Mexico - Hydroelectric Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 7391-ME STAFF AP11AISAL REPORT MEXICO HYDROELECTRIC DEVELOPMENT PROJECT MAY 16, 1989 Country Department II Infrastructure and Energy Operations Division Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used,by recipients only in the performance of CURRENCY EQUIVALENTS Currency unit Mexican Peso (Meg8) US$1.00 a Mex8 2326.00 (Exchange rate as of March 16, 1989. The exchange rate I currently being devalued by 1 Mexican Poe daily) UNITS AND MEASURES ton (T) a metric ton a 1000 kg Yel = teracalorles a 98.04 TOE = 1012 calories TOE ton of oil equivalent = 0.0102 Tceal kW a kilowatt = 103 watts MW a megawatt = 10 kW OW gigawatt = 10 MW kWh = kilowatt hour a 10 watt hostr MWh m aegawatt hour a 10 kWh GOWh gigawatt hour = 108 kWh TWh = terawatt hour = 10 kWh kV = kilovolt = 108 volts MVA a megavolt ampere a 106 volt-ampere bbd = barrels per day ACRONYMS CFE = Comil6n Federal de Electricided (Government owned national electric utility) CLFC = Complife de Lux y Fuerza del Centro (Electricity distribution company, subsidiary of CFE, serving the metropolitan area of Mexico Cityj FRA = Financial Rehabilitation Agreement (Between Government and CME) IoB = Inter-American Develope. Bank INAN = Instituto Nacional de Antropologia e Historia (National Institute of Anthropology and History) NAFIN = Nacional Financiers, S.N.C. (Government owned national development agency) PEMEX = Petr6l*os Mexicanos (Government owned national oil company) SARN = Secretarfa de Agricultura y Recursos Hlidrdulicos (Ministry of Agriculture and Hydro Resources) SEDUE = Secretarla de Desarrollo Urbano y Ecolog(a (Ministry of Urban Development and Ecology) SEMIP = Secretarft do Energia, Minaes * Industria Paraestatal (Ministry of Energy, Mines and State Enterprises) SHCP = Secretarfa do Hacienda y Cr6dito Pdblico (Ministry of Finance and Public Credit) SRA = Secretarta de Reforms Agraria (Ministry of Agrarian Reform) SPP = Secretarfa do Programaci6n y Presupuesto (Ministry of Planning and Budget) FISCAL YEAR January 1 - December 81 r JR UnstaIAL Lb ILY MEXICO HIDROBLECTRIC DEVELOPMENT PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. 1. LOAN AND PROJECT SUMMARY........................... ........... 1 2. THE ENERGY AND POWER SECTORS................................. 3 A. INTRODUZTION..................................... ......... 3 B. THE ENERGY SECTOR.......................................... 3 Energy Resources....................................... 3 Energy Demand and Supply............................... 4 National Energy Policy and Sector Objectives........... 4 Problems of the Energy Sector.......................... 5 C. THE ELECTRIC POWER SECTOR.................................. 6 Sector Organization and Regulation..................... 6 The Electric Power Market.............................. 7 Operational Performance................................ 9 Power Sector Planning.................................. 9 The Investment Program................................. 10 Mexico's Nuclear Power Program......................... 11 Electricity Pricing.................................... 12 Financial Performance.................................. 13 Government Subsidies and Cash Transfers................ 13 Financial Rehabilitation Agreement (FRA)............... 14 Financial Forecast..................................... 15 Bank and Country Goals and Sector Lending Strategy..... 15 CFE's Procurement Practices............................ 16 Bank Participation in the Sector....................... 16 3. THE PROJECT................................................... 17 Project Origin................................ ........... 17 Objectives and Long-Term Strategy.......................... 17 Project Description....................................... 17 Estimated Cost..................................... ...... 18 Financing Plan................................... ........ 19 Legal Arrangements.................. ...................... 20 Project Implementation and Status of Q:oject Preparation... 20 This report is based on the findings of an appraisal mission consisting of Messrs. Luis H. Luzuriaga (Principal Power Engineer. Task Manager), Jose M. Bakovic (Senior Financial Analyst). Ricardo Klockner (Financial Analyst) and Gabriel Sanchez-Sierra (Energy Specialist) that took place in November 1987. The report was updated in February 1989. Messrs. Alvaro Covarrubias (Sr. Power Engineer), Shelton Davis (Senior Sociologist), Bernard Baratz (Environmental Officer), Fernando Camara (Anthropologist-Consultant), Theodore Downing (Anthropologist-Consultant), and Mrs. Mirtha Pokorny (Economist) also contributed to its preparation and Ms. Norah Arancibia assisted in its production. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Page No. Procurement ................ 22 Disbursements .............................................. 23 Auditing................................................... 24 Environmental and Social Aspects........................... 24 Dam Safety and Inspection.................................. 25 Performance Indicators..................................... 25 Risks...................................................... 25 Economic Justification..................................... 26 Project File............................................... 27 4. AGREEMENTS REACHED AND RECOMMENDATION......................... 27 ANNEXES: 2.1.0 - Historical Energy Balance...................... 30 2.1.1 - Fuel Prices in Mexico.......................... 31 2.2.0 - CFE: Institutional Aspects..................... 32 2.2.1 - CFE's Organization Chart....................... 38 2.3.0 - The Electric Pover Market....................... 39 2.3.1 - Historical Data for the Public Power Sector 42 2.3.2 - Existing Power Plants as of December 31, 1986 43 2.3.3 - New Power Plants Planned for 1988-1997.......... 44 2.3.4 - Performance Data on CFE's Thermal Power Plants 45 2.3.5 - Demand Forecast by Type of Service (GWh) 46 2.3.6 - Global Demand Forecast.......................... 47 2.3.7 - Global Energy Balance Forecast (GWh)............ 48 2.3.8 - Global Capacity Balrnce Forecast (MW).......... 49 2.4.0 - Power Sector Investment Program................ 50 2.4.1 - Investmet Program Period 1980-1997............ 52 2.4.2 - Power Sector Investments and Market Growth 3 . 5 2.5.0 - Electricity Pricing ............................ 54 2.5.1 - Tariff Schedule ................................ 56 2.6.0 - Sector Finances ................................ 57 2.6.1 - Income Statements .............................. 60 2.6.2 - Sources and Application of Funds............... 61 2.6.3 - Balance Sheets ................................. 62 2.6.4 - Evolution of Electricity Rates................. 63 2.6.5 - Funding Mix Period 1980-1996................... 64 2.6.6 - Subsidies to the Power Sectors ................. 65 2.7.0 - Financial Rehabilitation Agreement (A) ... 66 3.1.0 - Project Dascription and Cost ................... 70 3.1.1 - Project Cost and Financial Details.............. 74 3.1.2 - Implementation Schedule and Procurement Methods 76 3.1.3 - Estimated Loan Disbursement Schedule........... 77 3.2.0 - Environmental and Social Considerations........ 80 Page No. 3.3.0 - Economic Analysis.............................. 83 3.3.1 - Internal Rate of Return........................ 85 3.3.2 - Economic Comparison of Hydro vs. Thermal Plants. 86 3.4.0 - Performance and Financial Indicators........... 87 3.5.0 - Project File................................... 88 MAP: IBRD No. 20849 MEXICO HYDROELECTRIC DEVELOPMENT P;.OJECT 1. LOAN AND PROJECT SUMMARY Borrower: Nacional Financiera, S.N.C. (NAFIN). Guarantor: The Government of Mexico. Beneficiary: Comision Federal de Electricidad (CFE). Amount: US$460.0 million equivalent. Terms: Repayment in 17 years, including five years grace, at standard variable interest rate. Onlending Terms: The loan proceeds would be relent by NAFIN to CFE, under terms and conditions which would include, inter alia, (i) the sub-loan would be denominated in US dollars, (ii) the onlending terms and conditions would be the same as the Bank loan; and (iii) NAFIN would charge a fee amounting to 10% of the interest charged by the Bank. US dollar to Mexican peso exchange and interest rate risks would b; borne by CFE, and NAFIN would bear the US dollar to basket of currencies exchange risk. Project Objectives: The project would assist in achieving the sector's objectives of: (a) promoting an efficient use of electricity through realistic pricing policies, energy conservation and improvement of sector * operations; (b) diversifying sources of power generation from the now mainly oil-based generation; (c) strengthening CFE's financial condition by implementing a Financial Rehabilitation Agreement; (d) making electricity available to an increasing number of consumers; and (e) improving CFE's capabilities to deal with social and environmental aspects of hydroelectric power projects. The loan would assist the Government and CF. -o meet the . power sector's financing needs by providing funds to finance about 32% of ' the costs of the Aguamilpa and Zimapan Hydroelectric Power Plants. * Project Description: (a) Construction of the 960 MW Aguamilpa (66.7% of : the total cost) and the 280 MW Zimapan (32.5%) Hydroelectric Power Plants and resettlement of affected population; (b) development of a social and environmental program designed to strengthen CFE's capacity to construct and operate hydroelectric projects with due consideration to affected people and the environment (0.3%); (c) execition of energy related studies on energy conservation and efficient use of energy, co-generation and optimization of the operation of CFE's power system (0.4%); and (d) management and electricity tariff studies (0.1%). Project Risks: Both the Aguamilpa and Zimapan Projects include important civil works that involve a degree of physical risk in their execution; the risk, however, would not be greater than the one in other projects successfully constructed in the past by CFE, as extensive geological exploration has been conducted to minimize the main risk element. In - 2 - addition, if electricity rates are not set at tLe levels required to permit a financial recuperation of CFE, there is a risk of shortage of counterpart funds to carry out the project; this risk is mitigated by the commitment of the Government and CFE to carry out a Financial Rehabilitation Agreement endorsed by the Bank. Such plan is already being implemented and up-front actions have been taken. Estimated Cost: Local Foreign Total ----a/ Million US$------ Aguamilpa Projectbi 399.7 266.6 666.3 Zimapan Projectb/ 187.0 124.7 311.7 Social and Environmental Program 2.0 1.4 3.4 Energy Related Studies and Management Studies 3.2 2.1 5.3 Total base cost (January 1989 prices) 591.9 394.8 986.7 Physical Contingency 94.2 62.8 157.0 Price Contingency 85.9 57.2 143.1 TOTAL PROJECT COSTb/ 772.0 514.8 1,286.8 interest During Construction 0.0 153.2 153.2 TOTAL FINANCING REQUIREMENTS 772.0 668.0 1,440.0 Financing Plan: CFE's own resources 590.0 143.0 733.0 Government contributions 100.0 0.0 100.0 IBRD Loan 82.0 378.0 460.0 Other Loansc/ 0.0 147.0 147.0 TOTAL FUNDS 772.0 668.0 1,440.0 a/ Includes approximately US$135 million of identifiable t&xes and duties. b/ Includes US$12.5 million for environmental and resettlement works for the Aguamilpa Project, and US$17.6 million for the Zimapar. Project. c/ Bilateral and/or supplier's credits. Estimated Disbursements -------------------------Million US$------------------- Bank FY 1990 a/ 1991 1992 1993 1994 1995 1996 Annual 46.0 27.0 72.0 99.0 95.0 67.0 54.0 Cumulative 46.0 73.0 145.0 244.0 339.0 L06.0 460.0 a/ Includes deposit of US$35.0 million in the Special Account, and retroactive financing up to US$20 million for eligible expenditures mae. after August 31. 1988. Rate o!. Return: 13% on CFE's Investment Program. MAP: IBRD No. 20849 -3- 2. THE ENERGY AND POWER SECTORS A. INTRODUCTION 2.01 Two issues have dominated the performance of the Mexican economy in the eighties: the overhang of a massive debt, which requires attaining significant trade surpluses to service it and to reduce its relative weight over time, and a mounting problem in containing inflation, fueled to a large degree by fiscal deficits. T'.3 Governmen.'s present economic strategy addresses these two issues through a program of structural reforms aimed at opening up the economy to external competition, limiting the role of the State in the productive sectors and fostering the development of non-traditionpl exports. In addition, the stabilization program that was put in place in November 1987 seeks to sharply reduce inflation by addressing the fiscal issue by, amongst other measures, raising the prices for goods and services provided by public enterprises, and by following a restrictive monetary and fiscal policy and implementing short-term price and wage controls. 2.02 In this context, energy sector policies play a very important . role. In addition to the significance of p6troleum exports as a source of - foreign excnange, there are major issues regarding the size of the subsidies that the power sector has been receiving from the Federal Government, the distortions to resource allocation caused by subsidized fuel prices and electricity rates, and the costs to the economy of investment and procurement policies in the power sector, which were not based on economic considerations. The Mexican Government has begun to address these issues: fuel prices have been raised in real terms (para. 2.09), procurement by public sector enterprises is being opened to external competition, and under the proposed project, electricity rates would be increased (para. 2.31) and investment programs would be based on economic criteria (para. 2.20). B. THE EVERGY SECTOR Energy Resources 2.03 Mexico is endowed with substantial and diversified energy resources, both renewable and non-renewable. Its main resources are hydrocarbons, with reserves of 55 billion barrels of crude oil (about 61 years reserve at the 1986 average rate of production of 2.5 million barrels per day) and 76 trillion cubic feet of natural gas and gas liquids (equivalent to 13.5 billion barrels of crude oil). Coal reserves discovered so far amount to 643 million tons (equivalent to 3.2 billicn barrels of crude oil); this coal is not suitable for coking purposes and is used mainly for electricity generation. The known uranium reserves are 14,500 T, but total reserves are probably much larger. 2.04 Of the renewable energy resources, the most important is hydropower. A recent study identified 594 sites with a theoretical output of 150 TWh/year, of which approximately 80 TWh/year (equal to Mexico's electric energy production in 1984) are technically feasible, equivalent to 22,000 MW, of which at present 35Z have been installed. About 400 known geothermal zones have a potential for the installation of 3,9U0 MW in thermal plants; at present only 182 have been installed. Non-conventional potential resources, like solar and biomass energy, would not contribute significantly to energy production in the country in the medium-term. Energy Demand and Supply 2.05 In 1988, Mexico's gross energy production was 2,038 thousand Tcal (equivalent to 200 million TOE), of which nearly 91Z was hydrocarbon production. Gross internal energy consumption was 1,245 thousand Tcal or 1.4 TOE per capita.1 The 1988 energy balance is shown in the next table, and the evolution of the energy supply and consumption in Annex 2.1.0. Mexico's 1988 Energy BalAnce Thousand Tcal Percentage Gross Energy Supply Hydrocarbons 1,830.9 89.8 Biomass (Wood and Bagasse) 101.4 5.0 Hydroenergy 62.7 3.1 Coal 38.5 1.9 Geothermal Energy 12.5 0.6 Imports and Stock Variations (7.7) (0.4) Total Supply 2,038.3 100.0 Eneray Uses Internal Consumption: Industrial Sector 292.7 14.4 Transport 269.6 13.1 Residential and Coimercial 178.6 8.8 Power Sector 169.9 8.3 Other Uses 106.0 5.2 Energy Sector Consumption and Losses 227.9 11.2 Subtotal, Internal Consumption 1,244.7 61.1 Exports 793.6 38.9 Total Uses 2,038.3 100.0 National Energy Policy and Sector Objectives 2.06 The National Energy Program, prepared by the Ministry of Energy, Mines and State Enterprises (SEMIP) and approved by the Government in August 1984 as part of the National Development Plan, presents an analysis of the role of energy in country development, the main problem! faced by the sector, and sets general sectoral objectives and medium term (1984-88) aad longer term (to the year 2000) targets and strategies. The broader sectoral objectives are: (i) meeting overall energy demand including export 1/ As compared to Brazil with 1.3 TOE per capita, Chile 0.80 and Colombia 0.70. of hydrocarbons; (ii) energy conservation, particularly in the state-owned industries with emphasis on simple, inexpensive measures to cut down irrational energy use; (iii) energy diversification away from the current excessive reliance on hydrocarbons, towards greater use of alternative primary evergies such as hydroelectricity; and (iv) improving the financial situation of sector enterprises, so as to achieve full cost recovery. Most of the goalz established for the period 1984-86 have been achieved (para. 2.07 through 2.09). Problems of the Energy Sector 2.07 A major problem of the sector is the high consumption of energy per unit of output, which has caused a high growth of energy consumption. Gross energy consumption in the country has grown at an average ennual rate of 9% during 1975-82; although this high rate was partly due to high rates of economic growth and urbanization and to the transformation of the industrial structure in Mexico toward more energy intensive industries, it also reflected the inefficient use of energy, fostered by very low prices and lack of a conservation program. Energy conservation efforts since 1982 have produced energy savings in 1987 equivalent to 115,000 barrels of oil per day (bbd), plus an additional 40,000 bbd from reduced flaring of associated gas compared to the National Energy Program target for 1988 of 200,000 bbd. Because of these savings, as well as economic stagnation, energy consumption in the 1982-88 period increased only slightly. 2.08 A second problem is the high dependency on non-renewable resources, due partly to a biased pricing policy towards hydro-carbons; their share in internal consumption of primary energy in 1988 amounted to 83% (Annex 2.1.0). An important potential for diversification is in electricity generation through the development of hydro, coal, geothermal and nuclear generation. However, the goal of the Government of reducing the share of hydrocarbons to 70% by the year 2000 might be too optimistic. 2.09 A third problem of the sector is the poor financial situation of sector enterprises, which the Government is addressing through a pricing policy that takes into account border prices, production costs, relative price structures and development priorities. Much has been accomplished so far, particularly regarding petroleum product prices: in the period 19d3-88 these have been increased, in real terms, 127% for natural gas, 128% for residual oil, 83% for LPG and 61% for diesel. At the end of February 1989, the domestic prices for most of petroleum products, were at least at, and for some products considerably above, the relevant international (border) prices, the exception being fuel oil, LPG and gasoline, whose domestic prices despite their recent increases were about 88%, 39% and 83% of their border prices (Annex 2.1.1). Significantly, fuel oil is an important cost element in the price of electricity, which itself needs to be further increased in order to recover the cost of electricity supply. The Bank supports the policy of the Mexican Government to correct remaining energy price distortions. 2.1%) During negotiations, the Government agreed that SEMIP would execute, with the assistance of consultants under a schedule and terms of reference acceptable to the Bank, a Program to Promote Energy Conservation and Efficient Use of Energy in Mexico, and a Co-Generation Study. These two studies are relevant in the context of the energy conservation and - 6 - diversification pursued by the Government. Final terms of reference will be presented to the Bank by September 30, 1989, the studies will be completed by September 30, 1991, and views will be exchanged with the Bank on the conclusions and recommendations of such studies by December 31, 1991, (para. 4.01 b). Moreover, agreements were reached with Comisi6n Federal de Electricidad (CFE), on the following energy sector issuess (i) appropriate changes in the level and structure of electricity tariffs (para. 2.27) and (ii) execution of energy studies related to the power sector, including reduction of electric power losses (para. 2.23). C. THE ELECTRIC POWER SECTOR Sector Organization and Regulation 2.11 Electricity service in Mexico is under the responsibility of one public utility: Comision Federal de Electricidad (CFE), in operation since 1937. It generates, transmits and distributes electricity on a country- wide basis, except for distribution in the area of Mexico City and environs which are served by Compaflia de Luz y Fuerza del Centro (CLFC), a former private utility, now wholly-owned by CFE. CFE is under the jurisdiction of the Ministry of Energy, Mines and State Enterpriser (SEIP) rbich supervises energy-related activities. The Ministry of Finance and Public Credit (SHCP) regulates electricity prices and the financial operations of state enterprises, while the Ministry of Planning and Budget (SPP) supervises the budget and regulates the contracting and procurement activities of the sector. Finally, the Ministry of Agriculture and Hydro Resources (SARH) is concerned with the regulation of water resources. 2.12 As established by the General Law of the Electricity Service, amended in December 1983, CFE has an Administrative Council (Junta de Gobierno) as the governing unit in its organizational structure, with overall corporate responsibility for company affairs. Its Chairman is the Minister of Energy, Mines and State Enterprises (SEMIP) and its other members are the Ministers of Finance and Public Credit (SHCP); Agriculture and Hydro Resources (SARH); Commerce and Industrial Development and Planning and Budget (SPP); the General Director of the National Government Oil Company (PEMEX); and three labor delegates. A Supervisory Council has three members representing the Federal Comptroller, SEMIP and the Administrative Council. The General Director is the Chief Executive Officer of the company. The directors of Construction, Operations and Administration report directly to him, as well as the heads of the Accounting, Finance and Legal departments. An organization chart is shown in Annex 2.2.1. 2.13 CFE's distribution activities are carried out by 14 geographical regional offices with a limited degree of autonomy. A total of about 123,000 persons work for the power sector, of which 92,000 belong to CFE and 31,000 to CLFC; out of the total sector employees, about 78,000 operate the power system, 29,000 are temporary workers in the construction force and 16,000 are contirgent workers for major maintenance of power plants and transmission and distribution installations. Bank missions have identified some areas where institution building efforts are needed (greater degree of autonomy for the regional offices, overstaffing in some areas, improvements in accounting and inventory management); however, the sheer size and - 7 - complexity of CFE merit a management study, which the proposed Bank loan will finance, to adequatcly evaluate the areas that may need strengthening and develop a program to achieve this. At negotiations, CFE agreed tot (i) carry out a Management Study with the assistance of consultants satisfactory to the Bank, under a schedule and terms of reference acceptable to the Bank, to be presented not later than September 30, 1989; (1i) complete the study by June 30, 1991; (iii) by December 31, 1991, exchange views with the Bank on the conclusions and recommendations of the study and provide to the Bank a plan of action satisfactory to the Government and the Bank, to implement such recommendations including a timetable for implementation; and (iv) implement the plan of action in accordance with such tinetable (para. 4.01 e). Annex 2.2.0 gives a more detailed description of CFE. The Electric Power Market 2.14 In 1988, the total installed capacity for public service was 23,921 MW, of which 32% were hydroplants (see Annexes 2.3.1 and 2.3.2). In addition, there were 2,290 MW of captive capacity, mainly thermal. The following table presents an overall view of Mexico's historical (1981 and 1988) and projected (1992) power sector: Main Data on Mexico's Power Sector 1981 1988 1992 (actual) (actual) (forecast)b/ Installed Capacity (GW) Hydroplants 6.6 7.7 8.1 Oil and gas fired plants 10.3 14.3 16.2 Coal fired plants 0.3 1.2 1.9 Geothermal plants 0.2 0.7 1.0 Nuclear plants 0.0 0.0 0.7 Total installed capacity 17.4 23.9 27.9 Net Maximum Demand (GW) 11.8 16.1 20.8 Gross Generation (TWh) Hydroplants 24.4al 20.8 25.8 Oil and gas fired plants 42.8 69.7 85.3 Coal fired plants 0.0 7.2 9.8 Geothermal plants 1.0 4.4 6.4 Nuclear plants 0.0 0.0 3.4 Total gross generation 68.2 102.1 130.7 Energy sales (TWh) 57.5 83.9 108.0 Net energy losses (Z) 13.0 13.6 13.0 Number of customers (million) 10.4 14.4 15.8 Population served (M) 80.0 86.0 88.0 a/ 1981 was an exceptionally rainy year, which explains the high generation from hydroplants. b/ Bank forecast based on projections prepared by CFE -8- 2.15 In 1988, gross production of electricity was 1,174 kWh per capita.2 Of the total sales of 83.9 TWh, 56Z were consumed by the industrial sector, 20% by the residential sector, 92 by thz commercial sector, 8% in agricultural activities, 5% by public institutions and 2% for exports to the USA. About 86% of Mexico's population have access to electricity; urban population access is 94%, and rural 67%. A rural electrification program, started"in Mexico more than 30 years ago, aims to increase access to 75Z by year 1995. Energy losses are 13.6% with respect to net generation, suggesting that there is room for improvement. An optimization study of the operation of CFE's electric power system, to be executed as part of this project, will analyze means to improve the overall efficiency of the system, including transmission and distribution losses and plant utilization. During negotiations, CFE agreed to (i) carry out a study to improve the operation of CFE's electric power system, including analysis of design criteria, operating practices, and efficiency of transmission and distribution installations, under terms of reference to be agreed with the Bank not later than September 30, 1989; (ii) complete such study by June 30, 1991; (iii) exchange views with the Bank on the conclusions and recommendations of such study not later than December 31, 1991, and provide to the Bank a plan of action, satisfactory to the Government and the Bank, to implement such recommendations, including a timetable for implementation; and (iv) implement such plan of action in accordance with such timetable (para. 4.01 e). 2.16 The power sector is an important user of hydrocarbons: in 1988 an equivalent of 170 thousand Tcal were used for power generation, equivalent to 8.3% of total gross internal energy consumption. According to recent estimates, in 1992, 190 thousand Tcal will be used for thermal power generation (8.5%) and in 1997, 264 thousand Tcal (10%). In 1988, residual oil provided for 77% of the total output of CFE's thermal generation, gas 15% and coal 8%; for the future, CFE will consider the possibility of expanding the use of gas as thermal fuel, a decision which will depend on Government policies for the exploitation and uses of natural gas. CFE's program of diversification of energy resources will be carried out through the installation of 2,860 MW (of which 1,240 MW will be financed by the Bank loan) in hydroplants in the period 1989-1997, 418 MW in geothermal plants, 1,308 MW in a nuclear plant (Laguna Verde, whose first unit (654 MW) is expected to be commissioned in 1989, para. 2.25), 2,100 MW in domestic coal plants and 4,150 MW in dual fuel (oil and coal) thermal plants. In order to further increase diversification, the Government has entrusted to CFE the prospection for coal, as this type of fuel will be used mainly for power generation; coal exploitation is made by a semi- public enterprise (Minera Carbonifera Rio Escondido SA - MICARE), of which CFE is a shareholder. 2.17 In the period 1976-1988, gross electric energy generation increased at an average rate of 7.1% p.a. The current demand projection prepared by CFE forecasts an overall rate of growth for gross generation of 6.5Z p.a. for the period 1988-1998. It takes into account an increase in consumption by existing consumers (approximately 4.0%) and the connection of new services including important industrial loads already requested to 2/ As compared to 1,250 KWh per capita in Brazil, 950 in Colombia and 1200 in Chile. LFE. This projection, which is the result of aggregation of local demand forecasts, was verified by CFE using econometric models that correlate electricity consumption with macroeconomic indicators (GDP, gross public investment and population). The econometric estimates show that demand is not responsive to price changes; however, since the envisioned real price changes are significant, it will be necessary to monitor very closely the evolution of demand, to ensure that investment decisions are based on, realistic estimates. Furthermore, in view of the many open questions regarding Mexico's future economic growth, CFE's energy demand forecast is subject to cot.siderable uncertainty; however, as a significant part of CFE's generation expansion within the next few years will be based on standardized thermal plants that would require relatively short periods of construction, future adjustments to different demand growths could be accomplished relatively easily. On occasion of the annual review of CFE's Ten-year Investment Program, the adequacy of the demand projections will also be reviewed (para. 2.20). Annex 2.3.0 presents details f Mexico's Power Market. Operational Performance 2.18 During its 50 years of existence, CFE has extended electricity service across the entire country, reaching high rates of electrification. CFE has the staff to perform efficiently the planning, design, construction and operation of the electric power system. The number of customers per employee in operation is 183, about average for the larger Latin American countries. During the last five years, because of financial constraints, CFE was forced to limit investments and to reduce expenses in the maintenance of power plants; as a result, the existing installations were overworked, decreasing the availability of the thermal power plants to 65Z in 1981. Lately, however, a rehabilitation program improved their performance (in 1988, availability was 76%) and the goals are to achieve international industry levels (over 77Z) by 1994 (see Annex 2.3.4). Power Sector Planning 2.19 The National Development Plan, approved by the Government in August 1984 (para. 2.06) establishes global objectives, policies, strategies and goals. Since 1962 CFE prepares and updates annually a detailed Ten-year Investment Plan for the Power Sector (Programa de Obras e Inversiones del Sector Electrico-POISE), which is approved by CFE's Administrative Council (para. 2.12), getting in this way implicit approval from the central Government. Considering macro-economic conditions, SPP and SEMIP define investment ceilings for CFE, which in the past resulted in investment programs that favored thermal generation (the least capital intensive option) at the expense of hydroelectricity. 2.20 With the initial assistance of Electricite de France, CFE developed mathematical models for the optimization of decisions on the power system investment program. The least cost generation expansion program established by CFE for 1989 and 1990 has been modified to corsider an investment ceiling imposed by SPP due to financial constraints. After 1991 no financial restrictions have been considered. For that reason, not all of the hydropower projects determined by the least cost program would be started; instead, during 1989 and 1990 several oil fired thermal -10 - generation projects would be started, i.e.: Tuxpan (700 MW) and Lerdo (320 MW), which are based on a least-cost investment program subject to a financial constraint (which is analogous to assuming a higher opportunity cost of capital). Had the financial constraint not been introduced, the investment program would have advanced other hydroelectric and dual fuel (oil and coal) thermal projects, which are more capital intensive. Considering both CFE's own financial position and the macroeconomic situation, which in the near future calls for a continued fiscal effort to achieve the Government stabilization targets, the investment program and the corresponding financial requirements are reasonable. The Government and CFE agreed during negotiations that CFE shall: (a) each year during implementation of the Project, carry out a technical and economic analysis in order to update the investments proposed to be made in the power sector under the Ten-year Investment Plan and shall, when making such analysis: (i) utilize least-cost principles; (ii) utilize export prices for oil derivate products; (iii) consider all environmental and resettlement costs associated with making such investments; and (iv) take into account financial restrictions on CFE due to macroeconomic conditions. Each updated Ten-year Investment Plan shall include an updated financial projection to carry out the Plan, and an economic justification of, and a viable financing plan for, major generation installations not previously included in the Ten-year Investment Plan. CFE shall review with the Bank each updated Plan, promptly after it has been completed; (b) execute only the installations included in the Ten-year Investment Plan; and (c) by September 1 of each year during implementation of the Project, and at the request of either the Bank or the Government, review with the Bank and the Government, the progress in carrying out the Ten-year Investment Plan (para. 4.01 c). The Investment Program 2.21 The proposed power sector Ten-year Investment Plan which is discussed in detail in Annex 2.4.0, is based on a generation expansion program which considers updated demand forecasts. A total investment equivalent to US$29.6 billion (constant 1989 prices) is proposed for the period 1989-1997, during which a total of 15,389 MW would be added to the system, at an average unit cost of US$1,923 per kW installed for the entire system; the program includes 59Z to be invested in generation, 21Z in transmission and 20% in distribution (see Annex 2.4.1). Unit costs used by CFE to prepare the investment program are in line with international costs. It should be mentioned that durin& this period the Laguna Verde nuclear power plant (1,308 MW), construction of which began in 1976, will be completed at an expected unit cost of close to US$2,400 (1988 base) per KW, excluding financial charges; no further nuclear developments would be started in the next decade (para. 2.24). 2.22 The proposed investment program is sound, as it adequately addresses sectoral objectives and takes into account both economic and financial concerns. However, the allocation of 20% of the investment program to distribution, although higher than the average 15% invested in the past five years, is still low, particularly if CFE sets out to reduce distribution losses, now equal to about 7% (total loss;s are 13.6%, para. 2.15). Further allocations to distribution would mean higher capital investments for CFE, which is not now possible, due to the need to keep - 11 - public sector investments low under the ongoing stabilization program. A proposed future Bank operation would focus on and would help to allocate more resources to transmission and distribution investments, and would assist CFE in carrying out programs to improve further the efficiency and reliability of the distribution network, to extend metering to all customers now connected directly, and to shorten the billing period through decentralization of the process. 2.23 At negotiations, CFE agreed to commission a study on co-generation in Mexico (para. 4.01(b)). This study is to be carried out by SEMIP with the assistance of CFE, and will consider the possibilities of utilizing for public service part of the 2,290 MW privately owned in Mexico and possible incentives for new investments in co-generation as means to reduce CFE's investments in generation facilities (see Annex 3.1.0). Mexico's Nuclear Power Program 2.24 The Laguna Verde nuclear power plant, with two units rated 654 MW each, is located 70 km NNW of Veracruz, in the coast of the Gulf of Mexico. No other nuclear plant is being considered for the expansion of the power generating system during the next 16 years. Although the construction was decided by the Government and the site was selected in 1970 with assistance of the International Atomic Energy Agency (IAEA), its construction only started in 1976. The first unit is now completed, nuclear fuel was loaded in October 1988, it reached operational tests at 5% power in March 1989, and is scheduled for commercial operation at 100% power in August 1989. Construction of the second unit is progressing well and is scheduled for commercial operation in 1992. The plant has a Boiling Water Reactor with a Mark II type containment building, engineered and constructed to meet the American Nuclear Regulatory Commission's safety and environmental protection standards and codes and licensing regulations - including the backfittings recommended as a result of the analysis made of the Three Mile Island nuclear plant accident - as well as the recommended radiation exposure limits set by the International Commission of Radiation Protection. CFE has submitted to the National Commission of Safety and Safeguards (NCSS, empowered by law to exert the nuclear regulatory functions in Mexico) the Final Safety Analysis Report, and the NCSS is in the process of issuing the operating licence for the first unit. In the past 20 years the CFE and NCSS (or its equivalent in the past) have been able to develop the manpower required to regulate and implement a nuclear power project to meet international standards of quality and safety, at present with only essential support from consultants and manufacturers. 2.25 Three Operating Safety Analysis Review Teams-OSART, fielded by the IAEA upon request of the Mexican Government (the latest one was held in September 1987), have advised CFE and CNSS on additional measures to be taken to get Laguna Verde operating without undue risks to the population and the environment; CFE has followed the OSART recommendations. Also, twice a year the IAEA safeguard inspectors make the material balance of the nuclear fuel as established in the tri-lateral safeguard agreements entered among IAEA, Mexico and nuclear suppliers, in compliance with the full scope of nuclear safeguards required by the Nuclear Weapons Non-Proliferation Treaty and the Tlatelolco Treaty (Treaty for the Prohibition of Nuclear Weapons in Latin America), of which Mexico is a party. Nuclear fuel and - 12 - radioactive wastes will be stored at site during at least 10 years. Through an environmental program comprising sixteen stations, a laboratory and suitable equipment, CFE is doing the radiological monitoring of the air, water, animal, vegetable and marine life since 1982 and will continue to do it so through the nuclear power plant lifetime and beyond. Two important emergency plans are already in place at Laguna Verde: the Internal Emergency Plan, intended to mitigate the effects of accidents and to protect the health and safety of the nuclear plant staff, and the External Radiological Emergency Plan, intended to face, at regional level, emergencies derived from accidents or incidents in the plant that may affect the population and ecosystems, including the evacuation of about 17,000 persons in a 16 km radius around the Laguna Verde nuclear plant. Electricity Pricing 2.26 Since the early '70s, an important issue confronting the Mexican power sector has been the Government's policy of subsidizing electricity rates. CFE's 1986 revenues covered operating costs and left a positive margin of 6.2Z due to fuel costs that were subsidized by the Government (set a level of about 65Z of international prices). At that time it was estimated that the fuel subsidies plus government contributions to CFE amounted to about 1.1Z of GDP and, consequently were a significant contributor to the total fiscal deficit, which then was 15.6Z of GDP. The Government is now committed to a sounder policy under targets included in the sector's Financial Rehabilitation Agreement (FRA) (para. 2.33) and by 1990 Government contributions would only be required to subsidize low- income residential and agricultural consumers (or 2Z of total revenues). Annexes 2.5.0 and 2.5.1 present additional information on CFE's electricity rates. 2.27 The electricity price issue refers not only to rate levels but also to the tariff structure, as rates are not in line with the cost of supplying electricity to each class of consumer. Previous Bank missions had recommended that a tariff study based on marginal cost principles be carried out and strategies for its implementation be planned. CFE, with IDB financing, engaged the services of the National Electric Utility of Chile (ENDESA) to assist in the preparation of the study, which the Bank reviewed and found satisfactory as a guideline for policy actions. Although additional comprehensive studies would be required, CFE has already started to apply tariffs based on marginal costs to industrial consumers; by January 1990, 1,000 industrial customers consuming one third of CFE's sales are expected to be billed under this program. At negotiations, CFE agreed to: (i) carry out a Second Phase of a Tariff Study to set up a tariff system based on marginal costs for medium voltage consumers, under terms of reference, satisfactory to the Bank, by September 30, 1989, (ii) complete the study by June 30, 1991; (iii) exchange views with the Bank on the conclusions and recommendations of such study and provide to the Bank a plan of action, satisfactory to the Government and the Bank, to implement such recommendations, including a timetable for implementation not later than December 31, 1991; and (iv) implement such plan of action in accordance with such timetable (para. 4.01 e). - 13 - Financial Performance 2.28 Power sector finances showed a deteriorating trend during the 1916-1985 period. Operating income which was positive until 1982, became substantially negative in 1983. Positive results were obtained during 1984-1986 but again became slightly negative in 1987 basically because rate increases did not keep up with inflation. During this period, heavy interest charges on debt resulted in negative net income for every year. This required subsidies and cash transfers from the Government as well as large levels of borrowings, some years in excess of the investment program, resulting in a great and increasing dependency on external funding. In 1988, CFE's finances started to rehabilitate as a result of the FRA (para. 2.33); a positive rate of return was achieved (1.4) and, for the first time, the self financing rrz4.o was positive (1.8%). Annex 2.6.0 contains supplementary information ont CFE's finances together with actual and forecast financial statements. Key financial indicators are detailed in Annex 3.4.0. 2.29 Electricity rates fell, in real terms, about 37% between 1980 and 1983; between 1984 and 1986, rates were sharply increased in nominal terms (136%, 46% and 120% respectively in 1984, 1985 and 1986) but due to higher than expected inflation, they still failed to reach the 1980 level. In 1987, 1988, and 1989 (through April) average rates were increased 113%, 125% and 24%, respectively in nominal terms but, again, the real rates did not yet achieve the 1980 level due to offsetting inflation. Government Subsidies and Cash Tranfers 2.30 As compared to the GDP, total Government subsidies and cash transfers increased from 0.7% in 1979 to 2.3% in 1983, and then declined to 0.4% in 1988, as shown in the following table: 1979 19:3 1985 1988 1989 a/ a) In 1980 billion Mex$ 48.4 105.9 83.4 18.3 17.4 - Fuel oil subsidies 20.9 40.4 27.2 5.0 3.2 - Cash transfers 27.5 65.4 56.2 13.3 14.2 b) As Percentage of r-DP 1.2 2.3 1.7 0.4 0.4 - Fuel oil subsidies 0.5 0.9 0.6 0.1 0.1 - Cash transfers 0.7 1.4 1.1 0.3 0.3 a/ Bank forecast based on CFE's projections. 2.31 Fuel oil subsidies increased from 0.5% in 1979 to 0.9% in 1983, and then declined to 0.1% in 1988, as a result of the Government policy of reducing the difference between domestic and export Mexican oil prices. Currently, the domestic fuel oil price is estimated at 88% of the export price. The financial forecasts assume that in 1992 both prices would be the same; this would require real increases of about 5% per year in the domestic price between 1990 and 1992, over the international prices increase - in real terms - of 2% per year. - 14 - Z.i2 Cash transfers increased from 0.7Z in 1979 to 1.42 in 1983, to help meet the heavy debt service burden (para. 2.28). Since then, cash transfers have declined to 0.3Z as a result of the application of the FRA (para. 2.26 and 2.33). The graph in Annex 2.6.6 shows the evolution of government subsidies and cash transfers during 1979-1989. Financial Rehabilitation Agreement (FRA) 2.33 In view of the serious deterioration of sector finances, and within its general policy of adjustment with growth, in August 1986 an agreement for the financial rehabilitation of the power sector was signed between the Government and CFE, which included as a first step the conversion of about US$8.6 billion of CFE's debt into equity, leaving CFE with a balance of about US$1.7 billion debt. The agreement foresees substantial rate increases in real terms and improvement of productivity (efficiency targets and operating costs). It also includes actions to strengthen institutionally CFE, including improvements in organization and accounting, and establishes a reporting scheme which would be used by Government authorities to monitor its implementation. Annex 2.7.0 presents a summary description of the FRA and proposed targets, some of which have been expressed in loose terms and are difficult to monitor. During negotiations, the Government and CFE agreed to amend the FRA by September 30, 1989, (para. 4.01 a) in order to define more precisely its terms and to reschedule the achievement targets, to levels which while realistic, still remain ambitious, to ensure that the momentum achieved is not lost. The amendment would include, inter alia, the following targets: a) extend the period of validity of the existing financial Rehabilitation Agreement at least until December 31, 1993; b) to limit CFE's short-term borrowing (less than one year) from internal and external markets to no more than 10 percent of its annual cash operating expenses; c) reformulate the criteria for establishing electricity rate increases, to ensure that they are consistent with the agreed financial covenants; in any case, electricity rates shall be increased in real terms not less than 9X average in 1990 and 9% average in 1991; d) by 1990 and thereafter, funding mix for new investment shall have the following compositions 401 minimum internal funding, 10Z maximum Government contribution and 50% maximum borrowings; e) to achieve as a minimum the following performance targets by 1990: customers/employee: 184; sales in GWhlemployee: 1,150; to annually update and review these targets, by October 31, of every year; and f) include a revised definition of the pri:.ce to cost ratio (para. 2.35) that would take into account the effects of high inflation scenarios, or, alternatively, a financial target (i.e. rate of return, self-fi-nancing ratio) which would reflect better the objectives pursued than the current price to cost ratio. In either case the revision would require mutual agreement to ensure that the financial rehabilitation targets pursued are maintained. - 15 - Financial Forecast 2.34 CFE's financial situation is expected to substantially improve during project implementation, provided that electricity rates are adjusted according to the agreements reached (para. 2.33 (c)). Under these assumptions, CFE would be ables (i) to earn a rate of return on average net fixed assets in operation of about 32 in 1990, 52 in 1991, 7Z in 1992 and 82 in 1993 and thereafter; (ii) to generate an average of 60Z of its total financing requirements; (iii) to achieve a debt service coverage ratio higher than 1.5 starting in 1989; and (iv) to eliminate all need for Government equity contributions starting in 1991, except for small subsidies for electric service to low-income residential and agricultural consumers. The graph in Annex 2.6.5 shows how CFE's financing mix would evolve as a result of these policies. 2.35 To assure the successful rehabilitation of CFE's finances, during negotiations, CFE agreed to the following financial covenants, which are consistent with those established in the FRA (para. 2.33 and Annex 2.7.0) and with the ratios traditionally used for Bank power loans (para. 4.01 g)% a) to maintain an average ratio of total operating revenues to the sum of total operating expenses (including charges for depreciation) plus interest and other charges on debt and an adequate provision of funds for CFE's capital expenditures, of not less than 902 during 1989, of not less than 952 during 1990, and 1002 in 1991 and each year thereafter; and b) to seek the Bank's concurrence before incurring on any new borrowing if the debt service coverage ratio is lower than 1.5; It is expected that to achieve these targets CFE will have to increase real electricity rates on average by about 9Z in 1990 and 1991, 102 in 1992 and lower amounts thereafter (see Znex 2.6.4) Bank and Country Goals and Sector Lending Strategy 2.36 Within the framework of its general energy policy, the Government has established the following objectives for the electric power sectors a) to promote an efficient use of electricity through realistic pricing pelicies, energy conservation, and improvement in sector operations; b) to diversify the sources of power generation by supporting the development of cost-effective alternatives to conventional oil- fired steam plants, such as hyd-oelectric, coal fired, and geothermal power plants; c) to strengthen the financial condition of the sector by implementing the FRA, through significant conversion of debt into equity, rate increases and reduction of operating copts; and - 16 - d) to make electricity available to an increasing number of consumers with emphasis on low-income consumers and on productive rural consumers. 2.37 The Bank's role in the sector is to support the general energy policy of the country and the objectives established by the Government for the power sector by: a) assisting the country to obtain added foreign currency for financing, on adequate terms, the power sector investment program, through the Bank's own lending instruments or acting as a catalyst for other sources of financing; b) ensuring the adequate consideration of least-cost principles in the power sector investment program; c) promoting financial policies that will eliminate the need for Government subsidies, and ensuring that pricing policies lead to an efficient allocation of resources; d) prompting the Government to open gradually the procurement in publi: enterprises, including the power sector to international competition; e) helping CFE in its institution building efforts, through implementation of streamlined norms and procedures and clear delimitations of accountability; f) strengthening the sector'b norms and procedures on environment and social matters as related to construction and operation of power projects; and g) through adequate policies to promote co-generation and efficient use of energy. CFE's Procurement Practices 2.38 In accordance with Government legislation and policies, in the past CFE restricted its sources to national -mppliers, and permitted international competition only when no Mexican manufacturer or contractor existed or had the capacity to do a job. However, after Mexico joined GATT in 1986, public enterprises, including CFE, are slowly opening their market to international competition. Under the proposed operation, all of the contracts financed by the Bank will be procured in accordance with Bank guidelines (civil works and hiring of consultants). One of the objectives of the Bank's strategy towards the Mexican power sector is to support the Government policy of a gradual opening of procurement to international competition. Bank Participation in the Sector 2.39 The Bank participated actively in financing development plans in the power sector in Mexico until 1974, when the Eleventh Power Project was completed. Until then, the Bank had made eleven loans to the power sector - 17 - fnr a total of about US$605 million. Du-ing the period of Bank I cticipation, the sector grew at a steady pace and its finances and i.tstitutional aspects were substantially strengthened. Thereafter, Bank missions visited Mexico in several occasions to consider resuming lending, but no further loans were possible as important financial and procurement issues remained unsolved and dialogue with the Government was difficult. During the absence of the Bank, sector finances deteriorated substantially as the Government let electricity rates erode, in real terms, following a policy of subsidies financed by petroleum revenues. Only two project performance audit reports have been prepared for Bank power loans to Mexico: No. 859 and 1775 for the Third and Fourth Power Sector Programs (loans 659-ME and 834-ME), respectively. Both PPARs show th- positive contr3bution of Bank resources to the sector's physical development and to the achievement of an important technical objective: frequency unification. They also show the Bank's inability to solve CFE's institutional problems and to reverse the deteriorating trend in sector finances which resulted in its long absence (15 years) from sector operations. 3. THE PROJECT Project Origin 3.01 In August 1986, the Government and CFE signed a power sector Financial Rehabilitation Agreement (para. 2.33), which focused on some of the critical issues that the Bank had been raising and proposed measures to address them; subsequently and as a response to the Government's interest in Bank financing for a hydroelectric development project of the power sector, three preparatory missions visited Mexico in October 1986, March 1987 and May 1987. Appraisal took place in November 1987 and negotiations in September, 1988 and April, 1989. Objectives and Long-Term Strategy 3.02 The proposed loan would be the first step, to be followed by possible future Bank operations, to assist the sector in achieving its * objectives (para. 2.36). The project would assist in achieving the * sector's objectives of: (a) promoting an efficient use vf electricity through realistic pricing policies, energy conservation and improvement of sector operations; (b) diversifying sources of power generation from the now mainly oil-based generation; (c) strengthening CFE's financial condition by increasing electricity rates and implementing a new Financial Rehabilitation Agreement; (d) making electricity available to an increasing number of consumers; and (e) improving CFE's capabilities to deal with social and environmental aspects of hydroelectric power projects. The loan would assist the Government and CFE to meet the power sector financing needs, by providing funds to finance about 32% of the costs of the Aguamilpa and Zimapan Hydroelectric Power Plants. Project Description 3.03 The proposed project is part of the least cost development program of the sector (para. 3.23). The loan would finance the components described in detail in Annex 3.1.0 and summarized as follows: - 18 - The Aguamilpa Hydroelectric Project: (66.7% of the total project cost) Construction of a 960 MW hydrcelectric power plant, with an annual average generation of 2,131 GWh. The project is located about 40 km NNE of the city of Tepic. The main works include (i) a concrete faced rock-filled dam. 187 m high, 675 m wide at the crest, which will form a reservoir with a useful storage of 2,575 million m3; (ii) a spillway with a 13,000 m3/sec capacity; (iii) three 215 m long pressure tunnels; (iv) an underground power house with three generating units, each rated 320 MW; (v) an outdoor substation; (vi) two 400 kV transmission lines, 255 km total length, for interconnection with the national grid; and (vii) environmental and resettlement works related with the power plant. The Zimapan Hydroelectric Project: (32.5Z) Construction of a 280 MW hydro-electric power plant, with an annual average generation of 1,292 GWh. The project is located 250 km north of Mexico D.F. The main works include (i) a concrete arch dam, 200 m high, 80 m wide at che crest, which will form a reservoir with a useful volume of 680 million m3; (ii) a spillway with a capacity of 2,960 m3lsec; (iii) a 4.5 m diameter pressure tunnel 20.2 km long; (iv) an underground power house with two generating units, each rated 140 MW; (v) an underground substation; (vi) r.ne 115 kV and another 230 kV transmission lines, 150 km total length, for interconnection to the national grid; and (vii) environmental and resettlement works related with the power plant. Social and Environmental Program: (0.32) Execution of a program which wi. include measures to prepare policy statements and field manuals, to strengthen the central, regional and project social and environmental units, to salvage archeological treasures, to develop resettlement and rehabilitation plans, and to train staff and provide specialized equipment as required, for the execution of the Aguamilpa and Zimapan Projects in particular, and for the execution and operation of other hydro projects in general (see Annex 3.2.0). Energy Related Studies: (0.4Z) Execution of (a) a Program to Promote Energy Conservation and Efficient Use of Energy in Mexico, (b) a Co-Generation Study, and (c) an Operations Improvement Study of CFE's Electric Power System; and Other Studies: (0.12) Execution of (a) a CFE's Management Study and (b) the Second Phase of a Tariff Study. Estimated Cost 3.04 The total project cost, including physical and price contingencies is estimated at US$1,287 million, of which approximately 40% is the foreign cost. Interest during construction and other financial charges on the Bank loan and other loans amount to about US$153 million. Local cost estimates include approximately US$135 million of identifiable taxes and duties. Above estimate includes the costs of the environmental and resettlement works related directly with the Aguamilpa and Zimapan Projects, as shown in -19 - Annex 3.1.1, which amount to approximately US$12.5 million (current costs) for Aguamilpa and U3$17.6 million for Zimapan and the costs of CFE's Social and Environmental Program (US$4.4 million current costs) related with training and technical assistance to improve CFE's overall capacity in that area. Detailed cost estimates of the project are given in Annex 3.1.0 and are summarized below: Project Cost Estimate Local Foreign Total Project Component ---- Million US$ ---- Aguamilpa Project 399.7 266.6 666.3 Zimapan Project 187.0 124.7 311.7 CFE's Social and Environmental Pro&ram 2.0 1.4 3.4 Energy Related Studies and Management Studies 3.2 2.1 5.3 Total Base Cost (January 1989 prices) 591.9 394.8 986.7 Physical Contingency 94.2 62.8 157.0 Price Contingency 85.9 57.2 143.1 Total Project Cost 772.0 514.8 1,286.8 Interest During Construction 0.0 153.2 153.2 Total Financing Requirements 772.0 668.0 1,440.0 3.05 Project cost estimates were prepared by CFE planning and engineering staff, based on detailed engineering design for the Aguamilpa Project and advanced feasibility studies for the Zimapan Project, and manpower requirements for the studies. These cost estimates were reviewed by specialized consultants, engaged by the Bank, and found reasonable. Physical contingencies have been added to each proiect component, varying from 5Z to 30% of base cost, according to the risk involved, resulting in an average of 16%; price contingency has been added to both foreign and local costs, expressed in US dollars, at the following escalation rates: 1989-90, S%; 1991-95, 4Z. It is assumed that in the medium term, the exchange rate will be periodically adjusted to reflect the difference between the internal inflation rate and the evolution of external prices. Financing Plan 3.06 The sources of funds tor the project are the following: - 20 - Financial Plan Source Local Costs Foreign Costs Total ------- Million US$ ------- CFE's own resources 590.0 143.0 733.0 51 Government contributions a/ 100.0 0.0 100.0 7 IBRD Loan 82.0 378.0 460.0 32 Other Loans 0.0 147.0 147.0 10 Total Funds 772.0 668.0 1,440.0 100 a/ Includes US$ 1.70 million to finance SEMIP's energy studies. 3.07 The total financial requirements for the project, including interest during construction and duties and taxes are estimated at US$1,440.0 million, of which U3$668.0 million or 46Z of the total requirement would be foreign currency. A Bank loan of US$460.0 million is proposed to finance 32? of the project financing requirements. Bilateral and/or suppliers credits for a total of US$147.0 million would finance 10; the remaining 58% would be financed from internally generated funds (51?) and Government contributions (7?). Legal Arrangements 3.08 The Borrower of the loan will be Nacional Financiera, S.N.C. (NAFIN), a Government-owned national development agency, which will act as the administrator of the loan; the Beneficiary of the loan will be CFE, which will be responsible for the execution of the project. The total amount of the loan, US$460.0 million will be on-lent by NAFIN to CFE, under terms &nd conditions which would include inte alia, (i) the sub-loan will be denominated in US dollars, (ii) the onlendi.g terms and conditions would be the same as the Bank loan, and (iii) NAFIN will charge a fee amountIng to 10? of the interest charged by the Bank. CFE will assume the exchange of US dollar to Mexican peso and interest risks; NAFIN will bear the US dollar to basket of currencies exchange risk. A condition of loan effectiveness is the signature of a satisfactory subsidiary loan agreement between NAFIN and CFE (para. 4.02 a). CFE will transfer to SEMIP, as a contribution, part of the loan (US$2.5 million) to finance part of the energy related studies (Annex 3.1.0). Project Implementation and Status of Project Preparation 3.09 CFE, the Beneficiary of the loan, will be in charge of the execution of the project. It has the organization, expertise and staff required for its successful implementation. The Aguanilpa Project is at a level of detailed engineering design, while the Zimapan Project has reached an advanced level of feasibility at pre-design level and engineering design is underway (engineering design to bid the river diversion and auxiliary roads is ready). Although CFE has a long and successful record of executing hydroelectric power projects without major delays or cost - 21 - overruns, and in order to assure that the execution of the Zimapan Project proceeds as scheduled, at negotiations, CFE agreed to complete the final engineering for the project by September 30, 1989. No disbursements for Bank financed contracts related with this project component will take place until this condition is met (para. 4.01 1). Design and studies were prepared by CFE's staff and reviewed by the Bank and by an independent consulting firm hired by the Bank under a Consultant's Trust Fund, who confirmed the technical viability and cost estimates of the two power plants. Supervision of construction of the Aguamilpa and Zimapan Projects will be done by CFE; consultants and specialists will be engaged only if required to solve unusual situations. During negotiations, CFE agreed to hire an independent Board of Consultants, to be composed of internationally-known experts in hydro plant design, geology, foundations and seismology, to review the design of both power plants, and periodically supervise their construction (para. 4.01 j). Most of the construction will be done employing contractors; however, CFE will also use its important construction force to carry out preparatory or auxiliary works for the two projects. Although in the past some projects have had delays beyond average construction periods (some of which were due to financial constraints), in general, CFE has a good record in executing projects on time and within budget. The construction of both projects will be coordinated by the Hydroelectric Projects Department from CFE's central offices in Mexico City; local project offices will be fully responsible for the execution of each project. It is expected that the proposed project can be successfully implemented by CFE; however, Bank supervision is expected to be intensive, especially in the first years of project execution, to assist CFE in the execution of the resettlement programs and in solving procurement problems in the period of transition from mostly local procurement to international competitive bidding. Agreement on satisfactory bidding documents were reached prior to negotiations (para. ?.12). Construction work for river di-ersion for the Aguamilpa project started ot April 1, 1989, with CFE's own resources; construction for the Zimapan project is planned to start in November, 1989, and commercial operation in July and November 1995, respectively; the official project completion date for both projects is June 1996, to allow time for site clean-up and closing of all contracts. 3.10 CFE's Social and Environmental Program will be coordinated by CFE's Director of Construction and will involve the Hydroelectric Projects Management Unit, with the assistance of consultants as required. The environmental works related with the Aguamilpa and Zimapan Projects, and resettlement of about 3,500 persons in both projects will be carried out by the local offices in charge of the construction of the projects. During negotiations, CFE agreed to 'lire experts in environment and resettlement issues, to assist in the execuLion of the program (para. 4.01 j). The environment and resettlement plans for Aguamilpa and Zimapan were reviewed by the Bank and found acceptable; a condition of loan effectiveness is that CFE has made progress satisfactory to the Bank in the implementation of the resettlement and environmental plans (para. 4.02 b). 3.11 The energy related studies (Promotion of Energy Conservation and Efficient Use of Energy in Mexico and Co-Generation) will be executed by SEMIP (para. 2.10). It is anticipated that CFE and PEMEX will actively participate in the execution of the studies. CFE will be in charge of the execution of the Operations Improvement Study of CFE's Electric Power - 22 - System (para. 2.16), of the Second Phase of the Tariff Study (para. 2.27), and of the Management Study (para. 2.13); ad-hoc task groups will be formed. Procurement 3.12 Funds from the Bank loan would finance the following: (a) for the Aguamilpa Froject, civil works contracts covering the river diversion and main infrastructure works, the dan construction and the spillway and power house construction; (b) for the Zimapan Project, civil works contracts covering the river diversion, the intake works and pressure tunnel, and the dam and spillway; (c) consultants for the execution of energy related and management studies; and (d) staff training and specialized training and environmental equipment. Procurement of civil works will be carried out under International Competitive Bidding (ICB) in accordance with Bank Procurement Guidelines, and consultants will be hired following Bank guidelines (para. 4.01 h). Bidders for the civil works included in the Project shall be prequalified. Due to the limited number of suppliers, the equipment related with the environment and resettlement program and the energy conservation study would be purchased under Limited International Bidding (LIB), with a limit of US$2.0 million total cost and US$500,000 per contract. Procurement documents for contracts over US$500,000 equivalent, which represent over 98Z of the total loan, will be subject to prior review by the Bank. Agreement on standardized procurement documents for the procurement of civil works was reached prior to negotiations. 3.13 About 1OZ of the cost of the Aguamilpa and Zimapan Projects (US$129 million) is considered reserved procurement and its cost was deducted from the total cost in order to determine the amount of the proposed loan; its foreign component will not be financed by the proceeds of the proposed Bank loan. Such reserved procurement corresponds to some civil works contracts and minor mechanical and electrical equipment which would be bought locally, even though its characteristics would justify ICB procurement. However, the principles of economy and efficiency shall be preserved as total costs are not expected to be affected in any significant way. 3.14 The following table summarizes procurement arrangements for the project, shown in detail in Annex 3.1.2: - 23 - .......---Procurement Method1.-------- I C B2 L C B2 Other Total Cost Project Element -- (Million of current US Dollars) -- Aguamilpa and Zimapan Projects: - Main civil works contracts 635.5 - - 635.5 (455.0) - - (455.0) - Other auxiliary civil works, resettlement, - 116.4 10.0 126.4 environmental, and miscellaneous - (0.0) (0.0) (0.0) works - Electromechanical equipment and - - 340.13 340.1 transmission lines - - (0.0) (0.0) - Engineering, administration and - - 174.0 174.0 supervision - - (0.0) (0.0) Social and environmental programs, - - 4.44 4.4 including training - - (1.0) (1.0) Energy and management studies, - - 6.44 6.4 including training - - (4.0) (4.0) TOTAL 635.5 116.4 534.9 1,286.8 (455.0) (0.0) (5.0) (460.0) 11 Figures in parenthesis are amounts financed by the Bank loan. 2, ICB: International Competitive Bidding; LCB: Local Competitive Bidding. 3/ To be procured either under international bidding with supplier financing or from specific countries offering bilateral financing and CFE's own resources. 4/ Includes a total of US$2.0 million to be purchased under Limited International Bidding. Disbursements 3.15 Proceeds of the loan would finance the following: (a) 85% of the cost of civil works for the river diversion and main infrastructure works and the construction of the dam, spillway and power house of the Aguamilpa Hydroelectric Project, up to US$320.0 million; (b) 85Z of the cost of civil works contracts for the construction of the river diversion intake works, pressure tunnel, dam and spillway of the Zimapan Hydroelectric Project, up to US$135.0 million; (c) 100% of the foreign cost related with staff training and purchase of equipment for the Social and Environmental Program; and (d) 100% of the cost of consultants required for the execution of energy, management and tariff studies, including the cost of the Board of Consultants. - 24 - 3.16 The loan is expected to be disbursed over a period of seven years (Annex 3.1.3), in accordance with the Bank's standard disbursement profiles; retroactive financing in an aggregate amount of up to US$20.0 million is proposed, for any of the civil works contracts described in para. 3.12, awarded under ICB after August 31. 1988. All disbursements will be made through a Special Account, to be established with a limit of US$35.0 million, equivalent to about four months of estimated peak disbursements. Documentation would be retained by NAFIN and would be made available for periodic inspection by Bank staff. Statements of Expenditure would be used for all eligible expenditures made. At negotiations, NAFIN agreed to establish the Special Account, its terms and conditions, and to open separate accounting for all the components of the project (para. 4.01 (k)). Auditing 3.17 As required by Mexican legislation for all state companies, CFE has its financial statements audited by a firm of qualified independent auditors approved by the General Comptroller's Office. At present such firm is Despacho Roberto Casas Alatriste, Contadores Publicos, which acts as correspondent of Coopers & Lybrand, an international independent audit firm. They are acceptable. During project execution, CFE shall continue to engage the services of independent auditors acceptable to the Bank and shall present in accordance with terms of reference acceptable to the Bank duly audited financial statements and project accounts within six months of the close of the fiscal year (para. 4.01 h). During negotiations, NAFIN agreed to implement controls for the management of the Special Account, and to engage independent and qualified auditors, to audit the accounting of the project, including the Special Account (para. 4.01 k). Environmental and Social Aspects 3.18 Mexico has legislation that sets regulations and policies for the protection of the environment, but has no specific law for protecting rights of resettled people affected by new power projects; the "Ley de Reforma Agraria" (Agrarian Reform Law) regulates the indemnization due to peasants in the rural communities ("ejidos" and "comunas") for their lands in cases of resettlements. For the execution of any project that may alter the physical conditions of the environment, CFE has to file a petition and present satisfactory evidence that regulations are being observed, both to diminish the negative effects to the environment and to compensate and care for the people displaced or affected by the project. The Ministry of Urban Development and Ecology (SEDUE) is concerned with the effects to the environment by the construction of thermal, geothermal, hydro and nuclear power plants. The Ministries of Fisheries (SDP), of Agriculture and Hydro Resources (SARH), and of Agrarian Reform ('RA) are the governing entities that evaluate and provide information to SEDUE, so that the latter can decide on the approval of new hydroelectric projects based on their effect on the environment as well as on resettled people. SEDUE requirements are suitable for environmental evaluation of new projects. 3.19 The construction of the Aguamilpa Project will affect abaut 2,000 mestizo and Huichol indian people, of which about 1,000 will have to be - 25 - resettled; the Zimapan Project will affect about 3,500 people of which about 2,500 will have to be resettled (see Annex 3.1.0). In the past, CFE has successfully taken care of the social and environmental problems derived from the construction of power projects; however, in view of the large expansion of activities presented by the hydroelectric development program, CFE will have to expand the capability of their staff in this area (see details in Annex 3.2.0). In order to assist CFE to strcngthen their practices in the execution and operation of hydroelectric projects in general, and of the Aguamilpa and Zimapan in specific, during negotiations, agreements were reached with CFE for the execution of a Social and Environmental Program (para. 4.01 d) which will entail, as explained in Annex 3.1.0: (a) strengthening of CFE's Central Unit for Socioeconomic and Environmental Affairs and the four Regional Units; (b) execution of resettlement plans for the Aguamilpa and Zimapan Projects, and creation of local resettlement and environmental teams for both projects; (c) a program to survey and salvage any archeological treasures in both projecto; (d) execution of studies on the effects of impounding the waters of the rivers on which the two projects are located; (e) development of a set of environmental and resettlement guidelines; and (f) training of CFE staff. Loan effectiveness is conditioned to satisfactory progress in the implementation of the program (para. 4.02 b); failure to continue its implementation would be a condition for suspension of disbursements. Dam Safety and Inspection 3.20 The proposed project will include the construction of two dams: a rock-filled dam, 187 meters high for the Aguamilpa Hydroelectric Power Project, and a concrete arch dam, 200 meters high for the Zimapan Project. As is usual in Mexico, both dams, and in general all the structures for power plants, are designed considering seismic risks. During negotiations, agreements were reached that CFE shall propose to the Bank appLopriate arrangements for the Bank's review not laer than one year before the expected completion of each dam and related infrastructure works, with respect to pist-construction inspection and operation. Performance Indicators 3.21 The Financial Rehabilitation Agreement includes a reasonable number of indicators, which represent an improvement of CFE's technical and financial performance. Annex 3.4.0 shows a set of performance indicators derived from the FRA and the financial targets agreed with CFE. The Bank would monitor CFE's performance achievements through supervision missions and semiannual project progress reports to be prepared by CFE. Risks 3.22 Despite the seismic conditions in Mexico, physical risks are expected to be less than average in this type of work, as extensive geological exploration has been conducted and additional preparation studies are being carried out before proceeding with construction of both projects and the Mexicans have successfully implemented similar projects in the past. Independent experts hired by the Bank under a Consultant's Trust Fund, have confirmed the technical viability and reviewed the design and cost estimates of the two power plants, including geological conditions. - 26 - The resettlement risks are expected to be minimal as adequate measures will be implemented before and during project execution. Failure to implement adequately the FRA would adversely affect sector finances and could result in delays of the execution of the CFE's investment program. Economic Justification 3.23 The proposed Aguamilpa and Zimapan Hydroelectric Projects are part of CFE's Ten-year Investment Program. A least-cost analysis shows that the two projects represent the most economical solution to satisfy CFE's generation expansion requirements. Had CFE chosen to build thermal plants with approximately equivalent energy generation capacity, the incremental cost to the economy in present value terms is estimated to amount to US$348.0 million (at a discount rate of 11%) or 41% higher than the hydroelectric alternative. Annex 3.3.? shows the result of the comparison. 3.24 It is not feasible to calculate a rate of return for an individual generation project, as benefits are contingent upon complementary investments in transmission and distribution and upon the coordinated operation of the two projects within CFE's power generation system. Hence, the internal rate of return (IRR) of the total 1989-1997 CFE's investment program was computed as the discount rate equalizing the present values of the stream of costs and benefits associated with it. The cost stream, expressed in 1989 constant prices, includes: (i) the overall investment program, including environmental and resettlement costs; and (ii) incremental operation and maintenance costs. All inputs, including fuel, are priced at their opportunity cost. Taxes and inteinal transfers are excluded. As a proxy for benefits, the revenues derived from incremental energy sales were applied, at the retail rates considered to reach the goals of the FRA which entail reaching long-run marginal coats by the year 1996. The economic evaluation is conservative, since no attempt was made to reflect other benefits to the economy of the country: the dam to be constructed at the Aguamilpa Project would regulate the river flow and would provide the possibilities for irrigation of an area of 70,000 hectares suitable for agriculture, and would provide for improved flood control; neither of these benefits have been quantified. Consumer surplus would be a significant benefit which has not been quantified either (data from other countries shows that the cost of energy not supplied to industry may be 10 to 30 times the prevailing electricity rate). Annex 3.3.0 presents details of the economic analysis and sensitivity tests. Based on the above assumptions, the internal rate of return for the proposed investment program is 13Z. Sensitivity analyses show the rate of return to be very sensitive to changes in electricity rates (IRR is about 11% if rates are 10% lower) and to energy sales (IRR is 11% if sales grow at 1Z p.a. lower than forecast), relatively sensitive to capital cost increases, and to fuel cost increases (IRR is about 12? if these costs are 10? higher) and, moderately sensitive to change in operation and maintenance costs. 3.25 The analysis confirms the economic merits of the proposed investment; if rates are set at levels in accordance with the requirements of the FRA, the rate of return on the investment program would be above the estimated cost of capital in Mexico (approximately 11?). - 27 - Project File 3.26 Annex 3.5.0 lists the documents consulted for processing the proposed operation. 4. AGREEMENTS REACHED AND RECOMMENDATION 4.01 During negotiations, agreements were reached on the following conditions: With the Government and CFE: a) by September 30, 1989, to amend the Financial Rehabilitation Agreement, in terms and conditions satisfactory to the Bank, in order to define more precisely its terms and reschedule the achievement targets (para. 2.33): With the Government: b) execution by SEMIP, with the assistance of consultants under a schedule and termis or reference acceptable to the Bank, of a Program to Promote Energy Conservation and Efficient Use of Energy in Mexico and a Co- Generation Study. Final terms of reference shall be presented to the Bank by September 30, 1989; the studies shall be carried out by September 30, 1991; views shall be exchanged with the Bank on the results and recommendations of such studies by December 31, 1991, (para. 2.10); With CFE: c) Execution of a technical and economic analysis in order to update the investments proposed to be made in the power sector under the Ten-year Investment Plan each year during implementation of the Project and shall, when making such analysis: (i) utilize least-cost principles; (ii) utilize export prices for oil derivate products; (iii) consider all environmental and resettlement costs associated with naking such investments; and (iv) take into account financial restrictions on CFE due to macroeconomic conditions. Each updated Ten-year Investment Plan shall include an updated financial projection to carry out the Plan, and an economic justification of, and a viable financing plan for, major generation installations not previously included in the Ten-year Investment Plan. CFE shall review with the Bank each updated Plan, promptly after it has been completed, execute only the installations included in the Ten-year Investment Plan and, by September 1 of each year during implementation of the Project, and at the request of either the Bank or the Government, review with the Bank and the Government, the progress of carrying out the Ten-year Investment Plan (para. 2.20). d) execution of a Social and Environmental Program, including specific plans for the Aguamilpa and Zimapan Projects, under a schedule acceptable to the Bank, designed to assist CFE in improving their existing practices and staffing (para. 3.19); - 28 - e) execution, with the assistance of consultants, under terms of reference to be agreed with the Bank not later than September 30, 1989, of (i) a Management Study (para. 2.13); (ii) a Study on the Operations Improvement of CFE'P Electric Power System, (para. 2.16); and (iii) the second phase of a Tariff Study (para. 2.27); by June 30, 1991 complete such studies; not later than December 31, 1991, exchange views with the Bank on the conclusions and recommendations of such studies, and provide to the Bank a plan of action, satisfactory to the Government and the Bank, to implement such recommendations, including a timetable for implementation; and implement such plan of action in accordance with such timetable; f) submission to the Bank of a program of periodic inspections to assure the safety of the dams for the Aguamilpa and Zimapan Projects during operation (para. 3.20); g) inclusion of the following financial covenants (para. 2.35): (i) to maintain an average ratio of total operating revenues to the sum of total operating expenses plus interest and other charges on debt and an adequate provision of funds for CFE's capital expenditures, of not less than 90X during 1989, of not less than 95Z in 1990, and of not less than 100Z during 1991, and each year thereafter; and (ii) to seek the Bank's concurrence before incurring on any new borrowing if the debt service coverage ratio is lower than 1.5; h) inclusion of other covenantr for procurement (para. 3.12) and auditing (para. 3.17); i) completion of the final engineering for the Zimapan Hydroelectric Power Plant not later than September 30, 1989. No disbursements for Bank financed contracts related with Zimapan would take place until this condition is met (para. 3.09). j) hiring of an independent Board of Consultants and of social and environmental specialists, satisfactory to the Bank, to assist CFE in the review of the design and supervision of construction of the Aguamilpa and Zimapbn Projects (paras. 3.09 and 3.10). With NAFIN: k) establishment of a Special Account, its terms and conditions, accounting methods, internal controls for the managEment of the account, and engagement of independant and qualified auditors to audit the accounting of the project, including the Special Account (paras. 3.16 and 3.17); 4.02 Conditions of loan effectiveness are: a) the signature of a satisfactory subsidiary loan agreement with CFE (para. 3.08); - 29 - b) that CFE has made progress satisfactory to the Bank in the implementation of the environmental and resettlement plans for the Aguamilpa and Zimapan Hydro Plants (para. 3.19); 4.04 With the above assurances, the project constitutes a suitable basis for a loan of US$460.0 million equivalent under terms and conditions applicable to Mexico. May 16, 1989 - 30 - ANNEX 2.1.0 MEXICO COMISION FEDERAL DE ELECTRICIDAD HYDROELECTRIC DEVELOPMENT PROJECT Historical Energy Balance (in thousand Tcal) 1975 1980 1982 1988 1984 1985 1986 1987 1988 2/ Gross Supply Gross Production 789.9 1681.7 2227.6 2160.2 2148.4 2096.6 1960 - 2043.2 2088.8 Exports (51.0) (480.8) (834.5) (869.6) (855.7) (804.3) (72( 8) (768.9) (720.9) .mports 4.1 6.1 4.9 2.0 1.7 4.8 1.8 0.2 0.2 Stock Variatione and Leeses1 (88.7) (55.1) (187.1) (79.0) (85.4) (80.7) (28.3) (3.0) (38.0) Total Supply 659.8 1121.7 1260.8 1228.8 1254.0 1265.9 1218.9 1266.5 1284.6 Grose Consumption by Source Petroleum 829.1 611.7 646.6 615.7 684.8 697.4 068.5 701.6 698.1 Natural Gas 178.8 844.5 484.2 428.1 876.6 886.9 864.6 861.0 371.4 Biomess 86.6 90.7 87.6 91.1 96.8 95.2 99.2 100.8 101.4 Hydroenergy 47.1 47.6 88.0 55.4 68.9 69.6 62 q 47.4 62.7 Coal 21.4 24.5 26.9 29.5 29.6 82.1 85.-. 34.2 88.5 Geoenergy 1.6 2.6 8.6 8.6 8.9 4.4 8.9 11.5 12.5 Total Consumption 6859.8 1121.7 1260.8 1228.8 1254.0 1285.9 1218.9 1256.5 1284.8 1/ Feedstocks processed abroad and barter 2/ Preliminary figures Surce: MEXICO. Secreterl de Energfe, Minas * Industria Pareestatal. BelancesNaionales 1965-195, 1996 and 1987. 2/15/89 - 31 - ANNEX 2.1.1 MEXICO HYDROELECTRIC DEVELOPMENT PROJECT Fuel Prices in Mexico 198 1984 1986 198 1987 198 1981 Unit Avg. Avg. Fe Avg. Avg. Feb. 1. Prices In 1966 Constant Peso. Residual Oil */ Liter 57.69 98.51 97.41 121.18 108.71 114.01 112.00 Dieel Oil Liter 825.78 841.88 888.84 448.94 481.65 456.20 442.18 Natural Ges as 94.09 148.59 168.11 208.81 178.29 167.62 108.00 desoline Nove Liter 569.18 628.98 514.05 612.47 477.98 505.48 496.00 LPO Liter 118.17 91.91 75.17 172.84 178.8 168.96 179.86 Coal Kg 111.85 100.87 94.01 105.27 108.65 79.07 95.14 2. Prices in 1988 US Dollars Ref. Residual Oil 1 Barrel 8.81 6.86 7.86 9.58 8.28 8.67 9.64 10.901/ Diesel Oil Barrel 21.46 26.16 26.69 86.49 82.87 84.46 29.80 18.00.1 Natural Gs 1000 cu.ft 1.11 1.9 2.19 2.96 2.40 2.52 2.87 2.85 b/ Oassoile Nova Gal. 0.89 0.98 0.92 0.96 0.85 0.91 0.75 0.90 c/ LP0 Gal. 0.18 0.16 0.14 0.82 0.81 0.88 0.27 0.69d/ Coal Ton. 48.84 46.70 44.65 62.85 51.68 87.68 42.18 88.90 !/ Notes: E/ PEMEX export prices of January 1989. b/ Wholesale price to US electric utilities. c/ Price of regular lesoed gasoline. d/ Propane, consumer grads. ./ Coal delivered to US electric utilities. */ Low quality residual oil, with high contents of sulphur and vanadium. Source: CFE ANNEX 2.2.0 Page 1 of 6 MEXICO COMISION FEDERAL DE ELECTRICIDAD HYDROELECTRIC DEVELOPMENT PROJECT CFE: Institutional Aspects Background and Ownership 1. CFE is a decentralized entity of the Mexican Government, originally established by Presidential Decree in 1933; it started operations in 1937. Although it was created with the objective of meeting electricity demand in those areas that were not attractive for private owned utilities, the creation of CFE meant the initiation of a process of total Government ownership of electric utilities which culminated in 1960. 2. Article 27 of the Mexican Constit1ution, as amended in 1960, grants to the Government the exclusive right to provide electric power services to the public. As part of this program, CFE acquired the assets of American Foreign Power Company, including the generatiLn and distribution facilities of the most important cities outside of Mexico City, including ten state capitals, and some agricultural and industrial areas. CFE also acquired majority ownership of the Mexican Light and Power Company (Mexlight), a Canadian electric utility established in the 1890s. Mexlight installations were transferred to a separate legal entity, Compafia de Luz y Fuerza del Centro (CLFC). CLFC exists as a separate public entity controlled by CFE and supplies electric power purchased from CFE to Mexico City. CLFC is under a liquidation process which is being carried out slowly, largely due to the labor problems which might be caused by the integration of CLFC's organization into CFE, as the workers have different unions and their contracts provide for different benefits. Relationship with the Government 3. As a decentralized public agency, CFE is subject to the control of the Federal Government through the Ministry of Energy, Mines and State Enterprises (SEMIP). The annual budget of CFE is submitted to the Ministry of Planning and Budget (SPP) for its review and inclusion in the Federal Budget which is subject to approval by the House of Representatives. Electricity tariffs, as most public sector prices, are determined by a unit under the Ministry of Finance and Public Credit (SHCP) based on requests presented by CFE and taking macroeconomic conditions into account. Organization 4. As established by the Electric Energy Public Service Law, amended in December 1983, CFE has an Administrative Council (Junta de Gobierno) as the governing unit in its organizational structure, with overall corporate responsibility for company policy and supervision of its overall corporate affairs. Its Chairman is the Minister of SEMIP and its other members are - 33 - ANNEX 2.2.0 Page 2 of 6 the Ministers of Finance and Public Credit (SHCP); Agriculture ard Hydro Resources (SARH); and Planning and Budget (SPP); the General Director of the State Oil Company (PEMEX); and three labor delegates. A Supervisory Council has three members representing the Federal Comptroller, SEMIP and the Administrative Council. The General Director is the Chief Executive Officer of the company. The Directors of Construction, Operations and Administration report directly to him as well as the Comptroller and the heads of Finance, Legal Department and Social Communications. The company is divided for each one of its functional areas in different geographical regions which have limited autonomy as most of the major decisionr are taken at headquarters. CFE's organization is adequate for a company with its characteristics but a system of decentralized authority, giving the regional offices a greater degree of autonomy, needs to be established. Management 5. CFE is well managed, considering its size and the market it serves. It has qualified and competent managers and an adequate management information system. The particular conditions created by Mertcan culture and economy, characterized by a significant concentration of power in the Federal Goveriment and by using the state owned companies to foster the macroeconomic and social objectives of the Government (such as employment targets and promotion of local industry), have placed some constraints on management which, however, have not resulted in costs which are out of line with international standards. A feature common to Mexican state-owned companies is the significant participation of labor representatives in the decision making process; at CFE they are members of the Administrative Council and other collegiate bodies in the organization. Their participation has allowed smooth labor relations within the company as the union has taken the company's objectives as their own. Information Systems 6. The data processing unit of CFE, located in the Mexico City headquarters, operates the information systems related to the national offices and assists and monitors the regional offices in the creation and implementation of the norms and procedures of the company regarding data processing. The system has the following objectives: (a) to establish an interconnected net of local and regional computer systems; (b) a system master plan with operational and strategic components; and (c) a quality control program. During the next five years, it plans to implement the following projects: (i) complete tho computerized billing alld collection system by including small isolated localities and by consolidating the information on a regional basis; (ii) set up an inventories system, under national norms and procedures, which would allow a better administ:ation and control of stocks; (iii) the integration of the accounting and budget information of the company; and (iv) administration and control of human resources. Parallel to these projects, there is a plan for the acquisition of the equipment required for their adequate implementation. - 34 - ANNEX 2.2.0 Page 3 of 6 Staffing and Training 7. CFE's personnel policy is to promote the integral development of its human resources in line with the development of the company. For this purpose and within the general tradition established for Government-owned entities in Mexico, labor relations are managed in close coordination between the company and the labor union reflected in a labor contract which is renegotiated every two years. The one presently in force constitutes, in fact, the personnel manual of the company as it sets the policies and procedures for human resources administration. 8. The sector is the second major employer in the country, after the state oil company (PEMEX). At the end of 1988, it had a total of 123,000 employees of which 92,000 belonged to CFE and 31,000 to CLFC. Out of the total sector employees, 78,000 operate the power system, 29,000 are temporary workers in the construction force and 16,000 are contingent workers for major maintenance of power plants and transmission and distribution installations. The evolution of the sector operational staff is shown in Annex 3.4.0 (Performance and Financial Indicators). 9. CFE has a comprehensive training program and adequate facilities to implement it. A Central Unit for Training and Development establishes the basic norms, plans, organization, evaluation and coordination of the program to be applied at a national level and it implements the training activities for the headquarters personnel. The regional distribution offices are in char&e of regional training centers and the implementation of their corresponding activities. The training activities cover all aspects of CFE's operations, including engineering and design, operation and maintenance, safety, public and community relations, finances and administration and general education. In 1987, about 48,000 employees participated in 5,300 courses and seminars, with an average attendance of about six hours per participant. Accounting and Auditing 10. CFE's accounting unit is under the Deputy Comptroller who reports to the Comptroller. The company's accounting system reflects the institutional objective of delegation of functions to the regional offices. This objective is in the process of being achieved by delegating more functions to the regional offices and leaving for the central unit at headquarters the consolidation of the accounting information, the registration of entries for the national offices and the establishment of norms and procedures for functions in general. Many of the new systems are being incorporated under the data processing projects now under execution (para 6). 11. CFE has a system of accounts that consists of a computer listing with a detailed description of each account. The external auditors report for the 1987 financial statements show that some deficiencies exist both in the accounting system and in the internal control system. These - 35 - ANNEX 2.2.0 Page 4 of 6 deficiencies notwithstanding, the company issues reliable monthly financial statements within thirty days. One matter which needs assessment is the valuation of CFE's assets, as (i) CFE's assets may be overvalued as the revaluation index that has been used has exceeded the consumer price index for several years, (ii) the depreciation quota (2.9Z) seems to be low for a power utility with 76% of thermal generation, and (iii) all interest is charged to income, and no charge for interest during construction is made. 12. The internal audit unit of CFE also reports to the Comptroller. It has regional units assigned to the operations divisions and to the construction coordinating units. The central unit establishes the norms and procedures for auditing within the company and monitors their adequate implementation. CFE, by law, has to engage the ervices of external auditors registered under the country's General omptroller Office. At present such firm is Despacho Roberto Casas Alat-iste, Contadores Publicos, which acts as correspondent of Coopers & Lybrand, an international independent audit firm. Both firms are acceptable to the Bank. During project execution, CFE will engage the services of independent auditors acceptable to the Bank and will present in accordance with terms & reference acceptable to the Bank duly audited financial statem*:'.s, project accounts and statements of expenditures related to the project within six months after the end of each year. In addition, the Special Account to be opened under the Bank loan will also be audited in accordance with terms of reference and by an auditing firm, both acceptable to the Bank. Budgeting and Planning 13. As a Government-owned entity, CFE follows the general principles of fiscal budgeting established by the Mexican Government which is basically a cash budget. The unit in charge of budget preparation is under the Finance Department while the unit in charge of budget control is under the Comptroller. The company has a coherent management information and control system. Besides budget preparation, the Budget Department is basically in charge of the accounts payable system. Financial projections are prepared by the Economic and Planning Studies Lnit under the Construction Directorate, which is in charge of the medium and long-term planning of the company. This unit also prepares the sales forecast and the long-term investment program of the company, based on least cost principles (The main text, para 2.19 and 2.20, provides an explanation of the planning scheme used by the company). Procurement and Inventories 14. CFE is subject to national legislation dealing wlth procurement of goods and services following Government directives. In the past, CFE restricted its sources to national suppliers, and permitted international competition only when no Mexican manufacturers existed. However, after Mexico joined GATT in 1986, public entittes, including CFE, are slowly opening their market to international. competition. Under Bank's present and possible future operations, all trocurement shall be made under international competitive bidding. - 36 - ANNEX 2.2.0 Page 5 of 6 15. CFE's purchases are made by the Technical Services Unit (civil works) and the Supplies Unit (goods) and the regional offices which are authorized to make small and medium purchases. The size and complexity of the enterprise have resulted in a list of about 400,000 items purchased by CFE. To safeguard and handle these items, CFE has 421 warehouses which at the end of 1986 had a stock of about US$390 million, of which about 23Z were for operation and maintenance and 77Z for construction. As opposed to the general philosophy of concentration that existed in the company until 1985, the warehouses seem to have had excessive autonomy. There are no coordinated systems of inventory management and clearly defined policies regarding obsolescence. The company also lacks a clearly defined nomenclature of goods which would supDort a well managed inventory system and avoid unnecessary duplication of names. Preliminary efforts are being made by CFE to implement a data processing system which would.provide the necessary information for management decision. The problems outlined above shall be reviewed under the management study financed by the Bank loan. Billing and Collection 16. Billing and collection at CFE are successfully carried out by the regional offices, with a good degree of coordination at the national level. CFE is divided in 14 regional distribution divisions, each division is divided ir zones for a total of 100 and each zone in agenciec for a total of 850. The computerized billing system is centralized in the regional divisions while bill collection is made at each zone and agency. As a next step in the deconcentration process, and with the intention of accelerating the collection process, CFE intends to move the billing process to the zones. The collection system of CFE is reasonably efficient as the collection period is about 60 days and the uncollectable accounts represent only 0.1Z of total billing. An important factor for this achievement, rare for Latin-American utilities, is a compensation mechanism operating under the federal budget system for collecting from other public enterprises and from Government agencies. However, the collection record of CFE seems to be under an initial process of aeterioration as many districts are falling behind, basically because of the significant nominal tariff increases of the last year, especially in those states where opposition parties have become stronger and represent an important challenge to the Government party. Major problem related to consumer billing is the lack of meters (about one million at present) due to the financial constraints facing CFE. The Bank has initiated the preparation of a follow up project which would focus on CFE's distribution needs, under which these problems would be addressed. General Services 17. The General Services Unit of CFE has, among other functions, the responsibility for the air and land transportation systems of CFE. At present, CFE has a fleet of ten airplanes which, in 1986, were 80Z of the time available for service, flew 1,633 hours and carried 6,678 passengers. The helicopter fleet flew 5,262 hours transporting about 4,000 tons and 19,772 passengers. - 37 - ANNEX 2.2.0 Page 6 of 6 This service warrants an in-depth assessment regarding its economic convenience as compared with procuring it from private companies. The financial constraints encountersd by the company have resulted in the aging of the existing fleet which has reached an average of eight years. This and the normative matters regarding land transportation shall be reviewed under the management study to be carried out under the present operation. Insurance 18. The Insurance Unit of CFE is in charge of contracting, processing, statistical control, signature and general administration of the insurance policies of the company. The coverage of these policies include transportation, fire and vehicles, but does not include plant breakdown and damage to third parties. These aspects shall be analyzed under the management study. . 3o . ANNEX 2.2.1 MEXICO HYDROELECTRIC DEVELOPMENT PROJECT CÆs Organzation Chait PIANNING THERMO- ELECRIC PROJIS GEC- DIRECTO OF CONSMCnONPRaJECI ELEC COOR TION PROJECIS oFRE~10) TRAN&M~SIO PRJC ADMWNPS E --AT S REGCOAL~ DIECTE OPOER OCES(4) GGRGEOALL ATION ENERGY DWSATCH l PG .- OPERAROSTE1ESM6 i REGIONAL 0NMØNS(4) i i REGI!NL~ DELEGATIONS(1i) -- SPIES AýDýMýUNIONN LEGAL wodm B~n-41013 - 39 - ANNEX 2.3.0 Page 1 of 3 MEXICO COMISION FEDERAL DE ELECTRICIDAD HYDROELECTRIC DEVELOPMENT PROJECT The Electric Power Market Description of the Electric Power System 1. CFE is in charge of the planning, development and operation of installations for the entire country; as the geographical area is extense (approximately 2.0 million kma) and the power system large (23,900 MW installed capacity), CFE has divided its activities by geographical regions. Corporate planning and the engineering and design activities of larger projects are carried out centrally at CFE's headquarters in Mexico City. For the construction and operation of other power system components, the country has been divided in the following regions, which operate with a limited degree of autonomy from the central offices: Hydroelectric power plants 5 regions Thermoelectric power plants 5 regions Transmission lines 7 regions Distribution networks 14 regions 2. The Central distribution region, where Mexico City iz located, accounts for 25? of all energy consumption. Except for the Yucatan and Baja California areas, most of the country is interconnected through high voltage (400 kV and 230 kV) transmission lines. There are, however, power transmission limitations in the interconnection among regions that do not permit the full exchange of power plant reserve; in some cases CFE has decided to reinforce the interconnection, but in others, because of the large distances involved, it has been determined that it is more economical to add more generating capacity than to invest in transmission facilities. 3. At the end of 1988, CFE had a total installed capacity of 23,921 MW, 56,000 Km of high voltage (115 kV, 230 kV and 400 kV) interconnecting transmission lines, 255,000 Km of distribution lines and 16,500 MVA of distribution transformers through which about 50% of electric energy is sold, the rest is sold at high voltages. Annex 2.3.1 shows the evolution of CFE's system in the past, and Annex 2.3.2 the existing power plants as of December 31, 1988. Operation of CFE's Power System 4. The National Center for Energy Control (Centro Nacional de Control de Energia, CENACE), which operates under CFE's Director of Operations, is in charge of the control of the operations of the power system in the entire country, including the control of fuel supply for the thermal plants and water reservoir level for hydroplants. The system is operated - 40 - ANNEX 2.3.0 Page 2 of 3 considering service reliability, economy of operation and quality (voltage level) of service. The structure of CENACE includes a Central Control Group (Centro Nacional de Control, CNC), which counts with modern facilities such as a real-tme computerized central load dispatch center and off-line programming facilities to determine short-term (daily and weekly) planning or medium- and long-term analysis for the operation of the system under normal and emergency conditions. There are also six regional control centers (Centros de Control de Area, CCA), in charge of the operation )f their respective areas; they also count with modern facilities, including computer installations, remote terminals at main power plants and substations, etc. Demand Forecast 5. CFE has developed an econometric model to study the evolution of electricity demand; th model has shown a good correlation with statistical data and good forecasting qualities; it is based on correlations of electricity consumption with population, gross public investment and internal gross production. The demand forecast on which the Investment Program is based, was determined by CFE (Annexes 2.3.5 and 2.3.6) based on aggregation of short- and medium-term demand forecasts made by the distribution regions and an analysis made with the help of the above aggregate model; for the decade 1988-98, demand (gross generation) is forecasted to grow at 6.5% as compared to 7.1% of the previous period (1976-88). This scenario assumes that population will grow at an average of 2.16% during the period, public investment at 8.7% in real terms and GDP at 5.1%. Despite many attempts, CFE has not been able to establish a statistically significant correlation between electricity demand and tariffs with long lasting effects. This will continue to be studied, as the real electricity rate increases required over the next few years are substantial. 6. Several other scenarios were analyzed by CFE: the low growth scenario shown in Annex 2.3.6 assumes a GDP growth of 3.8Z and 7.OZ for public investment for the period, and results in an electricity demand growth of 5.6%; another scenario considered zero growth for public investment and GDP, and resulted in a 4.0% electricity demand growth for the 1987-92 period. These results lead to conclude that at least in the short run, the growth of electricity demanded by existing consumers and population is not heavily influenced by economic development. The influence of the increase in activity of the parallel or secondary economy, not accounted for in official figures, is also a definite factor of demand of electricity services. Based on the assumption that the Mexican economy will grow to accomodate at least the growth of active population (about 3.5% per year), CE has decided to use the first growth scenario for planning purposes. Any deviations in the short- and medium-term will be corrected by advancing or delaying the construction of thermal power plants. - 41 - ANNEX 2.3.0 Page 3 of 3 Energy and Capacity Balances 7. The generation expansion program for the period 1989-97 includes the conetruction of a total of 15,590 MW in new power plants, of which 2,860 MW (18%) are hydro (see Annex 2.3.3). Energy and capacity balances (Annexes 2.3.7 and 2.3.8) prepared for the CFE's global system, consider the above program, and take into account existing restrictions to energy transfer among regions because of limitations in the transmission systems or the lack of interconnection (para 2 above), and restrictions during the testing period of new generating plants or restrictions in hydro plants during dry hydrological years. It is considered that the availability of thermal plants, which was very low in the past, will gradually improve to industry levels (Annex 2.3.4). - 42 - ANNEX 2.3.1 MEXICO HYDROELECTRIC DEVELOPMENT PROJECT Historical Data for the Public Power Sector 1970 1976 1980 1986 1986 1987 1988 A. INSTALLED CAPACITY MW 6,068 9,830 14,626 20,807 21,266 23,145 28,921 HYDRO POWER PLANTS 8,228 4,044 6,992 6,632 6,532 7,548 7,716 THERMAL POWER PLANTS: 2,640 5,788 ,6838 14,276 14,784 16,699 16,205 Fuel Oil (Steam Plants) 2,816 8,76 6,618 9,599 9,949 10,299 10,000 Combined Cycle 410 540 1,450 1,450 1,66o 1,624 Coal 87 87 900 900 1,200 1,200 Geothermal 76 150 426 585 650 700 Gas Turbines 216 1,026 1,190 1,769 1,789 1,789 1,792 Other 271 251 187 112 111 111 69 B. GENERATION 09N Hydropower Plants 14,606 15,016 16,740 26,087 19,676 18,200 20,774 Thermal Power Plants 11,226 26,210 46,760 59,282 69,626 78,110 81,101 Total Cross Generation 26,080 41,226 62,490 85,869 89,504 96,419 102,069 Less: Plant Uses 796 1,484 2,712 1,992 4,221 4,841 5,048 Total Net generation 25,284 89,742 69,778 8,877 85,288 91,778 97,026 C. SALES OWN 21,659 84,667 62,801 70,614 74,290 79,492 68,661 Residential 8,562 8,056 10,089 14,286 15,079 16,712 16,826 Industrial 11,795 19,202 28,744 40,115 40,946 44,071 46,898 Public Service 1,580 2,619 8,667 4,181 4,882 4,506 4,456 Comercial 8,268 4,224 6,821 7,004 7,057 7,166 7,802 Agricultural 1,849 2,267 8,746 4,962 5,418 6,006 6,409 Resale 209 275 8 0 0 0 Exports 10 114 1,461 2,042 1,996 D. EMPLOYEES AND CONSUMERS Number of Permanent Employees (0 A M and Administration) 29,815 87,565 50,972 73,154 78,989 75,675 77,886 Number of Consumers ('000) 6,260 7,810 9,720 12,60 18,216 18,620 14,447 - 43 - ANNEX 2.3.2 MEXICO COMISION FEDERAL DE ELECTRICIDAD HYDROELECTRIC DEVELOPMENT PROJECT Existing Power Plants as of December 31, 1988 Ceaclt. lM *enoration wr&ry_ Aver~g feminal Year ~aita Maum fleimm Av, tå vaarl Plant Parer 9 Plant Paceor Remgion Instatlation l.i tgnmaml PfAa8ar~~O k~ f L DaU )100 1800 5819 4830 35 42 Orientel e900 ISp*e= 1080 1080 3406 i3m4 3 38 Orientel 1969-7 Inflernlllo 1032 1000 3329 2673 31 3 Central 1965-78 Anotura 900 900 20a0 26 26 Orlentt 1975-78 Sstea. Miguel Alemn 806 308 1539 29 58 Central 1944-37 villit 0 240 1198 1c 50 57 Centra1 1973 Maseaepe 209 218 *86 6an 84 30 Orental 1962-4 Crco1 594 594 1.861 6m 13 30 Oriental 198847 P*"Itec 420 420 1.692 1.223 33 46 Or2entel 1987 Te,aecal 184 184 809 6a 84 60 Or,entel 1959 Other Planta 1354 1310 3443 4731 41 30 Totel flydro Planta 7.849 7,716 25.112 22,672 2. Tharmoelectric Planta o1200 1200 7884 8853 el 78 Occldental 1981-44 mantantIlo 11 380 8a0 2300 37 27 7 Oceildental 198 måaten l 616 16 3777 3107 i8 70 Nbroeste 197841 <uym.. 11 414 8om 358 2394 49 73 Noroe~te 1973-80 Fr1nc.lec VilII 418 399 2888 2489 71 74 NPr"e 196441 Villa de Reyee 700 700 4899 2747 45 75 Occdentöl 198647 s2mayue M 318 1993 1134 41 72 Nort* 198 Puerto berull 474 474 2990 1544 37 72 Noroee 1985 Tijuang 20 300 194 1243 47 74 Da Cellf. 194-69 tnerp lants 81 899 4470 3770 62 73 Sub-total PueS 011 8.666 5,812 36.112 27.798 87 i a~100 100 893 85m3 60 Central 19702 Solaenne 916 820 4986 4257 89 69 OccIdantel 1970-70 Atteulra 916 740 4473 8m2 59 69 OOI-nte 1975-78 Valla de N9.IcO 776 780 4476 3744 60 70 Central 196-74 Nonterrey 477 406 3014 2444 65 74 Norta 193-74 RIo Sr.. 378 378 2267 2183 85 69 Noroste 198442 Locherip 228 224 1482 1081 85 74 Centrat 192-60 Other Plante 319 334 210 1621 55 72 Sub-totl ual Fue 3.507 5.168 31,600 27,698 66 42 482 22 901 21 70 Central 1981-47 099 Boce 4110 380 1734 1617 51 70 Oriental 1974-76 Huftinael 424 378 121 11 49 70 Neroemte 1981-85 El Seux 801 224 1C79 768 39 70 OccNdentel 1981-«8 Omme Pelacio 240 110 067 902 87 70 Norte 1976 Sub-total CombIne4 Cycl 1.927 1,824 7,824 5,00m 41 de 1.200 1,200 6,000 4,607 54 65 Norocet 198247 0220 2 1484 112 57 77 Sa a Cal If. 198861 Cerro Prigto 11 100 180 1214 688 67 77 ign.CslI. 1973-e1 Cerro Prieto I1 220 220 1484 1069 6 77 Saja Cal I . 19887 A~ufren 1 30 30 202 154 83 77 Occdental 198247 Tejemale 80 50 337 28 6 77 Occiden6el 1988 Sub-totl Oeothermf 700 700 4,722 3,590 59 Om TurbinS 1.931 1.792 3,140 704 4 20 Internal Co~uatogn 102 69 624 se 7 60 Total Thoral Planta 17,055 16,208 91.460 71,380 80 3. 7O7AL Ca~ 24.904 23,921 116,572 91,052 45 3/6/69 - 44 - ANNEX 2.8.8 MEXICO HYDROELECTRIC DEVELOPMENT PROJECT New Power Plants Planned for 1989-1997 (Capacity In Mw) 1989 1990 1991 1992 1993 1994 1996 1996 1997 Total 1. HYDRO POWER PLANTS 0 0 295 6 160 580 780 0 90 2,860 Ague Prieta 0 0 240 0 0 0 0 0 0 240 Comedoro 0 0 55 55 0 0 0 0 0 110 Chilatan 0 0 0 0 40 0 0 0 0 40 Aguamllpa 0 0 0 0 0 320 640 0 0 960 Zimapan 0 0 0 0 0 340 140 0 0 280 Temoscal II 0 0 0 0 120 120 0 0 0 240 S.J.Tetelcingo 0 0 0 0 0 0 0 0 414 414 Huites 0 0 0 0 0 0 0 0 876 876 Monterrey Bombo 0 0 0 0 0 0 0 0 200 200 2. THERMAL POWER PLANTS 1,278 1,260 100 755 1,944 2,037 2,278 1,144 1,644 12,780 A. FUEL OIL (STEAM) 508 1,180 286 0 1,104 244 388 244 484 4,887 Libertad 158 0 0 0 0 0 0 0 0 158 MenzanIllo II 350 0 0 0 0 0 0 0 0 350 Lordo 0 320 0 0 0 0 0 0 0 820 Tuxpan 0 700 0 0 700 0 0 0 0 1,400 Rosarito 0 160 160 0 0 0 0 0 0 820 Topolobampo 0 0 0 0 820 0 0 0 0 820 Ensenada 0 0 0 0 0 160 0 160 0 820 Libertad II 0 0 0 0 0 0 360 0 360 700 Other 0 0 75 0 84 84 8 84 84 449 8. DUAL (FUEL/COAL) 0 0 0 0 700 700 1,100 550 1,100 4,160 Lazero Cardenas 0 0 0 0 700 700 0 0 0 1,400 Pto. Altamire 0 0 0 0 0 0 0 550 1,100 1,8650 Colml 0 0 0 0 0 0 1,100 0 0 1,100 C. COMBINED CYCLE 70 70 80 0 0 0 0 0 0 220 V Iledol id 70 70 80 0 0 0 0 0 0 220 D. COAL 0 0 0 700 0 860 700 860 0 2,100 Carbon II 0 0 0 700 0 350 860 0 0 1,400 Carbon III 0 0 0 0 0 0 850 850 0 700 E. OAS TURBINES 0 0 0 0 80 80 30 0 0 90 F. OTHER 0 0 65 0 0 0 0 0 0 65 0. GEOTHERMAL 20 10 20 56 110 38 65 0 110 418 Cerro Prieto IV 0 0 0 56 55 0 0 0 0 110 Maritero 0 0 0 0 0 88 0 0 0 88 Humeroe 10 10 0 0 56 0 0 0 55 130 El Chino 0 0 0 0 0 0 56 0 0 65 Other 10 0 20 0 0 0 0 0 56 85 H. NUCLEAR 676 0 0 0 0 876 0 0 0 1,860 8. TOTAL COUNTRY 1,278 1,280 695 810 2,104 2,817 8,058 1,144 2,684 16,590 - 45 - ANNEX 2.3.4 MEXICO HYDROELECTRIC DEVELOPMENT PROJECT COMISION FEDERAL DE ELECTRICIDAD Performance Data on CFE's Thermal Power Plants Maximum Capacity Availability Plant Factor Heat Rate Efficiency Year MW 3 S/ 1 Keel/kWh X CFE's Plant. in Operation 2/ 1977 $,666 65.5 61.4 2,92 29.4 1978 7,485 66.7 55.9 2,920 29.9 1981 9,189 64.7 56.6 2,914 29.6 1988 10,68 70.9 66.5 2,679 82.1 1984 10,961 70.6' 59.4 2,666 82.0 1985 12,874 69.6 56.9 2,659 82.8 1986 12,984 78.4 68.7 2,611 82.9 1967 18,699 74.9 66.1 2,60 88.8 1966 14,824 70.0 65.9 2,668 88.5 1994 1/ 19,019 77.4 67.4 2,600 84.4 Typical USA Syem 8/ 74.0 - 61.0 Tula (2,100 MW) Power Plant 4/ 1982 1,00 66.8 65.0 2,610 82.9 1988 1,100 61.4 60.5 2,576 88.8 1984 1,500 59.6 S9.1 2,662 82.8 1965 1,500 58.7 58.2 2,618 82.9 1986 1,600 68.1 64.8 2,5681 88.8 187 1,500 76.7 74.0 2,681 84.0 198 1,600 79.0 74.1 2,469 84.8 Menzanillo (1900 MW) Power Plant 6/ 1962 600 80.5 71.2 2,824 87.0 1988 900 68.8 64.2 2,824 87.0 1964 1,200 96.0 72.6 2,819 87.1 19865 1,200 85.7 88.2 2,825 87.0 1966 1,200 87.2 65.7 2,294 87.5 1967 1,200 86.0 68.6 2,801 87.4 1968 1,200 65.8 62.2 2,299 87.4 1/ Proposed goals. 2/ CFE"* thermal plants in operation, including only oil-fired steam, coal-fired steam, geothermal steam and combined cycle. 8/ Typical range for well organized utilities. 4/ Tula started operation in 1975 and Is typical of some of CFE's power plants, whose maintenance in the past was neglected due to excessive service (because of capacity shortage) and lack of parts (because of fiscal restrictions); Tula, like many other similar plants, has now a well structured rehabilitation plan. 5/ Manzanillo started operation in 1961 and Is typical of the new CFE's type of power plants, which are well designed, operated and maintained. 8/ Net availability, excluding scheduled maintenance and forced outages. MEXICO HYDROELECTRIC DEVEPMENT LOAN Demand Forecast by Typa of Service (Wh) Ycar Residential Industrial Public Cosrcial Agricul- Export Total Losem LOsses Net Plant utoSS Service toral Sales 1/ Generation UsS GE^ERATION Historical 1976 8,904 21,222 2,902 4,528 2,440 220 88,211 6,880 12.8 48,591 1,881 44,972 1981 11,475 81,762 3,948 6,878 8,846 68 67,455 8,244 12.6 65,699 2,514 68,218 196 15,201 40,96 4,847 7,108 5,414 1,481 74,482 10,812 12.7 85,294 4,211 #9,506 1987 15,806 44,071 4,04 7,157 6,010 2,042 79,590 12,184 18.8 91,754 4,665 98,419 1988 16,900 48,897 4,459 7,880 6,410 1,996 88,992 18,197 18.6 97,189 4,880 102,089 Forecast 1989 18,167 50,096 4,902 7,805 6,912 1,917 89,298 18,446 18.1 102,744 6,272 108,226 1990 19,422 58,688 5,186 7,480 7,480 1,917 .Z,028 14,862 18.1 109,885 6,548 116,044 1991 20,767 67,876 6,422 7,44 8,029 1,917 101,045 15,164 18.0 116,209 6,160 122,407 1992 22,889 61,689 6,699 7,688 8,718 1,922 108,046 16,147 18.0 124,192 6,668 180,781 1998 28,996 68,206 $,98 7,780 9,486 1,917 116,822 16,997 12.8 182,819 7,1386 189,848 1994 26,887 71,062 6,280 7,867 10,209 1,917 128,162 17,958 12.7 141,116 7,788 148,781 1995 27,809 76,284 6,688 7,896 11,020 1,917 181,568 18,900 12.6 150,488 8,199 18,66 1996 29,868 81,667 7,062 7,96 11,796 1,922 140,200 19,791 12.4 159,991 8,901 168,816 1997 82,048 87,408 7,489 7,867 12,619 1,917 149,888 20,828 12.2 170,161 9,416 179,440 Nota: 1/ Percentag* with respect to net generation. - 47 ANNEX 2.8.6 MEXICO HYDROELECTRIC DEVELOPMENT PROJECT Global Demand Forecast Gres Gross 1/ Year Generation iublic Population OWh ODP 1/ Investment (Million) 1. HISTORICAL DATA 1976 44,972 888,940 82,872 81.98 1981 68,218 460,981 66,494 71.26 1986 89,506 466,005 81,100 80.97 1988 102,069 492,189 29,188 84.98 Accumulated Growth (X): 1976-06 7.07 8.11 -0.87 2.66 1981-88 6.98 0.04 -11.12 2.64 2. FORECAST: SCENARIO POISE 2/ 1989 108,226 302,008 81,858 00.99 1990 115,044 680,868 85,106 69.01 1991 122,407 557,199 86,694 91.04 1992 180,781 5688,619 44,160 98.07 1998 189,848 617,128 47,606 95.11 1994 148,751 658,848 51,608 97.14 1995 156,566 690,066 55,772 99.17 1996 168,616 728,949 59,886 101.18 1997 179,440 756,816 68,949 108.20 1996 160,820 790,116 60,76P 105.20 Accumulated Growth (): 1986-98 6.46 5.06 6.86 2.18 1988-98 8.42 5.06 10.82 2.28 1998-98 0.49 6.07 7.00 2.04 8. FORECAST: LOW GROWTH SCENARIO 1988 102,069 482,189 29,188 84.98 1998 188,600 672,600 46,000 94.75 1998 176,800 896,600 57,200 108.79 Accumulated Growth (S): 1988-98 6.62 8.75 6.99 2.02 1988-98 5.52 8.50 9.09 2.20 1998-98 6.72 4.00 4.91 1.84 4. FORECAST: ZERO GROWTH SCENARIO 1986 102,069 462,189 29,188 84.98 1998 127,560 482,189 29,188 94.75 1998 161,400 482,139 29,138 108.79 Accumulated Growth (): 1988-99 4.02 0.00 0.00 2.02 1988-98 4.56 0.00 0.00 2.20 198-98 8.49 0.00 0.00 1.84 Notes: 1/ In billion pesos of 1989 (10^9 pesos), based on the new national accounting system (ONuevo Sisteme Nacional do Cuentes, Base 19806) 2/ CFE's proliminar forecast of March, 1989. MEXICO HYDROELECTRIC DEVELOPMENT PROJECT Global Energy Balance Forecast (OWh) 1989 1990 1991 1992 1998 1994 1995 1996 1997 1. Gross Energy Requirements 108,226 115,044 122,407 180,781 189,848 148,751 156,566 168,816 179,440 2. Available Sources Hydroelectric Plants 1/ Existing as of Dec. 1988 25,112 26,112 26,112 26,112 25,112 26,112 25,112 25,112 26,112 New Power Plants 0 0 482 838 775 1,278 4,5680 4,560 6,712 Water Restrictions (1,768) (1,768) (1,788) (1,788) (1,768) (1,768) (1,768) (1,768) (1,898) Total Sources Hydro 28,844 28,844 28,776 28,982 24,119 24,822 27,904 27,904 29,931 Thermoelectric Plants Existing as of Dec. 1988 8/ 91,460 91,460 91,460 91,480 91,460 91,460 91,460 91,460 91,460 41 New Power Plants 5,845 9,611 17,191 25,195 38,865 42,913 49,928 60,171 69,709 Nuclear Power Plants 1,218 2,416 3,008 8,425 4,829 8,532 7,246 7,823 7,910 Summer Generation 1675 1888 1688 188 1691 1721 1745 1745 1745 Less Retirements (124) (422) (885) (885) (885) (885) (1,555) (1,655) (1,555) Less Aging Factor 2/ (868) (562) (770) (966) (1,198) (1,451) (1,718) (2,008) (2,806) Total Sources Thermal 99,708 104,086 111,687 119,912 129,062 140,290 147,108 157,486 168,964 Total Available Sources 128,047 127,480 185,468 148,894 153,181 184,912 175,007 186,840 198,895 8. Energy Balance Total Available Sources 123,047 127,430 185,468 145,894 168,181 164,912 175,007 186,840 196,895 Les Transmission Restrictions (1,198) (1,098) (720) (759) (1,624) (782) (797) (882) (1,299) Total Unrestricted Sources 121,864 126,882 184,748 148,185 151,557 14,i80 174,210 184,508 195,596 Less Energy Requirements 108,226 116,044 122,407 180.781 189,848 148,751 168,566 168,816 179,440 Energy Reserves in Wh 13,828 11,288 12,838 12,404 12,209 15,429 15,644 15,692 16,156 Energy Reserves in 5 12.8 9.8 10.1 9.5 8.8 10.4 9.9 9.8 9.0 si Notes: 1/ For an average hydrological year (805 probability). 2/ De-rating due to aging of equipment. 8/ Considering unavailability of equipment. MEXICO HYDROELECTRIC DEVELOPMENT PROJECT Global Capacity Balance Forecast (MW) 1988 1989 1990 1991 1992 1998 1994 1995 1998 1997 1. Maximum Demand 18,120 17,340 18,250 19,500 20,830 22,200 23,700 25,990 26,900 28,600 2. Available Capacity Hydroelectric Plants Existing as of Dec. 1988 7,718 7,716 7,716 7,718 7,718 7,716 7,718 7,716 7,716 7,716 New Power Plants (Cumulative) 'I 0 0 295 850 510 1,090 1,870 1,870 2,880 Total Hydro 7,716 7,716 7,716 8,011 8,066 6,226 8,606 9,586 9,586 10,576 Water Restrictions 1/ (1,110) (1,110) (1,230) (1,165) (1,150) (1,230) (1,594) (1,374) (1,965) (1,551) Total Available Hydro 6,808 8,808 8,486 8,846 8,918 6,996 7,212 8,212 7,621 9,026 Thermoelectric Plants Existing as of Dec. 1988 16,205 16,209 16,205 16,205 18,205 18,206 18.205 18,205 16,205 16,205 Z, New Power Plants (Cumulative) 0 598 1,858 2,258 3,018 4,957 8,319 8,592 9,7386 11,380 Nuclear Power Plants 0 875 876 875 675 675 1,350 1,350 1,850 1,350 Less Retirements 0 (25) (188) (138) (133) (13) (133) (233) (233) (233) Total Thermal 16,205 17,453 18,805 19,005 19,780 21,704 28,741 25,914 27,058 28,702 Less Restrictions on New Plants 2/ (908) (1,003) (1,473) (955) (1,228) (1,622) (841) (1,714) (1,144) (1,611) Availability Factor (X) 75.0 75.0 75.5 76.0 76.0 78.0 78.0 76.0 78.0 78.0 Total Available Thermal 11,473 12,338 12,935 18,718 14,088 15,282 17,404 18,392 19,695 20,885 Total Installed Capacity 28,921 25,189 26,321 27,018 27,826 29,930 82,547 35,500 38,644 89,278 Total Available Capacity 18,079 18,944 19,421 20,584 21,004 22,258 24,618 28,804 27,318 29,890 3. Capacity Balance Total Available Capacity 18,079 18,944 19,421 20,664 21,004 22,258 24,816 28,604 27,318 29,690 Less Transmission Restrictions (188) (202) (188) (122) (98) (275) (124) (135) (141) (220) Total Firm Capacity 17,913 18,742 19,235 20,442 20,906 21,983 24,492 28,489 27,175 29,470 Less Maximum Demand 18,120 17,340 18,250 19,500 20,830 22,200 23,700 25,250 28,900 28,800 Capacity Reserves in MW 1,793 1,402 995 942 76 (217) 792 1,219 275 870 Capacity Reserves in X 10.0 7.5 6.1 4.6 0.4 -1.0 3.2 -e.6 1.0 3.0 Notes: on 1/ Restrictions during dry seasons or due to irrigation or drinking water priorities and restriction on new plants 2/ Restrictions during the first year of operation of new power plants to account for the lower availability of the units during that period. - so - ANNEX 2.4.0 Page 1 of 2 MEXICO HYDROELECTRIC DEVELOPMENT PROJECT COMISION FEDERAL DE ELECTRICIDAD Power Sector Investment Program Investments in the Power Sector: a Retrospective View 1. In the past, investments in the power sector were sizable as compared to gross public investment (GPI): in the decade of the oil boom of the 70's, CFE's investment were an average of 13% of GPI; in 1982, CFE's investments reached about US$2.1 billion (1989 constant currency) or 9.52 of GPI, but then they declined to about US$1.2 billion in 1986, 1987 and 1988, reflecting restrictions imposed by the Government because of macroeconomic conditiors (see Annex 2.4.1). The investment restrictions of the last five years did not permit CFE to carry out a least cost investment program, but rather a program in which hydroelectric and other non oil- based projects were postponed and investments in power plant maintenance and upgrading and transmission and distribution networks were restricted to minimum levels; these restrictions have not yet caused measurable negative effects to the quality of service, but if not corrected through adequate investment, may bring serious problems to the power sector, among others: decrease of power plant reserves, increase of energy losses, decrease of thermal power plant availability and efficiency, etc. This, in turn, would affect the reliability of service, which is of particular importance to industry. Future Investments 2. CFE has developed computer models to analyze the expansion programs for generation and transmission facilities and determine a least cost investment program. Based on yearly reviews of the power market projections and considering border prices, CFE determines a Ten-year Investment Plan for the Power Sector (Programa de Obras e Inversiones del Sector El4ctrico, POISE). The models reflect the state of the art in planning methodology. The investment program presented in Annex 2.4.1 is not a true least cost program, as it was modified to consider an investment ceiling imposed by SPP for 1989, and probable restrictions expected for 1990. However, it is the intention of CFE to gradually shift the investment decisions to least cost principles; after 1991 no financial restrictions have been considered. As shown in the annex, the proposed investment program considers a gradual recuperation of the investment in the power sector as compared to the GPI, surpassing past relative levels after 1991. If appropriate tariff policies are pursued, the financial projections developed show that CFE would be able to finance its investment requirements without financial assistance from the Government. Any deviations from the least cost program required because of macroeconomic - 51 - ANNEX 2.4.0 Page 2 of 2 reasons, would be discussed with the Bank at the time of the annual review of the investment plan (para. 2.20). Annex 2.4.2 presents graphically the evolution of CFE's annual investments and the growth of the p-wer market. Optimization of CFE's Investments 3. In discussions with the Bank, CFE agreed to carry out studies which will define required actions to improve the overall power system efficiency and the optimization of investments. The first study will consider the Optimization of the Operation of CFE's Electric Power System, and determine recommendations regarding efficiency, reduction and control of electric energy losses, etc. The second study, Co-Generation in Mexico, to be carried out by SEMIP with the assistance of CFE, will consider the possibilities of utilizing for public service part of the 2,290 MW privately owned in Mexico and possible incentives for new investments in co-generation (see Annex 3.1.0). MiNiUiRIC 1EVELP.If FiTE Invstment Progree Period 1960-1997 In Csmt~n æld-1989 Di 1i0n P~ma. (10:9 Pa~n~) 'Total 1982 1988 1984 1988 19"8 1987 1988 1989 1990 1991 1992 199 1994 1995 1996 1997 P*riod 1. CFE's Invøten% Prograe 0~neroticn 2.Ø8 2,868 2,18 1,969 1,847 1,688 1.852 1,85 2,617 4,107 4,729 5.075 5,491 5.917 6.377 6.870 42.718 Taogelon 1,256 78 880 949 8m 692 770 637 8M0 1.175 1,31 1,882 2,076 2,244 2,428 2.621 15,822 Di"lribution 1,026 W88 691 498 822 684 678 88 1.08 1.296 1,644 1,914 2,138 2.370 2.6 14.f2l TOTAL (Canlm~n Price.) 5.128 3652 8,829 S,09 2,968 8,002 8.0.6 2.850 4,810 8.815 7,8 8,871 9.102 10,294 11,173 12,11 72,766 TOTAL in VM Milion Suiv. 1/ (Mid-199 Comt Pric~.) 2,064 1,470 1.461 1,45 1,195 1,208 1,290 1,147 1.735 2,542 8,= 8,450 8,664 4,144 4,498 4,877 29.00 Istllod Capacity (M0 18,390 19,004 19,180 20.807 21.266 23,145 25.921 25.260 26,82 27,049 27.889 29,98 32.580 3,552 36,676 39.810 Iner~untal Capacity (l) 994 614 3U6 1,447 489 1,879 M 1,299 1,412 417 810 2,104 2,617 2.952 1,144 2,684 bnwStaeno/Inerment I Chpcits UM/kW: 2/ Aerag* lat 5 y"erg 1,975 1,427 1,381 1,064 1,119 1,80 2,08 1,979 1,986 1.897 1,957 1,802 Av*rag. laat 10 years 1,806 1.745 1,688 1,86 1,89 1,733 1,879 2. Gros Publ ic Investment 2/ 38,973 34,5883 85,950 6,270 31,106 26,067 29,138 81.353 35,10S 38894 44,180 47,0 51,802 55.772 59,888 68,949 428,302 8. CFE's to Public Invau. Rbio 9.5 10.8 10.1 30.0 9.5 10.7 10.5 9.1 12.3 18.2 17.3 18.0 17.8 18.5 18.7 18.9 17.0 1/ Convered at rt. of 2484.2 p«mos pr US do[ ler. 2/ In coat amild-1989 Prica*. (In accordancø with the Nuevo W ~t. N~cicel dø Cuene cem mas n 1980 ) Source: CFE'* Inv~stnt Program of March. 1989. .1- MEXICO COMISION FEDERAL DE ELECTRICIDAD RYDROELECTRIC DEVELOPMENT PROJECT Power Sector Investment and Market Growth 12- s ii 220 a O * 4 0 10 200 *160 7 ..140 6-,. 120 8 5 '100 4 - 80 3 60 82 83 84 85 86 87 88 89 0 91 92 93 94 95 96 971 D Generation0Growth + Investment - 54 - ANNEX 2.5.0 Page 1 of 2 MEXICO COMISION FEDERAL DE ELECTRICIDAD HYDROELECTRIC DEVELOPMENT PROJECT Electricity Pricing Approval Process 1. The General Law of Electricity Service establishes the procedure for approving electricity tariffs. The Ministry of Finance (SHCP), taking into consideration the opinions of the Ministries of Commerce and Industrial Development (SECOFIN) and of Energy, Mines and State Enterprises (SEMIP) and based on the proposal submitted by CFE, sets electricity tariffs, their adjustment or restructuring. Present Situation 2. During the recent past, decrees were issued by SHCP at the end of each year, for tariff level adjustment during the following year, which included a substantial increase in January and smaller fixed increases every month, in order to keep up with the expected rate of inflation. However, since often the rate of inflation was greater than expected, electricy rate levels have deteriorated in real terms; average rates (in 1989 US cents per kWh), were as follows: 1980: 4.4; 1983: 2.8; 1986: 4.3; 1987: 4.0; and 1988: 4.1. (See evolution of electricity rates in Annex 2.6.4.) On December 1988 rates were increased by 24? in nominal terms. Until July 1989 both electricity rates and the prices of CFE's main inputs (wages, fuel prices) are frozen as part of the Government's short-term stabilization strategy ("Pacto de Solidaridadg). Forecast 3. Electricty rates have been projected to reach the long-run marginal cost level by 1996. In 1989, because of the stabilization program, rates would not increase significantly over the real levels of 1988; rate increase of about 9% are expected in 1990 and 1991, and 10% in 1992 with a decreasing trend down to 1% in 1995. These rate increases take into account the measures stated in the FRA (see Annex 2.7.0), resulting in the elimination of a subsidized tariff system, except for some low income residential and agricultural consumers. Tariff Study 4. During 1986, CFE carried out the first phase of a tariff study based on marginal costs for high voltage consumers (69 kV and higher voltage). This work, performed with the technical assistance of the national electric utility of Chile (ENDESA) and with IDB financing, has been adjusted and updated in a continuous process by CFE staff. At - 55 - ANNEX 2.5.0 Page 1 of 2 present, CFE is in the process of implementing the recommendations of the study, for example, hourly metering equipment for most of the existing high voltage clients (type 8 and 12 of consumers) has been installed. A pilot plan of time-of-day tariffs with 50 of the major costumers was started early in 1988. It is expected that by January 1990, most of the industrial customers with demands higher than 1,000 kW (about 1,000 customers), consuming about 392 of CFE's energy sales, would be incorporated to the program. CFE has started a public relations campaign to convince major consumers about the advantages of the tariff scheme based on marginal costs. 5. The second phase of the tariff study, to be carried out under the present operation, will cover the medium voltage tariffs for the remaining main consumers; it will also include some analysis and follow-up of the first phase, and the purchase of metering and data processing equipment required for the execution of the studies. ANNEX 2.5.1 MEXICO COMISION FEDERAL DE ELECTRICIDAD HYDROELECTRIC DEVELOPMENT PROJECT Tariff Schedule (January 1989: Nominal Rate of Exchange 1.00 U.S.$ - 2298 Hex $) Type of Range Charge (in Hex $) Service Demand(KW) Energy(KWh) Fixed Per KW Per KWh 1. Residential 0-25 40.57 (Non-Summer) 26-50 57.88 51-75 76.13 76-100 88.39 101-200 97.73 201 and up 108.42 LA. Residential 0-25 32.46 (Summer) 26-50 46.30 51-75 60.90 76-100 70.71 101-200 78.18 201 and up 108.42 2. General 2 0-25 0-50 2,141.48 161.37 51-100 201.81 101 and up 225.61 3. General 3 25 and up 22,320.33 110.99 4. Tortilla Hills 57.24 5. Public Lighting KV 110.63 LV 131.79 6. Water Supply and Sewerage 20,417.19 102.60 7. Temporary 14,017.03 350.48 8. High Voltage (General) 14,927.39 74.67 9. Irrigation 1-5000 44.54 5001-15000 53.25 15001-35000 58.77 35001 and up 65.26 12. High Voltage 66 and up 15,430.06 62.24 Sources CFB - 57 - ANNEX 2.6.0 Page 1 of 3 MEXICO COMISION FEDERAL DE ELECTRICIDAD HYDROELECTRIC DEVELOPMENT LOAN Sector Finarces Income Statements 1. During the last ten years, the Mexican power sector has been experiencing financial difficulties. The rate of return decreased steadily from 1977 (4.7Z) until 1983 (-4.12), at which time the Government's fiscal problems induced it to increase the level of electricity rates, eroded in the past in real terms because of inflation. In spite of a significant rate increase of about 1202 in nominal terms, the 1983 rate of return reached such a low level because of increases in other costs, particularly fuel oil which increased by about 300Z. During 1984-1986, the deteriorating trend in the sector's finances reversed and positive rates of return were achieved; however, in 1987 the rate of return became negative once again, basically because higher-than-expected inflation eroded the electricity rate increases. Furthermore, the interest charges resulting from CFE's heavy debt burden resulted in permanent losses for every single year since 1976. 2. In December 1987, the Government, in line with the provisions of the FRA, authorized a hike of 85% average to electricity rates; this increase allowed CFE to start to rehabilitate its finances. A positive rate of return of 1.4? was achieved in 1988 and a rate of return of 1.92 is expected for 1989 as a result of a 372 nominal tariff increase to industrial consumers authorized in December, 1988. Starting in 1990, CFE will continue improving the rate of return reaching 8Z in 1993. Net income is also expected to be positive starting in 1989 and to continue improving in subsequent years. To reach these results, electricity rates would have to be increased in real terms on an average of 5.52 p.a., reaching the level of long-run marginal cost by 1996. Expected rate levels for the period (excluding 152 sales taxes), expressed in 1989 constant Mexican pesos and equivalent US currency converted at the average exchange rate of 2,484 Mexican pesos per one US dollar, are as follows: Average Rate Real Increase Year Pesos/kWH US Cents/kWh (2) 1988 1/ 103.0 4.1 - 1989 103.0 4.1 0 1990 112.1 4.5 9.0 1991 132.0 4.9 9.0 1992 134.3 5.4 10.1 1993 138.3 5.6 3.0 1994 141.8 5.7 2.5 1995 143.0 5.8 0.8 1996 149.8 6.0 4.8 1/ Actual figures - 58 - ANNEX 2.6.0 Page 2 of 3 3. During the projection period, the most important component of the operating costs would continue to be fuel costs which on average would account for about 33Z of the revenues. The financial projections are based on fuel prices projected by CFE assuming price hikes in real terms. Residual oil (Bunker C) accounts for about 632 of CFE's fuel bill; the price subsidies that still remain would be eliminated by 1992. Diesel oil accounts for 72 of CFE's fuel bill, and has a price of about 40Z over border prices. The remaining 302 of CFE's fuel bill is composed by gas and coal, which are priced at or over border prices. The following table presents the fuel prices assumed for financial projections: Price in Thousand 1989 Pesos (Annual Average) Residual Oil (bbl) Diesel Oil (bbl) Coal (Ton) Year CFE Border1 CFE Border1 CFE Border1 1989 19.3 21.0 53.4 39.1 91.0 84.5 1990 20.0 21.6 55.2 40.0 94.1 87.2 1991 21.4 22.4 59.1 41.7 100.7 88.9 1992 22.9 22.9 63.3 42.3 107.8 90.7 1993 23.9 23.8 66.1 44.2 112.6 91.9 1994 24.4 24.4 67.4 46.2 114.8 93.2 1995 24.9 24.9 68.7 47.5 117.1 94.1 1996 25.4 25.4 70.1 49.7 119.5 95.6 1/ Derived from Bank's Commodity Forecast of October 17, 1988. Flow of Funds 4. For the ten-year historical period, a heavy debt service resulted in a low level of internal funding, which even with Government contributions was insufficient to cove. the debt service, requiring borrowings higher than the investment irogram, and an increasing dependency on external funding. This situation w.%j alleviated in 1986, with the conversion of about US$8.6 billion of debt into equity (see Annex 2.7.0), that resulted in a funding mix with 412 of borrowings. 5. CFE's financing plan for the 1989-1996 period is summarized below: Current US$ million 2 Requirements 26,713.4 100.0 Investment Program 24,413.7 91.4 Interest during construction 1,278.0 4.8 Increase in working capital & other 1,021.7 3.8 - 59 - ANNEX 2.6.0 Page 3 of 3 Financing 26,713.4 100.0 Gross internal cash generation 21,105.5 79.0 Less: Debt Service 4,692.3 17.6 Net internal cash generation 16,613.2 61.4 Capital contributions 1,801.5 6.7 Borrowings: 8,498.8 31.8 Proposed loan 460.0 1.7 Existing loans 44.6 0.2 Future loans 7,994.2 29.9 6. Assuming that the financial objectives are achieved, CFE would continue to improve its funding mix and its debt coverage ratio would improve from 1.0 times in 1988 to over 4.0 times in 1991. CFE would be able to generate 612 of its total financial requirements between 1989-1996, allowing to reduce the need for Government's equity contributions to 72 and borrowings to 32?. Government cash transfers in form of equity contributions of US$502 milliin and US$210 million would be required only in 1989 and 1990 respectively. Starting in 1991 Government contributions would be required to subsidize energy consumed by low-income residential and agricultural customers (about 2% of the total revenues). Balance Sheets 7. The poor financial performance of the period 1976-1986 resulted in a low degree of liquidity (current ratio lower than 1.0), and a high, albeit fluctuating, degree of indebtedness (debt/equity ratio of 78/32 in 1976 and 60/40 in 1985) which was substantially changed in 1986 (10/90) thanks to the first set of measures included in the FRA. 8. The projected balance sheets for the 1989-1996 period show that the debtlequity ratio will increase but it will be maintained strong and end up in 1996 as 17/83. Liquidity is expected to be adequnte as the current ratio would be higher than 1.0 every year. The collection period is expected to be about 60 days, which is reasonable. MEXICO COMISION FEDERAL DE ELECTRICIDAD (CFE) HYDROELECTLC DEVELOPMENT PROJECT Actual and Forecast Income Statements (Billions of Mex) <------H'i stor i cl--- -------(-- -Forecast in 1989 Mex Pesos --- 1988 1964 1985 1988 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 Total Sales (TWh) 62.8 8.1 71.1 74.6 79.8 84.1 89.8 95.0 101.0 106.0 116.3 123.2 131.6 140.2 - Internal Market 62.2 66.0 70.9 73.0 77.6 82.1 87.4 93.1 99.1 106.1 123.4 121.2 129.0 183.8 - Exports 0.1 0.1 0.1 1.6 2.0 2.0 1.9 1.9 1.9 1.9 1.9 1.9 1.9 1.9 Average Tariff ($/kWh) a/ 2.8 6.4 7.9 17.4 37.0 88.1 103.0 112.1 122.0 184.8 138.3 141.8 148.0 149.8 Gross Operating Revenues 144.7 882.5 585.4 1852.9 8094.8 7049.0 9268.0 10710.6 12387.9 14670.8 18011.5 17524.4 19878.4 21064.8 Electricity Sales Revenues 148.1 858.7 561.8 1298.9 2946.9 6987.0 9198.0 10648.6 12825.9 14608.8 16949.6 17462.4 189816.4 210023.8 - Internal Market 6987.0 8998.8 10451.1 12128.5 14810.9 16752.1 17285.0 18819.0 2004.4 - Exports 0.0 197.4 197.4 197.4 197.9 197.4 197.4 197.4 107.9 Other Revenues 1.6 3.8 24.1 64.0 147.9 62.0 62.0 62.0 62.0 62.0 62.0 62.0 62.0 62.0 Operating Expenses 198.6 849.8 581.6 1269.1 8802.6 6474.0 8359.8 9076.1 9862.0 10811.0 11767.5 12697.6 13509.4 15124.1 Labor b/ 98.8 141.0 212.6 356.8 863.4 1911.0 2240.0 2848.8 2449.8 2681.2 2677.8 2799.1 2926.8 8061.4 Materials, services and other c/ 16.2 29.8 48.0 94.9 292.3 616.0 887.0 889.7 946.7 1011.0 1077.7 1160.4 1226.8 1806.6 Taxes and duties d/ 0.8 1.1 1.6 6.0 18.8 28.0 76.0 89.0 94.7 101.1 107.8 115.0 122.6 130.6 Fuel */ 49.6 106.0 176.2 485.1 1109.6 2410.0 8052.8 8885.8 8906.3 4683.9 6092.3 6808.2 6952.4 7025.4 t Administrative expenses f/ 4.6 6.8 10.8 18.6 44.6 100.0 127.0 180.8 138.5 186.8 140.2 148.7 147.8 161.1 0 Depreciation g/ 83.5 86.8 182.8 327.7 979.4 1409.0 2028.0 2287.0 2882.0 2467.0 2662.0 2898.0 8185.0 8450.0 Operating Income -53.8 18.2 8.9 88.8 -207.8 576.0 898.7 1685.4 2626.9 8769.8 4264.0 4826.9 6889.0 6940.2 Non-operating income (net) 3.1 6.6 11.2 16.5 42.9 68.8 68.8 68.3 58.8 68.8 53.8 68.8 68.8 58.3 Income before interest -60.7 19.8 16.1 100.4 -164.9 628.8 952-0 1698.7 2579.2 8818.1 4807.8 4890.2 6422.8 6993.5 Interest Charged to Operation 141.6 228.8 807.4 448.0 462.6 922.0 769.4 628.6 288.1 288.7 223.8 408.6 570.8 940.6 Interest Charges 206.4 827.9 487.4 446.0 482.6 922.0 759.4 686.9 528.6 661.8 818.4 1000.1 1206.6 1485.8 Less: Interest During Construction 88.9 104.1 180.0 0.0 0.0 0.0 0.0 148.8 287.5 427.6 589.8 596.6 634.9 495.8 Net Income -192.2 -204.0 -292.8 -845.8 -827.5 -298.7 192.6 1185.1 2848.1 8579.4 4088.7 4476.8 4851.7 5058.0 / t assumes 95 rate increase in 1990 and 1991; additionally, starting in 1991, a price/cost ratio equal 1.0, as defined below (o) b/ It asumes a 2.5 annual staff increase and 2.X in salaries. c/ Forecasted as function of the installed capacity (about 6.75 annual increase) d/ 10X of materials, services and others. */ It assumes annual price increase of 5X a.*. (during 1990-1992) to reach Mexican export price plus 2X a.a. In real terms. f/ Forecasted as a functior of the permanent staff. See note b/. g/ It assumes a depreciation rate of 8W. (*) Price/cost rtio is defined as:I Gross operating revenues divided by the sum of total operating operating expenses plus interest payments plus an adequate provision of funds for Sector's capital oxpenditure. 26-Apr-89 MEXICO COMISION FEDERAL DE ELECTRICIDAD (CFE) HYDROELECTRIC DEVELOPMENT PROJECT Actual and Forecast Sources and Application of Funds (Billions of Mel) <--- Hsorical -----------------Forcast In 1989 Max Pesos --- 1968 1984 1986 1966 1987 1966 1969 1990 1991 1992 1993 1994 1995 1996 S 0 URCES ------------------------------------------------------ Gross Internal Cash Generation -9.0 96.6 169.1 449.7 814.5 2528.0 8180.0 4125.7 5111.2 6480.1 7189.8 796S.2 8757.8 9648.6 Income before Interest -50.7 19.8 15.1 100.4 -164.9 626.8 952.0 1666.7 2579.2 8618.1 4807.8 4660.2 6422.8 5993.6 Depreciation 88.5 66.6 182.6 827.7 979.4 1409.0 2026.0 2287.0 2882.0 2407.0 2662.0 2883.0 3185.0 8450.0 Other 8.2 18.2 21.2 21.8 0.0 486.0 200.0 200.0 200.0 200.0 200.0 200.0 200.0 200.0 Less: Net Debt Service 804.1 622.5 624.8 715.0 1182.8 2089.0 1806.8 1502.4 1118.9 1148.8 1008.6 1874.8 1429.2 2276.6 Amortization 160.6 891.4 514.7 269.0 669.7 1117.0 1046.9 978.6 677.6 909.6 765.0 970.7 658.6 188.1 Interest Charges 205.4. 827.9 487.4 446.0 482.6 922.0 769.4 66.9 628.6 661.8 813.4 1000.1 1205.5 1436.8 Financing of debt service 2.1 7.8 2.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total Debt Service 866.0 728.6 964.6 716.0 1182.8 2039.0 1806.8 1646.7 1401.4 1570.9 169.4 1970.8 2064.1 2771.9 Less: Interest During Construction 68.9 104.1 180.0 0.0 0.0 0.0 0.0 148.8 287.5 427.6 569.8 696.5 684.9 496.8 Nat Internal Cash Generation -818.1 -528.9 -655.7 -265.8 -817.8 484.8 1871.7 2628.8 8997.8 5886.8 6160.7 658.9 7826.1 7866.9 Other consumer-based contributions 18.8 85.1 87.8 21.6 48.7 91.2 91.2 91.2 91.2 91.2 91.2 91.P 91.2 91.2 Net consumer-based funding -299.6 -486.8 -617.9 -248.7 -269.1 141.2 1482.9 2714.5 4066.5 5426.0 6251.9 680.1 7419.6 7456.1 Government Contributions a/ 294.1 839.6 650.5 716.0 1294.8 1102.0 1246.0' 522.0 242.6 288.2 815.0 846.8 872.4 416.1 Subsidy to consumers 191.1 208.0 295.0 681.5 1294.8 1102.0 1248.0 522.0 242.6 288.2 316.0 845.8 872.4 416.1 Equity Contributions 108.0 186.0 255.5 168.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 c Borrowings b/ 224.9 550.4 681.8 827.7 687.6 1812.0 68.8 1482.4 2507.7 2569.4 2829.0 8370.1 8892.2 4826.0 Proposed IBRD Loans 0.0 0.0 0.0 0.0 0.0 0.0 86.9 64.7 108.8 228.6 256.4 201.2 144.1 87.1 Existing Loans 224.9 550.4 661.6 827.7 687.6 1812.0 97.2 18.5 0.0 0.0 0.0 C.0 0.0 0.0 Future Loans 0.0 0.0 0.0 0.0 0.0 0.0 479.7 1864.2 2400.9 2865.6 2670.6 8166.9 8246.1 4260.9 TOTAL SOURCES 219.2 401.2 594.4 799.0 1718.5 2989.6 8872.7 4668.9 6888.8 6808.6 9895.9 10896.6 11188.9 12202.2 APPLICATI 0 NS Construction Program 286.8 88.8 642.8 618.9 1428.2 280.0 2650.2 4452.8 6602.8 6088.4 9160.8 10077.9 10928.8 11667.6 Ongoing and Future Projects 171.9 279.7 412.8 618.9 1428.2 2880.0 2860.2 4809.8 6815.1 7656.8 6570.6 9481.4 16,3.9 11172., Interest During Construction 8.9 104.1 180.0 0.0 0.0 0.0 0.0 148.8 287.5 427.8 589.8 596.5 884.9 495.8 Variation In Working Capital -7.9 17.9 160.8 178.6 879.1 224.7 522.6 216.8 286.2 220.2 285.9 817.3 255.1 584.7 Other Applications -8.7 -0.5 -108.5 11.5 -88.8 -85.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 TOTAL APPLICATIONS 219.2 401.2 594.4 799.0 1718.5 2989.5 8872.7 4688.9 6886.8 8808.6 9896.2 10895.2 1118.9 12202.2 s/ In 1991 and thereafter, it assumes a 25 of total revenues as subsidles for low Income consumers. b/ Terms for future borrowings were assumed as follows: 15 years, 6 years of grace and 9S Interest rate (real). c/ Includes variation in other assets and liabilities. fi