the de facto suspension of existing regulatory legislation, the lack of clear guidelines in the rnormative law and the lack of specificity in the draft general law, a specific rate covenant similar to the draft general law's interim allowable-earnings clauses (paragraphs 4 and 5) is proposed for inclusion in the loan and guarantee agreements (see paragraph 6.02 of the text). 7. Even with government agreement to this covenant, Electrolima's self- finanicing capability would be closely monitored during project supervision, for there is a risk that Electrolima will not be granted tariff increases of sufficient size or with sufficient frequency to maintain its self-financing capability in the face of continued high inflation rates (see paragraph 3.17 of the text).  Annex 3 Page 3 of 3 pages Electrolima's tariffs 8. Electrolima's present tariffs, which are summarized in the attachment, contain both reasonable and questionable features. Among the reasonable ones are: a. lower charges for off-peak consumption, both for water pumping and for large industrial consumers, which have day-night metering; b. reactive energy charges for all but the smallest industrial custom- ers; and c. some allowance (an 8% discount) for lower-income residential con- sumers' (living in pueblos jovenes) basic consumption. Other features deserve further investigation. _ Among the more notable are: differing demand charges among various sizes of industrial customers; the lack of a significant spread (or, in the case of nighttime large industrial consumption, the existence of a negative spread) between Electrolimals industrial tariffs and its incremental costs (Electroperu's tariffs); the very large differential between industrial/residential tariffs and commercial/general, which may indicate that the latter are subsidizing the former; and relatively high connection fees, which, while offsetting to some degree the financial effects of low residential tariffs, may inhibit lower-income residents' access to public-service electricity supply. 9. As far as can be determined, the differentiation among tariffs of various customer classes reflects the government's desire for popular support and to stimulate industrial development rather than any assessment of the cost of providing service. The proposed loan includes funds for studies to determine the incremental cost of providing electricity to the various customer classes in the metropolitan Lima area, to assess the effect on the economy of Electrolimats existing tariff structure (assuming that it does not reflect marginal costs) and to propose an alternative structure which reflects marginal costs. 10. Prompt completion of such a study is feasible because Electrolima has adequate market statistics for its service area ( which may not be available for the rest of the country) and particularly necessary because the general scheme of Electrolima's tariff structure exemplifies the approach which DGE intends to take in establishing regional and ultimately, national tariff schedules. By assessing the effect of Electrolimats tariff structure on energy consumption and the econory the study could serve as a basis for reviewing tariff policies for not only Electrolimals service area but the rest of the country. Attachment September 1975  M4onthly Electricity Tariffs in Metropolitan Lima Area (in sales) Electroperu E.Lectroiit" tariffs tariffs Tariff no. 20: Tariff no. 21: Residential - Residential - other than pueblos jovenes pueblos jovenes Residential service First 30 kWh: minimum bill per month 31.00 28.50 Next 100 kWh - per kWh 1.i36 1.27 Next 70 kWh - per kWh 1.15 1.15 Excess over 200 kWh - per kWh 1.V( 1.00 Industrial service Tariff no. 30: Tariff no. 31: Tariff no. 32: Tariff no. 33: Tariff no. 34: Installed capacity Less than 50 kW 50 kW or higher 50-1000 kW 1000 kW or higher 1000 kW or higher N.A. Voltage Al' 0.22 or 2 kV 10 or 30 kV 10 kV 30 or 60 kV 220 kV Maximum demand - per kW 114.00 104.00 145.00 104.00 93.60 Installed capacity - per kW 27.00 Daytime energy (10 as' to 10 pm) - per kWh o.69 5.56 Nifhttime energy (10 pnm to 10 am) - per kWh 0.34 0.28 All energy - per kWvh 1.00 n.71 0.69 0.59 Reactive energy - per kVArh 0.35 0.34 0.44 0.37 0.30 Tariff no. 40: Commercial service Commercial First 20 kWh: minimum bill per month 80.00 Next 1980 kWh - per kWh 3.85 Next 4000 kWh - per kWh 3.55 Next 4000 kWh - per kWh 3.05 Excess over 10,000 kWh - per kWh 2.75 Tariff' no. 51: Tsriff no,. 50: Governmental Tariff no. 60: ueneral excl. water Water Other service Ilse pumping pumping First 20 kWh: minimum bill per month 80.00 ov.00 Next 80 kWh - per kWh 3.80 Next 100 kWh - per kWh 2.50 Next 180 kWh - per kWh 2.'0 First 200 kWh: minimum bill per month 500.00 ox Excess over 200 kWh 2.00 1.30 0.75 it September 1975  P. ?'PRATS F FIl?FT. 1 PR(JTCE - PERU Installed Generating Capacity, Electric Energy Generation and ConsuTnption 1961 1969 1970 1971 1972 1973 1974 Installed Capacity mW Public Suppliers 480 851 863 9 1076 1320 1431 Captive Plants 573 801 811 823 854 834 831 Total 1053 1652 1677 1797 1930 2154 2265 Hydro 539 918 923 989 1057 1278 1388 Thermal 511 734 754 808 873 876 877 Generation G`Th Public Suppliers 16214 2786 2930 3297 3525 3892 4312 Caftive Plants 2078 2502 2599 2652 2761 2763 2960 Total 3702 5238 5529 5949 6289 6655 7272 Hydro 2280 3701 3821 4283 4536 4769 5219 Thermal 1422 1587 1708 1666 1753 1886 2053 Eiectric Energy Consun)tion and Losses - GWh Public Lighting 156 176 170 185 205 Residential 776 855 909 948 1067 Commercial 374 409 389 435 505 Industrial 1620 1660 2025 2126 2279 Agricultural 74 83 78 61 67 Mining 1681 1683 1612 1704 1770 Fisheries 145 130 165 76 67 Other Uses 88 119 82 122 37 Losses 3714 14114 519 496 658 Total 72i9 59149 F73- (1) Z6WT (' ) Refers to 97.85>' of Generation SOURCE: Direccion General de Electricidad - Anuario de Estadistica Electrica 0  PERU Maximun Denand and Electric Energy Generation Main Systems 1970 1971 1972 1973 194_ 1. Maximum Demand (MW) Central Re-gion Lima-CalJio (Electrolima) 391 425 444 488 516 Centromln-/ 12tE 129 130 128 N.A. North Region Electroperu (Santa) 53 60 57 71 N.A. Subtotal - North and Central-/ 7 612 31 687 Southeastern Region Electropera (Machu Picchu) 3-0 31 30 5 N.A. Southwestern Region Arequipa 20 23 24 26 N.A. Electroperu (Aricota) 8 10 11 10 N.A. Southern Peru Copper 1/ 47 49 19 55 N.A. Subtotal - Southwestern7/ 75 82 84 91 2. Electric Energy Generation (Glri) Central Region Lima-Callao 3/ 1994 2204 2346 2556 2727 Centromiln 924 876 974 967 N.A. North Region Electroper'u (Santa) 118 250 261 333 N.A. Subtotal - North snd Central 3036 3330 3584 3856 Southeastern Region Electroperu (Machu Picchu) 146 173 166 208 N.A. Southwestern Region Arequipa 95 102 110 130 N.A. Electroperu gAricota) 26 31 36 33 N.A. Southern Peru Copper 321 311 325 314 N.A. Subtotal - Southwestern 442 447 471 477 1/ Centromin and Southern Per(a Copper are mining companies that have their own generating facilities, sell only a minor percentage of their production to third parties and will purchase their incremental needs from Electroperu. t/ Diversity disregarded. 3/ Includes energy generated by Electroperuts Mantaro and sold to Electrolima but not that sold to others. SOURCE: Direccion General de Electricidad - Anuario de Estadistica Ealectrica - 1973 excent 1??7l data for which source is Empresas Electricas Asociadas - Datos Estadisticos - 19714. 0  PERJ Installed 7eneratinet Capacity and Electric Energy Ganeration and ConsuLrpticrn by Power Sectcr Regions2/ Public Captive '.tal Service Plants TNW ILa ydro Thermal Installed Capacity- NW 1. Northern Region 254.6 196.0 450.6 20.9 110.9 339.7 2. Central Region 917.7 467.7 13ii5.4 64.3 1057.9 327.5 Subtotal 1172.3 663.7 I-36.0 85.2 116.8 667.2 3. Eastern Region 135.6 162.1 297.7 13.8 109.5 1881.2 4. Southern Regicn 12.? S .C 20.2 l.0 - 20.2 TOTAL - NW 1320.1 833.- 2153.9 100 127k.3 875.6 % 61.3 36.7 -To= ~ _59.3 ' 40.7 GWh Electric Energy Generation - GWh 1. Northern Region 523.4 481.1 1004.5 15.1 343.9 660.6 2. Central Region 2939.5 1838.5 477c.0 71.8 4048.9 729.1 Subtotal 2319.T 5782.5 8K.9 392.8 3. Eastern Region 394.9 410.3 805.2 12.1 376.0 429.2 4. Southern Region 34.2 33.0 67.2 1.0 - 67.2 TOTAL - G-Jh 3892.0 2762.9 6654.9 100 4768.8 1886.1 v5 1.5 100 71.7 28.3 Public Total Lighting Residential Commercial Industrial Agriculture Yining Fisheries Other 6Wh % Electric Energy ConsumptionL/- GW, 1. Northern Region 26.8 116.6 24.0 603.8 49.3 57.5 25.2 3.5 906.7 15.1 2. Contra.l Reon 151.5 832.8 457.2 1392.3 13 1414.8 34.8 14 4310.4 71.9 Subtotal 178.3 949.4 4 8 1.2 1996.1 75 17423 dO0O 17.5 5217.1 -7. 3. Eastern Region 2.3 14.5 6.5 32.8 - - - 2.4 58.5 1.0 4. Southern E'egion 24.4 102.8 17.0 250.3 4.4 298.1 6.9 16.8 720 7 12.0 TOTAL - GWh 205.0 1066.7 5