Mauritania - Societe Nationale Industrielle Et Miniere (SNIM) Rehabilitation Project

Document of The World Bank FOR OMFICiAL USE ONLY t j/, . - C, Y( 9r;3 Report No. 5819-MAU STAFF APPRAISAL REPORT ISLAMIC REPUBLIC OF MAURITANIA SNIM REHABILITATION PROJECT November 12, 1985 Industry Department This doument lus a res&ided dbatli ad may be uW by recipients oYuy in the Pence Of &eir SSCW dnl's lts contes_t mayot odherwise be disclosed without World BDk authorlratiou.  CURRENCY EQUIVALENTS Currency Unit = Ouguiya (UM) UM 67 = US$1.00 UM 1,000 = US$14.93 UM 1 million = US$14,930 WEIGHTS AND MEASURES 1 meter (m) - 3,2I, feet (ft) I cubic meter (m3) = 33.3'5 cubic feet (ft3) 1 kilometer (km) = 0.62 .niles 1 kilogram (kg) = 2.205 pounds (lb) 1 metric ton (tonne, t) = 1,000 kg or 2,205 lb ABBREVIATIONS AND ACRONYMS AFESD - Arab Fund for Economic and Social Development BRGM - Bureau de Recherches G6ologiques et Miniares BRPM - Bureau de Recherches et de Participations Miniares CCCE - Caisse Centrale de Cooperation Economique EIB - European Investment Bank KFTCIC - Kuwait Foreign Trading, Contracting and Investment Company MIFERMA - Mines de Fer de Mauritanie OECF - Overseas Economic Cooperation Fund of Japan SAFA - Societe Arabe du Fer et de l'Acier SNIM - Societe Nationale Industrielle et Miniere SOCOMINE - Societe de Cooperation Miniare et Industrielle SOFRESID - Societo FranSaise d'Etudes de la Siderurgie MAURITANIAN FISCAL YEAR January 1 - December 31  FOR OMCIAL USE ONLY 1AURITANIA - SNIM REHABILITATION PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. Io INTRODUCTION ............... . . * .............6...6 1 II. THE MAURITANIA} MIXING SECTOR ............. 2 A. Role of Mining Sector in the Economy ...... 2 B. Mineral Resources and Reserves 3 1. Iron Ore.. 3 2. Other Minerals 4 ............................ 4 III. THE COOPANY . ..o.... 5 A. Organization and Management 6 B. Operations *6.o....6.. . ......... 7 C. Past Production and Sales Performance and Recent Financial Position 8.....*... 8 D. SNIM's Medium- and Long-Term Outlook ................... 11 IV. THE IRON ORE MARKET ........................ 12 A. Demand and Supply of Iron Ore 12 B. Iron Ore Prices ........... ............................ 14 C. SNIM's Market Position 16 V-. THE REHABILITATION PROJECT ...*........666 17 A. Background and Bank's Role 17 B. Project Objectives .... 17 C. The Rehabilitation Program (1984-1988) 18 1. Management and Organization Improvements 18 2. Operacions and Maintenance Improvements ........... 21 3. Procurement and Investment Policies .... ....... 22 4. Personnel Policy 22 5. Overhead Cost Reduction ...... 22 6. Cash Management Improvements ....................... 23 This report was prepared by Messrs. Heiaz Hendriks, Thorkild Juncker and Pierre Larroque and Ms. Maria Kutcher of the Industry Department. i This document has a restricted distnibution 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.  -ii- Page No. D. Description of Project Components to be Financed ..... 23 1. Replacement of Equipment ..... .................... 23 2. Major Overhauls and Improvement of Equipment ..... 23 3. Tools and Control Equipment ..... ................. 24 4. Training and Technical Assistance ................ 24 E. Implementation Arrangements and Schedule .........0... 25 VI. PROJECT COST, FINANCING PLAN AND PROCUREMENT ............. 26 A. Project Cost * ........................................ 26 B. Financing Plan ....................................... 27 Co Procurement ........ ............. ... ........ 29 D. Allocation and Disbursement of Bank Loan .... .......... 30 VII. FINANCIAL ANALYSIS ..................32 A. Financial Projections 33 B. Sensitivity Analysis 35 C. Financial Covenants 36 D. Auditing and Reporting 36 E. Financial Rate of Return and Sensitivity Analysis .. 37 Fe Risks ................................................ 37 VIII. ECONOMIC ANALYSIS ..... ....... 38 A. Economic Rate of Return 39 B. Foreign Exchange Benefits 39 C. Other Benefits .... 39 IX. AGREEMENTS REACHED AND RECOMMENDATIONS ................... 40 ANNEXES 3-1 SNIM Organization Chart 3-2 SNIM Audited Financial Statements 4-1 The Iron Ore Market 5-1 Project Implementation Schedule 6-1 IBERD Financed Project Components 6-2 Estimated Disbursement Schedule for IBRD Loan 7-1 SNIM Projected Income Statement 7-2 SKIM Projected Sources and Applications of Funds 7-3 SNIM Projected Balance Sheet 7-4 Cash Flow for Financial Rate of Return 8-1 Cash Flow for Economic Rate of Return 9-1 Selected Documents and Data Available in the Project File MAPS IBRD 19048 IBRD 19049  -iii- MAURITANIA SN1M REHABILITATION PROJECT LOAN AND PROJECT SUMMARY Borrower: Soci-te Nationale IQdustrielle et Miniere (SNIM). Amount: US$20.0 million. Terms: Repayable in 15 years, including 3 years of grace, at the Bank standard variable interest rate plus a guarantee fee to the Government of 1OZ of the variable interest rate. Project Objectives SNIM's increasing production costs and debt service, and Description: both due to the now completed Guelbs Project, require tight financial management in the coming years. The Project's main objective is to secure the mediuw-term financial and economic viability of SNIM, one of the most valuable assets of the Mauritanian economy. The Project would consolidate and furtber advance the ongoing action program for managerial and technical improvements and would in particular: Ci) help SNIK contidue to improve its management and reduce its production costs; and (ii) assist with the necessary financial restructuring of SNIM by transforming part of its short-term debt/overdraft into long-term debt. The Project consists of Ci) measures by SNIM aimed at improvements and cost reductions in management, operations, procurement and investments, personnel, overhead costs and cash management; and (ii) purchase of equipment and supplies, and provision of training and technical assistance necessary for the implementation of these measures. Project Risks: The Project faces maj:.- financial, but also managerial, commercial and technical risks. Sound project preparation, conservative assumptions for the financial projections and the fact that SKIN has already successfully started its rehabilitation program limit the risks to an acceptable level.  -iv- Estimated Cost (net of taxes): Local Foreign Total --(USS million)--- Replacement of Equipment 2.5 25.7 28.2 Major Overhaul and Improvement of Equipment 13.3 30.9 44.2 Tools and Control Equipment - 4.6 4.6 Training and Technical Assistance - 8.5 8.5 Base Cost (Mid-1985 Prices) 15.8 69.7 85.5 Physical Contingencies 0.2 1.3 1.5 Price Contingencies 0.8 4.4 5.2 Total Project Cost 16.8 75.4 92.2 .~~ ~ ~ - Financing Plan: Local Foreign Total - (USS million))- External IBBD - 20.0 20.0 Kuwait/Arab Funds - 18.2 18.2 Abu Dhabi Fund - 5.8 5.8 Saudi Fund - 5.7 5.7 OECF - 3.1 3.1 CCCE - 3.0 3.0 Internal SNIM 16.8 19.6 36.4 Total 16.8 75.4 92.2 Estimated Disbursements of IBRD Loan: Bank FY 1986 1987 1988 (-{USS million) - Annual 3.0 7.0 10.0 Cumulative 3.0 10.0 20.0 Economic Rate of Return: 25% MAPS IBRD 19048 IBRD 19049  I. INTRODUCTION 1.01 The Government of Mauritania has requested the Bank's assistance in financing a project for the rehabilitation of Societe Nationale Industrielle et Miniere (SNIM), the parastatal company in charge of iron ore mining in Mauritania. The estimated cost of the Rehabilitation Project is US$92.2 million, of which SNIM will contribute US$36.4 million out of its internal cash generation. The Bank and the other colenders: Kuwait Fund, Arab Fund for Economic and Social Development (AEESD), Abu Dhabi Fund, Saudi Fund, Overseas Economic Cooperation Fund of Japan (OECF) and Caisse Centrale de Cooperation Economique (CCCE) will finance the balance of US$55.8 million. The Bank contributes US$20.0 million equivalent. 1.02 The proposed Rt-abilitation Project will be the Bank's third intervention in the iron ore sector in Mauritania. In 1960, a Bank loan amounting to US$66 million out of a total project cost of US$190 million was made to Societe Anonyme des Mines de Fer de Mauritanie (MIFERMA), a company owned predominantly by French, British, German, and Italian interests. -j The loan was requested to finance the development of the Iedia iron ore deposits, the exploitation of which started in 1963 (Map IBRD 19049). In 1979, the Board approved a US$60 million loan to SNIM to finance part of the first phase of the Guelbs Iron Ore Project, the development of a new iron ore mine, beneficiation plant and infrastructure to replace the gradually depleting Kedia mines. 2/ In addition to the Bank loan and to the equity principally from Arab leIing institutions and governments, SNIM financed the Guelbs project with about US$278 million of loans from Arab development banks (65%) and European and Japanese development banks (35Z). 1.03 SNIM's operations are critically Important for Mauritania. In 1983, iron ore mining accounted directly for about 9X of Mauritania's GDP at market prices and represented about 40% of its foreign exchange earnings. Since 1981, the Guelbs Iron Ore project has 'ad several problems: (i) a three-year commissioning delay (the first Guelbs ore was shipped in March 1985 instead of 1982); (ii) SNIM sales in 1978-83 decreased to about 7-8 million tonnes per year (tpy) from the 10-12 m-illion tpy envisaged at appraisal, mostly because of the depressed iron ore market; (iii) iron ore prices in real terms are at present 15S below appraisal estimates; and (iv) decreasing productivity. While these problems have already affected SNIM's financial position seriously, they will be further compounded starting in 1985 by the start of the repayment of the US$338 million Guelbs loans. 1/ Loan 249-FR, of March 17, 1960. The loan has been fully repaid. 2/ Loan 1747-MAU, of December 14, 1979.  -2- 1.04 SNIM has formulated a series of measures in a rehabilitation program that will help (i) face the Company's debt service difficulties; and (ii) restore its financial viability in the medium- and long-term and hence its contribution to the Mauritanian economy. The rehabilitation program is at the core of the proposed Rehabilitation Project for the financing of which SNIM has requested assistance from the Bank and the other colenders of the Guelbs Project. II. THE MAURITANIAN MINING SECTOR A. Role of Mining Sector in the E-onomy 2.01 Despite the recent development of the fisheries sector, mining continues to be the most important sector of the Mauritanian economy. The mining sector consists almost exclusively of the exploitation of iron ore, which dates back to 1963, when Mines de Fer de Mauritanie (MIFERMA), the predecessor of SNIM, commenced operations. From the beginning, production capacity has increased from 6 million tpy to about 11.5 million tpy. The most recent expansion was the Guelbs mine project that started production in March 1985. The operations are located inland at Zouerate, about 650 km east northeast of Nouadhibou, the port of shipment, which is connected with Zouerate by a company-owned railway. 2 .02 Iron ore mining has been a mainstay of the Mauritanian economy, and its development has been the chief determinant of the country's economic growth. The two tables belov illustrate the role of the mining sector in terms of its share in GDP and merchandise exports. Maritaia - GP In (astant 1982 Prices, 1975, 1980 nd 1983 1975 1980 1983 U4 hilll Z 1M biUl. Z TM bd I flm z Prznay Sector 8.E 26.6 10.5 27.5 13.4 32.4 Seondary Sector 8.0 24.2 8.6 22.5 7.8 18.8 (of hiddh mining) (4.6) (13.9) (4.3) (11 3) (3.8) (9.2) Tertiazy Sector 13.1 39.5 16.8 44. 15.9 3L84 Gl] at Factor Cost 29.9 90.3 35.9 94.0 37.1 89.6 Tndirect Thus Net of Subsidies 3.2 9.7 2.4 6.0 4.3 10.4 GDP at Market Prices 33.1 100.0 38.3 100.0 41.4 100.0 Sonces: Mauritadan AutbDrities, IW and Bark staff isntimtes. 2.03 While still a very Important sector in the Mauritanian economy, the mining sector's direct contribution to GDP has fallen from 13.9% in 1975 to 9.2% in 1983, partly due to declining iron ore output and partly due to growth in other sectors, in particular the fisheries sector which  -3- increased its contribution to GDP at market prices from 3.6% in 1975 to 7.7% in 1983. Also, government services and trarsport and commnmications have grown relative to other sectors in the period 1975-1983. However, in addition to its direct contribution to GDP, iron ore mining has some indirect impact on GDP through value-added in the industrial, construction and services sectors. Mauritania - Merchandise Exports 1975, 1980 and 1983 (UM billion, f.o.b. at current prices) 1975 1980 1983 UM billion Z UM billion % IIM billion Z Iron Ore 6.2 86.1 6.9 76.7 7.3 42.0 Fish Products 0.7 9.7 2.0 22.2 8.9 51.0 Other 0.3 4.2 0.1 1.1 1.2 7.0 Total 7.2 100.0 9.0 100.0 17.4 100.0 - -_ - - Sources: Mauritanian Authoritles, D? and Bank staff estimates. 2.04 Foreign excchange generation, rather than financial return on the investment, was the principal argument for the Guelbs project. Local labor is the only source of local value-added and amounts to about 40-45% of total costs of operation. Since the initiation of the Guelbs project in the mid-1970s, the fisheries sector has grown substantially, and iron ore export is no longer the almost exclusive source of foreign exchange for Mauritania. The iron ore sector's share in merchandise exports fell from 862 in 1975 to 42% in 1983, basically due to the growth of the fisheries sector. Local value-added in the fisheries sector has been estimated at approximately 55-60% of gross earnings. Mauritania's dependence on iron ore exports for foreign exchange generation is projected to be further lessened in the future due to the Government's policy in the fisheries sector of gradual replacement of foreign licensing agreem-ents with Mauritanian-controlled joint venture companies. 2.05 SNIM contributes to public revenue directly through the payment of a 10Z royalty on all iron ore export sales and indirectly through the tax payments of its about 6,100 employees. In 1984, the royalty alone amounted to US$13.8 million, or 8Z of total public revenue. B. Mineral Resources and Reserves 1. Iron Ore 2.06 The presently mined iron ore deposits are located in the Kedia mountains near Zouerate (Map IBRD 19049). Two different ore grades are available at Kedia: (i) high grade ore (iron content 62-64% Fe, silica content 4-8% SiO2); and (ii) low grade (siliceous) ore (50-55Z Fe, 12-16% SiO2). Both qualities are mainly sold as sinterfeed; only a small portion  -4- is recoverable as lumpy ore. Other than crushing and screening, the ore does not require further treatment. The reserves of high grade ore presently remaining in the Kedia mountains are only in the order of 30 million tonnes. The reserves of siliceous ore are larger; however, over the last few years, SNIM has not been able to extend the share of siliceous ore in its exports beyond 20-25%. The market restrictions for siliceous ore are expected to persist in the future. In the past, siliceous ore bas been mined as a by-product of high grade ore: it forms part of the overburden which has to be removed to get access to the rich ore. Mining of the low priced siliceous ore on its own, without the benefit of co-production with high grade ore, would probably not be economical. Thus, the limiting factor for the expected life of the Kedia mines is availability of the high grade ore. Assuming in the future an average yearly extractiot of about 3 million tonnes of high grade ore, the reserves would last until about 1995. 2.07 As the Kedia mines are being depleted, an increasing amount of Guelbs ore will be mined. The raw, untreated Guelbs ore has an iron content of only 38% Fe. Upgrading through magnetic separation is required to achieve a marketable product of 64% Fe. All Guelbs products will be sinterfeed of only one single grain size class marketed in two varieties: (i) ore with a high magnetite content (18% Fe+4); and (ii) ore with a low magnetite content (6% Fe++). The Guelbs feasibility study defined about 350 million tonnes of raw ore reserves at Guelb El Rhein and about 100 million tonnes at Guelb Oum Arwagen. However, the unfavorable development of iron ore prices necessitates a reassessment of economical reserves. Bank staff recently estimated that only about 50-60% of the reserves may be economically recoverable at present ore prices. Since about 2.3 tonnes of raw ore are needed to produce 1 tonne of product, the economical reserves would allow an operation of the existing Guelbs plant (6 million tpy capacity) over a period of 18 years. Under the assumption of continuing low iron ore prices, there would be no reserve base for a phase 2 Guelbs plant. 2.08 Ore from other known iron deposits near Zouerate would be of lower grade, or, more importantly, of finer grain size than the Guelbs ore and its upgrading would necessitate fine grinding with subsequent pelletizing, a non-economical process for a country without cheap energy sources. This would also apply to the large, low grade Thasiast deposit, located about 200 km east of Nouadhibou, close to the existing rail link between Zouerate and Nouadhibou. 2. Other Minerals 2.09 The relatively small, mediuw grade Akjoujt copper deposit, located about 200 km northeast of Nouakchott, was mined by S'nciftg des Mines de Mauritanie (SOMINA) in two short periods: from 1971 to 1974 and from 1975 to 1978. 3/ Operations were stopped in 1974 after a decline of 3/ IFC participated in the establishment with share and loan capital in an amount of approximately US$20.0 million. IFC has since sold its shares in the company.  -5-. copper prices and the steep increase in fuel prices connected with the first oil shock. To maintain employment, the Government of Mauritania took over the company, integrated it with SNIM, and operations resumed in 1975. Due to continuous high losses and their serious impact on SNIM's financial situation, the operations were shut down in 1978. Market and prices for zopper deteriorated further, and the outlook for a successful reopening of the mine is bleak. In addition, a relatively high arsenic content of the ore makes its marketing difficult. 2.10 Gypsum from an area north of Nouakchott has been mined since 1973 by SNIM. In 1983, this operation was separated from ShN?. The output is small (17,000 tpy) and entirely sold to the Rufisque cement plant in Senegal in return for a rebate on cement sold to Mauritania. Even before the start of gypsum exploitation, some small sulfur nodules had been found in the gypsum strata. Exploration work in 1947 by Bureau de Recherches Ggologiques et Minieres (BRGM) demonstrated that the existence of economically recoverable reserves could be precluded. Nevertheless, due to the present high sulfur prices, the Senegalese phosphate fertilizer industry has recently shown an interest to review exploration results. 2.11 Other minerals, which are not mined but have been reported existing in Mauritania, include phosphate, rare earth and gold. About 90 million tonnes of raw phosphate rock have been identified near the Senegal river, some 300 km from the sea. The market situation, the relatively low reserves and the lack of transport infrastructure preclude an economical exploitation for the time being. Similarly, market considerations, remote desert lcation and poor geological indications do not suggest any possibility of economical exploitation of rare earths or gold. III. THE COMPANY 3.01 Since the nationalization of NIFERMA in 1974, the Mauritanian iron ore mines have been operated by Societe Nationale Industrielle et Miniere (SNIM), established as a State company in 1972. In 1978, SNIM was made a state-controlled, limited liability corporation (Societe d'Economie Mixte a Majorite d'Etat), permitting private and foreign ownership. SNIM's share capital is currently held by the Mauritanian government (70.9%), Kuwait Foreign Trading Contracting and Investment Company (9.6%), Arab Mining Company (7.6Z), Iraq Fund for External Development (6.2%), Bureau de Recherches et de Participations Mini4res of Morocco (3.1Z), Islamic Development Bank (2.4%) and Mauritanian individuals (0.2%). The shareholders are represented in the Board of Directors which is chaired by a Mauritanian official designated by the Government. 3.02 Apart from the iron ore mining operation (SNIM Fer), SNIM includes a few minor ventures: (i) SNIM Explosifs, a small expl--qives factory entirely captive to the iron ore mine which is ncw being made redundant through the introduction of modern ANFO explosives mixing trucks and will therefore be discontinued;  -6- (ii) SNIM Acier, a small steel plant producing steel bars used in construction mainly for the local market; this operation has so far made cash losses. The majority of the shares in this company has been sold to the Arab Mining Company and Bahrein shareholders in July 1984. Without any new cash contribution from SNIM, a new company, Soci t Arabe du Fer et de l'Acier (SAFA) was formed, in which SNIM holds 33% shares. The steel plant has been legally, financially and administratively separated from SNIN; any remaining operational and commercial links between SAFA and SNIN are at arms' length; and (iii) SNIM Paris, the marketing branch located in Paris. A. Organization and Management 3.03 SNIM's organization chart is presented in Annex 3-1. The Board of Directors has delegated all powers and authority for managing the operations to the General Manager. The Company started a reorganization in 1984. Previously a flat structure (22 departmental managers reporting directly to the general manager), the organization has since late 1984 a more traditional pyramid shape (10 managers reporting to the general manager, each with three to seven divisional managers reporting to them). The new general manager, appointed in February 1985, was the mine mansger at Zouerate. He has an appropriate background and experience for implementing manageme.at, production and cost improvements. A review of the management and organizational structure by consultants CEGOS/METCHEM of France/Canada, whose terms of reference were reviewed by the Bank, confirmed that the new overall organizational structure of SNIM is adequate. 3.04 From 1979 to 1984, SNIM's work-force increased by about 17%, or 1,000 persons. This strong growth in the work-force is a major reason for the company's present financial difficulties and will be addressed in the proposed Project (para. 5.17). On the other hand, SNIM has achieved a reduction in the amount of expatriates, from about 400, or 8% of the workforce in 1979, to about 100, or 2%, in 1984. SNDI - Average Local and Expatriate Work-Force, 1973 and 1979-84 1973 1979 1980 1981 1982 1983 1984 Local 3,715 4,757 5,212 5,292 5,806 5,901 5,947 Expatriate 665 408 400 295 2:4 135 112 Total 4,380 5,165 5,612 5,587 6,020 6,036 6,059 Expatriate (%) 15.2 7.9 7.1 5.3 3.6 2.2 1.8 Source: SNIM.  -7- B. Operations 3.05 SNIN's headquarters are located at Nouadhibou, the port of ore shipments. The iron ore operations are managed from Zouerate; the port and railway operations from Nouadhibou. SNIM also maintains (i) a small office in Nouakchott for liaison with the Government; and (ii) since 1984, a small purchase office in Las Palmas which has become SNIM's main solrce for food and small supplies. Despite the large labor force, SNIM's operations are reasonably efficient and equipment maintenance is in general appropriate. 3.06 The Kedia mining operations are spread over six small pits with two crushing and train loading stations, one at Rouessa and one at Tazadit, each having a capacity of about 5 million tpy. The mines are equipped with older 4m3-electric rope shovels and tnrcks of varying size, predominantly in the 60-tonne class. The equipment, large in number and of advanced age, needs continuous planned maintenance and overhaul for its efficient operation. The ore is trucked over an average distance of about 3 km to the primary crushers at Rouessa and Tazadat. Full secondary a>.' tertiary crushing and screening is done at Rouessa; ore from Tazadit undergoes secondary crushing and screening only at the port in Nouadhibou. Overhauls of the ore handling facilities at Zouerate are essential for securing sufficient production capacity over the medium-term. Service stations for mining equipment are located near the two primary crushers. The central workshops, mechanical and electrical, are located in Zouerate along with other services, such as power and water supply and warehousing. The town of Zouerate now has about 50,000 inhabitants, of which about 2,500 are employed in SNIM's Zouerate operations. All inhabitants depend on SNIM's operations for a livelihood. Although major services for the township, such as schools, hospitals, food distribution and airport operation have to a large extent been transferred to Government agencies or private enterprises, SNIM is still responsible for power and water supply to the town of Zouerate, as well as for major road maintenance. By the end of 1986, SNIM will decide on further cost saving measures in this area. 3.07 The railway connects over a distance of about 650 km Zouerate with the port at Nouadhibou. Although SNIM has regularly maintained the railway track, some of its sections are now so heavily worn that replacement becomes critical to sustain present production levels. Some of the locomotives are worn out and need either new engines or complete replacements. The port equipment, consisting of ore tipping, crushing, screening, stockpiling and shiploading facilities, is basically in good operating condition; only the shiploader requires an overhaul in the near future to secure high availability. 3.08 In view of the depletimg ore reserves at Kedia, exploration drilling for other ore reserves was already started under MIFERMA. The drilling, together with subsequent pilot plant testing, engineering and design work, led to the definition of the Guelbs project. The first phase consisted of a beneficiation plant of 6 million tpy capacity and a mine at El Rhein; in the second prhase the beneficiation plant was to be doubled in  -8- size and a mine at Oum Arwagen was to be added. Financing for the first phase from 12 lenders, including the Bank, was obtained in 1978, and the first contracts for the project were issued in 1979. After initial delays caused by late effectiveness of the loans and procurement inefficiencies, construction was completed end 1984 at a cost of $350.0 million, about 20Z lower than estimated at appraisal, mainly due to the lower than expected inflation and the highly competitive bid prices obtained. The first beneficiated ore was shipped in March 1985. Apart from the initial delays and except for the remaining problems with the running-in of the beneficiation plant (para. 3.10), the project was implemented satisfactorily from a technical, financial and managerial point of view. 3.09 The Guelbs pinject consists of a new mine at the Guelb (mountain) El Rhein, about 30 km north of Zouerate, a beneficiation plant and some extension of the existing railway and port. Mine and beneficiation plant are modern and well designed. The mine is equipped with efficient, large equipment: 4 shovels (12m3 capacity), 14 trucks (100 tonnes capacity) and 3 drills for blastholes of 9" diameter. The beneficiation plant is the key component of the project. Due to lack of water, a completely dry semi-autogenous grinding process followed by dry magnetic separation was selected. The plant consists of two production lines, each of 3 million tpy capacity. Provisions have been made for a possible later addition of another two lines. A new 60 MW diesel power station has been added. The existing railway has been extended to join the Guelbs site. Some rolling stock has been added and port facilities have been slightly extended to accommodate the Guelbs ore. 3.10 Presently, the Guelbs benefication plant is operating at 2 shifts/day and 5 days/week. The output for 1985 is estimated at about 1.0-1.5 million tonnes. SNIM plans to increase the production over the next two years to 4.5 million tpy (75% of capazity) and accordingly decrease the production from Kedia. Although all major operating parameters have been verified to range within design limits and previously estimated production cost elements have been confirmed so far, SWIM has experienced during start-up some technical problems, in particular with the control of dust from the totally dry process. The plant designer (SOCOMINE), a FLe!nch steel company (SOLMER), the French steel industry;s consulting branch (SOFRESID) and various equipment suppliers all provide technical assistance for the start-up. Based on the experience gained during the first six months of operation, SNIM has prepared a detailed plan for improvements and has created a task force to solve technical problems. These measures are considered appropriate. C. Past Production and Sales Performance and Recent Financial Position 3.11 With production and sales of 9.5 million tonnes, SNIM managed in 1984 to reverse a trend of declining production and sales from 11.7 million tonnes in 1974 to 7.4 million tonnes in 1983. The recent increase was primarily due to sales to Italy, Belgium and the UK, where SNIM's share of imports increased from 1982 to 1984 by 5%, 4%, and 2%, respectively.  -9- 3.12 The develooment of SNIN's iron ore sales and unit production cost is shown in the table below: Sales Volume, Iron Ore Prices, and Unit Production Costs, 1980-84 1980 1981 1982 1983 1984 Sales Volume, million tonnes 8.7 8.9 7.7 7.4 9.5 Exchange Rate, US$1 - UM 45.9 48.3 51.8 54.8 63.8 Average Iron Ore Price, US$/t 19.8 18.0 19.2 17.6 16.3 Production Cost, USS/t 16.2 15.0 17.2 15.0 12.6 Average Iron Ore Price, UIM/t 908.8 869.4 994.6 964.5 1,039.9 Production Cost, UN/t 743.6 724.5 891.0 822.0 803.9 Labor Cost as Z of Total Costs 39.9 42.9 43.4 46.3 42.0 Source: SNIM. Whereas SNIM's average iron ore price in US dollar terms declined, production cost in US dollar terms remained about the same until 1984. In 1984, the ouguiya was devalued by about 20%, and in addition production volume increased. SNIM managed to benefit from both these events and avoided any slippage in production costs. As a result, unit costs declined by 16% in US dollar terms and by 2% in ouguiya terms. The share of labor costs in total costs, which essentially represent the local cost component, reached 46% in 1983. The 1984 devfiluation led to a remarkable decrease in labor cost and a drop in its share to 42%; this illustrates the importance of the newly adopted flexible exchange rate regime for SNIM's future inteLnational competitiveness. 3.13 Present total unit production cost, including interest and depreciation, amount to US$12.6/t. They do not yet take into account the increases caused by the Guelbs Project. Presently, direct operating cost for mine, railway and port represent about 70% of the total operating cost, leaving a relatively large balance of 30% of overheads. 3.14 SNIM's financial position for the years 1981-1984 is summarized below. Annex 3-2 provides details of the financial situation for the years 1981-1984.  -10- SNIM - Selected Financial Indicators 1981-84 (UM million) 1981 1982 1983 1984 Production, million tonnes 8.9 7.7 7.4 9.5 Average Iron Ore Price, USS/t 18.0 19.2 17.6 16.3 Total Revenues 8,877 9,613 7,760 10,372 Operating Income 1,163 1,051 207 1,319 Net Income After Royalties 1,025 708 (119) 112 Internal Cash Generation Before Royalties 2,476 2,501 1,565 2,345 Capital Expenditure .. 6,774 5,336 4,767 Royalties 463 427 401 925 Debt Service 742 534 277 436 Net Cash Surplus/(Deficit) Before Financing e. (5,234) (4,449) (3,783) Financing (Except S/T Financing) .. 5,034 4,352 3,180 Net Cash Surplus/(Deficit) .. (200) (97) (603) Ratios Operating Income Z of Revenues 13.1 10.9 2.7 12.7 Net Income After Royalties as Z of Revenue 11.5 7.4 (neg.) 1.1 Current Ratio 1.5 1.1 1.1 0.9 Long-Term Debt/Equity Ratio 20:80 37:63 48:52 50:50 Debt Service Coverage Ratio 3.0 3.9 2.1 3.1 Source: SNIM. In 1984, SNIM managed to put an end to declining sales, revenue and income. Sales revenues were 34% higher than the 1983 level, achieved by increased sales, despite lower average iron ore prices. The production cost reduction in 1984, mentioned above (para. 3.12), resulted in a marked improvement in operating income from 2.7% of total revenue in 1983 to 12.7% in 1984. The internally generated cash position also Improved in 1984, but SNIK faced heavy outlays: (i) SNIM invested a significant amount and mre than it drew down colenders' loans; (ii) the royalty paid by SNIM to the Government, which was 6% of total sales during the Guelbs project implementation, returned to 10% upon the completion of the Guelbs project and amounted in 1984 to about 40% of self-generated cash. As a result, SNIM incurred additional short-term debt, and total current liabilities, relative to total sales, increased from 14% in 1983 to 19% in 1984. The current ratio, still above 1.0 in 1982 and 1983, dropped to 0.9 in 1984, implying that SNIM is in default of the financial covenant of the Guelbs loan, stipulating a current ratio of at least 1.3.  -11- 3.15 Whereas SNIM dfd not pay dividends in the period 1981-1984, its direct contribution to the Government revenues in the form of royalty payments amounted to UH 2.2 billion (US$39.6 million), and, in the same period, SNID paid approximately UM 11.8 billion (US$216.5 million) in wages. D. SNDM's Medium- and Long-Term Outlook 3.16 Starting 1985, SNIM will over the medium-term operate its traditional Kedia operations and the new Guelbs plant in parallel. Ore sales are expected to amount to 9-10 million tpy, of which the Guelbs plant, after the initial start-up period, would produce up to 6 million tpy, the remainder of 3 to 4 million tpy being produced as high grade and siliceous ore by the Kedia mines. Due to the low grade and the resulting high mining volume and beneficiation costs, the Guelbs project leads to higher production costs as shown below. Kedia and Guelbs Ore Cash Operating Costs Kedia Guelbs Physical Data Grade of ore (C Fe) 62.0 a/ 38.0 Waste removal (t of waste per t of raw ore) 1.0 0.7 Raw ore mined (t of ore per t of product) 1.0 2.3 Cost Data (1984 US$/t of product) Mining 1.8 2.6 Crushing and Handling 1.4 ) Beneficiation - )4.8 Total b/ 3.2 7.4 a/ High grade ore only. b/ Cash operating costs only, excluding overheads. Sources: SNIM and Bank staff estimates. The difference in operating costs between Guelbs and Kedia of US$4.2/t means an increase of SNIM's overall cash production cost (including depreciation) from US$12.6/t to about US$15.0/t, or by 20Z, once the Guelbs plant is in full operation and then accounting for about 60% of SNIM's production. In addition, SNIM will, during this period, have to serve the Guelbs debt with about US$3.5/t initially, and US$1.5/t in 1995. 3.17 After depletion of the Kedia mines, estimated to occur around 1995, and given the economic ore reserves (para. 2.07), the implementation of the second phase of the Guelbe project does not seem a viable option at present. SNIH's production and sales volume would then decrease.  -12- Dependiag on the amount of siliceous ore SNIM could produce and sell at that time from Guelbs, the drop in production may be in the order of 20%, so that the long-term production rate may be about 7-8 million tpy. The combined effect of lack of low cost ore from Kedia and lower production would be an increase in production cost in the order of 30%. Possibly about half of this increase could oe compensated by further drastic adjustment of production and overhead cost beyond the cost cutting measures of the proposed Project. Considering that presently SNIM's unit cash production cost are still well below the iron ore price and most of the Guelbs debt will have been repaid after the depletion of Kedia, a financially viable operation appears still possible at that time. IV. THE IRON ORE MARXET 4.01 The international iron ore market is the major external determinant for SNIM's financial viability and for the value of SNIM to the Mauritanian economy. The uncertainty of this market is a major source of financial risk for SNIM and the proposed Project. This chapter summarizes recent market developments and presents the Bank's price projections, as well as an assessment of SNIM's market position. A more detailed discussion of the iron ore market is presented in Annex 4-1. A. Demand and Supply of Iron Ore4/ 4.02 An estimated 98% of iron ore is used in the steel industry. Consequently, the demand for iron ore is directly derived from the steel market. 4.03 Demand for Crude Steel. The character of the international steel market has changed markedly in the past two decades. During the 1960s, world steel consumption grew strongly at an average rate of 5.5% per year. In the 1970s, the annual average steel growth rate declined to 1.9%. From 1980 to 1983, the world steel market experienced the severest reversal in decades, with consumption declining from 712 million tonnes in 1980 to 668 million tonnes in 1983. Steel consumption in industrialized countries is expected to show only minor growth in the next decade or so. However, for developing countries, especially the larger LDCs, substantial growth in steel consumption is expected in the next decade because these countries are developing their basic industries and infrastructure, as well as housing and capital stock. Estimates indicate that world steel production and consumption would increase from about 710 million tonnes in 1980 to somewhere in the range of 760 to 880 million tonnes by 1995. For industrialized and developing countries, production and consumption would increase from about 510 million tonnes in 1980 to 540-640 million tonnes by 1995. The remainder of the increase, about 30 million tonnes, would be accounted for by centrally planned economies. 4/ This section is based on a recent IND paper: "Iron Ore: Global Industry Prospects 1985-95."  -13- 4.04 Demand for Iron Ore. The liternarional Iron ore market has contracted severely in the face of the atee m.arvet collapse. Steel companies have traditionally viewed security of supply and stable prices of their raw materials as a critical requirement for their long-term viability and therefore own mines or have long-term ore purchase arrangements. Recently, Japanese and European mills have developed major interests in Brazilian iron ore operations. In addition, the mines produce different products, namely, lumpy ore, sicterfeed and pellets. Long-term sales arrangements reflect a matching of the ;,eel mills' requirements with particular grades and types of ore available at specific mines. 4.05 For the future, growth in iron ore requirements will come from steel mills in developing countries. Whereso in induatrialized countries iron ore requirements of steel producers are c.cpected to remain below the level of the early 1980s, in developing countries they are projected to increase from about 180 million tonnes average in 1980-83 to 250 to 290 million tonnes in 1995. 4.06 Supply of Iron Ore. World production of iron ore peaked at 903 million tonnes in 1975 and fluctuated between about 850 and 900 million tonnes from 1976 to 1981. In 1982 and 1983, production collapsed to 777 and 746 million tonnes, respectively, in tbe face of large inventory overhangs and sharp cutbacks in offtake by steel mills of a previously unprecedented nature. Major producing regions are the US (Mlnnesota), Canada (Quebec-Labrador), Australia (Northwest), Brazil and West Africa (Mauritania-Liberia) who account for about two thirds of market economies' production. Cutbacks have been most severe In industrialized countries where 1983 production was at 190 million tonnes compared to 337 million tonnes in 1975. However, developing countries' producers have also faced cutbacks from 324 million tonn6s in 1975 to Z .illion tonnes in 1983. 4.07 There is presently substantial excess world iron ore production capacity. Current market economy production capacity is estimated at 556 million tpy compared with a production of about 41' r.'2.lion tpy in 1983. From 1985 to 1990, production capacity is expecte. co increase by about 15 million tpy, allowing for capacity additions from new projects in Brazil, India and Iran, while mines may be closed in the US, France and Liberia. Thereafter, from 1990 to 1995 closures of about 20 million tpy capacity are expected as mines are del .eted In Australia, the US, Canada and Liberia. 4.08 Seaborne Iron Ore Market. Internativ-:al trade in iron ore reached a peak of about 400 million tonnes iln 979 and declined to about 300 million tonnes in 1983. The major international seaborne trade in Iron ore is from Brazil and Australia to Japan and Europe. Smaller but significant exporters include India (about 25 million tpy) and South Africa, Liberia, Canada, Sweden and Venezuela (about 10-20 million tpy each). Future market projections indicate poor growth for seaborne iron  -14- ore trade with total requirements expected to increase from about 295 million tonnes in 1985 to 300 to 390 million tonnes in 1995. For industrialized countries, growth in requirements will 'Se minimal. For developing countries, iron ore requirements are expected to increase from 37 million tonnes in 1985 to between 55 and 85 million tonnes in 1995. The Republic of Korea accounts for 28% of the incremental requirements, and China for 17%. B. Iron Ore Prices 4.09 There are two distinct price structures in the world. North Aiaerica comprises one pricing area, while the rest of the market economies forms the other. North American mines are largely captive to steel mills, and prices are generally determined by production costs. They are higher than the prices elsewhere, which are determined by market forces. Most ores are priced in US dollars and on an FOB basis. 4.10 International iron ore prices from 1960-84 and forecast for 1985-95, as exemplified by Brazilian sinterfeed prices cif Europe, are shown in the graph on the following page, both, in US dollars from 1960-1984, and in DM from 1975-1984. In constant US dollar terms, iron ore prices declined steadily by 62% between 1960 and 1978, but remained relatively unchanged between 1978 and 1983. However, due to the strengthening of the US dollar as from 1981, the iron ore price increased in terms of currencies not tied to the US dollar. As an example, the price of iron ore in real DM terms increased by 18% in the period 1980 to 1984. Iron ore producers benefited from these market conditions to the extent that their costs are incurred in currencies not tied to the dollar. Brazil, Australia and other major producers clearly benefited on this account due to a high local content in their cost of production. In Mauritania, however, the local currency was, until early 1984, essentially tied to the US dollar; since February 1985, the Government has followed a flexible exchange rate policy. 4.11 Total production costs and returns on equity for existing efficient mining operations are important yardsticks for future price levels as iron ore sales prices generally will allow reasonable returns to efficient producers over the longer term. Australian and Brazilian ore exports have played an increasingly important role in the European and world markets, and are expected to remain the dominant and price determining forces in the world iron ore market. Apart from having benefited from the above-mentioned iron ore price increases in real local currency terms, their infrastructure is well developed, and existing iron ore operations are profitable. This, together with the continuing excess supply situation, implies that iron ore prices in real terms are unlikely to increase over the medium- to long-term. 4.12 The Bank's iron ore price projections are shown below. With slight fluctuations during the period, the price of iion ore in real terms is projected to decrease by 8% in the period 1985-1995.  -15- Projected Iron Ore Prices a/,1985-1995 1985 1986 1987 1988 1989 1990 1995 Constant 1983 US$/t 24.2 24.0 23.5 23.0 22.5 22.0 22.1 Annual Percentage Change 2.5 (0.8) (2.1) (2.2) (2.2) (2.2) 0.1 a! Brazilian, 65%, CIF North Sea ports. IRON ORE PRICES 1960-1995 CNsTrAmT AND cuRt Iwr US* IW- mrmc TNm 03 A0 20- to 1903 196 1970 1th7 t9D 19g s9g0 1956 - CURFT US, 4. CONSrANT US# IRON ORE PRICES 1975-1984 CONSTANAWr t US L AND OM PR MICT iON 70- _ . La 0 0 40 40 .-I 20 19Th 1977 1979 198t 1983 CONSrANT US$ 4 CONDIa DM  -16- C. SNIM's Market Position 4.13 SNIM's major markets in 1984 were Italy (accounting for 31% of the Company's sales), France (23Z), Belgium (23%), the United Kingdom (11%) and Germany (&6). SNIM exports are concentrated (77% of total sales), in three countries - Italy, France and Belgium - where its market share reaches around 15%; SNIM has only little (1%) market penetration in Germany, which is the major European market for imported iron ore (40% of the imports of rhe five previously mentioned countries). SNIM's recent export performance has been acceptable. Even at a time when European iron ore markets were particularly depressed, SNIM has consistently captured about 7% of the European seaborne iron ore market, gaining in Italy and Belgium what it lost in Germany and the UK (it increased significantly its share of Italy's and Belgium's markets in 1984 with sales of siliceous ore). Furthermure, SNIM also opened new markets for its ore in developing countries by starting exports to Tunisia, Turkey and Yugoslavia. The quantities involved, however, are small. 4.14 It does not appear easy for SNIM to improve its market position since: (i) its ore (including the Guelbs ore, a new product on which it will soon have to rely for the bulk of its sales and for which it has yet to secure market outlets) contains comparatively high levels of silica, which some modern steel mills regard as a penalty, although the ore could suitably be used for blending with low silica ore, which would be increasingly available after start-up of the Brazilian Carajas project; (ii) Germany is likely to fulfill its import requirements from Bong (Liberia) and Ferteco (Brazil) where it has equity interests, as well as from Canadian companies, and Compania do Vale de Rio Doce (CVRD) (Brazil), with high quality low silica, natural ore, in an increasing amount from the new Carajas project; and (iii) supp2ies to developing countries around the Mediterranean (Tunisia, Turkey and Yugoslavia) are expected to remain low, due to slow economic growth and efforts to use local raw materials. For supplics to the faster growing Asian developing countries, SNIM's geographical position is unfavorable. Therefore, it appears unlikely that SNIM could, over the long-term, significantly increase its sales above the 9-10 million tonnes level reached in 1984. 4.15 On the other hand, and as discussed above, SNIM's share of the total European market is relatively small at 7%, and its Guelbs sales are basically to replace some of its existing Kedia sales. Also, European steel mills may wish to retain supply capabilities in West Africa to avoid concentrating their supply sources in Brazil and Australia. To the extent  -17- that reserves are being depleted in Liberia and that prospects are not favorable for any new iron ore projects in Africa adding substantial new capacity in the near/medium-ters, SNIM should be able to maintain its sales level in the European iron ore market. SNIM's good recent marketing performance also supports this assumption. V. THE REHABILITATION PROJECT A. Background and Bank's Role 5.01 Since 1981, Bank staff have during supervision of the Guelbs Project projected a serious future cash deficit of the Company, if no remedial action would be taken. The cash deficit would be caused mainly by low iron ore prices and increased production cost and debt service payments due to the Guelbs Project. At SNIM's initiative, meetings with the Guelbs colenders were held to explore possibilities for financial assistance. After SNID declared its intention to start a full rehabilitation program, Arab colenders agreed to making available unused portions of their Guelbs loans and reschedule loan repayments. The CCCE uade a new loan available for technical assistance for the Guelbs start-up. The Bank considered a new loan, provided SNIM made progress in implementation and further definition of its rehabilitation program. 5.02 In 1984, SNIM's management embarked on a rehabilitation program affecting most of the Company in the areas of technical and financial management, organizational structure, and personnel policy. Certain results have already been achieved, such as the organizational change, the slow-down in recruiting and some cost savings. The proposed Project will continue these efforts, consolidate the positive results already achieved and kurther integrate new technical and financial managerial practices. The Project includes the purchase of critical equipment, as well as training and technical assistance, necessary for the implementation of the rehabilitation program. 5.03 The Project fits well into the Bank's lending strategy for Mauritania and the West African region, aiming at creating economies which do not depend on continued external financial assistance. SNIM is a major asset of the Mauritanian economy with considerable positive macroeconomical impact and its technical and financial viability is crucial. The scope for improvements exists, and SNIM and the Government started taking actions. The Bank's support for these efforts helps focussing on priority actions and implementing them in a timely manner. The Bank's support is also welcomed by the colenders who recognize the benefit of the Bank's leadership in this connection. B. Project Objectives 5.04 SNIM's rehabilitation program, along with necessary expenditures for equipment replacements and measures to improve efficiency of operations, have the overall objective to secure in the medium-term  -18- financial viability of the Company and its contributions to the Mauritanian economy. Generally, adverse market conditions and SNIM's particularly difficult market position underscore the importance of SNIM's strong sustained efforts to remain a source of economic benefits to the Mauritanian economy in addition to staying a financially viable operation. 5.05 The Project consolidates and further advances the ongojug action program for managerial and technical improvements during the years 1986-1988 and in particular will: (i) help SNIM continue to improve its management and reduce its production costs; and (ii) assist with the necessary financial restructuring of SNIM by transforming part of its short-term debt/overdrafts into long-term debt. C. The Rehabilitation Program (1984-88) 5.06 The Program, of which the Project forms part, consists of a series of measures by SNIM a'med at improvements and cost reductions in the following areas: (i) manageiaent; (ii) operations; (iii) procurement and investments; (iv) personnel; (v) overhead cost; and (vi) cash management. In almost all of these areas, SNIM has started to implement improvements since 1984. As part of the proposed Project, further actions are planned from January 1986 to mid-1988. Major actions in each of the above areas are described below. A detailed list of the actions already completed and the actions planned is presented on the following two pages. 1. Management and Organization Improvements 5.07 The management and organization improvements concern the organizational structure, planning and information/control systems. 5.08 Organizational Structure: SNIM has started to simplify and improve the Company's structure and better define responsibility, authority and accountability of managers. To this end, SNIM also completed a study by a management consultant/mining firm (CEGOS/METCREM). The study was financed by the Kuwait Fund as part of the Project. Terms of reference were reviewed by the Bank. The study concluded that SNIM's new overall organizational structure is adequate. A few minor measures for additional cost savings were indicated which SNIM will implement as part of the rehabilitation program. 5.09 Planning: In view of the expected depletion of the Kedia reserves over the next 10 years and the consequent extra need for careful financial planning, SNIM has introduced 10-year financial projections and started to work on a detailed 5-year production/investment plan. The 10-year financial projections are being reviewed and updated annually. The first 5-year production/investment plan is expected to be completed by the end of 1985. Assurances were obtained during negotiations that this plan be reviewed annually and a copy submitted to the Bank for approval (para. 7.10).  -19- mamrnmP m o . ~~~EbShb ilatma ~~~~~~.^-. ... mar11 U. 135 ........... .r n (a) Umaraa.lagtima at Iampmafa Simmammam - kmwmma ta . - ma dm a 3t53 r t_ai. - _tamIh1111a. ,amlbri* am (S)mmgmat =..lamuaa l.ma_I_i - Samlmm mat_ _Pm 13 mabamami - *ma1a .t Ul1md _3 - Umw .