Uruguay - Fourth Power Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 2280 PROJECT PERFORMANCE AUDIT REPORT URUGUAY: FOURTH POWER PROJECT (Loan 712-UR) November 28, 1978 Operations Evaluation Department 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.  FOR OFFICIAL USE ONLY PROJECT PERFORMANCE AUDIT REPORT URUGUAY: FOURTH POWER PROJECT (Loan 712-UR) Table of Contents Page No. Preface (i) Project Performance Audit Basic Data Sheet (ii) Highlights (iii) Project Performance Audit Memorandum I - Project Summary 1 II - Main Issues 5 A. Changes in Project Scope 5 B. Borrower's Compliance with the Loan Covenants 7 C. Incremental Financial Rate of Return (IFRR) 11 III - Conclusions 13 Appendices A - Schedule of Disbursements B - Financing of 6th Unit at Batlle Power Station C - UTE Balance Sheet as of 12/31/74 D - IFRR on 6th Unit at Batlle Power Station Attachment: Project Completion Report I. Project Preparation Al II. Project Description A4 III. Objective and Justification of the Project A4 IV. Project Implementation A8 V. Project Cost Estimates A9 VI. Consultants and Contractors All VII. Financial Performance All VIII. Institutional Performance Al3 IX. Bank Performance Al5 X. Conclusions Al7 XI. Lessons to be Learned Al8 Annexes I - Rate of Return on 6th Thermal Unit (125 MW) Power Station II - Montevideo Distribution Rehabilitation Program III - 1974 Income Statements 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.  (i) PROJECT PERFORMANCE AUDIT REPORT URUGUAY: FOURTH POWER PROJECT (Loan 712-UR) Preface This report presents the results of a performance audit of the Fourth Power Project in Uruguay, for which a loan of US$18 million (Loan 712-UR) was made to Usinas y Telefonos del Estado in 1970. 1/ The loan was signed in November 1970, became effective in June 1971 and was closed in June 1977. The Project Performance Audit Report consists of a Memorandum, prepared by the Operations Evaluation Department (OED), and a Project Completion Report (PCR) prepared by the LAC Regional Office. OED had reviewed the PCR, which was found to be a comprehensive and critical docu- ment, against the Appraisal Report and other documents and discussed the project with Bank staff. Following normal procedures, a copy of this Project Performance Audit Report was sent to the Government for comments. However, none were received. 1/ The name of the organization was later changed to Usinas y Transmisiones Electricas when UTE's telecommunications activities were taken over by the Administracion Nacional de Telecomunicaciones (ANTEL) in 1974.  (ii) PROJECT PERFORMANCE AUDIT BASIC DATA SHEET URUGUAY USINAS Y TRANSMISIONES ELECTRICAS (UTE) FOURTH POWER PROJECT Loan 712-UR KEY PROJECT DATA Appraisal Actual or Item Expectation Current Estimate Total Project Cost (US$ million) 22.6 38.9 Overrun (1) 66 Loan/Credit Amount (US$ million) 18.0 Disbursed - 18.0 / Cancelled -75 Repaid to (2-28-78) 1.3 Outstanding to " " " - 16.7 Date for completion of Physical Components 12/73 11/76 Proportion Completed by Appraisal Target Date ()- 50 Proportion of Time Overun (%) - 37.5 Incremental Financial Rate of Return (%) 14 14 Financial Performance Satisfactory Unsatisfactory Institutional Performance Improving Unsatisfactory OTHER PROJECT DATA Original Actual or Item Plan Revisions Current Estimate First Mention in Files or Timetable - - 10/02/64 /_ Government's Application - - 10/02/64 /2 Negotiations - - 8/28 to 9/4/70 Board Approval - - 01/24/7a Loan/Credit Agreement Date - - 01/25/71 Effectiveness Date 03/25/71 06/25/71 06/18/71 Closing Date 12/31/74 12/31/75-76 06/30/77 Borrower UTE Executing Agency UTE Fiscal Year of Borrower 12/31 Follow-on Project Name /3 Fifth Power Project Loan/Credit Number N.A. Amount (US$ million) 20 Loan/Credit Agreement Date N.A. MISSION DATA Month/ No. of No. of Date of Item Year Weeks Persons Manweeks Report Identification /L 03/69 4 1 4 04/15/69 Preparation & Preappraisal 08/69 1 1 1 09/09/69 Appraisal 03/70 3 3 9 03/30/70 Total 8 14 Supervision I 04/71 1 2 2 05/07/71 Supervision II 06/72 1.5 2 3 07/03/72 Supervision III 01/73 1 1 1 01/22/73 Supervision IV 07/73 0.5 2 1 09/17/73 Supervision V 01-02/75 1.5 2 3 02/20/75 Supervision VI 08-09/75 1.5 3 4.5 09/24/75 Supervision VII 02-93/76 1 1 1 03/25176 Supervision VIII 06 /76 0.5 1 0.5 06/18/76 Supervision II 11/76 1.5 3 4.5 12/13/76 10.0 =5 COUNTRY EXCHANGE RATES Name of Currency (Abbreviation) Peso (Ur$) Year: Appraisal Year Average (1970) Exchange rate: US$1 = Ur$250 Intervening Years Average (1970-76) US$1 = Ur$1,308 Completion Year Average (1976) US41 = Ur$3,395 /(J zbet,to was canceled. /2 Receipt in Bank of financial and technical reports on UTE's expansion program. /3 All data on this project is tentative as loan agreement has not been signed as yet. 5 Missions of Mr. Salazar.  (iii) PROJECT PERFORMANCE AUDIT REPORT URUGUAY: FOURTH POWER PROJECT (Loan 712-UR) Highlights Loan 712-UR, for the Fourth Power Project in Uruguay, was made in 1970 after an interruption in lending for power of 14 years. The interrup- tion was due to UTE's unsatisfactory performance and inefficient management. Macroeconomic actions taken by the Government and steps taken by the power company to improve its organization and management in the late 1960s and in early 1970 convinced the Bank that lending for power was again justified. Through the project, the Bank was successful in increasing the generating capacity and strengthening the distribution facilities of the Montevideo system, thus making possible the higher electricity sales which were necessary to support the post-1974 economic recovery. However, there was a delay of 18 months in installing the steam unit, which formed the main component of the project, and there were substantial cost overruns. In making the loan, the Bank also had certain important institu- tional objectives. Progress towards meeting these objectives has*been slow and generally disappointing. The financial reorganization component of the project encountered difficulties and only now is it beginning to show rewards. A study of ways of improving the company's operating efficiency, organization and procedures was never implemented, although it was part of the project as presented to the Board. Another institution-building component of the project was the elaboration, by consultants, of a long-term plan for generating plant development. This was successfully carried out. The borrower's financial performance was unsatisfactory, and UTE did not comply with some of the loan covenants. In part, the power sector's problems reflect the various economic crises which affected the overall economy but, additionally, the difficulties stem from poor management, since the company has enjoyed too little autonomy in making day-to-day decisions. These and other issues are being addressed by the Bank in connection with a fifth power project. Points of special interest are: - reasons for cost overruns and time delays (PCR paras. 4.2, 5.1-5.4); - reasons for actual power sales being below the appraisal estimate (PCR paras. 3.3-3.4); (iv) changes in project scope (PPAM paras. 12-15 and PCR para. 4.3); incremental financial rate of return methodology (PPAM paras. 33-41 and PCR paras. 3.10-3.11); use of General Manager of Chilean power company to make detailed review of UTE's institutional and financial problems as part of project preparation (PCR para. 1.3); borrower's unsatisfactory compliance with loan covenants (PPAM paras. 16-32 and PCR paras. 7.1-7.2, 7.5); ineffectiveness of power tariff regulations (PCR para. 7.3); direct involvement of Board of Directors in day-to-day running of the company, resulting in lack of delegation of authority to management (PCR paras. 8.1-8.2, 9.2); - delay in project implementation leading to higher oil imports (PCR para. 3.5); - reasons for delay in implementing financial reorganization component of the project (PCR para. 4.5); - reasons for poor financial performance (PPAM para. 23 and PCR paras. 7.2-7.4); inadequate salaries leading to shortages of qualified man- power and a corresponding adverse effect on the project (PCR paras. 8.4-8.5); effectiveness of supervision (PCR paras. 9.4-9.5); incremental financial rate of return adjusted to economic costs may be more relevant as an indicator of adequacy of tariffs than of project justification (PPAM paras. 34 and 40-41). PROJECT PERFORMANCE AUDIT MEMORANDUM URUGUAY: FOURTH POWER PROJECT (Loan 712-UR) SECTION I PROJECT SUMMARY 1. The Bank has made four loans to Uruguay for power projects, for a total amount of US$82 million, and is currently considering a fifth power loan. The loans were made to the Administracion General de las Usinas Electricas y Telefonos del Estado (UTE), the Government-owned power entity which at that time had sole responsibility for public power supply in the country 1/. The loan which forms the subject of this audit (Loan 712-UR) was for US$18 million to cover the foreign exchange component of the Fourth Power Project which, at appraisal, had an expected total cost of US$22.58 million. The actual project cost is now estimated at US$38.88 million (PCR Section V) 2/. The reasons for the cost overrun are discussed below. The loan was approved in November 1970 and became effective in 1971. Loan disbursement was completed in 1977. The schedule of actual disbursements is shown with the appraisal estimate in Appendix A. Although the project for which the loan was made has been completed, albeit after some delays, UTE's institutional performance and its compliance with the covenants of the loan have been unsatisfactory (Section II). 2. The physical components of the project consisted of the addition of a 6th steam unit at the existing Batlle station and the rehabilitation and expansion of the Montevideo distribution system. On the basis of an anticipated load growth of 5%-7% p.a., it was expected that the steam unit would be needed by the second half of 1973. Apart from meeting the antic- ipated increase in peak demand the unit was justified for its energy produc- tion since it was required as a back-up for the hydroelectric stations in dry years (PCR paras. 3.1-3.2). The distribution component was needed because the Montevideo system was heavily loaded and in poor condition. As a result, transmission and distribution losses were about 19% of energy sent out in 1969 and it was hoped that these would fall to 15% after project implementa- tion (PCR para. 3.9). I/ The Government has since created COMIPAL to build the Palmar hydroelectric plant. As UTE's name indicates, it was also, at the time of the granting of the past loans, responsible for the telephone service in Uruguay. In 1974, the Government established a telecommunications administration (ANTEL), which took over UTE's telecommunications operations. UTE and ANTEL are still in the process of separating. 2/ This estimate of actual total cost is slightly different from that in the PCR, being based on more recent information. The allocation of the loan proceeds is also shown in PCR Section V. - 2 - 3. The appraisal report showed that installation of a 100 MW steam unit at the Batlle plant was the least-cost solution for expanding generat- ing capacity in the Montevideo-Rio Negro interconnected system (PCR paras. 3.6-3.8). After receiving bids, UTE requested permission to award the contract for a 125 MW set on a turnkey basis. The Bank eventually agreed, although the size of the loan was not altered. UTE did not at the time provide the Bank with a satisfactory quantitative comparison of the relative economic advantages of the 125 MW unit compared with a 100 MW unit and it would be difficult to do so in retrospect (Section II). On balance, however, Uruguay has probably gained from the increase in unit size (Section II and PCR para. 4.3). The unit was commissioned in June 1975, 18 months behind schedule, and has been operating successfully. The main reasons for the late completion were: (i) an initial construction schedule which was too optimistic; (ii) delays in the manufacture and delivery of equipment; and (iii) delays in procurement due to cumbersome legal procedures in Uruguay (PCR para. 4.2). 4. At appraisal, the 6th unit was estimated to cost US$13.80 million. The latest estimate of actual cost is US$33.88 million, the increase being due to the increased unit size, unexpectedly high inflation, and the longer than expected construction period (PCR Section V). The cost overrun was financed principally by supplier credit (GIE of Italy, see Appendix B). 5. Despite the delay in implementation of the project, the Uruguayan economy was probably not seriously affected as the power market did not expand as rapidly as forecast. The appraisal forecast of sales and maximum demand for 1974 were not reached until 1977. Load shedding was necessary in 1972 and 1974, which could have amounted to about 115 GWh and 80 GWh respectively, i.e., 4%-6% of actual sales. However, some load shedding may have taken place in any case to save fuel and ease the impact of rising oil prices on the balance of payments after 1973. Some evidence for this is the fact that load shedding also took place in 1975, even though the 6th unit was available at the time of system peak 1/. Nevertheless, oil imports would have been lower if the unit had been finished on time as UTE could have reduced production from its less efficient thermal plants. Savings in fuel imports in 1974- 1975 could have been approximately US$8 million (PCR paras. 3.3-3.5). At appraisal, the incremental financial rate of return (IFRR) was calculated as 14%. Recalculation on the same basis again gives a return of 14% (PCR paras. 3.10-3.11). However, the original basis, although consistent with Bank prac- tices at that time, was incorrect and if a more reasonable methodology is used, the IFRR is probably in the order of 7%-11% 2/ (Section II). 1/ The evidence is not conclusive, since it is possible that the system may have suffered from water shortages. 2/ Data are inadequate to make a proper recalculation and the range covers different assumptions about the fuel cost savings effect of the unit. - 3 - 6. The main part of the rehabilitation and expansion of the Montevideo primary distribution system was also finished some eighteen months behind schedule, i.e. in the middle of 1975 1/. Delay has been attributed to a lack of skilled work force in UTE and supply problems with local manufacturers (PCR para. 4.4). The scope of this part of the project was reduced due, among other things, to UTE's financial problems. Nevertheless, UTE does seem to have lowered distribution losses from about 19% to about 15%, although it is difficult to reach a clear conclusion on this point as the statistics on sales (and hence losses) are unreliable (PCR para. 3.9). The IFRR at ap- praisal was calculated at 10% (although the methodology is dubious). It was not possible to recalculate the IFRR because of poor data on costs and benefits, but in any case the distribution component is relatively small - about 9% of total project costs (PCR paras. 3.10-3.11). However, the audit has concluded that the distribution component of the project was necessary in order to rehabilitate and strengthen the Montevideo distribution system and to carry the additional energy produced by the 6th unit. Further strengthen- ing and expansion of the distribution system, which is again approaching the limits of its capacity, are envisioned under the fifth power project. 7. A major Bank objective during loan preparation and appraisal was to improve UTE's institutional and financial performance. For this reason, prior to the decision to appraise, the Bank had engaged a consultant in 1968 to spend six months with UTE in reviewing its problems. Attempts to implement his recommendations were an important element in the preparation of the project (PCR paras. 1.3-1.8). 8. Through its participation in the sector, the Bank was successful, prior to project appraisal, in bringing about the appointment of a competent General Manager and assisting in the passage of electricity tariff regulations. The latter were intended to strengthen UTE's financial situation but, due partly to the difficulties which have been faced by the Uruguay economy, the Government has made periodic tariff adjustments on an arbitrary basis rather than following the provisions of the tariff regulations. The Bank also hoped to convince the Uruguayan authorities to give the General Manager greater control over the day-to-day operations of the company and to reduce the in- fluence of the Board, which consisted essentially of political appointees 2/. Attempts to achieve this, through changes in UTE's bylaws, failed since the Government argued that it could not carry through Congress certain constitutional changes which were also felt to be required. As a result, the Bank has largely failed to achieve this objective and the position of the General Manager continues to be weak (PCR paras. 7.2-7.3 and paras. 8.1-8.2). 1/ Some 60% of low voltage overhead conductors and 40% of meters (not financed by the loan) remain to be installed. 2/ The utility was managed by a five-member Board of Directors - three appointed by the majority political party and two from the minority party (PCR para. 1.2). Also prior to project appraisal, the Bank succeeded in persuading UTE to introduce progressivity in the domestic tariff to discourage the wasteful use of electricity for space heating, cooking and water heating (PCR para. 10.3). While this represented a modest improvement, UTE's tariff structure is not satisfactory in relation to the economic costs of supply (Section II, para. 39); hopefully it will be further improved with the implementation of the tariff study now being recommended in the preparation of the fifth power project. 9. Attempts to tackle other institutional and financial problems in UTE were made by including certain covenants in the loan documents and by including as part of the project the appointment of consultants (i) to assist in the reorganization of UTE's accounting system; (ii) to study ways of improving its operating efficiency, organization and procedures; and (iii) to assist in the elaboration of a long-range plan for its generating plant development. UTE's performance in relation to these covenants (requiring audited financial statements, a rate of return of 8%-10% on power operations and 10% on telecommunication operations, reduction of accounts receivable and debts payable, insurance of assets and reduction of overstaffing) 1/ was unsatisfactory (Section II). In part, this can be explained by the fact that item (i) above suffered a long delay, encountered numerous problems and is only now beginning to show real benefits 2/ (Section II and PCR para. 2.1). As a result, it is not possible to make any proper assessment of UTE's financial performance during the project period, but it appears to have been well below that required by the loan covenants (Section II and PCR paras. 7.1-7.5). The principal causes of the delay in the implementation of item (i) can be traced to the rather ambitious task taken on by the consultants, disagreement with UTE's Board over their recommendations, and a lack of qualified staff in UTE to assist in and implement the study (PCR para. 4.5). The delay might have been reduced if the Bank had taken a more active role in ensuring that the study was focussed more sharply on UTE'S crucial problems (e.g., in assisting in the preparation of terms of reference) and in support- ing before the Board and Government those recommendations of the consultants which seemed reasonable in relation to UTE's immediate needs. Item (ii) above was never implemented (Section II and PCR para. 8.2). Item (iii) was carried out and is providing UTE with a useful basis for making its long term decisions on generation development (PCR para. 10.2). 10. The Bank also hoped, during supervision of the project, to use its efforts to encourage UTE and the Government to attract, train, and retain qualified staff. UTE agreed, prior to receiving the loan, to specific-nume- rical targets for training staff at various levels. These numerical targets 1/ Strictly, reduction of overstaffing was not a loan covenant but was covered by a side-letter in which UTE explicitly interprets one of the standard loan covenants to include the reduction of overstaffing. 2/ For example, while UTE'S financial system was so disorganized, it was not reasonable to expect an auditor to certify UTE's financial statements. - 5 - have largely been met but the results, in terms of the effect on staff per- formance, seem to have been disappointing (PCR para. 8.7). On the matter of attracting and retaining qualified staff, at least at the management and technical level, there has clearly been a lack of success. A major reason for this has been UTE's uncompetitive salary structure, which has caused UTE to lose qualified staff to other organizations. Apart from the consequences upon the general performance of UTE, the shortage of qualified staff has contri- buted to the delays in two components of the project, namely the rehabilita- tion of the Montevideo distribution system and the financial reorganization (PCR paras. 8.4-8.7). 11. A discussion of selected main issues is in Section II. General conclusions drawn by the audit from the experience of Loan 712-UR are in Section III. SECTION II MAIN ISSUES A. Changes in Project Scope 12. The mission which appraised the Fourth Power Project originally recommended an 80 MW thermal unit, to be installed at the Batlle plant. During negotiations, UTE requested that the size should be increased to 100 MW and the Bank agreed. The appraisal report showed that the 100 MW alter- native was more economic than the 80 MW alternative for discount rates up to 13%, although it commented on the fact that a 100 MW unit would represent 16% of total installed capacity of the system at the time, which was consid- ered to be "soiiewhat large". 13. In the tender documents for supply of the 100 MW unit, UTE provided for the possibility of quoting for a 125 MW unit on a turnkey basis. This fact was not drawn to the attention of Bank staff. Given the voluminous nature of the tender documents, and the obscure way in which the provision was included, it was understandably overlooked by the Bank and the Bank did not become aware of it until after the tenders were opened. When UTE even- tually informed the Bank that it wished to award the contract for a 125 MW unit, on a turnkey basis, rather than for a 100 MW unit, strong objections were raised within the Bank on the grounds that: (i) UTE should have alerted the Bank to the existence of the provision for a 125 MW unit in the tender documents, since it was different from the project agreed during negotiations and, consequently, different from the description of the project in the Loan Agreement, which refers to a 6th steam unit of "about 100 MW to be installed at the Batlle plant"; (ii) tenders for the 125 MW unit were invited on a turnkey basis only; and (iii) UTE had not demonstrated that a 125 MW unit was the next step in the least-cost development program. It was also pointed out that the 125 MW unit would amount to 19.5% of installed capacity whereas, as mentioned in para. 12, the appraisal report had expressed some concern that a figure of 16% was already rather high. - 6 - 14. As a matter of principle, these objections were well-founded. The Bank in general, and in this project in particular, stressed to its Borrowers the importance of selecting projects on the basis of a proper economic com- parison of alternatives. However, as a practical matter, the Bank accepted that the additional capacity provided by the 125 MW unit was justifiable since it could already be seen that the project would be delayed by 6-12 months due to procurement difficulties and the additional capacity was equivalent to about that much load growth at the time. The extra capacity would also give greater system reliability in the face of adverse hydrological conditions. Bidding on the 100 MW unit had indicated that the turnkey alternative was cheaper than bidding by components and the same could reasonably be expected in the case of the 125 MW unit. Although bidding on a component basis had not in fact been invited in the latter case, it was believed that retendering would involve undesirable further delays in project implementation with little likelihood of achieving any real benefit in terms of cost. Finally, it was argued that, although UTE had not demonstrated that a 125 MW unit was the next step in the least-cost development program, the turnkey price of the 125 MW unit was lower than that of the lowest qualified bid on the 100 MW unit in terms of cost per kW (US$165 per kW as against US$189 per kW). 1/ 15. It would be an extremely difficult task to reassess the least-cost development program either in retrospect or as it would have looked in 1971. It seems clear that, at that time, a thermal plant was the appropriate next step in such a program, since fuel prices were low and made the most logical hydro alternative (Palmar) economically unattractive. Furthermore, it was estimated that Palmar could not be completed before 1976 while it was judged that additional generating capacity would be needed by the second half of 1973 in order to avoid load shedding. Even in retrospect, the addition of a new thermal unit appears economically justified, despite the steep increase in fuel prices which took place after appraisal, the cost overrun on the project, and the delay in project completion. The Appraisal Report's estimate that the earliest date for the commissioning of Palmar was 1976 now appears to have been optimistic so that the need for additional generating capacity before that date was in fact true, as events have shown. Without it, Uruguay would have faced several years of energy shortages. If Palmar could have been commissioned in 1976, a complementary thermal plant would have been necessary in any case as a back-up, due to the erratic hydrology of the Rio Negro, the river on which Palmar is located. As a matter of interest, Uruguay is currently proceeding with the construction of Palmar and the first unit is not expected to be commissioned before 1982. Whether or not the next thermal development should have been 100 MW, as recommended in the Appraisal Report, or 125 MW, as finally agreed, does not appear to the audit, in retrospect, as a significant practical issue and UTE's view that it was worthwhile to have the extra capacity at a low incremental cost (US$68 per kW) was probably correct. 1/ A bid of US$174 per kW on the 100 MW unit, referred to in the PCR para. 5.3, had been disallowed on the grounds that it did not meet the tech- nical specifications. - 7 - B. Borrower's Compliance with the Loan Covenants 16. An important argument for the Bank's financial participation in the power sector in Uruguay, through the vehicle of the Fourth Power Project, was to bring about financial and institutional improvement in the entity respon- sible for power supply (UTE). For this reason, the Bank in 1969 provided the services of a consultant to draw up a set of measures for reorganizing UTE which would create the basis for new Bank lending. Following the consul- tants' careful review of the situation, the Bank, in March 1970, appraised the project for which Loan 712-UR was made. [7. Many of the basic organizational and financial objectives of the loan were embodied in the loan covenants. In most cases, UTE's performance in relation to these covenants was inadequate. 18. According to Section 5.02(i) of the Loan Agreement, UTE was to have its accounts audited by an independent auditor starting with the 1970 accounts, and under Section 5.02(ii), was to submit the audited accounts to the Bank no later than four months after the end of the fiscal year. An exception was made for 1970, where the period was to have been 6 months. UTE has never complied with this covenant. Even unaudited financial statements were re- ceived only after delays of 15 months or more. The 1974 accounts were, for example, received in June 1976. 19. The Bank was almost certainly over-optimistic in expecting an independent audit of UTE's accounts so soon after the start of the project, even if the financial reorganization component of the project had proceeded smoothly. Audited accounts for 1970 were required by July 1971, whereas loan signing did not take place until November 1970. In the event, there were considerable delays in the financial reorganization and, as the PCR correctly points out (para. 7.1), it would have been pointless for the Bank to insist on an independent audit when it was known that no reputable auditor would have been prepared to certify UTE's accounts until the financial reorganization had been successfully implemented. 20. Section 5.03 of the Loan Agreement and Section 3.02 of the Guarantee Agreement required a rate of return on UTE's power operations of not less than 10% during the project period and application of the Electricity Rate Regula- tions thereafter. These Regulations had been passed in 1970 as part of the preparation of Loan 712-UR and on paper were an excellent basis for enforcing strict financial discipline on UTE. Principally, the Regulations stipulated that UTE should earn a rate of return on revalued assets of at least 8%. Section 5.04 of the Loan Agreement and Section 3.03 of the Guarantee Agree- ment contain similar provisions for UTE's telecommunications operations, except that the rate of return on revalued assets would be 10%. 21. For the period 1971-1973, UTE's accounts are particularly unreliable and it is difficult properly to assess its performance in relation to the rate of return covenants 1/ (PCR para. 7.1). From the limited and tentative 1/ Technically, UTE was probably, by implication, also violating Section 5.01 of the Loan Agreement, which specifies that "the Borrower shall maintain records adequate to reflect its operations and financial condition". - 8 - information available, however, it appears that the financial performance generally fell short of the requirements of the covenants. By 1974, the last year in the financial projections of the Appraisal Report, the financial statements were more reliable and suggest negative rates of return for power (-0.3%) and telecommunications (-3.3%) 1/. According to estimates made during the preparation of the fifth power project, the rate of return on UTE's power operations became positive in 1975 (3.4%) and 1976 (6.6%) and may have satis- fied the covenant of 8% in 1977, due partly to a very favorable hydrological year. 22. The poor financial performance of UTE, compared with the appraisal forecast, has meant that UTE was unable to contribute adequately to sector investment requirements, although internal cash generation was sufficient to cover debt service. 2/ (The appraisal mission forecast that UTE would generate sufficient cash to meet nearly 38% of its requirements for funds over the period 1970-1974). Despite lower financial needs for generation than anticipated during appraisal (see footnote 1/), UTE's poor financial performance affected investment in the transmission and distribution systems, which are in poor condition, and has resulted in a downward pressure on mid-level and top-level salaries, contributing to the loss of many qualified professionals. 23. UTE's failure in relation to the rate of return covenants was due in part to the Government's unwillingness adequately to apply the Electricity Rate Regulations. The situation should have been foreseen by the Bank, as the Government had objected strongly to the covenants during negotiations, arguing that compliance with the covenants could conflict with the Govern- ment's overall economic and financial policies for tackling inflation. Furthermore, although this can only be seen in hindsight, UTE's position was complicated by the problems encountered by the delay in the financial reorganization component of the project, which made any real financial man- agement and control extremely difficult. The Bank urged the Government to approve tariff increases during project supervision, but with only Limited success. Alternative financial covenants (e.g. specifying a percentage of self-financing of UTE's investment program) would have been equally un- successful in so far as the basic cause of the poor financial performance 1/ The 1974 income statement, comparing estimates of actual results with those forecast at appraisal, are in PCR, Annex III. A tentative estimate of the balance sheet for 1974, compared with the appraisal forecast, is in Appendix C. A large part of the difference between the actual value of fixed assets and the appraisal forecast is due to underestimation of the effect of revaluation at the time of appraisal. 2/ When the fourth power project was appraised, it was expected that further investments in generation would be carried out and financed by UTE. In the event, the main generation investments (Salto Grande and Palmar) are being handled by other agencies and financed by the Government. Thus, UTE's own financial requirements were reduced significantly. - 9 - was Government's unwillingness to raise tariffs in line with increasing costs. I/ This unwillingness reflected not merely the Government's macro- economic policies. The Government also expressed the view that electricity consumers, who were being asked to make sacrifices in the fight against inflation, should not be expected to provide UTE with an 8% rate of return regardless of its level of operating costs. In other words, the Government appears to have felt that UTE could have made greater efforts to improve its efficiency and that tariff increases were not the only way of meeting the rate of return covenants. However, it must be pointed out that, since the Government appointed UTE's Board and approved its budget, it was in a strong position itself to improve UTE's performance if it had chosen to use its powers. 24. Although the Borrower did not meet its obligations under the rate of return covenants, the inclusion of the covenants in the guarantee and loan agreements does seem to have been desirable in order clearly and explicitly to establish the principle of financial discipline in a public utility. Furthermore, they provided guidelines or targets to be achieved at least in the longer term. 25. Section 3.02(b) of the Loan Agreement required UTE or consultants to carry out studies which would form the basis for the improvement of the borrowers operating efficiency, organization and procedures. Although such improvement was part of the project description - in part (c) of Schedule 3 to the Loan Agreement - the studies were never carried out. The project description implies a fairly comprehensive review of UTE's operations but the Appraisal Report referred specifically only to activities of the auxiliary services divisions of UTE, notably printing and the manufacture of concrete poles. The supervision mission of February 1975 took up this issue and also added the issue of the staff vacation resort operated by UTE. The mission recommended studies, to be carried out by consultants, of the pole factory and the vacation resort. The mission concluded that, in the case of the printing operation, the main problems related to the seasonality of the printing of the telephone directory, which caused over-capacity during parts of the year. Since this operation was to be handed over to ANTEL (the tele- communications administration created in 1974), the mission did not propose that the Bank should insist that it be studied. The supervision mission of September 1975 again recommended studies of the pole factory and the vacation resort and reported that "UTE's Board was receptive to the suggestions of the mission". 26. These two missions in 1975 appear to be the only ones which seriously addressed the non-implementation of the studies, almost certainly because the problem was given low priority by the Bank in the face of other major problems, particulary relating to the need to complete the financial reorganization of UTE. Furthermore, a more comprehensive review of UTE's 1/ In constant (1970) prices, the average electricity rate per kWh for UTE in 1977 was only 70% of that obtained in 1970. - 10 - problems was initiated in 1976, when the Bank carried out a power sector review. However, this part of the project must be regarded largely as a failure. 27. According to Section 5.09 of the Loan Agreement, UTE was to make adequate provision for the collection of overdue receivables from the Govern- ment and its agencies and in turn to pay its debts to other public sector agencies. 1/ UTE has not complied with the covenant. It is estimated that the relevant overdue receivables and debts as of April 30, 1970, amounted to US$10.8 million and US$4.4 million respectively. By the end of 1974, accounts due from the public sector had increased to US$16 million while UTE owed a similar amount to other public sector agencies (principally to ANCAP, the Government oil administration). 28. The increase in accounts receivable from, and debts payable to Government agencies over the project period is a reflection of the basic financial and organizational problems suffered by UTE. Prior to the finan- cial reorganization component of the project, the system of recording and billing accounts was inadequate so that it could take long periods to iden- tify overdue accounts and those accounts were frequently questioned by the customer. In many cases, Government agencies did not have the cash to pay their electricity bills. Similarly, UTE's limited cash generation made it difficult to reduce its indebtedness to ANCAP. Supervision missions regularly drew the attention of Government and UTE to the situation but were unable to prompt them to take effective action. 29. Section 3.04(b) of the Loan Agreement contains the standard Bank requirement for the insurance of the Borrower's assets. UTE's assets are either under-insured, as in the case of the main project component, or not insured at all. 30. The reasons for UTE's failure adequately to insure its assets are not clear. Supervision missions refer to high premiums being quoted by the State Insurance Bank as a source of difficulty. The supervision missions also received the impression that there was a feeling on the part of UTE that insurance was not justified. However, this does appear to be an area where a more forceful approach by the Bank might have convinced UTE of the prudence of insuring its major assets. 31. Section 4.01(a) of the Loan Agreement is a standard Bank covenant, stated in a very general way, that UTE should act in accordance with sound business and utility practices. However, in a side-letter to the Bank, UTE referred to the elimination of overstaffing as part of its proposed actions under Section 4.01(a) and set itself certain numerical targets. These were to reduce the number of personnel by up to 300 in 1971 and by 500 employees per year during the period 1972-1974. In fact, staff increased by 164 in 1971 (from 15,815 in 1970) and although reductions were made after 1972, the number of employees in 1974 was still higher (by 558) than in 1970 1/. 1/ Excluding 1140 employees who were absorbed by ANTEL following the elimination of two central government departments. - 11 - 32. The problem of overstaffing was probably more chronic and embedded in the traditions of UTE than the Bank appreciated at the time of appraisal. Under the Uruguayan constitution, UTE did not have any real freedom to reduce staff but was subject to close Government regulation. Furthermore, UTE maintained that staff could not be reduced until enough qualified employees were available to man the utility and that it performs many tasks not normally carried out by public utilities. Because of its low pay scales, UTE was unable to attract and retain competent managers, a prerequisite for increasing its efficiency and reducing staff. Low pay was attributed by UTE to Government controls. However, other Government entities with a legal status similar to UTE's have been able to deal with this problem more effectively (PCR paras. 8.4 - 8.6). C. Incremental Financial Rate of Return (IFRR) 33. As was typical at that time, the Appraisal Report included the calculation of an IFRR. Such a calculation was intended to represent an estimate of the financial impact of the project on the utility but it was also frequently regarded as an indicator of the economic justification of the project. In both respects, the IFRR was frequently deficient. First, although the methodology often varied between projects, the cost stream did not always reflect the financial costs of the project to the utility (e.g. taxes paid by the utility were sometimes excluded and subsidies added back). Secondly, of course, the financial costs and benefits did not neces- sarily reflect the costs and benefits to the economy as a whole. 34. In recent years, Bank methodology has advanced considerably by attempting to make a rough estimate of the incremental economic rate of return (IERR) on the project investment or program of which the project is a part. In this calculation, financial costs and benefits are in principle adjusted, as far as possible, to economic terms. In practice, it is usually possible only to adjust the financial cost stream,e.g. through the substitution of shadow prices or conversion factors for market prices. In the majority of cases, revenues continue to serve as a minimum measure of benefits. Hence the IFRR adjusted in this way shows the relationship between the tariffs paid by the consumer and the incremental cost of output and provides an indication about the adequacy or inadequacy - from an economic point of view - of the level of tariffs rather than serving as a measure of the economic justifica- tion of the project. 35. In the case of the Uruguay Fourth Power Project, the calculation of the IFRR of the generation component of the project (the 6th unit at the Batlle power station) is a good example of its deficiency both as a financial and economic indicator of the impact of the project. Although UTE is respon- sible for generation, transmission and distribution, the Appraisal Report postulated a hypothetical generating entity selling the output of the 6th unit to a hypothetical transmission and distribution entity. Revenues from the sale of the project's output to final consumers were allocated to the generating entity on the basis of its long-run production costs. The discount rate equalizing the present value of the allocated revenues with the project's capital and operating costs (i.e. what was termed the IFRR) was found to be - 12 - 14%. It is not clear how the long-run production costs of the hypothetical generating entity were calculated but the logic is evidently circular because the costs of production of the 6th unit must have been included in the long- run production cost and therefore reappear, at least in part, in the benefits (revenues) allocated to it. A more appropriate approach would be to attri- bute to the project all revenues from the sale of its incremental output to final consumers and to include in the cost stream an estimate of the incre- mental transmission and distribution costs associated with these sales (see para. 39). 36. The PCR's recalculation of the IFRR of the 6th unit (PCR Annex I) follows basically the same methodology as the Appraisal Report, except that certain refinements have been introduced through the use of a simulation model which has been developed for UTE. From the simulation model, it was possible to estimate the system fuel savings attributable to the unit and the expected pattern of annual generation of the unit in the context of a system which will become increasingly dependent upon hydroelectric production. The fuel savings benefits arise from two sources. First, the unit will permit an improved regulation of the reservoirs of the hydroelectric stations in the intercon- nected system, thus reducing the amount of required thermal generation (the regulation benefits). Secondly, part of the unit's output will replace production from less efficient thermal units (the efficiency benefits). In the original calculation, fuel savings attributable to the 6th unit were not taken into account and its annual generation was estimated on the basis of simple assumptions regarding its lifetime load factor. 37. A further adjustment in the PCR recalculation is to increase the proportion of revenues allocated to the Batlle unit to 53%, compared with 41% at appraisal. The PCR acknowledged that the adjustment is arbitrary but considers it appropriate in view of the increased weight of fuel in UTE's total operating costs. All costs and benefits are expressed in constant prices, using US$ values, apart from the capital costs of the 6th unit, which are expressed in current US$ terms. The IFRR recalculated on these bases is equal to the IFRR estimated at appraisaL (14%). 38. In the way that it is presented, the PCR recalculation of the IFRR may involve double counting to the extent that the project's entire generation appears to be credited with a revenue benefit and, at the same time, part of its generation is shown as yielding an efficiency benefit. Furthermore, in the PCR recalculation, the regulation benefits are assumed to be held constant after 1981 whereas it can be argued that the regulation function will increas- ingly be taken over by plants to be installed in the future. 39. An alternative recalculation of the IFRR has been made in Appen- dix D, to test the sensitivity of the results to alternative assumptions about the efficiency and regulation benefits. Furthermore, to overcome the circular logic in the Appraisal Report's methodology, an estimate is made in Appendix D of the incremental transmission and distribution costs necessary to sell the project's output. Finally, all costs and benefits in Appendix D have been converted to Ur$ in 1977 prices. The effects of these changes in - 13 - the recalculation are that the IFRR falls from 14% to just under 11%, if the regulation benefits are kept as in the PCR, and to about 7% if the regulation benefits decline as in the alternative assumption. 40. As stated in para. 34, even if the financial costs used in the recalculation of the IFRR are adjusted to economic costs, the resulting IERR would have little significance for the economic justification of the project but would rather give an indication about the adequacy or inadequacy of the level of tariffs since the principal measurable benefits are the incremental revenues attributable to the 6th unit. The economic justification of the project is that it serves as a thermal back-up for the hydroelectric units, which have relatively small storage capacity and which are subject to wide variations in river flows. Without the unit, as in fact happened in 1972 and 1974, electricity restrictions would be necessary during periods of low water due to a shortage of peaking capacity. The adverse effects on the economy of such an event are not easily quantified. 41. As a generalization, the IFRR of a thermal back-up plant and its IERR, as usually calculated in a Bank power project, can be expected to be low because tariffs are almost always set on the basis of a utility's overall average financial requirements whereas the operating cost of a thermal unit such as the Batlle 6th unit will be relatively high, due to the high cost of fuel. The conclusion, therefore, is that UTE should consider some form of marginal cost pricing and this in fact is being recommended in the preparation of the fifth power project. SECTION III CONCLUSIONS 42. The physical objectives of the project were largely met, albeit with delays and cost overruns. The 6th unit at the Batlle power station is operat- ing successfully and the distribution component is essentially complete. 1/ Thus the project is helping to meet the growing sales of electricity which are necessary to support the recovery of the Uruguayan economy. 43. Progress towards the institutional and financial objectives of the project, which were an important justification for the resumption of lending to the power sector in Uruguay, was disappointing. The study of ways of improving UTE's operating efficiency, organization and procedures, which formed part of the project description, was never implemented. It was not possible to strengthen the position of the General Manager, an objective to which the Bank had given major emphasis, and the problems created by inadequate salaries and tariffs remained. Of course, UTE's performance must 1/ Some 60% of low voltage overhead conductors and 40% of meters (not financed by the loan) remain to be installed. - 14 - be seen in the context of the severe political and economic difficulties facing Uruguay during the period of project implementation. Furthermore, UTE's financial difficulties were not helped by the long delay in the finan- cial reorganization component of the project. On the positive side, this component is now beginning to provide UTE with benefits. The development of the long-term power program, another component of the project, will also assist UTE in making rational decisions in the future. The performance of consultants and contractors was generally satisfactory (PCR paras. 6.1-6.6) and the project received fairly intensive supervision, apart from a lapse in 1974 for acceptable reasons (PCR para. 9.4). 44. A significant conclusion drawn by the PCR (para. 9.2) is that in retrospect it might have been wiser for the Bank to defer lending on the Fourth Power Project until satisfactory assurances were forthcoming on the prerogatives of the utility's management relative to its Board and the Gov- ernment. The audit concurs and suggests that the experience of Loan 712-UR may provide a broader lesson for the Bank, which could be added to those described in the PCR (Section XI): where there are outstanding issues of major importance facing a public utility such as UTE, it may be wiser to resolve those issues before making a loan, rather than hope for success during project implementation. At the very least, a program of action should be drawn up that gives a realistic expectation that the issues will be resolved within a reasonable period of time after loan approval. The audit understands that such a strategy is being developed in preparation for a fifth power loan. APPENDIX A URUGUAY: FOURTH POWER PROJECT (LOAN 712-UR) Schedule of Disbursements (US$ millions) IBRD FY and Appraisal Semester Actual Estimate FY 71 2nd 0.7 FY 72 1st 0.1 2.4 2nd 1.5 3.4 FY 73 1st 3.0 9.6 2nd 3.3 14.4 FY 74 1st 6.1 16.8 2nd 10.5 16.8 FY 75 1st 16.9 18.0 2nd 17.7 FY 76 1st 17.9 2nd 17.9 1/ Closing date: 6/30/77 12/31/74 1/ US$27,426 of the loan was cancelled. APPENDIX B Financing of 6th Unit at Batl1e Power Station (US$ millions) IBRD 13.052 GIE (Italy)-/ 14.143 2/ UTE- 6.682 33.877 1/ Supplier's credits 2/ Actually disbursed in local currency. APPENDIX C Page 1 of 2 URUGUAY: FOURTH POWER PROJECT (LOAN 712-UR) UTE Balance Sheet as of 12/31/74 Apraisal Forecast Actual ASSETS (1) (2) (3) (4) 5/ Fixed Assets- Power Pln noeain75,600=--- 302.4 705,800 426.2 Plant in operation10/ Less: depreciation 172.7 36,0 222.1 32,430 129.7 338,000 204.1 Telecommunications 10/ Plant in operation 239200 92.8 235,087 142.0 Less: Depreciation 7,88610/ 31.5 105,123 63.5 15,314 61.3 129,964 78.5 Work in Progress 28,593 114.4 63,560 38.4 Current Assets Cash 848 3.4 15,287 9.2 Accounts receivable 8,180 32.7 6035737/ 36.6 Inventories 1,700 6.8 54,825- 33.1 10,728 42.9 130,685 78.9 Other assets 90 0.4 6.5 Total Assets 348.7 672,997 406.4 EQUITY 53,569 214.3 522,482 315.5 LIABILITIES Long-term Liabilities IBRD, loan 712-UR 4,451 17.8 27,968 16.9 IBRD, other loans 2,568 10.3 17,050 10.3 Banco de la Republica 3- 2,342 1.4 Future financing (Generation) 12,134 48.5 - - DFL loan 836 3.3 6,531 3.9 Other foreign currency loans 4,470 17.9 36,015 21.7 Peso loans 317 1.3 9625.8 Total 24,776 99.1 99,578 60.2 Current Liabilities 9/ Current maturities of long-term debt 2,749 11.0 2,743- 1.7 Other current liabilities 2,100 8.4 45,402 27.4 Total 4,849 19.4 48,145 29.1 Other Liabilities 3,961 15.8 2,792 1.7 Total Equity and Liabilities 87,155 348.6 672,997 406.5 Debt/Equity Ratio 32/68 32/68 19/81 19/81 APPENDIX C Page 2 of 2 Notes to UTE Balance Sheet 1/ Appraisal forecasts were presented in constant pesos. At the time, the rate of exchange was 250 old pesos to 1 US$, equivalent to 0.25 new pesos to 1 US$. 2/ Col.(l) t 250 3/ Current figures converted to old pesos to be comparable with appraisal forecast. 4/ Col. (4) = (3) + rate of exchange as of 12/31/74 (Ur.$ 1656 = US$ 1) 5/ Fixed assets were revalued using the procedure specified in the power tariff regulations. The revaluation index is an average of the cost of living index and the exchange rate. The cost of living and exchange rate increased between appraisal and 12/74 by 662% and 562% respectively, which partly explains higher actual as against appraisal values. 6/ Work in progress is revalued when it is transferred to operations. Prior to that it is recorded at historic cost. 7/ Includes "goods in transit", a substantial part of which represents work in progress. 8/ Includes various accounts with Government, as well as assets deposited in warranty for loans outstanding. 9/ Only includes current maturities of IBRD loans; for other loans current portion is included in the long term total. 10/ Appraisal estimates developed from mission estimates of 1969 fixed asset revaluation. URUGUAY: FOURTH POWER ZROJECT (LOAN 712-UR) IFRR on 6th Unit at Batl1e Power Station,- Fuel2/ Operation- Generation Transmission and Total Regulation Regulation Total Bene- Total Bene- Net Bene- Net Bene- Year Sales 2/ Cost- al Cost 2/ Investment2/ Distrib. Cost 3/ Cost 4/ Revenues 5/ Benefits I 2/ Benefits II 6/ fits 1 7/ fits II 8/ fits 1 9/ fits It 10/ (1) (2) (3) (4) ()(6) (7) (8) (9) (1l 0) (11) (12) (13) (14) 1972 6.59 6.6 - 6.6 -6.6 73 36.38 36.4 -36.6 -36.6 74 87.34 87.3 -87.3 -37.3 1975 182 10.8 1.68 39.16 6.3 57.9 38.7 3.68 3.68 42.4 42.4 -15.5 -15.5 76 468 41.1 2.48 13.86 23.9 81.3 102.4 11.03 11.03 113.4 113.4 32.1 32.1 77 504 62.0 3.47 5.32 35.9 106.7 104.5 16.63 16.63 121.1 121.1 14.4 14.4 78 559 68.8 39.9 112.2 115.9 17.81 17.81 133.7 133.7 21.5 21.5 79 621 76.4 44.3 124.2 128.8 19.00 19.00 147.8 147.8 23.6 23.6 1980 396 48.7 28.2 80.4 82.1 17.10 17.10 99.2 99.2 18.8 18.8 81 306 37.6 21.8 62.9 63.5 15.20 15.20 78.7 78.7 15.8 15.8 82 352 43.3 ' 25.1 71.9 73.0 14.25 13.30 87.3 86.3 15.4 14.4 83 297 36.5 21.2 61.2 61.6 ' 11.40 75.9 73.0 14.7 11.8 84 297 36.5 21.2 61.2 61.6 9.50 75.9 71.1 14.7 9.9 1985 356 43.8 25.4 72.7 73.8 7.60 88.1 81.4 15.4 8.7 86 428 52.6 30.2 86.3 88.8 5.70 103.1 94.5 16.8 8.2 87 513 63.1 36.6 103.2 106.4 5.23 120.7 111.6 17.5 8.4 88 490 60.3 35.0 98.8 101.6 4.56 115.9 106.2 17.1 7.4 89 480 59.0 1 34.2 96.7 99.6 4.28 113.9 103.9 17.2 7.2 1990 470 57.8 33.5 94.8 97.5 F 3.99 111.8 101.5 17.0 6.7 91 459 56.5 32.7 92.7 95.2 F 3.71 109.5 98.9 16.8 6.2 92 449 55.2 ' 32.0 90.7 93.1 3.42 107.4 96.5 16.7 5.8 93 439 54.0 F 31.4 88.9 91.1 3.14 105.4 94.2 16.5 5.3 94 429 52.8 F 30.6 86.9 89.0 F 2.85 103.3 91.9 16.4 5.0 1995 419 51.5 ' 29.9 84.9 86.9 ' 2.57 101.2 89.5 16.3 4.6 96 409 50.3 29.1 82.9 84.8 ' 2.28 99.1 87.1 16,2 4.2 97 398 49.0 ' 28.4 80.9 82.5 2.00 96.8 84,5 15.9 3.6 98 388 47.7 F 27.6 78.8 80.5 1.71 94.8 82.2 16.0 3.4 99 373 45.9 ' 26.6 76.0 77.4 ' 1.43 91.7 78.8 15.7 2.8 2000 367 45.1 ' 26.1 74.7 76.1 ' 1.14 90.4 77.2 15.7 2.5 01 357 43.9 25.5 72.9 74.0 .86 88.3 74,9 15.4 2.0 02 347 42.7 24.8 71.0 72.0 F .57 86.3 72.6 15.3 1.6 03 327 40.2 23.3 67.0 67.8 ' .29 82.1 68.1 15.1 1.1 2004 327 40.2 3.47 23.3 67.0 67.8 14.25 0 82.1 67.8 15.1 .8 1/ Sales in Col.(2) are in GWh. All other values are expressed in Ur$ millions at 1977 prices. 2/ Source: PCR Annex 1. The original data for Fuel cost, Operational cost and Regulation Benefits I in PCR Annex 1 are epressed in US$ at 1977 prices. Conversion to Ur$ has been made using the following average yearly exchange rates (Ur$ per 'JS$): 1972, 0.565; 1973, 0.875; 1974, 12216; 1975, 2.299; 1976, 3.395; 1977, 4.750. The data for generation investment in PCR Annex 1 are in current US$. Conversion to Ur$ at 1977 prices was carried out using the same exchange rates and the following index of inflation, 1972, 14.99; 1973, 7.65; 1974, 4.30; 1975, 2.37; 1976, 1.57; 1977, 1.00. 3/ Assuming an incremental investment and operational cost for transmission and distribution of US$0.015 per kwh at 1977 prices (Ur$0.071 per kwh with Ur$4.75 =US$l ). Strictly speaking, the number depends upon the discount rate since it should be derived from a present value calculation in the absence of direct information on yearly total costs for transmission and distribution related to the project output. The figure of US$0.015 per kwh is in line with recent estimates made in the context of the Fifth Power Project for discount rates below 8%. A/ Col.(3) + Col. (4) + Col. (5) + Col. (6). 5/ Taking average revenues (expressed in Ur$ and excluding the 10% energy tax) of 0.0896, 1T1394, 1.2074 in 1975, 1976 and 1977 respectively. Multiplying these average revenues by the dorresponding sales in Col (2) and adjusting the results by the inflation index in note 2/ above gives the revenues in Col. (8). In this calculation, in order to test the effect of of possible double counting (see para. 38) the extreme assumption is used that the efficiency benefits are zero and that the entire generation of the 6th unit is used to meet additional sales. 6/ Assuming the regulation function is increasingly taken over by other plants (see para. 38). The basic Lata for this alternative are taken from the UTE simulation model and are (in US$ million), 1975 1.C0 1980 3.60 1985 1.60 1990 0.84 1995 0.54 2000 0.24 1976 3.25 1981 3.20 1986 1.20 1991 0.78 1996 0.48 2001 0.18 1977 3.50 1982 7.80 L987 1.10 1992 0 72 1997 0.42 2002 0 12 1'7s 3.75 1983 2.40 1988 0.96 1993 0.66 L998 0.36 2003 0 06 1979 4 00 194 2.00 1989 0.90 1994 0 60 1999 0,30 2004 0 00 Conversion to Ur$ at 1977 prices is made with the exchange rales and inflation index in note 2/ above. m 7/ Col. (8) + Col. (9) 8/ COl. (8) + Col. (10) X 9/ Col. (11) - Col. (7) 10/ Col. (12) - Col. (7) IFRR with NPE Benefits f - 10.75% IFRR with Net Benefits 11 = 6 75% Attachment URUGUAY: FOURTH POWER PROJECT (Loan 712-UR) Project Completion Report I. Project Preparation 1.1 UTE was one of the earliest of the Bank's LDC borrowers. It received its first loan from the Bank in 1950 and two more in 1955 and 1956, with the three loans aggregating US$64 million. During this period, UTE's performance was considered generally satisfactory and its financial situation was strong. The Bank and UTE had subsequently discussed a fourth loan for many years but were unable to reach agreement on several major issues. One of these was the definition of the project: UTE was interested in obtaining Bank financing for its Palmar hydroelectric project but was unable to demon- strate the project's economic justification to the Bank's satisfaction. (The project's economics improved after the 1973-74 petroleum price increases--see para. 8.3.) Financial performance was also a point of difference since UTE's finances had deteriorated substantially when inflation accelerated in Uruguay in the late 1950s. However, the major obstacle to Bank support for the pro- posed fourth power project was the need to introduce substantial improvements in UTE's organization and management. 1.2 UTE's organizational structure was not conducive to efficient operation. The utility was managed by a five-member, full-time Board of Directors (three from the majority political party, two from the minority) which participated actively in the smallest details of day-to-day operations. The divisional managers (for telecommunications, pover operations, power construction, finance, administration, etc.) reported directly to the Board and no single individdal could be held responsible for the utility's performance. Salaries were low-and this, in conjunction with lack of management authority as a result of the Board's extensive involvement and a very comprehensive system of controls by various government departments, had led to a steady decline in the quality of UTE's higher level staff. As was the case with most other Uruguayan institutions, UTE was beset by difficulties associated with the social and political strife which the country suffered in the late 1960s and early 1970s. (The President of UTE was twice kidnapped by guerrillas.) 1.3 In 1968, the Bank agreed to engage the General Manager of the Chilean state power company as a consultant to review UTE's problems and prepare recommendations to the Bank and UTE on their resolution. The consultant (Mr. R. Salazar) spent six months in Montevideo and prepared a report recom- mending that the Bank make a loan provided that the Government and UTE ful- filled the following seven conditions: (i) UTE should undertake not to incur any new debt or financial obligations for 12 months. UTE should conclude arrangements under discussion with other governmental entities for the rescheduling of UTE's foreign and local currency debt payments. A2 (ii) UTE should recommend and the Government authorize immediately changes to the electric tariff structure to increase revenues and discourage the use of electricity for non-industrial heating. (iii) UTE should immediately appoint an Executive Vice President who would have the responsibilities of a General Manager of UTE. UTE's Board should approve bylaws limiting its own activities to policy matters and decisions and giving the Executive Vice President full authority and responsibility for the daily management of UTE. (iv) The Executive Vice President should appoint his senior staff immediately and institute through them a new salary scale which would start the process oE improving morale and efficiency. The higher salaries would be conditional on full-time attendance at UTE by the persons involved. (v) The Executive Vice President would immediately initiate the reorganization of the accounting department of UTE with the assistance of consultants or other suitable outside personnel. (vi) The Government should undertake to give full effect within two years to the draft Electric Tariff Regulations already agreed with the Bank. (vii) The Government should undertake to include in the constitutional changes it had under study, the necessary amendments for imple- mentation of the institutional changes required to place UTE on a sound basis. These should include, among other matters, the appointment of a General Manager with adequate authority to permit UTE to conduct its affairs free from the restrictions imposed by the Government on entities which are nominally autonomous; and the right to engage, promote or dismiss employees or staff without regard to civil service regulations. Also, consideration should be given to making the telephone section of UTE a separate entity. 1.4 UTE took substantial steps towards meeting these conditions including: (i) appointment of a General Manager to whom the divisional managers were to report; (ii) recommendation to the Government of sizeable tariff increases; and (iii) selection of generally qualified senior staff to head UTE's divisions. 1.5 UTE's Board indicated in mid-1969 that it was willing to comply with condition 1.3(i) above, if the Bank expressed its willingness to extend finance and stated the proposed amount and timing of its loans. With respect to the new bylaws (1.3(iii)), it indicated that it was willing to find a A3 mutually acceptable solution. It also stated its readiness to implement sub- stantial salary increases for the newly appointed senior staff (1.3(iv)). Finally, it indicated that it would be willing to reorganize the accounting department. The Government indicated its readiness to proceed with the imple- mentation of new tariff regulations (1.3(vi)) but noted that it could not initiate constitutional changes (1.3(vii)) because of the difficulty of securing Congressional approval of such changes. 1.6 After the Government approved a 45% tariff increase in early 1970 and implemented recommendation 1.3(ii), the Bank dispatched an appraisal mission (March 1970). The main issues raised by the appraisal mission referred to: (i) the possibility of including in the project (originally conceived as a distribution project) a generation component (see paras. 3.6 - 3.8); (ii) the need to modify the power tariff regulations (which had been approved by the Government during the appraisal mission--see para. 1.7); (iii) the strengthening of the authority of the General Manager (see paras. 8.1 - 8.3); (iv) the reduction of UTE's unskilled workers and the increase of other categories of staff (see para. 8.6); and (v) the formulation of plans for training, organization, management and system planning. 1.7 With regard to the tariff regulations, the appraisal mission recom- mended that a provision allowing UTE to implement new tariffs automatically if they were not objected to by the Government within sixty days (which had been in the draft regulations cleared by the Bank but which was subsequently deleted) be reintroduced. The mission also recommended that UTE be allowed to earn a return of 12% on its revalued rate base, rather than the 10% maximum provided for in the tariff regulations. The latter recommendation was based on the need to ensure a reasonable contribution from internal resources to the financing of UTE's construction program. However, the Bank conceded the matter during negotiations, accepting the regulations as approved and a somewhat lower contribution to investment. 1.8 Most of the institutional issues (para. 1.6(iii) - (v)) were regarded as matters on which the Government, UTE and the Bank were generally in agree- ment, and it was expected that satisfactory assurances would be forthcoming prior to or during negotiations. However, serious differences of opinion developed between the Bank and the Uruguayan negotiators on point 1.6(iii). The Bank yielded on this matter by accepting UTE's proposals to expedite Board decision-making in lieu of delegating responsibility for day-to-day operations to the General Manager. On points 1.6(iv) and (v), targets were established for the reduction of UTE's staff and for training. Dates for hiring consultants to assist in the reorganization of accounting and in the A4 A4 selection of data processing and for completing studies on other organizational improv#minttgigrefa tedproatspiagaaed igreQGmlhatiUgEstodidshdaeotbfuttattzational for en I%thmYggtpr enteatatednd ZbnWaSuAltOnaspevtbbnUZ11 whalorb4ttdsnsultants generaftigetgiapeftg angrQoupeepateaadgeonsardotiepaup&nhiptogrQai. thnprgeet' s ject wSn9tingaeo OintBank'to EnepateeaDteneattodneNDebes 9090fam. The pro- ject was presented to the Bank's Executive Directors in November 1970. II. Project Description II. Project Description 2.1 The original project consisted of: 2.1 The original project consisted of: (i) The installation of a sixth steam unit of about 100 MW at the B&flleT4aMasialkshievirdiGo4 sixth steam unit of about 100 MW at the Batle plant in Montevideo; (ii) The installation of distribution equipment for the Montevideo 6fl em htntdatthtEabUtoBofikbWt futhdtrgap4idefbeb btfontevideo 3,300 &rsEmovtrkeditnabQQi 1LOukm245 M&ergrtAdstakkrsqut 3,300 km of overhead line and about 275 MVA of transformers;/ (iii) The improvement of UTE's operating efficiency, organization and ( i6tedil%smprovement of UTE's operating efficiency, organization and procedures; (iv) The reorganization of UTE's accounting system; and (iv) The reorganization of UTE's accounting system; and (v) The elaboration of a long-range plan for its generating plant d6ho6T*rAlaboration of a long-range plan for its generating plant development. 2.2 The main changes in the project as it was actually implemented were: 2.2 The main changes in the project as it was actually implemented were: (i) Increase in the size of the sixth steam unit to 125 MW (see pkt. Zndqase in the size of the sixth steam unit to 125 MW (see para. 4.3); (ii) Reduction in the scope of the distribution component (see Aith. e4qtkqW in the scope of the distribution component (see para. 4.4); and (iii) and (iv) Limited progress in achieving improvements in UTE's efficiency (iii) and 43)rebighidiiResaciounchigvAystetewompatasin4UTE'adetWQiency and reorganizing its accounting system (see paras. 4.5 and 8.2). III. Objective and Justification of the Project III. Objective and Justification of the Project 3.1 The addition of a sixth steam unit at the Batle plant in Montevideo was to3allow UTETIRO AOtttOA 4manxhitheb" ttteat iel0l81ktspeirfchRtMontevideo to exc%t" theaThNc3Tl Itenetatal bdantrutlhsbacbbtompn4va%fe3c%tw4stforecast contint h c a e i&vt9i#4end a)hsiade(toatematieAA cte to expectq nltntckt]s9etvyahlbt44 ;61 194,7gd the demand for electricity was expected to increase at an annual rate of 5 to 7%. I/ These magnitudes are taken from para. 4.06 of the appraisal report. I/ These magnitudes are taken from para. 4.06 of the appraisal report. A5 3.2 In addition, an increase in thermal capacity would help reduce the risk associated with the variability of hydrological conditions of the Rio Negro plants, Bonete and Baygorria. Finally, the new unit was expected to be more efficient than UTE's older thermal plants and would lead to fuel savings. 3.3 UTE's sales in 1970-71 grew approximately as forecast, but they experienced a decline in 1972, as a result of restrictions due to poor hydro- logical conditions and of Uruguay's political and economic problems and stagnated thereafter. The dramatic change in the world economy which began in late 1973 affected Uruguay adversely as the country depends heavily on imported oil. As shown in the following table, UTE's power sales did not recover from the 1972-74 recession until 1975. Projections Actual Sales Growth Rate Sales Growth Rate Year (GWh) (%) (GWh) (%) 1970 1,739 6 1,727 5.2 1971 1,861 7 1,881 8.9 1972 1,973 6 1,763 1' -6.3 1973 2,072 5 1,806 2.5 1974 2,196 6 1,797 1/ -0.5 1975 n.a. n.a. 1,941 1 8.0 3.4 The following table compares forecast and actual values for peak demand in the Montevideo-Rio Negro system. Projections Actual Peak Demand Growth Rate Peak Demand Growth Rate Year (MW) (%) (MW) (%) 1970 408 5 402 3.3 1971 428 5 444 10.4 1972 448 5 450 1/ 1.3 1973 468 4 447 -0.7 1974 497 6 425 1/ -4.9 1975 n.a. n.a. 414 1/ -2.6 1/ Power restrictions applied due to water shortages in these years. A6 3.5 If the project had been completed on schedule, restrictions in 1974 could have been avoided, and sales might have been higher. However, as is shown by the data for 1973 (when sales were below the 1971 level despite the absence of restrictions) the increase would probably have been very modest. The restrictions affected residential and commercial consumption as well as public lighting, and were imposed in part to save fuel and relieve the impact of the 1973-74 oil price increases on Uruguay's balance of payments. Thus restrictions were applied in 1975, despite the availability of Batl1e Unit No. 6 at the time of the system peak. Industrial consumption, after stagnating in the period 1968-73 (industrial sales in the latter year, when there were no restrictions, were actually below the 1967 level) grew strongly in 1974-75. The delay in the project, therefore, probably did not affect Uruguay's industrial production. It did, however, have an adverse impact on the country's balance of payments. UTE was forced to use its inefficient older generating equipment to a greater extent during 1974-75 than would have been the case if the project had been completed on time, resulting in higher oil imports of approximately US$8 million. 3.6 The alternatives to the 100 MW steam unit proposed in the appraisal report, which were available to UTE were: (i) Purchase of a smaller (80 MW) steam unit from the same supplier which had built Unit No. 5 at the Batlle plant; and (ii) Gas turbine units. 3.7 There were no pure hydroelectric alternatives available to meet the load growth as projected at the time of appraisal. UTE had been discussing its proposed Palmar hydroelectric project with the Bank and other possible lenders for many years, without eliciting their interest. The project is located on the Rio Negro and therefore requires standby thermal capacity to mitigate the problems noted in para. 3.2. Given the oil prices prevailing before 1974, it was difficult to prove that Palmar was economically justified. The other hydroelectric project which might have been an alternative for supplying the Uruguay market was the Salto Grande international project on the Rio Uruguay (on the border with Argentina). While Argentina and Uruguay had agreed to proceed with this project, the related feasibility study had not been completed at the time of appraisal. Another possible alternative, inter- connection with Argentina, was also under study at that time. 3.8 In view of the high cost (US$200/kW, excluding the civil works, in prices of 1969, compared to bids of US$125-140 for plants of similar size in other countries) and unfavorable financing terms offered, UTE decided to reject alternative 3.6(i) and requested the Bank to finance the unit. UTE recommended that the unit size be increased from 80 MW to 100 MW, and the appraisal report showed that this solution was lower in cost than 3.6(ii) for discount rates of up to 13%. As noted in para. 5.3, the estimated cost of the 125 MW steam unit actually purchased by UTE was US$165/kW in prices of 1971. It,therefore, appears that UTE may have benefited from the decision to reject alternative 3.6(i), though the actual savings were not as large as originally expected. However, this conclusion must be qualified, due to the fact that differential price increases between the countries in which the suppliers of the equipment A7 included in both alternatives are located, might have been large enough during the construction period of the project to affect the initial savings in unit price. On the other hand, by proceeding with alternative 3.6(i), UTE might have avoided the delays (and higher oil imports) noted in para. 3.5. 3.9 In 1970, the Montevideo distribution system was heavily overloaded and in poor condition. It urgently needed rehabilitation and strengthening in order to be able to carry the additional energy to be produced in the new generating unit. The proposed distribution program represented the minimum UTE needed to restore to the system an adequate reliability and to reduce losses from the then prevailing 19% to a more acceptable 15%. As noted in para. 4.3, UTE has not met all the program's physical targets. However, the shortfalls appear to be in the less critical items, and the objective of reducing losses has been achieved. The figures shown in the following table are not reliable, due to poor metering. UTE does not keep records on sales (data on sales reflect actual billings) or measure the energy supplied to its substations. As losses are estimated by taking the difference between billings and genera- tion, it is likely that increased pilferage and problems experienced by UTE's billing section (para 7.4) have contributed to distort data on losses. % Losses in Power Generation % Consumed in Transmission Year GWh Station Service and Distribution 1972 2,307 3.4 22.1 1973 2,430 2.6 24.8 1974 2,273 2.9 19.5 1975 2,373 3.2 15.3 1976 2,572 3.1 15.3 3.10 The forecast incremental financial rates of return computed with the projected values for cost and revenues yielded returns of 14% and 10% on the investment for the sixth unit at Batlle and the Montevideo program respectively; 41% of revenue was allocated to generation and 59% to transmis- sion and distribution. The rate of return recalculation for the sixth unit at Batlle (Annex I) includes two important aspects not taken into account in the original calculation: (i) the unit has important effects on the regulation of the reservoirs causing considerable fuel savings in addition to savings due to reducing the average heat rate; and (ii) UTE now has a simulation model with which the probable lifetime plant factor (average hours of operation per year) of a thermal unit that, in the future, operates in a largely hydro environment, can be estimated. This reduced the average annual hours of operation from 6000 (appraisal report) to about 3500. 3.11 The estimated actual return is practically identical to the forecast 14%. In the recalculation, 53% of all revenue was allocated to generation. While this allocation is necessarily arbitrary, an increase from the 41% used at the time of appraisal is appropriate in view of the increased weight of fuel in UTE's total operating costs. The rate of return on the relatively A8 small Montevideo distribution program (less than 10% of project costs) was not recalculated because the available information does not permit meaningful estimates of costs and benefits. IV. Project Implementation 4.1 The Bank project was expected to be completed in 1973, although disbursements were expected to extend into 1974. There were serious delays in implementation (averaging approximately eighteen months) and certain aspects of the project have yet to be completed. 4.2 The main element of the project, Batlle Unit No. 6, only started delivering power to the network in July 1975 (eighteen months later than expected at appraisal). The main reasons for this delay are the following: (i) The initial schedule may have been optimistic in the amount of time allocated for installing the unit. (ii) There were a series of unexpected delays due to labor problems in Italy which slowed down manufacture of equipment. The 1973-74 petroleum price increases led to delays in shipment due to fuel conservation. Fewer ships came to the Rio de la Plata, and these ships remained at their port of origin until they were fully loaded. (iii) The procurement of the unit was delayed because of the ex- tensive legal procedures which must be followed by Uruguayan government agencies. Some eight months were required between the call for bids and the bid award recommendations by UTE to the Bank. Six more months were required to resolve the disagreement with the Bank on the proposed award (see below), to negotiate the contract with the suppliers and to secure final Government approval. 4.3 In the bidding documents for supply of the 100 MW Batlle Unit No. 6, UTE offered bidders the possibility of quoting for a larger (125 MW) unit. This provision was contained in an obscure section of the documents and was overlooked during review of the documents by the Bank since UTE did not draw attention to its inclusion. According to UTE's evaluation, which was forwarded to the Bank in late May 1971, the lowest evaluated bid was in fact for a 125 MW unit. There was considerable disagreement between UTE and the Bank on the propriety of increasing the scope of the project by purchasing the larger unit which was finally resolved after two months by accepting UTE's proposal.l/ The increase in project scope was financed partly by the suppliers of the unit and partly by reducing the scope of the distribution rehabilitation component of the project. 4.4 The main part of the rehabilitation of the Montevideo distribution network was completed by mid-1975 (eighteen months behind schedule) but not the installation of meters and construction and rehabilitation of low tension lines, where no Bank-financed equipment was involved. This part of the project 1/ Since prices of steam generating plant have continued to rise at an above- average rate, UTE feels that it made the correct decision. A9 was delayed because of a lack of skilled work force in UTE and supply problems of the local manufacturers of this type of equipment. The original targets for the distribution component are compared with partial achievements through 1976 in Annex II. 4.5 There were also considerable delays in implementing the financial reorganization portion of the project. After initial delays due to the extensive procedures followed by UTE in selecting consultants, Arthur Young & Co. (AY & Co.) were hired in early 1972 to carry out the reorganization. Their initial recommendations were presented in 1973, as required by their contract, and rejected by UTE's new Board. The Board felt that AY & Co.'s proposal to quadruple UTE's computer capacity (from 16Kbytes to 64 Kbytes) was too ambitious. The Board directed AY & Co. to prepare a proposal based on a capacity of 32 Kbytes. This required triming back several applications (e.g., accounting could not be carried out entirely on UTE's own computer, but had to be farmed out to non-UTE computer installations, with very serious problems of coordination). These additional efforts required an extra year of work by AY & Co. By this time, however, UTE's Board had changed once again. A new data processing manager was brought in and, on his recommendation, the Board accepted that UTE should purchase a computer four times as large has had been recommended by AY & Co.--256 Kbytes. Since this machine had ample capacity to implement all the applications proposed by AY & Co. in 1973, the financial reorganization program reverted to the previous plan and most of the work done in the previous year became obsolete. Aside from the one-year delay resulting from this episode, additional delays are attributable to the lack of qualified UTE personnel and to the several months required to obtain approval by UTE's Board and the "Tribunal de Cuentas" of the purchase of the new computer and the renegotiation of the contract with AY & Co. This approval was finally obtained in November 1975 and the work only resumed December 1, 1975. The computer was installed in November 1976 (one month behind the revised schedule) and its initial and most important application (billing) became fully operational in the first quarter of 1977. Inventory accounting is being computerized gradually (as physical counts are made at the irious warehouse locations). Payrolls were first processed on the new computer in June 1977. UTE's 1977 accounts are being processed by the computer (the 1975 and 1976 accounts were delayed considerably, since they were com- puted manually, but already using the new system of accounts). V. Project Cost Estimates 5.1 The cost estimate in the appraisal report was based on a 100 MW generating unit and is therefore not directly comparable to actual costs. Similarly, there has been a reduction in the scope of the distribution com- ponent which distorts cost comparisons. However, as explained below, it is likely that the project's cost would have been considerably higher than the estimate even if the original scope had been retained. 5.2 The following table presents the original and the latest estimates of the cost of the project: A10 Original Actuall/ Local Foreign Total Local Foreign Total Batlle Unit No. 6 2.60 11.20 13.80 4.70 28.60 33.30 Montevideo Distribution 2.15 3.26 5.41 0.75 2.47 3.22 Consultants 0.25 0.60 0.85 0.22 0.76 0.98 Contingencies 0.61 0.74 1.35 -- -- -- Price Escalation 0.47 0.70 1.17 -- -- -- TOTAL 6.08 16.50 22.58 5.67 31.83 37.50 5.3 Prices offered for the Batlle sixth unit were high, reflecting a possible lack of interest in the Uruguayan market. The offers ranged from US$165/kW for a 125 MW plant to be constructed as a turnkey job, to US$174/kW for the cheapest 100 MW combination. Bidding also took place at a period when world prices for power generation plant advanced sharply after a long period of stability. 5.4 The price contingencies allowed in the original estimate were in- adequate to cover the price escalation actually experienced because of the increased project scope, higher-than-expected inflation and longer-than- anticipated project construction period. The allocation of loan proceeds was as follows: Allocation of Proceeds Original Final Category -------US$ Equivalent------- I. Imported equipment and material 14,150,000 16,502,406.12 for Batlle Unit No. 6 and Distribution II. Civil works and erection 400,000 0.00 III. Consultants' Services 600,000 771,556.91 IV. Interest and other charges on 1,500,000 698,611.18 the loan accrued on or before August 14, 1973 V. Unallocated 1,350,000 27,425.79* TOTAL 18,000,000 18,000,000.00 * Cancelled 1/ The cost estimates for Batlle Unit No. 6 and consulting services are pro- bably reasonably reliable. UTE has not maintained adequate records of the cost of distribution investment, and the figures shown must be regarded as highly tentative. All VI. Consultants and Contractors 6.1 UTE engaged an individual consultant (Mr. H.S. Napier of the firm of Kennedy & Donkin) to advise it in the preparation of bidding documents and bid evaluation for Batle Unit No. 6. Though he made a useful contribution to these tasks, the responsibility for both rested mainly with UTE. 6.2 Arthur Young & Co. (AY & Co.) was involved in the review of financial organization, policies and procedures, including the development and design of a system for computerization of the commercial accounting and management systems of UTE. AY & Co.'s assignment was made very difficult by UTE's lack of qualified counterparts and by the changes in direction from UTE's Board (para. 4.4). Within this framework, AY & Co. adhered strictly to its contractual commitments. However, AY & Co. might have obtained better results if they had tailored their recommendations to UTE's absorptive capa- city by proposing some reductions in scope of their terms of reference. 6.3 Auxiesa (Spain) was hired for the supervision of the construction of the Batlle Unit No. 6. Their performance was satisfactory and they have provided effective assistance to speed up the construction. 6.4 SOFRELEC (France) studied the needs for expansion of UTE's generating capacity in the Montevideo-Rio Negro system and the possible alternatives to satisfy these needs. Their performance was satisfactory. SOFRELEC was also engaged to review UTE's accounting system prior to the contracting of AY & Co. 6.5 The principal contractors were: Amount Financed by IBRD Contractor (thousands of US$ equiv.) GIE (Italy) 11,474 CITRA (France) 1,635 Brown Boveri (Brazil) 536 Pirelli (Argentina) 1,912 Magrini Galileo (Italy) 512 6.6 Some of the problems experienced by GIE have been noted in para. 4.2(ii). Their work on .Batlle Unit No. 6 appears to have been satisfactory apart from the delays occasioned by these problems. There were also substantial delays in deliveries by Pirelli, attributed to social and economic difficulties in Argentina. VII. Financial Performance 7.1 UTE was required to submitaudited financial statements to the Bank within four months from the end of each financial year. It has not complied with this obligation, and the Bank has recognized that no reputable auditor Al2 would be prepared to certify UTE's statements until it overhauls its accounting system completely, as is proposed under the financial reorganization component of the project (para. 4.5). UTE's financial statements for 1971-73 are particularly distorted (for example fixed assets which had been in operation for some time were still carried under work in progress; fixed assets had not been revalued for several years; normal account reconciliation procedures were not applied and long-overdue accounts receivable were not written off) and very little can be said about its financial performance in these years. Considerable improvement was achieved in 1974 after an intensive effort was made to reconcile the accounts and to revalue fixed assets. Annex I compares UTE's 1974 income statement with the forecast in the appraisal report. 7.2 As noted in para. 1.6, power tariff regulations were approved during the appraisal mission. They provide that UTE should earn a rate of return of between 8% and 10% on a rate base which includes revalued net fixed assets in operation and a provision for working capital. The loan and guarantee agreements require UTE and the Government to comply with these regulations and contain similar provisions for UTE's telecommunication operation. The actual rates of return achieved in 1974 were negative. The reasons for this poor performance appear quite clearly in Annex III: (1) Power sales were 18% lower than forecast (see para. 3.3). (ii) Telephone subscribers were 22% less than forecast because of delays in UTE's 1970-75 telephone expansion programs. (iii) Fuel costs were 83% higher than forecast because of the 1973-74 oil price increases and the delay in commissioning Batlle Unit No. 6 (para. 3.5). (iv) Depreciation was substantially higher than forecast despite delays in construction because the 1974 revaluation was much higher than had been expected at the time of appraisal; the higher revaluation also increased the power rate base (the effect on the telecommunications rate base was almost fully offset by construction shortfalls). (v) Other operating expenses (mainly labor) were higher than fore- cast by approximately 8%. (vi) Although power and telephone tariffs were higher, by 16% and 22% respectively, than forecast, this increase in revenues was insufficient to offset the cost increases noted above, resulting in an operating loss. 7.3 UTE's 1975-76 financial performance was not expected to be much better than the one for 1974, as the Government did not apply the power tariff regulations in the period. Instead, it has raised power and telephone tariffs more or less in line with changes in the exchange rate. This has limited UTE's internal cash generation and UTE has had to rely on advances from the Central Bank to pay its bills. The Government's rationale for this policy was that UTE, because of its general inefficiency, could not be entrusted Al3 with the funds that would have been generated by higher tariffs. 7.4 During the period 1971-73 UTE fell behind in all its financial operations. Particularly serious were the delays in billing, which reduced the funds available to the utility. After a change in financial management, UTE's billing performance has improved considerably in 1974-76; there has also been progress in inventory accounting and, as noted above, in the re- liability of financial statements. Despite this progress, however, much remains to be done to equip the utility with the financial systems required for its operations (para. 4.5). 7.5 The loan agreement contained a provision requiring UTE to collect its overdue accounts receivable from other public sector agencies and to pay its debts to these agencies. This provision has not been complied with. The amount due to UTE from other agencies at the end of 1974 stood at US$16 million (18% of total revenues). UTE owed a similar amount to other public sector agencies (mainly the Government oil administration). VIII. Institutional Performance 8.1 As noted in para. 1.4, one of the crucial considerations in the Bank's decision to go ahead with the loan was the appointment of a General Manager to whom UTE's various divisional managers were to report. Attempts to reinforce the General Manager's authority, by obtaining changes in UTE's bylaws, failed since the Government argued that it could not carry through Congress certain constitutional changes which were felt to be required prior to changing the bylaws. 8.2. In practice, UTE's Board has continued to participate actively in the daily management of the utility. The authority of the General Manager over the staff of UTE has been incomplete; for example, divisional managers (and working-level staff) have direct access to board members and can use it to bypass the General Manager and lower-level supervisors. The project included funds for consultants to study improvements in UTE's operating efficiency, organization and procedures. However, the General Manager's lack of authority and the problems experienced in the implementation of the first major institutional improvement to be undertaken, the financial re- organization (see para. 4.5), precluded any progress in this direction. 8.3 After the Uruguayan Congress was dissolved in 1973, the Government decided to create a new entity, Comision Mixta del Palmar (COMIPAL) to carry out the Palmar hydroelectric project. COMIPAL, headed by a retired army general, was exempted from most of the controls referrred to in para. 1.2. A14 COMIPAL has proven to be a fairly effective agency so far. It succeeded in in securing bilateral financing for Palmar 1/ and has assembled a small, well-paid staff. 8.4. After improving the salaries of its higher level staff in the course of project preparation, UTE failed to maintain them in real terms during project implementation. UTE's management attributed its failure to pay adequate salaries to Government regulations. However, other public sector entities appear to have been able to devise payment schemes or obtain exemptions which permitted them to attract and retain qualified staff despite such regulations. The result has been a steep decline in the number and quality of such staff (which was already inadequate at the time of appraisal). In addition to the emigration of skilled manpower, which affected the entire Uruguayan economy during the project period, there was a consider- able movement of staff from UTE to COMIPAL and to the binational agency respon- sible for the Salto Grande hydroelectric project on the border with Argentina. 8.5 UTE's failure to increase (and even to retain) its qualified manpower may prevent it from realizing the full benefits from the project. While UTE's generation department has demonstrated its ability to hire and train the staff required to operate the project's largest element, Batle Unit No. 6, the same cannot be said of the Montevideo distribution and the financial reorganization components. UTE's Montevideo distribution department is critically short of engineers and craftsmen. It has been unable to meet the physical targets of the rehabilitation program (para. 4.4) and is experiencing serious problems in system maintenance and in planning. UTE's financial department has experienced considerable difficulties in implementing those parts of the new financial systems developed by AY & Co. which are ready for operation because of its shortage of qualified staff. As a result of Bank recommendations during the preparation of theproposed Fifth Power Project, UTE has recently started to improve the salaries of its managerial staff. 8.6 The problem of insufficient qualified managerial and technical staff in UTE is compounded by overstaffing in the unskilled categories. UTE had agreed to take action to increase productivity and progressively eliminate overstaffing. Staff was to be reduced or held constant in 1971 and reduced by 500 employees per year in 1972-74. These objectives were not achieved and UTE's management argued then that staff could not be reduced until enough qualified employees were available to man the utility. Since the latter has not been possible (largely because of the factors described in paras. 8.1 - 4) staff was not reduced, and was even allowed to increase: 1/ Based on SOFRELEC's findings (para. 6.4) the Bank indicated its willingness to consider financing Palmar. However, the Government decided to seek financing from other sources. Al5 1970 '1972 1973 1974!! 19751/ Actual 15815 16980 16858 16373 16761 Target (maximum) n.a. 15315 14815 14315 n.a. When evaluating these figures it should be noted that UTE performs many tasks not normally carried out by public utilities, ranging from supervision of home installations to running a pole factory and a vacation resort for its employees. On the positive side, it can be noted that since 1972 there has been a modest growth in the scale of operations (as measured by sales and number of customers served) without increase in personnel. 8.7 UTE agreed to train specified numbers of employees at different levels in the various disciplines required for its operations during the pro- ject period. The quantitative targets appear to have been met, but the benefits to the utility of this training are not very apparent. Because of poor working conditions, low morale and inadequate salaries, staff does not have much incen- tive to apply the training it receives. In addition to correcting these problems, UTE will have to give more attention to follow-up of its training efforts in order to ensure that supervisors make use of the newly acquired skills of trainees. 8.8 In mid-1974, the Government enacted a law establishing a new tele- communications administration (ANTEL) under the Ministry of Defense. The new entity took over UTE's telecommunications operations and two smaller Government departments. A Board of Directors was appointed immediately to manage these operations, but no further progress has been achieved in separating the two entities. The creation of ANTEL has imposed an additional burden on the managers of the departments common to both entities. These supporting services (finance, administration, etc.) have had to report to the two boards of directors since the creation of ANTEL, thus compounding an already difficult situation. IX. Bank Performance 9.1 The major objectives stressed by the Bank in loan preparation and appraisal were: (i) The need to develop a least-cost program for the expansion of the Uruguayan power sector, rather than considering individual projects (such as Palmar) in isolation; (ii) The development and implementation of tariff regulations appropriate for the country's inflationary environment; 1/ Excludes 1140 employees transferred to ANTEL upon its establishment in 1974 (see para. 8.8). Al 6 (iii) The improvement of power tariff structures; (iv) Strengthening of UTE by reducing control by other Government departments, appointing a General Manager to take charge of oper- ations and limiting the Board's role to general policy guidance and review of the major decisions of the management; (v) Building up a qualified staff by improving salaries and training, while improving UTE's efficiency by reducing the excessive number of unskilled workers; and (vi) Reorganization of UTE's financial department. As noted in paras. 1.6 - 1.8, progress was achieved on many of these points prior to approval of the loan and concrete assurances were obtained on others. 9.2 The main point on which it proved impossible to obtain concrete action or assurances during negotiations was the limitation of the involvement of other government departments and UTE's Board in the utility's operations. The Bank accepted that the Government's position in Congress prerludcd the introduction of changes in the Constitution which were felt to be necessary before the needed amendments could be made in UTE's bylaws. Despite the lack of assurances on this point, it was felt that the Bank's advice during project implementation would encourage the Government and UTE's Board to strengthen management and consolidate the progress that had already been achieved. While UTE's performance would certainly have been affected by the general political and economic problems faced by the country during the project's implementation period, it is clear that the lack of a definite statement of the prerogatives of the utility's management vis-a-vis its Board and other Government depart- ments has been a major contributing factor to UTE's weak institutional per- formance. In retrospect, it might have been wiser to defer lending until satisfactory assurances were forthcoming on these points. 9.3 Except for the tariff structure (which while not ideal, continued to be relatively satisfactory) the Bank continued to stress these objectives during project supervision. The Bank also took up a series of points it normally pursues in supervision of power projects. Among the latter were the procure- ment and implementation issues noted in Section IV, and the questions of audit- ing and settlement of public sector debt discussed in Section VII. The issue of the separation of UTE and ANTEL has also received considerable attention since 1974. However, the main thrust bf project supervision has been in the area sof strengthening UTE's management, reducing the involvement of the Board and other Government departments in day-to-day operations, paying adequate salaries to its staff, and complying with the power tariff regulations. These questions and the need for adequate planning have also been central to the Bank's discussions with the Uruguayan authorities on proposals for further Bank lending for power. 9.4 The project received fairly intensive supervision, with at least one full mission (consisting of an engineer and a financial analyst) in each year of the implementation period (except for 1974, when the mission was delayed until January 1975 in order to allow general discussions to be completed with A17 the country's new economic authorities). Supervision missions usually met with the Minister of Industry and Energy (who is responsible for overseeing UTE) and the Bank's concerns were stressed in follow-up letters to the Government and UTE. 9.5 Supervision was stepped up after the achievement of more stable economic and political conditions under new authorities, and missions were then scheduled at approximately six-month intervals. While it is of course difficult to assess the effectiveness of these efforts, they appear to have been beneficial in obtaining decisions at times when there was much difference of opinion between UTE and the Government on how to deal with specific pro- blems, e.g.,the procurement of the new computer and the extension of the AY & Co., contract. On the major issues of management authority, adequate salaries and tariffs, however, little progress was made. X. Conclusions 10.1 The project has made a worthwhile contribution to the Uruguayan economy by providing the generation and distribution facilities needed to support higher sales resulting from the post-1974 economic recovery. As with many power projects appraised in the period 1970-72, there were serious cost overruns due to insufficient provision for price escalation. There were also some losses to the economy as a result of the eighteen-month delay in project implementation. Because of the slow growth in sales, these losses consisted mainly of additional oil imports of some US$8 million over two years, and do not appear to have affected power supply to industry. 10.2 The three areas in which the project appears to have made a lasting and worthwhile contribution (other than in the financing of the physical works it comprised) are in planning, improvement of tariff structures and reorganiza- tion of the financial department. The long-term power expansion program prepared by SOFRELEC as updated after the 1973-74 oil price increases, has provided a useful framework for policy choices which the Government will have to make in the future. Some of the major decisions which will have to be made (now that the Government has committed itself to the construction of Palmar) are the method to be used to provide firm power during dry years and the speed with which Uruguay will take up its share of the Salto Grande project. 10.3 While there has been some erosion, during recent years, of the improvements introduced in UTE's tariff structure in 1970, the present tariff still contains the progressivity introduced at that time to discourage wasteful residential consumption. 10.4 The concrete results of the financial reorganization component of the project have so far been modest, as noted in para. 4.5. However, the exposure to fresh ideas brought in by the AY & Co. team and the need to recruit a large number of recent graduates as counterpart staff has had a very posi- tive impact on UTE's financial and data processing divisions. The new recruits A 18 have received strong guidance from a competent and committed project manager. They have been willing to work hard in order to further their own professional development. Given minimum support by the Board and the General Manager, the financial reorganization should prove most beneficial. XI. Lessons to be Learned 11.1 The disappointing institutional and financial results are partly attributable to the very serious difficulties experienced by Uruguay during the period of project implementation. However, the lack of a clear definition of the relative roles of UTE's Board and its General Manager was at least partly responsible for the problems which developed during project implemen- tation. With a clear mandate, the General Manager would have had a better opportunity to develop and carry out institutional improvements. 11.2 UTE's poor institutional performance is also attributable to its inability to attract and retain qualified staff because of poor salaries. The Government has recently changed its policy of placing a low ceiling on UTE's salaries. The Bank should consider including a provision in its future loans to encourage the Government to allow public sector entities to pay adequate salaries. Latin America and The Caribbean Regional Office November 1977. URUIGUAY Fourth Poer FToject Rate of Return on 6th Thermal Unit (125 MW) Fower Station Bat1le y Ordonez al1. 1 2 3 4 5 6 7 8 9 10 11 12 Total Uet Generation Fuel Cost Operational Total Costa Efficiency Regulation Revenues Benefits Berfits Sales Losses 1.111 x (GWh)8 0.0259 x (GWh)s Cost Investment 4-5+6 0.025 x (Gw)s 8+9+10 11-7 (ear (W4) (Wh)g (MUS$) (M ----------------- ---- Mus:-,. ---------- 1972 0 10 1/0.9 times 0.0259 times 0 0.78 See P.V. 0.00 0.00 0.0225 times see P.V. See P.V. 3 0 Column I Column 1 0 5.46 0.00 0.00 Column 1 below belov 4 0 See P.V. See P.V. 0 16.72 0.00 0.00 See P.V. 1975 182 0.73 7.20 4.75 1.60 belor 6 468 2.60 4.75 3.25 7 504 1-12 4.75 3.50 8 559 5.70 3.75 9 621 7.13 4.0 1980 396 4.75 3.60 1 306 4.16 3.20 2 252 3.56 3.00 3 297 2.97 4 297 2.38 1985 356 1.78 6 428 1.19 7 513 1.02 8 490 0.96 9 480 0.90 1990 47o 0.84 1 459 0.78 2 449 0.72 3 439 0.66 4 429 0.60 1995 419 0.54 6 409 0.48 7 398 0.42 8 368 0.36 9 373 0.30 -n0 367 0.24 1 357 0.18 2 347 0.12 3 327 0.06 200l 327 10 0.73 0.00 3.00 2,2 ----- not required ----- 314.0 21.9 33.9 369.8 57.2 91.9 272.2 421.8 52.0 2 8,740 226.4 15.7 32.4 274.5 47.7 66.2 196.7 310.6 36.1 4 6.112 168.7 11.7 31.0 211.4 40.3 49.3 146.5 236.1 24.7 6 4,999 129.5 9.0 29,8 168,3 34.5 37.9 112.5 184.9 16.6 8 3,91.1 102.1 7.1 28,6 137.8 29.9 29.9 88.7 148.5 10.7 10 3,180 82.4 5.7 27.1 115.5 26.0 24.1 71.6 121.7 6.2 67.8 4.7 26.4 22.9 19.9 58.9 101.7 2.8 4 56.5 3.9 25.4 86.1 20.3 16.6 49.4 86.3 0.2 43.3 3.4 24.5 76.2 18.1 14.1 42.0 74.2 -2.0 1,606 41.6 2.9 23.6 68.1 16.2 12.2 36.1 64.5 -3.6 ANNEX II Montevideo Distribution Rehabilitation Program Appraisal Actual Unit (1970-73) (1970-76) Underground cable km 30 kV 47 75 6 kV 140 140 220 kV 120 120 Transformer capacity MVA (i) Existing substations 30/6 kV 150 135 e/ 6/0.24 kV 46 46 (ii) New substations MVA 30/6 kV 61 a/ 44 c/ 6/0.24 kV 18b/ 18d/ Overhead lines km 6 kV 150 - 220 V 3,120 1,100 Meters 95,000 58,200 a/ In 3 substations. b/ In 60 substations. c/ In 2 substations. d/ In 60 substations. e An additional 15 MVA are in reserve in stock. URUGUAY ANNEX III Loan 712-UR Fourth Power Project Usinas y Telefonos del Estado (UTE) 1974 Income Statements (US$ million) a! b/ Actual Forecast- Difference Amount % Power sales in GWh 1797 2196 (399) (18.2) Revenue per kWh in US4 3.30 2.85 0.45 15.7 Telephone subscribers (thousands) 187.5 240 (52.5) (21.9) Revenue per subscriber in US$ 154 126 28 22.0 Revenues Power 59.30 62.62 (3.32) (5.3) Telecommunications 28.85 30.26 (1.41) (4.7) 88.15 92.88 (4.73) (5.1) Operating Expenses Power Operations & maintenance 31.22-Sc 32.90 (1.68) (5.1) Fuel and purchased power 13.20 7.23 5.97 82.6 Depreciation 15.42 10.72 4.70 43.8 59.84 50.85 8.99 17.7 Telecommunications Operations & maintenance 25.44 -/ 19.81 5.63 28.4 Depreciation 5.49 4.18 1.31 31.4 30.93 23.99 6.94 29.0 Operating Income Power (0.54) 11.77 (12.31) (104.6) Telecommunications (2.08) 6.27 (8.35) (133.2) Rate Base Power 168.6 147.2 21.4 14.5 Telecommunications 63.0 62.8 0.2 0.3 Rate of Return on Rate Base % Power (0.3) 8.0 - - Telecommunications (3.3) 10.0 - a/ Converted into US$ at the average rate of Ur$1,555 = US$1. b/ Converted into US$ at Ur$250 = US$1. c/ Includes a provision for bad debts (not included in UTE's published accounts).  MAP 1 2B 56- URUGUAY 54 UD BUTE, POWER PLANTS AND TRANSMISSION LINES ArRää EXISTING PROPOSED """"""" 220 a 400 KV tronsmission lines 150 KV transmission lines 10 KV lransmisslon lines. 60,KV ond below fransmission lines Power plon s 0 Substations Rivers o-Rivero internationol boundaries 0 20 40 60 80 100 0 20 40 60 50OU1H Salto 0 U T H AMER ICA TURUGUAY -3-n R,. Ou.9..y Gr-d. Paysandu melo RnCwn del Bonrele Ria Yrs Reservor, Paso de los Toros z ~New, Loa Futur EL PALMAR 'oe BAYGORRA DELC PROPOSED B ~ ONE go Neo STATO Logn Froy oso del Puerto ',.©.YT Bentos , Mercedes Diurz Trinidad0 Nue CameoFlorida Casupa 34*• Charmso Rwo P. Lc Ros0r1o Son Jose Minas Ctna Juan Lacaze Cnelones 0 Rocha Liberta Rio de la Plata Pan de Son Carlos BENOS La Flores AIRES Maldo".do A4tla0nti c Ocean BATL.LE ND MONTEVIDEO CAtCAGNO (For detail see Map 2 Pun.o det THERMAL Este PLANTS 56e 54- MAY 1970 IBRD-298  于 MA丫1970 IBRD_2982