Peru - Industrial Energy Conservation and Rationalization Project

Document of The World Bank FOR OFFIC!AL USE ONLY Repot No. P-3955-PE REPORT AND RECOMMENDATIONS OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO EXECUTIVE DIRECTORS ON A PROPOSED LOAN OF US$4.0 MILLION EQUIVALENT TO PETROLEOS DEL PERU - PETROPERU S.A. WITH THE GUARANTEE OF THE REPUBLIC OF PERU FOR AN INDUSTRIAL ENERGY CONSERVATION AND RATIONALIZATION PROJECT APRIL 18, 1985 This docunet hbas a restixcted distribution and ay be ued by recipiets only in the performance of their official dutis Its contets -y not otherwise be disclosed widtnt World Bank authoriztion.I  Currency Unit - Sol (S/.) CURRENCY EQUIVALENTS The exchange rate is being adjusted daily roughly in line with the differential between domestic and international inflation. The exchange rate and currency equivalents as of April 3, 1985 were as follows: US$1 = SI. 7,321 SI. 1 = US$0.000136 Si. 1,000 = US$0.14 FISCAL YEAR January 1 - December 31 ABBREVIATIONS COFIDE - State Development Finance Corporation CENERCIA - Center for Energy Conservation CONADE - National Development Corporation IDB - Inter-American Development Batik ITINTEC - Institute for Industrial Technological Research and Standards MEM - Ministry of Energy and Mines NEC - National Energy Council PETROPERU - Petroleos del Peru kgoe - Kilogram of Oil Equivalent tcf - Trillion Cubic Feet toe - Tons of Cil Equivalent tpy - Tons per year USAID - United States Agency for International Develnnment  FOR OFFICIAL USE ONLY PERU INDUSTRIAL ENERGY CONSERVATION AND RATIONALIZATION PROJECT LOAN AND PROJECT SUMMARY Borrower : Petroleos del Peru (PETROPERU). In accordance with Peruvian law, the Corporacion Financiera de Desarrollo (COFIDE) would act as PETROPERU's financial agent. Guarantor : Republic of Peru. Amount : US$4.0 million equivalent Terms : Repayable in 17 years, including four years of grace, at the standard variable interest rate. Beneficiary : Center for Energy Conservation (CENERGIA). Use of Loan Funds : PETROPERU will use the proceeds of the loan exclusively for financing goods and services required for the Project. PETROPERD will repay the loan and bear the foreign exchange risk. Project Description : The Project would establish a Center for Energy Conservation to assist the industrial sector in Peru in reducing energy costs through conserva- tion and rationalization, including the carrying out of energy audits, development of energy conservation and rationalization legislation, carrying out an incentives study for energy savings, preparation of manuals and handbooks on energy saving measures in energy-intensive sub- sectors and training. The implementation of the Project would be carried out with the assistance - of the Energy Conservation Department (ECD) that * will be created by PETROPERU exclusively for purposes of the Project. The relationship between PETROPERU and the Center will be detailed in a Management Contract to be approved by the Bank. The Project would result in the identification of energy conservation measures and investments that, at today's oil prices, could eventually produce estimated net annual savings of about US$44 million excluding the benefits from inter-fuel substitution. This document has a rsicted distribution and may be used by rcipients only in the performnce of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Risks * The principal risks facing the Project relate to the quality of personnel and the managerial and institutional problems common to new undertakings; and the willingness of industrial companies to have energy audits performed, and to pay for them. The first risk is being minimized through the management contract with PETROPERU, which will provide management and other services to the Center. The second risk would be minimized by the Center's promotional and cost recovery efforts. The Project poses no environmental risks.  - iii - Estimated Projected Cost (US$000) Foreign Local Total I. Consultants and Technical Adviser 1,980 - 1,980 II. Travel Seminars and Overseas Ir ning 257 75 332 III. Salaries and Overheada/ - 1,091 1,091 IV. Maintenance, Office and Ot9her 15 210 225 V. Equipment and Instrumentation 1,027 100 1,127 Total Base Cost Estimate b/ 3,279 1,476 4,755 Physical Contingency (52) 149 89 238 Price Contingency(18.82) 572 367 939 Installed Cost 4,000 1,932 5,932 Working Capital - 140 140 Total Cost 4,000 2,072 6,072 Financing Plan Proceeds from Audit and Training Fees - 412 412 IBRD 4,000 - 4,000 PETROPERU -1600 1.660 4,000 2,072 6,072 a/ This includes salaries and overhead of PETROPERU staff assigned to the Energy Conservation Department but excludes salaries and overhead of staff seconded from ELECTROPERU and other local companies. Salaries and overhead costs of ELECTROPERU and other companies are estimated at about US$1,185,000 equivalent. b/ March 1985 prices. Disbursement Estimates (IBRD FY) (million US$) * 1986 1987 1988 1989 1990 Annual 0.5 1.2 1.2 0.8 0.3 Cumulative 0.5 1.7 2.9 3.7 4.0 Rate of Return: Not applicable Staff Appraisal Report: None  DNTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO PETROLEOS DEL PERU WITH THE GUARANTEE OF THE REPUBLIC OF PERU FOR AN INDUSTRIAL ENERGY CONSERVATION AND RATIONALIZATION PROJECT 1. I submit the following report and recommendation on a proposed loan to Petroleos del Peru 'PETROPERU) with the guarantee of the Republic of Peru for the equivalent of US$4.0 million to help finance an industrial energy conservation and rationalization project. The proposed loan would have a term of 17 years, including four years of grace, at the standard variable interest rate. PART I - THE ECONiOMY ?. A Peru Country Economic Memorandum (Report No. 5267) was distributed to the Executive Directors on November 6, 1984. The following is based on the findings of that report and the findings of an economic mission to Peru in November 1984. Country data sheets are attached as Annex I. Natural and Human Resources 3. Peru, the fourth largest country in Latin America, is divided by the Andes mountains into three distinct regions: the coastal region with 46 percent of the population and most of the country's modern economic activity; the mountain region with 44 percent of the country's population; and the sparsely populated tropical rain forests east of the Andes. 4. Peru's natural resources include large deposits of minerals--par- ticularly copper, iron, silver, and zinc--located mainly in the mountains and the southern coast. There are also large phosphate deposits and substantial petroleum resources in the rain forest and off-shore, but their full extent has not yet been ascertained. Another major natural resource is the large fishing potential in coastal waters, although the catch is subject to sharp fluctuations. Only a small portion of Peru's total land area is arable, and most of the soils suitable for intensive agriculture are already being farmed. Peru's energy resources are discussed further in part III, The Energy Sector. 5. After accelerating during 1930-1960, birth rates have fallen gradually, mainly caused by the urbanization process and improved education. But with declining death rates, population has continued to grow at about 2.5 percent p.a. between 1972 and 1981 to 17 million. Preliminary 1981 census information indicates that fertility declined by 20 percent during the past decade and the current rate of population growth  has dropped to 2.2 percent p.a. The census also indicates that the reduction in population growth is most marked among the 65 percent of the population living in the urban areas. The Government is quite population-conscious and is now supporting a family planning program. rast Development Policies and Performance (1968-78) 6. Two successive military Governments, in office from October 1968 until July 1980, aimed at promoting economic growth and improving the distribution of income and wealth. They nationalized many production and distribution activities, and conducted a sweeping land reform. However, many of their policies had an excessive cost, and implementation was often inefficient. In particular, expansionary fiscal and credit policies between 1968 and 1977 produced strong inflationary pressures and expanded external borrowing, raising Peru's external debt to almost US$8.4 billion (including short-term indebtedness); about two-third's of GDP. By mid-1978, the country was in the midst of a severe financial crisis; inflation had accelerated to an annual rate of about 100 percent and the banking system's net international reserves dropped to a negative level of US$1 billion. Peru was no longer able to service its foreign obligations. 7. Beginning in May 1978, the Government adopted a number of important measures aimed at strengthening public finances, improving the balance of payments and curbing inflation. It negotiated a stand-by-arrangement with the IMF and carried out major debt-relief operations, postponing repayment of about US$1 billion due in 1979/80 to the 1982-1986 period. The Government also adopted a complementary Economic Recovery Program, including measures to open up the economy, supported by a Us$115 million Bank Program Loan in May 1979. 8. The Government's program resulted in reducing the overall public sector deficit from 5.7 percent of GDP in 1978 to 1.7 percent in 1979, and the more careful management of public finances had a positive impact on the balance of payments. At the same time, an increase in petroleum exports and a substantial improvement in Peru's terms of trade generated a surplus in the current account of the balance of payments in 1979 and equilibrium in 1980, as well as strengthening Peru's net reserves position. GDP growth recovered, but the public sector deficit increased again to six percent of GDP in 1980, and inflation exceeded 60 percent. 9. After a new constitution was written by a popularly elected constituent assembly, elections were held in May 1980, and the winner, President Fernando Belaunde, was inauguirated on July 28, 1980. His Government confronted severe structural weaknesses only temporarily obscured by the improvements in the terms of trade and the resumption of growth. The Government initiallv accelerated import liberalization and streamlined export incentives. At the same time, new legislation offered greater incentives to investors. Substantial changes were made in the financial sector, through upward adjustments of the interest rate, and the reduction of legal reserve requirements. The Government also made progress  in correcting major price distortions by reducing food subsidies, eliminating some price controls and periodically adjusting public utility and petroleum product prices. Finally, the Government endeavored to strengthen public managemenm. and rationaLize public investment and its financing, an effort that was supported by a Bank-sponsored Consultative Group meeting in May 1981. Recent Developments and Outlook 10. The 1981-83 world recession radically changed Peru's economic a situation. In 1981, the first full year of the new Government, the world demand for Peru's main exports declined, interest rates on the country's external debt increased, and the terms of trade fell by 10 percent as a result of lower export prices. The overall negative impact of these external events on Peru's balance of payments was estimated at USS740 million. A substantial recovery of agricultural output (with a growth rate of almost 12 percent) and an even faster growth of construction (mostly public) allowed GDP growth of near four percent. However, industrial output stagnated, mini.g fell by four percent, the public sector deficit increased to about eight percent of GDP and the current account of the balance of payments closed with a deficit of US$1.7 billion. 11. By 1982, economic activity was slowing down, world commodity prices continued to fall, and the public sector deficit had also increased. The Government then adopted an austerity program and in June 1982, the IMF approved an SDR 850 million compensatory-cum-EFF arrangement to support Peru's stabilization efforts. The current account deficit in the balance of payments was reduced slightly (to US$1.6 billion) in 1982, despite lower export prices, but GDP growth slowed to less than one percent, industrial output fell more than two percent, the public sector deficit rose to 8.8 percent of GDP, and inflation continued at more than 70 percent. 12. The still sizeable public sector and current account deficits, combined with the reduced availability of external loans from international commercial banks, encouraged the Government to try to accelerate the adjustment process in 1983. The new measures included a large cut in public investment, acceleration of price adjustments of publicly supplied goods and services, and faster reduction of food subsidies. Also, the Government followed a restrictive monetary policy, and mini-devaluations from January to August 1983 again exceeded domestic inflation, as they had during 1982. 13. Peru's economic difficulties, however, were compounded by natural disasters suffered during the first half of 1983. Heavy rains flooded the northern part of the country; there was also a severe drought in the south, massive landslides in the central area, and a reduction in the fish catch. Most of these were linked to a change in El Nino, a current in the Pacific Ocean off the Peruvian coast. These disasters were costly; replacing the damaged infrastructure could require over US$500 million. Output losses  - 4 - were also substantial. Agricultural production was particularly hard hit in the north of Peru where cotton crops were destroyed. Flooding of the Talara oil fields and damage to the trans-Andean pipeline caused a 12 percent drop in oil production (to an average of 172,000 bpd), and a ten percent fall in petroleum exports. 14. In addition to the natural disasters, the private sector suffered from a severe credit squeeze when the Central Bank protected Peru's foreign exchange reserves as foreign interest payments rose and previous inflows of short-term capital reversed. The squeeze in the private sector was intensified by the dominant claim of the public sector on available credit. Despite the credit squeeze, inflation accelerated to 125 percent, in part a result of the natural disasters, but also of inflationary expectations fueled by the mini-devaluations. The 10.9 percent GDP decline was dominated by output drops in manufacturing, services and agriculture, although output in some smaller sectors, such as fishing and construction, fell more sharply. The current account deficit in the balance of payments was reduced to about US$900 million as imports declined with output. The financing of even this reduced deficit required a renegotiation of commercial bank debt (in March 1983) and of debt to member countries of the Paris Club (in July 1983). The rescheduling agreement with the commercial banks allowed for the phased release of US$450 million in "new money", subject to the Government's receiving continuing IMF support under the EFF agreement. Unfortunately, public sector revenues declined substantially during the recession, and the public sector deficit, at nearly 11 percent of GDP, substantially exceeded the Government's target under the EFF. 15. By the end of 1983, it was clear to the Government that it could not meet the terms of the EFF arrangement; it therefore negotiated with the IMF an 18-month Standby to replace the final period of the EFF. The Standby was approved in April, 1984. As part of its new program, the Government increased interest payments on bank deposits, raised electricity and water rates in real terms and confirmed its tight money program. On the strength of the Standby, Peru's commercial creditor banks agreed to a rescheduling of US$1.5 billion in amortization payments due to them between January 1984 and July 1985, and released US$100 million in new money. Bilateral lenders agreed under the Paris Club in June 1984 to reschedule over US$800 million of 1984/85 principal and interest payments. No drawings have been made against the Standby since June, 1984, since the Government found itself unable to meet the program targets. 16. In 1984, the economy experienced a modest recovery, with GDP increasing by about 4 percent as fishing rebounded strongly, agriculture began a slow recovery, and moderate growth resumed in most other sectors except Government services and manufacturing. The recovery in manufacturing was weak because real domestic demand remained depressed, reflecting continuing tight credit conditions. Since exports rose slightly, while imports again fell in response to continuing slack in domestic demand and rising protection, the current account balance of  payments deficit contracted to about US$770 million. Continuing substantial public medium- and long-term loan disbursements and diminished short-term capital outflows were the main factors contributing to a net capital inflow more than adequate to cover the current account deficit. However, the current account deficit had been substantially reduced by Government non-payment of interest due to commercial banks making the increase of US$75 million in Peru's reserves illusory. The inflation rate slowed perceptibly in the latter part of 1984, reflecting both tight money and renewed output growth. Inflation for the year dropped to about 112 percent, compared with 125 percent the previous year. In the last half of the year, the sol was devalued faster than domestic inflation, considerably improving Peru's international competitive position. With an improvement in public sector revenues and a drop in expenditures, the public sector deficit declined to a little over 8 percent of CDP. 17. At end-1984, arrears on Peru's external debt service payments were US$371 million, of which US$294 million represented delayed interest payments. The Government has since paid US$50 million of the interest outstanding and none of the obligations has been classified as value impaired.- The Government nonetheless confronts a very serious problem in servicing outstanding debt, estimated at US$13.3 billion at end-1984 (corresponding to 74.8% of GDP), of which public medium- and long-term debt was US$12.1 billion. The bulk of this will mature over the next four years and service paymert liabilities are in consequence projected to peak around 1987, when debt service requirements could be as much as twice actual 1984 levels. This profile poses major problems for the Government, unable to meet the current level of debt service and confronting an economy likely to remain weak for several years. Further commercial debt rescheduling will likely be required. 18. The Central Bank continues to exert strict control over credit and the Government's 1985 Budget aims at reducing the public sector deficit to 7.1 percent of GDP. The Government has recently initiated discussions with the IMF concerning a new EFF agreement that could potentially pave the way for an accelerated economic recovery, a resumption of commercial bank lending, and a higher level of Bank and other bilateral and multilateral lender disbursements. The Government is also exploring the basis for a multi-year debt rescheduling agreement with the commercial banks, which hold more than half of Peru's debt. Concrete agreements are unlikely to be reached until after the impending change of Government, following elections scheduled in April 1985. With such agreements, reinforced by a Government commitment to structural reforms required to raise the economic growth rate, Peru could remain creditworthy for Bank lending. Pending the resolution of present uncertainties, Bank lending will continue only at a substantially reduced rate. PART II - BANK GROUP OPERATIONS IN PERU 19. The Bank has approved 58 loans to Peru for a total amount of US$1,667.9 million, net of cancellations. About 22 percent of the Bank's  - 6 - lending to Peru has been for transportation (mainly highways and ports), 25 percent for egriculture, 19 percent for the energy sector, 1l percent for mining and industry, about 15 percent for education, health and urban development, 7 percent for a program loan in support of the Economic Recovery Program 4.a 1979, and 1 percent for a technical assistance operation. 20. Annex II contains summary statement of Bank loans and their disbursements status as of March 31, 1985. As of this date, US$746.9 million was undisbursed. Disbursements on Bank-financed projects moved slowly in the late 1970s, primarily because of weak project execution capacity and a shortage of counterpart funds that worsened as the economy deteriorated during this period. Disbursements improved until FY83, however, with vigorous efforts by the Bank and Government to correct the situation by: inter alia, (i) opening a Bank resident mission in Peru; (ii) restructuring a number of slow moving projects; (iti) Government provision of adequate counterpart funds; and (iv) Government creation of a special commission to monitor loan execution and resolve administrative problems. Disbursement rates (the rate of disbursements to undisbursed funds) in FY80-82 averaged 33 percent, well above comparable countries and above pre-1980 rates for Peru. Although actual disbursements continued to rise in FY83 (US$86.9 million) and FY84 (US$104.2 million), the rate decreased to around 20 percent because the large number of loans approved in 1982-83 increased the undisbursed balance and as a result of limited counterpart availability. To some extent, the counterpart problem has been ameliorated by the Special Action Program which the Bank initiated in Peru in 1983. The Program increased the percentage of costs which the Bank would finance in seven projects and established revolving funds in five projects. 21. The main objectives of Bank lending to Peru have been to assist in: (i) the expansion of productive capacity in crucial sectors, i.e., petroleum, agriculture and mining; (ii) the strengthening, through technical assistance loans and regular operations, of public sector management, including more effective economic policies; (iii) the creation of the physical infrastructure needed to sustain and foster economic development; and (iv) the improvement of living conditions for the urban and rural poor. In the years prior to 1980, Bank lending concentrated on infrastructure in the transportation and power sectors. More recently, the Bank's emphasis has shifted to more directly productive fields--petroleum, agriculture, mining, and industry--to help Peru to strengthen its balance of payments and to lending for socially nriented projects in the areas of health, education and urban development. The recently reduced program will focus on priority social projects or technical assistance projects that will provide a foundation for the resumption, if and when circumstances warrant, of a normal lending program. 22. Earlier this fiscal year, the Bank approved a US$27 million primary education project for Peru. There are two other loans in an advanced state of preparation. Both are aimed at providing technical  assistance. The first would aid the electric power sector by providing assistance to the new regional power companies that have been created by the Government to improve the efficie:.cy of the sector through decentralization. The second would continue and expand the work begun under the first Public Sector Management Project (Loan 2204-PE) which was approved in September 1982. Bank lending beyond these projects will depend very much on the economic program and development priorities that the new Government scheduled to take office in July 1985 adopts. Possible areas of lending could be in industry, petroleum development, water and electric power. Some project preparation work has been undertacen in all of these areas. 23. Bank loans constituted an estimated 6.0 percent of Peru's total public external debt outstanding and disbursed at the end of 1983, and absorbed about nine percent of the country's public external debt service in 1983 (taking into account the effects of rescheduling of 1983 principal and interest payments). 24. IFC commitments as of March 31, 1985, were US$42.6 million of which US$22.9 million is held by the Corporation. A summary statement of IFC investments as of September 30, 1984, is presented in Annex II. The other principal lending agencies active in Peru are the Inter-American Development Bank (IDB) and the United States Agency for International Development (USAID). Their total commitments as of December 31, 1984 were US$1.6 billion and US$438 million, respectively. In its future operations, IDB is expected to emphasize lending for agriculture, industry, mining, roads and small-scale irrigation. USAID is expected to stress rural, urban and private sector development. PART III - THE ENERGY SECTOR 25. Energy Resource Base and Balance. Peru has diverse and as yet largely untapped energy resources, consisting of hydroelectric power, oil, natural gas, coal, geothermal power, and renewable resources such as firewood and bagasse. Hydroelectric potential, of which less than 4 percent (2,000 MW) is presently exploited, is estimated at about 58,000 MW. Proven and probable oil reserves are estimated at about 1.4 billion barrels, natural gas at about 1.9 trillion cubic feet (TCF), and coal at about I biltion tons. Although hot water springs exist in many parts of the country, the Government is only now beginning to study these geothermal resources. Peru also has abundant forests covering almost 60 percent of its total land area. More than 95 percent of these forests, however, are located in the sparsely populated Selva region, with fuelwood scarce in most of the densely-populated areas. 26. Peru consumes annually about 11.3 million tons of oil equivalent (toe) of energy, resulting in a per capita consumption of about 690 kilograms of oil equivalent (kgoe), compared with a world average of  8 - 1,500 kgoe, and a Latin American average of 1,000 kgoe. Petroleum products accounted for the largest share of energy consumption (about 60%), followed by firewood (24%), electricity (6%), natural gas (5%), bagasse and other biomass (4.5%), and coal (0.5%). 27. Commercial energy consumption is about 8.3 million toe, accounting for 73 percent of total consumption; traditional sources accounted for the remaining 27 percent. The transport sector is the largest consumer of commercial energy (30%), followed by industry (22%), household (20%), and mining and metallurgical sectors (15%). Petroleum is the main energy source for industry, mining and transport sectors, accounting for 49 percent, 46 percent, and 100 percent, respectively, of consumption in those sectors. 28. During the last decade, the petroleum subsector in Peru has changed considerably. Successful commercial exploitation of its petroleum deposits transformed Peru from a net importer of petroleum to a net exporter by 1978. This was accompanied by an increased growth in domestic consumption of petroleum energy, partly due to a shift in consumption from non-petroleum to petroleum energy. Peru's petroleum production during 1985-88 is forecast to average about 9.8 million tons per year (tpy), beyond which it is expected to decline unless new wells are discovered. As a result, crude exports are likely to decrease sharply from the present level of about 2 million tons, further aggravating Peru's trade balance. As domestic consumption rises, Peru is likely to become a net petroleum importer by the late 1980s. In this context, energy conservation and inter-fuel substitution, especially in the industrial and mining sectors are of crucial importance for Peru. PETROPERU, the national petroleum company, therefore, is keen on energy conservation and rationalization as a means to maintain surplus petroleum for exports. Energy Sector Organization and Planning 29. The Ministry of Energy and Mines (MEM) is responsible for formulating energy policy and coordinating all energy planning activities in the country. It regulates the exploration and exploitation of all energy resources except forests, which is the responsibility of the Ministry of Agriculture. MEM also initiates energy pricing actions but these must be approved by the Minister of Finance and Economy. Operational responsibility of the sector is delegated to various public sector corporations which report to MEM. PETROPERU is responsible for the petroleum sub-sector; ELECTROPERU and associated electric utility companies for the electric power sub-sector. 30. The Government of Peru gives high priority to developing its energy sector. In 1981, it established a National Energy Council (NEC) to provide energy policy advice to the Minister of Energy and Mines; following approval of its statutes in June 1983, the Council was officially inaugurated in November 1983. The Council is comprised of a Directing Committee and a Secretariat. The Directing Committee consists of representatives from various public-sector companies in the energy sector.  - 9 - One of the tasks of the Council is to promote the creation of a Center for Energy Conservation (CENERGIA), along with appropriate energy conservation legislation. The Council's other tasks include preparing energy balances, recommending financial policies for hydrocarbon and electricity development, coordinating training programs for the energy sector, and carrying out energy planning for the country. Iuidustrial Energy Consumption 31. Peru has a fairly well-developed industrial sector which accounts for about 30 percent of its GDP. Total industrial energy constumption (including that of agro-industry and mining) is about 3.4 million toe, representing 30 percent of the country's total consumption (excluding wood). The main energy-intensive industries are mining, petroleum refining, chemicals, fertilizers, pulp and paper, brick-making, cement, glass, textiles, food processing, breweries, sugar, iron pelletizing, and steel. Most of these facilities were developed prior to the energy crisis of 1973, when petroleum energy was still relatively cheap and energy conservation equipment less economical. Industrial investors, keen on reducing capital costs to increase profitability, often ignored these energy conservation investments, and were content with plants which were less energy efficient than those built today. Rising petroleum energy prices, however, have made many of these energy conservation and inter-fuel substitution measures highly economical. 3i. Compared to some developing countries (e.g., South Korea), the energy conservation and rationalization efforts by Peru so far have been modest. Preliminary energy audits of some energy-intensive plants have been carried out with UNDP assistance. Further, under the Bank-financed Petroleum Refineries Engineering Project (Loan 2117-PE), energy saving and process optimization studies qre being implemented in two of PETROPERU's refineries: the La Pampilla refinery, near Lima, and the Talar _-. ery, 1,000 km northwest of Lima. These refineries account for 92 p* rcent of the refining capacity in Peru. The studies, now underway, will help develop a program for energy saving and operational efficiency improvement of the refinery sector. The project is proceeding satisfactorily, and is expected to result in identification, evaluation and implementation of energy conservation investments in the refinery sector. The proposed Industrial Energy Conservation and Rationalization Project will focus on energy conservation and rationalization potential in industries other than oil refining. 33. Based on preliminary survey results, it is estimated that a properly organized and implemented energy conservation and inter-fuel substitution program in Peru could yield petroleum energy savings of 565,000 to 755,000 toe per vear, as shown in the following table.  - 10 - Potential Petroleum Energy Savings from Conservation and Inter-fuel Substitution a/ (thousand toe) Manufacturing Conservation Industry Mining Total Average Short-term 95-135 10-30 105-165 135 Medium-term 65- 95 30-40 95-135 115 Sub-total 160-230 40-70 200-300 250 Inter-fuel Substitution 335-395 30-60 365-455 410 Total 495-625 70-130 565-755 660 == a/ Excluding savings achievable by implementing energy conservation measures in PETROPERU's petroleum refineries. 34. Of the total savings of 565,000 to 755,000 toe, 200,000-300,000 toe could be achieved through energy conservation and the remaining through inter-fuel substitution. About 54 percent of the potential savings from conservation could be achieved in the short-term with minimal investment; these savings could be achieved mainly by better housekeeping and some minor retrofitting which would be identified by the detailed energy audits proposed under the Project. Medium-term savings (those arising from major retrofits and process modifications) could range from 95,000 to 135,000 toe. At today's prices, annual savings from short- and medium-term energy conservation measures could amount to between US$35 million and US$52 million. The total investment (excluding taxes) required to achieve both the short-term and medium-term savings is estimated to be between US$56 million to US$88 million; the pay-back period for individual investments could range from 1 to 3 years. The economic viability of these energy conservation measures is discussed further in paras 63-64. 35. As shown in the table above (para 33), potential savings through inter-fuel substitution are also significant. In the manufacturing industries, 335,000-395,000 toe per year of fuel oil could be replaced by coal, hydroelectricity and biomass; in mining, an additional 30,000-60,000 toe per year of diesel and fuel oil could be replaced by coal, hydroelectricity and biomass, giving a total of 365,000 - 455,000 toe of hydrocarbon fuels which could be replaced by cheaper alternative energy sources in the industrial sector as a whole. Fuel oil and diesel thus saved could be exported. These annual savings from inter-fuel substitution could amount to between US$28 million and IJS$35 million. A total investment (excluding taxes) ranging from USS98 million to US$133 million would be required to achieve these savings. It is anticipated that the  - 11 - actual implementation of the investments will be carried out over a number of years, depending on the intersectoral priorities and availability of resources. These investments are likely to yield economic rates of return ranging from 20-30 percent. 36. The substitution of fuel oil would need to be based on imported coal because currently the domestic coal supply is very small and often not of high quality. If, in future, production of domestic coal could be increased and its quality improved, imported coal could gradually be replaced by cheaper domestic coal. 37. About 65 percent of the total potential energy saving from conservation and inter-fuel substitution lies in the public sector and the rest in the private sector. As noted, however, implementation of these investments is expected to stretch over a long period as many of the smaller plants would probably want to review the experience of other plants before investing in energy conservation and rationalization measures themselves. The proposed Project would provide the framework for identifying these energy conservation and rationalization investments, and evaluating their economic viability, with the aim of accelerating the pace of implementation of the most economic and promising measures. 38. Some of the large and sophisticated companies in Peru have already embarked on energy efficiency and rationalization programs of their own. For example, Cemento Lima, a joint sector company (51% private) and a major cement producer, has already implemented an energy conservation project. It plans to achieve further savings by switching from fuel oil to imported coal, and is investing in the necessary facilities, including the infrastructure and handling facilities at the port to import coal. These port facilities could also be used by other plants planning to switch from fuel oil to coal in the future. Energy Pricing 39. The most important measure to encourage energy efficiency is to set energy prices at levels that reflect their long-term economic opportunity costs. Peru has made significant progress in this direction. Currently, prices of all petroleum products, except kerosene, are either very close to or above the import parity price levels. As for kerosene, its prices are about 30 percent lower than the import parity price level. Any increase in kerosene prices, however, would result in an adverse social impact because a large proportion of kerosene is consumed by the low-income segment of the population; the existing prices result in subsidizing consumption of this segment. With the exception of domestic kerosene, the Government intends to maintain the prices of oil products near or above the import parity levels. Electricity tariffs in Peru are comparatively low, and do not provide a reasonable return on investment for power companies. As a result of the Bank's continuing dialogue with Peru, the Government increased electricity prices by about 40 percent in real terms between December 1983 and December 1984. The Government is considering further  - 12 - increases in power tariffs to enable power companies to achieve a reasonable return on investment as agreed under the Bank Loan 2179-PE. Need for a National Program for Energy Conservation and Rationalization 40. Even when energy prices are set at appropriate levels, as noted earlier, there is need for carrying out comprehensive special energy conservation measures since many consumers do not react adequatelY or promptly to energy price signals. This inertia is often due to energy conservation investments being complex, requiring intensive studies and, in many cases, requiring innovative devices. Also, these investments are not easily identifiable by non-specialists and they typically consist of a large number of discrete additions/modifications to the existing facilities. The experience of the industrialized countries suggests that in order to realize the potential for energy conservation in industry, there is a crucial need to undertake energy conservation campaigns and training to support a realistic energy pricing policy. The campaign should aim at creating an awareness in industry and the general public of the magnitude of the costs and benefits associated with the energy rationalization measures. In addition, there is need for technical assistance to carry out energy audits, especially in different industrial plants, and to identify and evaluate attractive opportunities for energy conservation and inter-fuel substitution. Following these audits, some financing should be available from existing uncommitted lines of credit with COFIDE and Banco Industrial for implementing the energy conservation and rationalization projects identified. 41. Peru is trying to develop an energy conservatlon and rationaliza- tion program on the above lines. As noted (para 30), to assist in the development of this program, it established the National Energy Council (NEC) in 1981. Since none of the existing organizations is equipped to implement such a program, one of the tasks of NFC is to help establish the Center for Energy Conservation to make necessary arrangements for the implementation of such a program. Rationale for Bank involvement 42. In 1982, as a part of the Petroleum Refinery Engineering Project (Loan No. 2117-PE), the Bank decided to finance studies for energy saving and efficiency improvement of PETROPERU's oil refineries and related industrial plants. The Project is being successfully implemented, and PETROPERU has already started benefitting from these energy saving measures. The proposed Project would extend similar benefits to other industrial units in Peru, thereby improving their profitability. The Bank has assisted in identifying key industries in public and private sectors which could benefit from a national energy conservation and rationalization program, in conceptualizing a framework under which such a program could be implemented, and in developing the scope of work and organizational structure of the proposed Center for Energy Conservation. By participating in the Project, the Bank could continue to assist the country in its energy conservation and rationalization efforts.  - 13 - 43. The Bank's role in the Project has proven helpful in attracting both private and public sector companies to participate in the energy conservation and rationalization program. Through possible participation in the financing of the projects that would emerge from the energy audits, the Bank could continue to play an important role in fulfilling the objectives of the program. PART IV - THE PROJECT Background 44. The project was identified by a Bank mission which visited Peru in February/March 1984, and appraised in November 1984. Negotiations were held in Washington from March 18 to March 25, 1985; the Peruvian delegation was led by Messrs. Luis Chang of CENERGIA, and Jorge Fernandez of PETROPERU and included representatives of COFIDE and the Ministry of Economy and Finance. A Loan and Project Summary is given at the heginning of this report, and a Supplementary Project Data Sheet appears as Annex *TI. Objectives and Project Description 45. The primary objective of the Project is to assist the industrial sector in Peru in reducing energy costs through conservation and rationalization, including the carrying out of energy audits, promotion, training, development of energy conservation legislation, and prepariug manuals and handbooks on energy-saving measures. For this purpose, a Center for Energy Conservation (CENERGIA) has been established as an autonomous entity with representatives from both public and private companies. The Center consists of a General Assembly, a Board of Directors and an Executive Secretariat which currently consists of a Director-General. While giving policy direction and guidance, and establishing priorities in undertaking audits, the Center will minimize overhead costs in carrying out its work, by signing a management contract with PETROPERU, the leading industrial enterprise in Peru with considerable experience in energy conservation (para 42). PETROPERU will also provide to the Center the necessary staff and resources, over and above those available from other sources (para 53). PETROPERU will be the Borrower under the Bank loan and use loan proceeds for purchasing goods and services exclusively for the Project. It will also be responsible for repayment of the Bank loan. PETROPERU has an interest in assuming this role since a successful energy conservation program will permit the expansion of petroleum exports, which--in addition to country economic benefits--would have financial benefits for PETROPERU. Further, given that PETROPERU has acquired significant expertise in supervising energy audits for its  - 14 - industrial plants under the Bank financed P'etroleum Refinery Engineering Project (Loan No. 2117-PE), and since that part of the project is neartng completion (para 42), PETROPERTI wotild have the abilitv and experience to assume implementation responsibilities for the Projert. Under the management contract, PETROPERLI will establish a new EnergyConservation Department (ECD) which will include staff assigned by PETROPERU, as well as staff seconded by other companies to the Center (para 53). ECD will also hire consultants to work in it on behalf of the Project. Inter alia, ECD, under the direction of the Center, wouid: (i) Carry out publicitv campaigns for energy rationalization throutgh radio, TV, exhibitions, seminars, articles, and puiblications; estahlish a computerized data hank to collect, exchange, and disseminate statistical information on energy use; and monitor progress and results achieved by the country under the energy conservation and rationalization program. (ii) Organize and execnte a program of energy audits in selected plants to identifv the rises and sources of energy at the plant level, the areas where waste occurs, and the most economically attractive energy rationalization opportunities, and to recommend measures and investment programs for typical firms, both in the short- and long-term; and following the audits, to carry out technical and economic appraisals of proposed energy conservation and rationalization investments to facilitate the provision of loans from lending institutions, and participate in negotiations for such loans, if necessary. (iii) Provide technical assistance and specialized advisory services to industrial enterprises on specific aspects of retrofitting, waste heat recovery, cogeneration of steam and power, process modifications, etc.; prepare energy conservation and rationalization manuals and handbooks for energy-intensive subsectors in industrv, mining, etc.; help develop energy conservation and rationalization legislation for Peru; and carry out an Incentives Studv for Energv Conservation and Rationalization. (iv) Provide courses and training for: (a) engineers, energy coordinators and energy managers of enterprises proposing to carry ont energy rationalization projects, and (b) local consulting firms interested in acquiring expertise in energy conservation nnd rationalization; and coordinate the energv rationalization work with technical institutions and tiniversities carrying out  - 15 - research and development activities, and execute demonstration projects on energy rationalization. The Borrower 46. PETPOPERU is the largest public sector corporation in Peru and employs about 9,000 people. It was established in 1969 following the nationalization of International Petroleum Company (IPC), a subsidiary of Exxon. PETRO'PERU acquired the assets of IPC, those of a small government- owned comrany and several other private companies. PETROPERU is currently involved in oil exploration, production, refining, and the marketing of finished petroleum products. In addition to oil exploration and product4.on, it operates the Transandean pipeline, and produces petrochemicals and fertilizers. PETROPERU has a ten member Board of Directors. The President, who is also the Chairman of the Board, has broad management authority within the company. Although senior management is competent, middle management, especially in exploration operations, has been weakened by the loss of mans of its qualified personnel who left the company in the late 1970s for higher paying jobs elsewhere. The Industrial Production Central Management, which is responsible for refinery and industrial operations, and which will supervise the proposed Energy Conservation Department, however, was able to retain a substantial number of qualified people as they had less opportunities in the private sector compared to exploration .rid production personnel. In 1981, PETROPERU was given greater autonomy to improve its salary structure. As a result, its salary scales are now competitive with the private sector, and the loss of experienced personnel has declined. To further strengthen its corporate structure, PETROPERU engaged Arthur D. Little, Inc., as consultants, to carry out an organizational and management study to recommend improvements. In early 1983, following the recommendations of the consultants, PETROPERU was reorganized. 47. A review of the financial situation of PETROPERU shows that its revenues in US dollars equivalent increased by 12 percent in 1984, reaching nearly US$1.5 billion equivalent. Its internal cash generation rose from US$177 million equivalent in 1983 to US$232 million equivalent in 1984, reflecting an increase of 31 percent. The debt/equity ratio of the Company continues to be at a satisfactory level of about 30/70 after revaluation. The liquiditv situation of the Company, however, is tight because of the increase in taxes by the Government on petroleum prodtucts, which has reduced PETROPERU's net sales realization from 53 percent of gross sales in January 1984 to 36 percent in March 1985. As a result, the quick ratio of the Company is less than the level of 1:1 agreed uinder the Petroleum Production Rehabilitation Project (Loan 1806-PE). The debt service coverage was at an acceptable level of 1.6 in 1984, but lower than the level of 2 agreed under Loan 1806-PE. As part of the supervision of the Petroleum Production Rehabilitation Project, the Bank has recommended a plan to the Government for gradually increasing PETROPERU's share of the oiL revenues to enable PETROPERU to improve its financial position. This plan has not been implemented so far and is being followed up by the Bank as part of the ongoing dialogtue with the Government under Loan 1806-PE.  - 16 - Organization and Management 48. The Center was established as an autonomous organization under the Civil Code, allowing it to have participation from private as well as public sector organizations; a Supreme Decree of the President of Peru signed on February 27, 1985 has recognized it as a non-profit entity for tax purposes. The Center has a General Assembly which includes representa- tives of the following seven founding public and private institutions: ITINTEC (the National Institute for Technological Development), CONADE (the National Development Corporation), PETROPERU (the National Petroleum Company), ELECTROPERU (the national holding company for electric power companies), Banco Industrial, Sociedad Nacional de Industrias (the National Association of Private Industries), and Sociedad de Mineria y Petroleo (the Association of Private Mining and Petroleum companies). These organiza- tions have indicated that their representatives to the Assembly would be high-level officials of those institutions. Other parties could also become members in future at the discretion of the General Assembly. Managing directors of several major companies have supported the establishment of the Center, and have expressed their willingness to second staff to work in the Center. There is at present a five-member Board of Directors (Consejo Directivo) which is elected by the General Assembly every five years. Agreement has been reached that the Board of Directors would always have at least one representative each from PETROPERU and ITINTEC (Section 6.01 (f) of the Draft Loan Agreement). Further, it is expected that at least one of the remaining three members would be from the private sector. The Director-General of the Center will attend the Board meetings but will have no voting rights. The Board will be responsible for formulating policies to implement the decisions of the General Assembly concerning the operations of the Center and supervising the use of funds. The Director-General of the Center will report to the Board for policy and other matters. Regarding administrative and implementation aspects, however, he will consult with PETROPERU's Central Manager of Industrial Operations. 49. As noted, the Center and PETROPERU will enter into a management contract which would define the scope of assistance that PETROPERU would provide to the Center. Inter alia, the management contract would state that PETROPERU would: (a) provide the Center with legal, procurement, personnel, billing and other administrative support services; (b) establish the Energy Conservation Department (ECD) within PETROPERU to work with the Center and provide one department head and two division chiefs for ECO--one for the Technical Division and the other for the Economics and Administration Division -- along with four energy specialists, one computer specialist, and two support staff; (c) provide the Center with goods and seivices procured under the Bank loan; and  - 17 - (d) allocate in its budget the necessary amounts for carrying out (a) and (b), estimated in current dollars as follows: 1985, US$150,000 equivalent; 1986, US$350,000 equivalent; 1987, US$370,000 equivalent; 1988, US$390,000; and 1989, US$400,000. 50. Under this contract, PETROPERU will also be responsible for selecting personnel and staff, and provide the Center with qualified technical and other services through its ECD personnel supplemented by personnel seconded from industrial plants to the Center. An outline for the management contract was discussed during negotiations and the contract will be finalized shortly by the Center, incorporating the Bank's comments. Signing of the management contract between the Center and PETROPERU, satisfactory to the Bank would be a condition of effectiveness of the Loan Agreement (Section 7.01 (b) of the Draft Loan Agreement). 51. The Director-General was appointed in March 1985, following the Supreme Decree referred to in para 48. He has been seconded by ELECTROPERU. The department head and the division chiefs of ECD referred to in (para 49) are expected to be appointed by July 31, 1985. Subsequently, a technical advisor, with qualifications and experience acceptable to the Bank, will be appointed to help the management of the Project to: (i) review on the institutional framework; (ii) formulate a training program; (iii) prepare a short-list of consulting firms for the execution of the energy audits; (iv) prepare letters of invitation to seek proposals from the consulting firms; (v) evaluate the proposals received and recommend the selection of the consulting firms for carrying out energy audits; (vi) select the industrial plants to be audited; (vii) control costs and schedules; (viii) supervise and coordinate the work of consulting firms; (ix) organize seminars, publications and promotional campaigns; and (x) help prepare national energy conservation and rationalization legislation. The Technical Adviser will be appointed by September 30, 1985 (Section 3.04 (c) of the Draft Loan Agreement). Establishment of ECD, and the appointment of the head of ECD and two division managers, will be conditions of effectiveness (Section 7.01(c) of the Draft Loan Agreement). It was agreed that in the absence of the Director-General, the head of ECD will act as Director-General (Section 3.04 (i) of the Draft Loan Agreement). It has also been agreed that if the position of the Director-General remains vacant for 180 days, the Government would take necessary measures to fill it on a permanent basis (Section 3.04 of the Draft Guarantee Agreement). Project Execution 52. Three consulting firms or consortia of firms are expected to be hired for energy audits and training, with each one of them dealing with one of the following groups of industries: (i) chemicals, fertilizers, tire, paint, paper and pulp, textiles, breweries, sugar, rice milling, flour mills, fish meal and saw mills; (ii) metallurgical industries (including concentrators and smelters of copper, zinc, lead and silver),  - 18 - foundries, iron pelletizing and steel; and (iii) cement, glass ceramics, bricks and refractories. If necessary, the same firm or consortium could be engaged to audit more than one group of industries. These firms or consortia, and the local staff working with ECD are expected to audit about 150 industrial and mining companies including approximately two very large (multi-plant), 20 large, 50 medium and 78 small enterprises over a period of three years. ECD will provide billing service for the Center to allow it to recover costs of the audits. Two audits of very large companies would be undertaken as demonstration audits. ks initial payment for the audits, the companies will provide two persons each on secondment for two years. The remaining costs of the audits will he reimbursed to the Center after one or more of the recommended investments have been implemented. The other 148 audits would be carried out on the following basis. In the first year, to get the audit program off to a good start while testing the market response, the plants selected for audit would he charged only a portion of the audit costs, with the rest of the audit costs on those plants to be recovered after one or more of the recommended investments are made by them to realize energy savings. As the audit program gets increasing response from the second year onwards, the Center would recover full cost in the course of energy audits (Section 3.04 of the Draft Project Agreement). Most audits of small enterprises are expected to be completed by local staff trained under foreign specialists. Further, in addition to the audits and related work, the Project will include an Incer.tives Study for Energy Savings and Rationalization in the Industrial, Commercial and Transportation Sectors that will be carried out by September 30, 1986, with the help of consultants acceptable to the Bank (Section 3.07 of the Draft Loan Agreement). 53. By early 1986, ECD is expected to have a permanent staff of eight professionals and two support staff. Of these, three professionals--the department head and two division chiefs--will be appointed by PETROPERU by July 31, 1985 as a condition of loan effectiveness. Four other professionals from PETROPERU as well as 10 professionals seconded by public and private companies (other than PETROPERU) would be assigned to ECD within six months from the hiring of the Technical Adviser, or within six months of the date of effectiveness, whichever period ends earlier, and the computer specialist will be assigned by PETROPERU to ECD within nine months of loan effectiveness (Section 3.04 (b) of the Draft Loan Agreement and Sections 2.02 and 2.04 of the Draft Project Agreement). The two secretaries will be assigned to ECD by PETROPERU within sixty days of loan effectiveness (Section 3.04 (c) of the Draft Loan Agreement). Further, by the time the first seven professionals from PETROPERU are in place, the ECD would also use the services of 10 professionals seconded by major public and private companies to the Center for at least two years for gaining on-the-job training while working with foreign experts. If required, in the second year, four more permanent staff would be recruited for ECD by PETROPERU. At the end of the first two years, when the first group of seconded personnel return to their parent organizations, possibly to become energy managers, a second group of 10 professionals would he seconded from public and private companies. In this context, the Government would  - 19 - require public sector companies to second at least six professionals (Section 3.01 of the Draft Guarantee Agreement); and the Sociedad Nacional de Industrias and the Sociedad Mineria y Petroleo (which are associations of private companies) have informed the Bank of their willingness to persuade private firms to second at least four professionals. It was also agreed that the consulting firms to assist ECD to carry out the Project would be hired by PETROPERU within six months from the hiring of the Technical Adviser, or within six months of the date of loan effectiveness, whichever period ends earlier (Section 3.06 of the Draft Loan Agreement and Section 2.02 of the Draft Project Agreement). It is expected that the consulting firms would start work early in 1986. 54. The Project will be Implemented over a five-year period, of which four years will be after all the foreign consulting firms start the work. On this basis, the Project is expected to be completed by December 31, 1989. By that time, adequate personnel would have been trained in Peru to continue the energy conservation work without foreign specialists. Agreement was reached with PETROPERU and the Center that they will review, at the request of the Bank and before the closing of the loan account, the continued need for the Center, taking into account: (i) the capability of other local entities to carry out energy audits; and (ii) the progress made in energy savings in the industrial sector and the prospects for such savings in the residential and commercial buildings, and the transportation sectors (Section 3.09 of the Draft Loan Agreement and Section 3.05 of the Draft Project Agreement). Project Cost and Financing Plan 55. The total cost of carrying out the Project and its operations during 1985-89 is estimated at about US$6.1 million equivalent, including US$4.0 million equivalent in foreign exchange. The cost estimate includes p1iystcal and price contingencies, and working capital. The Project cost was estimated on the basis that about 165 man-months of foreign consultancy service (including the service of technical adviser), would be required to execute the Project. The local staff of the Project would increase gradually from 11 to 25. Of the final total local staff, ten would be on secondment from private and public sector companies and would not have to be paid for under the Project. In addition to using seconded staff to reduce the operating costs under the Project, the Center would charge a fee for the services under the Project. The Center is expected to generate about US$2.5 million in fees during 1985-89. Pro-forma sources and uses of funds statements for 1985-89 are attached as Annex IV. 56. It is proposed that IBRD finance all foreign costs excluding interest during implementation and commitment fees, which together with the principal repayments, would be absorbed by PETROPERU; PETROPERU would finance all local costs except for local costs of consultants which will be covered under the Bank loan. Of the fees collected by the Center for energy audits and training, the initial US$50,000 equivalent will be retained by the Center and the rest will be passed on to PETROPERU towards  - 20 - covering the cost of its services to the Center. During neRotiations, the Government confirmed the tax deductible status of any outside contribution to the Center. The Government has also confirmed that the equipment to be imported for the Project to help carry out energy audits and to help develop the data bank will be exempt from duties and taxes. Agreement was reached with PETROPERU that it will provide the funds needed for the Project (Section 3.01 (a) of the Draft Loan Agreement). PETROPERU's budget allocation of US$150,000 to ECD for the first year of project implementation is a condition of loan effectiveness (Section 7.01 (c) of the Draft Loan Agreement). The following table shows the financing plan: Financing Plan (US$ million) Foreign Local Total Revenues from Audit and Training Fees - 0.4 0.4 IBRD 4.0 - 4.0 PETROPERU - 1.7 1.7 Total 4.0 2.1 6.1 =:= = = 57. Retroactive financing of up to US$300,000 is proposed for payments made after December 1, 1984, to meet the initial costs of the Technical Aeviser and foreign training of key management staff (Para III of Schedule I of the Draft Loan Agreement). Use of Loan Funds 58. The loan will be made to PETROPERU of Peru which will use the proceeds of the loan exclusively for procuring goods and services for the Project. Procurement and Disbtursement 59. The technical advisor and the consultant firms, or consortia thereof, would be selected in accordance with Bank Group Guidelines for the Use of Consultants (Section II of Schedule 4 of the draft Loan Agreement). The firms or consortia for the energy audits will be selected after inviting proposals from a short-list of firms satisfactory to the Bank. The proposals would be evaluated on the basis of criteria to be agreed with the Bank. Further, until local firms develop expertise in energy auditing, the Government would allow public sector firms to contract directly with the Center for carrying out the audits (Section 3.03 of the Draft Guarantee Agreement). 60. In view of the specialized nature and limited availability of the equipment for energy audits and data processing, the need for its early delivery, the small estimated cost of individual items, and the  - 21 - impossibility of their useful grouping, limited international bidding (LIB) would be used for procurement of all goods. Their total cost (excluding contingencies) is estimated at about US$1.0 million. Goods would be procured after soliciting prices from suppliers from at least three Bank Group eligible countries. Procurement provisions are described in Section I of Schedule 4 of the Draft Loan Agreement. 61. The Bank loan would be disbursed against 100 percent of foreign expenditures for equipment, materials, and training, and 100 percent of consultant services. Loan disbursement is expected to take about four and a half years, running from mid-1985 through end-1989. The Closing Date for the Loan will be June 30, 1990. A revolving fund special account of US$400,000 will be established for the Project (Section 2.02 (b) and Schedule 5 of the Draft Loan Agreement). Reporting and Auditing 62. The Center and ECD would maintain records adequate to monitor project implementation and would submit quarterly progress reports in a form acceptable to the Bank. The Center and ECD would maintain accounts satisfactory to the Bank for all expendittures incurred under the Project. The Center's and PETROPERU's annual financial statements (income statement, balance sheet and statement of changes in financial position) would be audited bv independent auditors satisfactory to the Bank, and the audited statements along with the report of the auditor submitted to the Bank within four months of the end of the financial year (Sections 4.01 (b) of the Draft Project Agreement, and 5.01 (b) of the Draft Loan Agreement). Further, FCD would maintain separate accounts for expenditures for which withdrawals are requested from the Loan account on the basis of statements of expendituire, and audit of this accotunt will be included in the audit of PETROPERU's financial statements (Section 5.01 (c) of the Draft Loan Agreement). Further, PETROPERU shall ensure that the independent auditor will provide a separate opinion as to whether the proceeds of the Loan withdrawn in respect of such expenditure have been used for the purpose for which they were provided (Section 5.01 (c) of the Draft Loan Agreement). Beaiefits and Risks 63. This Project would be the second major program aimed at energy conservation in the industrial sector in Perti; the first one being the Petroleum Refineries Engineering Project of PETROPERU (Loan 2117-PE), which is being implemented satisfactorily. The energy audits and studies to be implemented under the Project are expected to identiFv economically attractive energy conservation and rationalization projects. The economic viability of the energv conservation program was analyzed using average figures for investment and savings. The viability of each one of the major projects will be rev.iewed subsequently under detailed feasibility studies before investment decisions are taken. As discussed (para 34), the expected total cost of implementing these projects is estimated to be between US$56 million and USS88 million over an extended period and part of  - 22 - it is expected to be financed under the existing lines of credit with COFIDE (the State Development Finance Corporation) and Banco Industrial. The economic rate of return of these investments was computed using the midpoint of the range--US$72 million. These projects are expected to result in a net annual saving of about US$44 million and yield an average return of about 64 percent, as shown in the following table: Economic Analysis (March 1985 USS million) Economic Average Rate of Annual Return Investment Saving (%) Conservation Short-term 21 24 111 Medium-term 51 20 34 Total 72 44 64 64. Short-term conservation investments, consisting mainly of better housekeeping measures and some minor retrofitting, are expected to save about 135,000 toe per year, valued at about US$24 million (using fuel oil economic price of US$170 per ton, and I ton fuel oil = 0.96 toe). Economic rate of return of these investment is estimated at 111 percent. Medium-term investments, consisting of major retrofits and process modifications, are expected to result in an additional saving of about 115,000 toe, valued at about US$20 million. 65. The Project is expected to have a strong impact on institutional development in the industrial sector, through training of managers for industrial energy conservation and rationalization. Staff seconded from local companies to the Center would receive classroom training at the Project's training facilities; this would be supplemented with on-the-job training which they would obtain by participating with the foreign consultants in the energy audits. It is expected that the seconded staff would return to their parent companies as energy managers and would be able to disseminate energy conservation and rationalization practices to their colleagues. In addition, the Project would also have a program to train staff of local consulting firms as energy auditors. The consulting firms would be charged a training fee that would ensure 100 percent cost recovery. It is expected that by the time the Project is completed, Peru wculd have a large pool of trained energy auditors, thus reducing its reliance on expatriates for future energy audits. 66. The principal risks facing the Project relate to the quality of personnel and the managerial and institutional problems common to new  - 23 - undertakings, and the willingness of industrial companies to have energy audits performed and to pay for them. The first risk is being minimized through the management contract with PETROPERU, which will provide management and other services to the Center. The second risk would be minimized by the Center's promotional campaigns, films, and seminars to educate the people about the benefits of energy conservation and rationalization; and its cost recovery procedures allowing for less than full cost recovery for the initial auditp. The Project poses no environmental risks. PART V - LEGAL INSTRUMENTS AND AUTHORITY 67. The draft Loan Agreement between PETROPERU and the Bank: draft Project Agreement between the Center and the Bank; the draft Guarantee Agreement between the Republic of Peru and the Bank, and Report and Recommendattons of the Committee provided for in Article III, Section 4(iii) of the Bank's Articles of Agreement are being distributed separately to the Executive Directors. 68. These draft agreements conform to the normal pattern for loans for technical assistance projects. The main features of the draft Loan, Project and Guarantee Agreements are referred to in the text of this report and are listed in Annex III. Special conditions of effectiveness would be: (i) signing of a management contract between the Center and PETROPERU; (ii) creation of the Energy Conservation Department (ECD) by PETROPERU; (iii) appointment by PETROPERU of the head of ECD and two division chiefs for ECD; and (iv) confirmation of the budget allocation by PETROPERU of US$150,000 equivalent for the Project for the fiscal year 1985 (Section 7.01 of the Draft Loan Agreement). 69. I am satisfied that the proposed loan would comply with the Articles of Agreement oF the Banlk. PART xfI - RECOMMENDATION 70. 1 recommend that the Executive Directors approve the proposed loan. A. W. Clausen President Attachments April 18, 1985 Washington, DC  -24 - T A L t 3A Page 1 of 6 S. - SOCUIL 1NDICATOU RSA DA IMST (HST REINt BETRAY)f 0b h RITUI lb "ID t a mac. 19 9 TllAT _LAT. ANSRICA