Peru - Guideline study for a short- and medium-term strategy for the energy sector

UNDP/World Bank 10359 Energy Sector Management Assistance Programme National Energy Council - PERU PERU Guideline Study for a Short- and Medium-Term Strategy for the Energy Sector Washington D.C., December 1990 This document has a restricted distribution. Its contents may not be disclosed without Govermment, UNDP, or World Bank authorization.   PERU Guideline Study for a Short- and Medium-Term Strategy for the Energy Sector this report is the English version of a report issued in Spanish, in December 1990 Washington, December 1990 This report was prepared for the National Energy Council (CONERG) by a group of independent Peruvian and foreign consultants, in collaboration with a mission of the Joint UNDP/World Bank Energy Sector Management Assistance Program (ESMAP). This program was cofinanced by the United Nations, the ESMAP (UNDP/World Bank) Program and the World Bank.   This study was produced by the joint effort of a group of national and international experts, who worked between March and July 1990 under the sponsorship of CONERG, an energy sector organization. The consultancy group expresses its appreciation to the Ministry of Energy and Mines, and especially to Mr. Luis Ampuero Salas, Vice-minister of Energy, to the UNDP Representative Resident in Lima, to Mr. Maximo NuSez, CONERG Technical Secretary, and to Mr. Nestor Vargas, from the Cabinet of the Vice-minister of Energy, for the valuable cooperation given by all the energy sector enterprises of Peru. The collaboration of the officials and technical experts of PETROPERU, ELECTROPERU, ELECTROLIMA, CENERGIA, D.G. Forestal, Proyecto Forestal FAO-Olanda is also highly appreciated The Peruvian consultants who participated in elaborating this study are as follows: Mr. Rufino Cebrecos R. General Economist Mr. Jorge Flores M. Electricity Specialist Mr. Mario Gallo G. Energy Economist Mr. David Grandez G. Power Utility Administration and Organization Specialist Mr. Carlos Hertz Envirommental Protection Specialist Mr. Alfonso Lopez M. Forestry Economy Specialist Mr. Eleodoro Mayorga A. Natural Gas Specialist Mr. Augusto Morales C. Oil Exploration and Production Specialist Mr. Gustavo Navarro Oil and Oil Product Processing (Refining and Industrialization), Transportation and Distribution Specialist  The international consultants who participated in the elaboration of this study are as follows: Mr. Alfred de Gier Forestry and Fuelwood Specialist Mr. Thomas Houston Financial Analyst Mr. Bruno Philippi Energy Sector Regulation Specialist Mr. John Shillingford 'Downstream' Petroleum Operations Specialist (Refining, Industrialization) Mr. Giovanni Zappala Oil Legislation Specialist Mr. Hans Zeiher Coal Specialist nhe ESMAP Program (UNDP/World Bank) mission collaborating with the group of consultants in this study included the following members of the World Bank and Energy Department: Mr. Michel Del Buono Senior Economist and Mission Coordinator Ms. Emilia Battaglini General Economist Mr. Enrique Crousillat Electricity Specialist Mr. Philippe Durand Energy Conservation and Household Energy Use Specialist and the Head of the World Bank Hydrocarbons Unit for Latin America, Mr. Chakib Khelil, who was in charge of coordinating the work on oil and gas.  TABLE OF CONTENTS Em PREFACE ................................................. 7 I. ENERGY IN THE PERUVIAN ECONOMY ............................... 1 THE ECONOMIC CRISIS ....................................... 1 ENERGY BALANCE .......................................... I Reserves .............................................. 1 Energy demand forecast .................................... 5 INSTITUTIONAL ASPECTS ..................................... 6 THE ECONOMIC-FINANCIAL CRISIS OF THE POWER SECTOR .... ........ 7 Hydrocarbons .......................................... 7 Electric power .......................................... 8 FISCAL IMPACTS ............................................ 10 II. PROBLEMS OF THE SECTOR AS A WHOLE ............................ 12 PRICING AND TARIFF-SETTING POLICY ........................... 12 PROPOSALS FOR PRICES AND TARIFFS ............................ 14 IMPACT OF THE PROPOSED MEASURES ........................... 17 Impacts on the costs of other economic activities and on prices (that is, inflation) ......................................... 17 Impact on prices of final consumption goods ....................... 17 Impact on the Residential Sector ............................... 19 Effect of an increase in energy prices and tariffs on company sector finances . . . 20 PROPOSED INCREASES ....................................... 21 REGULATORY AND INSTITUTIONAL ISSUES ........................ 24 m. INVESTMENT AND REHABILITATION NEEDS .......................... 25 ELECTRICITY .............................................. 25 Lima-Callao Urban Area .................................... 26 HYDROCARBONS ........................................... 27 Oil Exploration and Development .............................. 29 CAMISEA GAS .............................................. 29 The Project ............................................ 29 Financial Analysis ........................................ 30 IV. ENERGY CONSERVATION AND SUBSTITUTION ........................ 32 SITUATION ................................................ 32 ENERGY CONSERVATION ..................................... 32 CENERGIA ........................................... 32 ITINTEC ............................................. 34 Constraints and Hindrances for the Conservation Program. 35 Production sector.36  Transportation sector ............. ......................... .37 Residential/Commercial/Public sector .37 ENERGY SUBSTITUTION .39 Residential sector .39 Situation and consumption trends .39 Comparative cooking costs .39 Substitution. 40 Kerosene and LPG distribution systems .41 Transportation sector .42 Production sector .42 RECOMMENDATIONS .42 nergy conservation .42 Substitution .45 LPG .45 Coal. 46 V. ORGANIZATIONAL AND REGULATORY ASPECTS .47 COMPONENTS FOR AN ENERGY STRATEGY .51 ENERGY POLICY AND INSTITUTIONAL STRUCTURE OF THE SECTOR .53 VI. ENERGY AND THE ENVIRONMENT .56 MAIN ENVIRONMENTAL PROBLEMS IN THE ENERGY SECTOR .56 Hydrocarbons .56 Forest Biomass and Energy .58 Electricity .59 STANDARDS AND INSTITUTIONAL STRUCTURE .59 GENERAL RECOMMENDATIONS .61 VY. HYDROCARBONS SUBSECTOR . . . 64 IMPORTANCE OF THE HYDROCARBONS SECTOR IN THE ECONOMY ...64 HYDROCARBONS SUBSECTOR SITUATION . . .64 Reconunendations for a medium-term action plan in the hydrocarbons subsector ...65 A. UPSTREAM OIL SUBSECTOR .68 Objectives and Strategy Guideline .68 SUMMARY OF SUGGESTED ACTIONS ...69 THE IMPACT OF LEGISLATION ON EXPLORATION INTENSITY ... 71 THE PETROLEUM CONTRACTS ...72 Historical background . . .72 Ongoing contracts . . .73 A. Occidental contract (1985 renegotiation) .74 B. Mobil contract (1989) .80 EXPLORATION EFFORT TO ACHIEVE STEADY PRODUCTION OF 200,000 BARRELS PER DAY . . .84 INVESTMENT REQUIREMENT ...84  PROFIT SHARING 8...................................... 8 B. HYDROCARBONS DOWNSTREAM SUBSECTOR ..................... 86 SUPPLY AND DEMAND OF OIL PRODUCTS .................... 86 PRODUCT SUPPLY ALTERNATIVES .......................... 87 IMPORT AND EXPORT OF OIL PRODUCTS ..................... 88 OPTIMUM LEVEL OF REFINING IN PERU ...................... 89 PETROCHEMICALS AND NON ENERGY PRODUCTS .... ........... 90 Fertilizers ........................................ 90 Carbon Black ...................................... 91 Solvents ......................................... 92 Gas and LPG processing ............................... 92 Lubes, greases and asphalt ............................. 92 NATURAL GAS ........................................ 93 REHABLITATION ...................................... 94 MODIFICATIONS AND EXPANSION .......................... 94 Talara refinery ..................................... 95 La Pampilla Refinery ................................. 96 Conchan Refinery ................................... 96 Iquitos Refinery .................................... 97 Pucallpa refinery .................................... 97 Marsella refinery ................................... 97 Catalytic Reforming .................................. 98 REMARKS ON THE PRIVATIZATION OF PETROPERU'S SUBSIDIARIES .................................... 98 PETROLERA TRANSOCEANICA S.A. .................... 98 COMPANIA PERUANA DE GAS S.A ...................... 99 PETROLEOS DEL MAR (PETROMAR) .................... 100 Servicios PETROLEROS S.A. (SERPETRO) .................. 100 RECOMMENDATIONS FOR A GENERAL SUPPLY STRATEGY .... .... 101 C. NATURAL GAS SUBSECTOR .................................. 103 GAS IN THE NORTHEAST ................................. 104 AGUAYTIA GAS ........................................ 105 CAMISEA GAS ......................................... 105 The Camisea reserves ................................ 106 POSSIBLE DEVELOPMENT AND PRODUCTION ESTIMATES .... ..... 108 Appraisal program .................................. 108 Development drilling ................................. 109 Production forecast .................................. 109 GAS AND CONDENSATES MARKET .......................... 110 Natural Gas Market .................................. 110 Fuel gas ......................................... 110 a. Utilization in the Industrial Sector .................... 110 b. Use of natural gas in electric power generation .... ........ 111 c. Household and Transportation Sector .................. 112 Feedstock Gas ..................................... 113  a. Fertilizer production ....................... .... . 113 b. Iron-sponge production .................... ... ... . 113 c. Petrochemical development possibilities ................ 113 Natural gas exportation ........... .. . ............ 114 Summary . ........ .. .......... ............ 115 LPG MARKET... .. . ............ 116 SOUTHERN REGION FUEL M 'iRKET ..... . .. 117 ECONOMY OF THE CAMISEA GAS PE. ..... .. .. ... ...E. .. 119 investments and financing scheme .. 119 Financial Assessment ..................... ........... 121 Risks ..................................... 122 VIII. ELECTRIC POWER SUBSECTOR .................................. 123 Introduction ................................................. 123 ORGANIZATION AND LEGAL FRAMEWORK ......................... 124 SUBSECTOR ASSESSMENT ..................................... 127 Technical Situation ....................................... 127 Financial Situation ........................................ 129 Institutional Aspects ....................................... 132 Main investment projects ................ ................... 135 EXPANSION PROGRAMS ....................................... 136 SHORT- AND MEDIUM-TERM STRATEGY FOR THE ELECTRIC POWER SECTOR ...... ....................................... 141 SHORT-TERM MEASURES ............ .......................... 142 Tariff-setting policy ............. .......................... 142 Electric power sector rehabilitation program ........................ 143 MEDIUM-TERM MEASURES .................................... 145 Investment projects ............. .......................... 145 Institutional framework ........... .......................... 146 ELEMENTS FOR SUBSECTOR ORGANIZATION ....................... 146 INVESTMENT PLANNING AND COORDINATION ...................... 148 OPERATION COORDINATION ................................... 149 FINAL REMARKS .1............................................ 0 IX. WOODY FUELS AND RENEWABLE ENERGY SUBSECTOR .................. 151 WOODY FUELS .5............................................. 1 Situation .............................................. 151 Main issues ............................................. 151 Demand . ............................................. 152 Supply ............................................... 153 Coast ........................................... 154 Sierra . ......................................... 154 Rain forest ............ ........................... 155  Institutional Aspects ................... ... ... ... ... ... ... . 156 Legal Framework . ....................................... 156 Monitoring and supervision ............................. 157 Supply and demand actions of woody resources ..................... 157 Recommendations . ....................................... 159 NEW AND RENEWABLE ENERGY SOURCES ......................... 160 Experiences and problems ........... ........................ 160 Mini-hydropower stations ........... ........................ 161 Solar power . ........................................... 161 Wind power ............................................ 162 Geothermal energy . ...................................... 162 Biomass and biogas .............. ......................... 162 Recommendations . ....................................... 162 X. COAL SUBSECTOR ............................................. 164 RECOMMENDATIONS . ....................................... 165 PERU'S COAL DEPOSITS: COAL AND RESERVE QUALITY ............... 167 Alto Chicama basin . ....................................... 167 Santa Basin ........................................ ..167 Oyon Basin ........................................ 167 Goyllarisquizga Basin ...................................... 168 latunhuasi Basin ....................................... 168 Quality and range of coals . .................................. 168 PERU'S COAL RESERVES ...................................... 169 COAL MINING ACTIV IES IN PERU ............ .................. 170 Coal production ....................................... 170 Analysis of active coal mines . ................................ 171 Public-owned mines ....................................... 172 Mining Methods ....................................... 172 Legal Aspects ... ....................................... 173 THE PERUVIAN COAL MARKET . ................................ 174 Current use of coal in the Peruvian market ........ ................ 174 COAL PRODUCTION COSTS AND MARKET PRICES ...... .............. 176 Production cost of ROM coal and price in the mine ...... ............. 176 Transportation Costs ...................................... 176 Coal price in the locality of the user .......... .................. 176 Prices of imported coal ..................................... 177 POTENTIAL USE OF NATIONAL COAL IN PERUVIAN INDUSTRIES AND DOMESTIC MARKETS ................................. 177 Coal substitution for generation, reduction or direct heat in industry ......... 177 Fuel substitution on the domestic market .179 ANNEXES ..... 182   PREFACE The main objective of this study is to identify and propose to Peruvian Government authorities a set of energy policy measures and institutional reforms to strengthen the energy sector's management and efficiency, after several years of neglect and/or policies that have weakened the sector and the institutions involved in energy activities. In addition, disseminating this study to the bilateral and multilateral cooperation agencies that could be interested in supporting the Peruvian energy sector will help reintroduce Peru into the sphere of international financial organizations. In this study they will find information and analyses that will help them to make energy sector decisions. In -keeping with these aims, the study will review the financial and operational situation of the various sector agencies and/or companies and their urgent rehabilitation and investment needs. This will be done bearing in mind that Peru needs resources to stabilize its economy in the short term and that the energy sector could be an important source of financial resources for the country's stabilization. In the medium and long term, these same policies would help to achieve the sector's own objectives, which are essentially geared toward ensuring the long-term supply of economical energy and its efficient use. In the short term, since resources received by sector companies will be substantially lower (despite increased tariffs and prices) and will barely manage to cover operating costs, it is assumed that required investments and rehabilitation costs will be implemented with foreign resources obtained directly by sector companies or through the government or, eventually, through private sector involvement. Intermediate objectives * To analyze how to supply, at a minimum cost, the energy required for a take-off in economic growth and to meet the basic needs of the population, bearing in mind that several energy sources are nonrenewable and that they must be used with maximum efficiency. * To define pricing, tariff, and regulatory policies which provide incentives for the rational use of energy, enable sector company finances to be put on a sound footing, facilitate the introduction of other economic agents (public, private, national, and foreign) into sector development, and generate public income to cover expenses (especially social) needed for minimum social welfare. * To determine the extent to which demand management or administrative policies, improved planning and technology selection policies can minimize investment needs.  - ii - * To identify an urgent rehabilitation program in the electric power and hydrocarbons subsectors that could be financed by foreign funds and an investment program (for the medium term) that reflects the shortage of public financial resources and the need to attract national or foreign private resources (investments). The first part of the study includes the following: a brief summary of Peru's economic situation and the energy sector's role in the economy (Chapter 1), followed by a very short assessment of the sector, especially focusing on pricing and tariff-setting policies and their impacts; a brief summary of the rehabilitation and investment needs of the electric power and hydrocarbons subsectors; a note on energy conservation and substitution (and the impact of setting economic prices on conservation and substitution); a discussion of organizational and regulatory aspects and an introduction to the analysis of environmental problems stemming from energy sector activities. In the second part, a deeper analysis of subsector problems is provided (Hydrocarbons including upstream, downstream and natural gas, Electricity, Woodfuels and Renewable Energy, and Coal). The following will be presented in a series of annexes: the economic forecasts and input- output calculations which were used to achieve certain quantifications in this study; an idea for an energy conservation and substitution project; a more in-depth discussion on an organizational option for the electric power subsector; and a few statistical tables. This study was carried out between March and August 1990 and essentially reflects the situation at that time, when a new government was coming into office. A preliminary version of this report was distributed in Lima, in August 1990. Nevertheless, the economic measures applied on August 8, 1990 are commented upon and, in certain cases, further developed afterwards since several members of the study group who were elaborating this report participated in a multisectoral mission of the World Bank that took place in October and November 1990. Although this study does not have an executive summary as such, Chapter I (which summarizes the impact of energy sector operations on the economy in general and vice-versa) and Chapter II (which analyzes the problems of the sector in its entirety and presents the main recommendations) mention virtually all the important aspects of this study. The subsector chapters, however, enter into far greater detail.  - ini - MONErARY EQUIVALENTS (intis per dollar, January-October 1990) Parallel Single Exchange Exchange Market January 13,013 5,804 February 13,532 7,213 March 18,553 9,663 April 27,967 13,548 May 39,45 19,259 June 74,031 28,163 July 118,000 44,215 August 316,652 September 430,050 October 447,808 ENERGY CONVERSION FACTORS (net content expressed in ton oil equivalents of 10 million kilocalories) OHl Crude Oil 0.138 TOE/B LPG 0.097 TOE/B Gasoline 0.124 TOE/B Kerosene and aviation fuel 0.131 TOE/B Diesel 0.138 TOE/B Fuel oil 0.148 TOE/B Electricity 86.000 TOE/GWh Biomass Fuelwood 0.430 TOE/ton Charcoal 0.650 TOE/ton Bagasse 0.183 TOE/ton  - iv - ACRONYMS BCR Central Reserve Bank of Peru CDEC Centro de Despacho Econ6mico de Carga (Economic Load Dispatch Center) CENERGIA Centro de Conservaci6n de Energfa (Energy Conservation Center) CNE Comisi6n Nacional de Energfa (National Energy Commission) CNTE Comisi6n Nacional de Tarifas Electricas (National Electric Power Tariff Commission) CONERG Consejo Nacional de Energfa (National Energy Council) DGFF Direcci6n General Forestal y de Fauna (General Forestry and Fauna Directorate) DIGESA Direcci6n General de Salud Ambiental (General Environmental Health Directorate) FACE Fondo Andino para Conservaci6n de Energfa (Andean Fund for Energy Conservation) IDB Inter-American Development Bank IMF International Monetary Fund INP Instituto Nacional de Planificaci6n (National Planning Institute) INTEC Instituto de Investigaci6n Tecnoldgica Industrial y de Normas Tecnicas (Institute of Industrial Technological Research and Technical Standards) MEM Ministry of Energy and Mines ONERN Officina Nacional de Evaluaci6n de Recursos Naturales (National Office for Natural Resources Assessment) OXY Occidental Oil Company PNAF Programa Nacional de Accidn Forestal (National Forestry Action Program) PP PETROPERU SICN Sistema Interconectado Centro-Norte (Central-North Interconnected System) SPCC Southern Peru Copper Corporation  - v - ABBREVIATIONS AAI annual average increase APC production sharing agreement B barrel BPD barrels per day BTU british thermal unit CIF cost, insurance, freight CPI consumer price index EAP economically active population EIS environmental impact study FOB free on board GDP gross domestic product GOP Government of Peru GJ gigajoule GW gigawatt GWh gigawatt hour ha hectare i/. inti IOC international oil company kgoe kilogram oil equivalent km kilometer kV kilovolt kW kilowatt kWh kilowatt hour LPG liquefied petroleum gas LRMC long-run marginal cost MBPD thousand barrels per day MMB million barrels MMBTU million BTU MMCF million cubic feet MMCFD million cubic feet per day MW megawatt NGL natural gas liquids NPV net present value TOE ton oil equivalent ton metric ton W watt   Peru - Guideline Sntdy 1 1. ENERGY IN THE PERUVIAN ECONOMY THE ECONOMIC CRISIS 1.1 The energy sector's deterioration should be analyzed within the context of Peru's general economic crisis, whose main features are indicated below: a. Monthly inflation rates on the order of 30% to 40%, with an upward trend. In 1989, inflation was 2,775%, and in the first six months of 1990, the annual rate increased to 3,400%. b. A slump in production, which has fallen by about 20%, compared to the first half of 1988. c. A drop in real salaries to less than half the level of two years ago. A rise in unemployment and underemployment to more than 75% of the labor force. d. A 4% reduction in real public expenditure in terms of GDP, as a result of a standstill in state investments and, above all, drastic cuts in public sector remunerations. e. A persistent fiscal deficit greater than 9% of GDP completely financed by monetary emission. Tax revenues have fallen from 14% of GDP in 1985 to less than 5% in 1989. The deficit of state-owned enterprises is on the order of 2% of GDP. f. Complete lack of international reserves in the Central Bank and the end of domestic credit even for short-term operations. ENERGY BALANCE Reserves 1.2 In 1988 the country's structure of proven energy resource reserves was as follows:  Peru - Guideline Study 2 TOE X 106% Hydropower (*) 142.6 35.0 Coal 42.6 10.4 Natural gas + NGL 165.8 40.6 Oil 56.8 14.0 Total 407.8 100.0 () Average energy from hydropower developments is taken into account, over 50 years. I Source: National Energy Plan Sectoral Commission. 1.3 Peru's 1988 energy balance is shown in Table 1. National primary energy production was 13.2 million tons of oil equivalent (TOE), of which 54% was oil, 26% fuelwood, 8% hydropower, and 7% natural gas. 1.4 Energy exports, consisting entirely of oil and oil products, amounted to 2.3 million TOE in 1988 while imports recorded 2 million TOE. On the basis of national production figures, in 1988 the Peruvian economy used 12.9 million TOE. Table 2 shows the performance of the commercial energy balance. Peru shifted from being a net energy (oil) importer to exporter in 1978, a position it has been losing to such an extent that it is now becoming an importer once again. If the downward trend of proven reserves persists, the deterioration could accelerate to such an extent as to prevent any possible attempt at recovery. In terms of foreign exchange, between 1979 and 1985, oil contributed more than US$400 million to the national economy per year. In 1989 the balance was almost zero. If the economy were to grow by only 2.5% per year, 125,000 barrels per day would be needed; since only 100,000 barrels would be produced, the cost of importing the remaining would amount to US$185 million. 1.5 The annual final energy consumption in 1988 was almost 0.5 TOE per inhabitant, including 0.15 TOE in the form of noncommercial energy. This level of consumption is similar to that of Ecuador and Colombia but less than the average for Latin America (about 0.75 TOE per inhabitant per year). This situation reflects low per capita incomes, inasmuch as the energy intensity of the Peruvian economy amounted to 0.48 TOE per US$100 of GDP in 1988, that is, 23.1 % greater than the Latin American average. This higher energy intensity is a result of Peru's export structure, where mining and fishing, which are energy-intensive activities, are prevalent.  Peru - Guideline Study 3 Likewise, low energy prices tend to increase the aforementioned coefficient, promoting the inefficient use of energy. 1.6 The growth of final energy consumption was 2.2% in the 1970-1980 period, was stagnant between 1980 and 1985 (-0.2% per year), and grew again to 3.5% between 1985 and 1988. The elasticity of final energy consumption in relation to gross domestic product (GDP) increased from 0.5% in the 1970-1980 period to 0.8% for 1980-1985, to reach 1.5% during the 1985-1988 period. 1.7 Tne consumption pattern by energy source shows a certain stability during the 1980-1985 period. It is worth mentioning that electricity consumption growth (3.8% per year) was much faster thazn oil product consumption growth (0.8% per year) and similarly for coal. The rate of consumption of fuelwood and residues was slightly lower than that observed during the same period in the rural population, indicating a slow penetration of oil products in this area of population.  Peru - Guideline Study 4 Table 1: Total Energy Balance 1988 (thousand TOE) (1) (2) Non- Com. Energy (1)+(2) Com. Crude Oil Energy Oil Gas Prods Elect. Other Total Total Primary Supply Production 3681 7137 882 1121 405 9545 13226 Export -255 -255 -225 import 1212 1212 1212 Inventory Var. 44 -213 -2 -171 -171 Unutilized Total 3681 8138 669 1121 403 10331 14012 Transformation Refineries -8329 -612 Elec. Power Stations 1161 Other -168 -119 Adjust. & Losses -135 -172 Total Supply 3378 6939 975 Trade Balance Export -2049 import 752 Domestic Supply 3378 5634 975 339 6948 10326 Financial Consumption Resid. Commer. 2945 1185 367 131 1683 4628 Public 229 229 229 Transportation 2607 2607 2607 Agro-Agroindust 105 18 123 246 246 Fishing 258 2 260 260 Mining-metalurgy 345 208 25 578 578 Industrial 433 902 308 60 1342 1775 Source: CONERG, 1988 Consolidated Energy Balance.  Peru - Guideline Sntdy S Table 2: Commercial Energy Balance, 1970-1988 (TOE X 106) Exports Imports Balance 1970 0.331 (1.485) (1.154) 1978 1.922 (0.407) 1.515 1988 2.304 (2.005) 0.299 Source: CONERG, Energy Balances; 1970 and 1988. 1.8 On considering final energy consumption by sector, the prevalence of the residential-commercial and public sectors is observed, with a relative share of 46% of total consumption, although they only account for 28% of the total commercial energy consumed. 1.9 In terms of growth, during 1980-1988 the commercial sector experienced the highest rate (2% per year), due to a considerable increase in the consumption of electricity (5.2%) and oil products (2.7%). Transportation sector consumption grew by 1.9% per year, and the gasoline and diesel consumption ratio in this sector shifted from 1.77 in 1980 to 1.3 in 1988, indicating a higher degree of dieselization in the motor vehicle fleet. Consumption of the mining- metallurgical sector declined (-2.9% per year) and growth of industrial sector consumption was low (0.8% per year) but a considerable increase was seen in electricity consumption (5% per year) at the expense of oil products. Energy demand forecast 1.10 The relative stability of the final energy consumption pattern during the 1980- 1988 period enables a forecast to be made for 1995, using consumption growth rates from the aforementioned period (Table 3). This biased forecast can only be used as a reference, since it assumes that energy prices, energy conservation and substitution actions, and macroeconomic indicators will follow the same trends until 1995 as those recorded during the last decade. Thus total consumption is estimated at 11.2 million TOE for 1995.  Peru - Guideline Study 6 Table 3: Biased Forecast of the FYnal Ener8y Balance, 1988-1995 (thousand TOE) 1988 % 1995 % Oil and Gas Products 5,635 54.0 5,925 52.9 Electricity 975 9.4 1,173 10.5 Fuelwood and Residues 3,378 32.7 3,668 32.7 Others (1) 340 3.3 437 3.9 Total 10,328 100.0 11,203 100.0 Source: Mission Estimate (1) Includes coal, charcoal, bagasse and coke. INSTITUTIONAL ASPECTS 1.11 The Ministry of Energy and Mines (MEM) was created in 1969. Mining activities, hydrocarbons, and electricity, regulated by the formulation of energy policies and plans elaborated by the Ministry, come under its jurisdiction. In addition, its duties include the regulation of state energy enterprises. In reality these companies play a decisive role in the preparation of such policies as they rely on a larger technical staff than the MEM. 1.12 In practice, the elaboration of energy policies and strategies has been relegated due to the more important and persistent issue of scarcity of resources, stemming from the reduction in prices and tariffs as a result of the rampant inflation being experienced by the country. The main concern of sector authorities and of those in charge of company management has been the continued negotiation of price and tariff adjustments with the Ministry of Economy and Finance, in order to ensure the operation of energy companies. 1.13 The National Energy Council (CONERG) provides advice to the minister in charge of formulating energy policies, financing and training in all energy subsectors. CONERG is composed of fifteen representatives from energy sector state companies and has a technical Secretariat divided into three sections which cover energy policy, conservation, and new and renewable energy sources. 1.14 CONERG's activities have been constrained by the economic crisis threatening the country; therefore, in practice, its role consists of providing information through the elaboration and publication of the country's annual Energy Balances.  Peru - Guideline Study 7 1.15 PETROPERU, by law, is exclusively in charge of exploring and developing hydrocarbons. On the one hand, it does this directly and, on the other, through international oil companies by means of contracts to work as contractors or partners. 1.16 According to General Electricity Law No. 23406, the Electric Power Company System was created with ELECTROPERU as the central utility and a group of ten regional public power service delivery utilities providing coverage to the entire national territory. As a result of the country's regionalization policies, which began to be implemented in June 1988 with the enactment of the corresponding Base Law, the set-up of electric power group utilities was altered and ownership of the regional companies was partially or even totally transferred to regional governments, so that ELECTROPERU's status as the main governing power utility was modified. Its responsibilities were clarified through Legislative Decree No. 597 (1-5-1990). ELECTROPERU, besides being responsible for formulating master electrification plans and for approving regional investment and auto-generating projects, is responsible for the ownership and administration of the multiregional interconnected power systems and for the ownership and administration of regional systems for regional companies (distribution systems, isolated generation systems, and those power systems that have exclusively regional scope). THE ECONOMIC-FINANCIAL CRISIS OF THE POWER SECTOR Hydrocarbons 1.17 The current situation of PETROPERU could be described as a virtual financial standstill. Regarding operational management, inventories have fallen to dangerously low levels, and not even minimum expenditures on maintenance and spare parts have been made in the last few years, which has led to rising operating costs and declining production capacity. The fall in oil production (estimated at 16,700 barrels per day or 18% of total production capacity) has entailed larger import requirements and higher unit production and transport costs. With respect to financial management, PETROPERU is in arrears with its contractors and suppliers and with the transfer of payments for production and sales taxes. 1.18 PETROPERU's performance forecast for 1990 clearly displays its financial deterioration. Net losses forecast for this year amount to US$850 million, a figure US$255 million greater than the losses recorded in 1989. When reserve entries for compensation, depreciation, tangible exchange differences and amortizations, and intangible exchange differences (which refer to contingent liabilities) are excluded, net losses in 1989 amount to between US$320 and US$350 million. The same adjustment for 1990 reduces projected losses by US$200 million. 1.19 PETROPERU is currently receiving income from sales on the domestic market on the order of US$5.20 per barrel, whereas unit production costs for January-March 1990 are estimated at an average of US$19.6 per barrel. For this same period, total costs (excluding depreciation) were recorded at about US$17.70 per barrel. These figures provide evidence that  Peru - Guideline Study 8 unit costs are not being covered, a situation that has been prevailing since 1986 and which obviously cannot continue. In contrast to international experiences, unit production costs have been increasing considerably since 1988. An explanation for this is the decline in crude oil production. It should be noted that oil operations are characterized by capital-intensive production, transport, and processing operations and relatively high fixed operating costs. In this industry, operating efficiency is achieved through high use of installed capacity and special focus on the operating costs for labor and the use of external services. Lower production capacity and lack of development of new reserves mean underutilization of capital and sector infrastructure and an increase in unit costs. 1.20 Lower earnings from sales on the domestic market, along with the erosion of net export earnings, have obliged PETROPERU to resort more frequently to financial support from the government, either directly (for example, through the payment of its liabilities to Occidental for contract payment arrears) or indirectly (for example, the loan relief granted to PETROPERU in 1987 for a seven-year grace period and exemption from royalty payments and export duties on its own production and purchases from Oxy-Bridas and Occidental). 1.21 The most important of these initiatives has been the PETROPERU Economic- Financial Recovery Program effective on December 31, 1988. This agreement provides PETROPERU with emergency working capital and entails relief on a large part of its foreign debt. The government assumes responsibility for payment of US$541.9 million, equivalent to 78% of total debt recorded at that time. It also includes a preliminary agreement for a long-term investment program for the development of the Camisea gas field, a rationalization program ('streamlining") of PETROPERU's operating divisions, and, more important, a program for the adjustment of domestic prices in line with PETROPERU's operating costs. The last three measures of the agreement were, for all practical purposes, ignored. Eledric power 1.22 In the case of PETROPERU and public service power utilities, the real drop in electricity tariffs stretched over a long period of time (since 1985), during which earnings were insufficient to cover operating costs. This has affected the efficiency of the utilities and has lead to a critical financial situation, characterized by the following: (a) Earnings are scarcely sufficient to cover expenditures incurred for paying staff salaries and benefits. (b) Fuel consumption has been reduced to a minimum, although this entails power supply outages for the users. (c) Progressive cuts have been made in the system's maintenance costs in the last four years, despite an increase in terrorist activity. This has meant an effective  Peru - Guideline Study 9 loss in capacity and a high percentage of system losses, aggravating the supply shortages. (d) Lack of funds to carry out or complete crucial rehabilitation projects that would have an immediate positive impact on the system's efficiency. (e) Service delivery and planning depend on negotiations with the government over tariffs and capital contributions, which have deteriorated the efficient management of a valuable and strategic sector for the economy. 1.23 The primary reason for the deterioration of financial performance, as in the case of the oil sector, is the decline in electricity tariffs. In real terms, electricity tariffs have fallen on average to 20% of their value in 1985; in terms of current dollars, the average reduction has gone from US$0.0423 per kWh in 1985 to US$0.0138 per kWh in 1988. In April 1990, the average unit tariff per kWh is estimated at US$0.031 per kWh. 1.24 ELECTROPERU's forecast for 1990 indicates net subsector losses amounting to US$211.4 million. The forecast is based on results adjusted for the first quarter with projected tariffs that increase at the same pace as inflation but remain at levels of US$0.031 per kWh. The projected operating costs for 1990 were US$0.049 per kWh, compared to US$0.04 per kWh recorded in 1989. The cost increases stem from personnel expenditures, which includes Compensation for Seniority. Labor costs are forecast at 62.7% of total operating costs for 1990. When these figures are adjusted for compensation, unit costs do not display a clear upward trend. 1.25 Beginning in 1986, electricity services have depended on capital contributions from the Public Treasury to finance operating deficits and capital investment. One modality to provide this kind of support has been debt service relief. The most significant initiative in this respect was the 1987 Economic-Financial Recovery Program for the Electric Power Subsector (DS 06J-87EF), a prerequisite for obtaining the IDB sector credit. The Recovery Plan included assuming the debt by refinancing arrears at December 1986 in the amount of US$472 million and the payment of US$1,360 million of debt from the 1987-1996 period. It also involved increases in electric power tariffs, the formulation of tariffs based on a marginal cost structure, and the establishment of financial income objectives for 1987-1990. In short, a comprehensive plan for the financial restructuring of the electric power subsector. 1.26 As in the case of the Oil Recovery Program, the government did not implement the complete program and continued with its policy of reduced tariffs. This has required increasingly larger contributions from the government to cover operating deficits. For example, in 1989, the government through DS 213-89-E assumed the short term debt in the amount of US$29.4 million, achieved a line of credit for USS20.4 million, and provided a capital contribution for US$53.1 million to ELECTROPERU. This has been increasingly important as a source of cash and at present accounts for 30% of total income.  Peru - Guideline Study 10 FISCAL IMPACTS 1.27 In order to more clearly visualize the impact of pricing and tariff-setting policies for energy products pursued during the last few years, suffice it to observe that, in 1989, assuming the same public expenditure in real terms, there would have been no fiscal deficit if electric power tariffs and prices for oil products had remained at real 1985 levels. In other words, the additional income of energy sector companies and the State would have been on the order of 9.3% of GDP, while the fiscal deficit was equivalent to 9.0%. 1.28 In addition, if 1985 oil production volumes had remained constant, exports in 1989 would have been greater by some US$400 million, and net additional earnings for PETROPERU and the Treasury would therefore have been on the order of 1.5% of GDP, considering only the direct fiscal effect. 1.29 Finally, if hydropower stations under construction since the last decade had come on line according to schedule and if existing thermal plants had been maintained at acceptable levels, about 0.5% of GDP per year would have been saved. 1.30 In short, the fiscal impact of pricing and tariff-setting policies for 1989 was on the order of 9.3% of GDP, that is, equivalent to total public sector financial requirements for that year. These calculations do not take into account setbacks in the development of the Camisea gas deposits. Fiscal Result Public Treasury and Public +7.3 Utilities (PETROPERU and ELECTROPERU) Oil exports +1.5 Saving in electricity generation +0.5 Total adjustments +9. Adjusted Fiscal Result 1.31 Fortunately, the pricing and tariff adjustments implemented in August 1990 and the reform and adjustment process initiated at the same time imply that the new govermnent has taken the resolution of energy sector problems seriously (within the general context of macroeconomic stabilization and adjustment). If the energy tariffs and prices achieved in August 1990 are maintained in real terms, substantial fiscal earnings can be expected in the short run (in fact, they have already enabled a large part of the fiscal deficit to be covered and runaway  Peru - Guideline Study 11 inflation to be curtailed), as well as a temporary solution to obtaining resources for sector companies. In the longer term, there will be substantial improvements in both efficiency of energy use and supply efficiency, especially if these pricing measures are supported by reforms that enhance competition in the sector.  Peru - Guideline Snudy 12 II. PROBLEMS OF THE SECTOR AS A WHOLE PRICING AND TARIFF-SETTING POLICY 2.1 The main issue, which has given rise to various other problems in the energy sector, is an unsustainable pricing and tariff-setting policy. There is a long story behind this situation, which we will not go into here. Suffice it to say that Peru made no adjustment for the first oil shock (of 1973) until three years later (by which time it was an oil importing country). Similarly, energy prices and tariffs have recently achieved a more reasonable level in 1985. Since then, Peru has become a net oil importer; regarding electricity supply, service quality and reliability, which were improving at least up until 1970-1980, have deteriorated to incredibly low levels (although terrorism should be added, at least in part, to the financial causes). In August 1990, the energy pricing and tariff-setting policy was radically altered. This new policy will have to be institutionalized so that it can become permanent. 2.2 In more specific terms, this is what has been occurring: (a) Real prices of oil products have fallen from an index of 100 in 1985 to an average of 25 to 30 in the latter half of 1990 (that is, they are sold today at real prices that are only a third or a quarter of what they were in 1985). Likewise, PETROPERU recorded fiscal losses of US$600 million in 1989, and losses of US$800-900 million are forecast for 1990. Simultaneously, oil production has fallen from its maximum of 195,000 barrels per day in 1982 to 130,000 barrels per day in the last few months, that is January-June 1990, and proven reserves declined from some 800 million barrels in 1980 to about 300 million barrels today (that is, seven years of current production). Regarding the level of exploration investment, which reached its maximum in 1975 with almost US$400 million (with US$100 milliorn from PETROPERU), it remained high between 1971 and 1975, then fell to zero in 1979, and rose to some US$135 million in the early eighties before dropping to almost nothing (US$40 million) in 1985- 1989. After the increase in domestic prices and international prices in August 1990, it is probable that Peru will export again in the short term. Also during these years, the Peruvian economy's energy intensity has grown, overtaking the Latin American average (which is 0.39 TOE per US$1000 of GDP) by 20% (that is, 0.48 TOE per US$1000 of GDP). Similarly, the GDP-elasticity of Peru's energy consumption increased from 0.5 in the seventies to 0.8 in 1980-1985 and up to 1.5 in 1985-1988 (that is, for every 19% increase in GDP, the energy consumption increases 1.5%). All this means that energy is used inefficiently in Peru, because it is too cheap.  Peru - Guideline Study 13 (b) In the electric power subsector, several recent well-done studies (funded by MDB, German Cooperation, and the World Bank, among others) indicate that the long- run marginal cost (LRMC) of electricity is between 7 and 8 US cents per kWh. In contrast with these figures, the average tariff has fallen approximately from 4.5-4.9 US cents in 1985 to less than 2 US cents since 1988 up till now (again bearing in mind the difficulties of calculating this in dollars). Predictably, income from energy sales fell from more than US$300 million in 1985 (1.5% of GDP) to US$140 million in 1988. Since 1986, the electric power subsector has had to rely on state subsidies (provided in several ways) to cover its operating costs. In comparison, as recently as 1984, ELECTROLIMA was believed to be able to cover its operating costs and to participate with 40% of its investment needs on the basis of its tariffs (and with firm financing from the World Bank). Finally, partly for financial reasons (the electric power companies do not have money to purchase fuel) and partly due to lack of safety, normal supply is impossible in Lima (Central-North Interconnected System - SICN) and in Piura and Talara (predominantly thermal systems). Thus, by combining the effects stemming from financial scarcity with insurrection and drought, Lima and the SICN suffer from load shedding, that is, a 20% electricity supply deficit (equivalent, in Lima, to more than 200 MW). This has produced an evident proliferation of small inefficient generators (more than 200 MW on small machines that range from a few kilowatts to several hundred kilowatts, or, in some cases, several MW). (c) In addition to the catastrophic effects that these reckless pricing and tariff-setting policies have exerted on the normal development of sector companies (both electric power and oil), the effect on public finances has been disastrous. For example, in 1988 and 1989, the State had to carry out current transfers to the energy sector in the amount of US$700 to US$800 million and for 1990, this could be more than a US$1 billion (without counting the transfers for investment, which have been almost nonexistent in the last few years), if things continue as they are. Fortunately, the August 1990 adjustment makes it likely that the losses that have been predicted will not occur. 2.3 Another indication of the sector's financial problems, which have repercussions on public finances, is the 1978 Energy Sector Recovery Program. The proposal was that, since the sector companies could not at the time cover their operating costs and ensure their debt servicing, the State would start from scratch and assume responsibility for arrears payment and payments due in the following years. The State therefore assumed, on behalf of PETROPERU, debts and payments in the amount of US$542 million (on a total debt of US$692 million) and, on behalf of ELECTROPERU and its affiliated utilities, in the amount of US$1.832 billion. The idea was that the companies would cover all their costs (including their debt service) on the basis of a suitable pricing and tariff-setting policy. In fact this, did not occur, and currently the sector  Peru - Guideline Study 14 theoretically owes the State US$2.474 billion over 20 years, free of interest (which still implies almost US$10 million per month, that is, almost equal to the electric power subsector's sales). At present, the State is not meeting these million-dollar payments (deferred and future); neither does it have the funds with which to make them. It is obvious then that these debts, which have been transferred to the State, should be covered by energy tariffs and prices. With the tariffs and prices established in August 1990, it is likely that all costs could be covered (although the part of the tariff that the power companies receive may be marginally insufficient). These prices and tariffs, clearly, should be maintained in real terms but, if possible, without making large adjustments until early 1991. PROPOSALS FOR PRICES AND TARIFFS 2.4 The analysis presented in the following sections, where the current policies are evaluated and the effects of other levels of prices and tariffs are calculated, indicates the direction proposed by the present study. Its main ideas are geared toward adjusting the prices of energy products to ensure that they do not distort the allocation of resources and that sector companies do not go bankrupt (and that other economic agents can get involved in production and distribution, marketing, etc., of the whole range of energy products). Provisionally, the energy sector could also, through several types of transfers (once the financial costs are covered), contribute to the stabilization of the economy and to financing social costs that should be provided by the State but for which no resources are available. For these reasons, the main proposals for prices and tariffs are that electric power tariffs should be established according to long-run marginal costs (LRMC), whereas the prices of oil products should be established at between 150% and 200% of their financial costs, especially with a view to creating an incentive for energy conservation, to improve income distribution (since the richest consume the largest part of commercial electricity), to enable the recovery of energy supply costs and, to a greater extent, to contribute to the general development of Peruvian society. Increased oil prices would also contribute to channeling resources towards the development of new fields and would thus contribute to maintaining the country's export position or minimize the need for imported hydrocarbons, a certainty for the next five years, especially if no energy is saved and investment is not channeled into oil field exploration. 2.5 Electric power tariffs should be established approximately at LRMC, that is, 8 US cents (average), with some tax to the high residential consumers (while exonerating the smallest consumers, who are also the poorest, from this tax). Once tariffs are established at a correct level, the majority of taxes and/or other charges should be eliminated. In addition, once a sufficient tariff level is achieved, the current consumption structure should be rearranged, inasmuch as it currently does not reflect service costs by consumer categories (it subsidizes residential consumers and penalizes commercial and industrial consumers). 2.6 Regarding oil products, it is clear that current price levels and patterns (June/July 1990) are highly distorted and provide no incentives for the rational use of oil products. Tbus,  Peru - Guideline Study 15 in view of the small price difference between diesel and fuel oil, many consumers who would normally use fuel oil are using diesel (to the detriment of the domestic economy, since diesel is a much more costly energy source). The following table illustrates the absolute and relative price patterns of oil products, comparing current domestic prices to world prices. 2.7 The difficulty with current prices is not so much a matter of structure as the absolute level of difference between product prices. That is, fuel oil is fair at 60% of the price of diesel, since the ratio is more or less the same in the world market. Unfortunately, the absolute difference between these two fuels is only 6,000 intis (or 5 US cents), while in the world market the absolute difference between these two fuels is close to 35 US cents, preventing the consumers who should use fuel oil from using diesel.  Peru - Guideline Study 16 LEVELS AND STRUCTURES OF OIL PRODUCT PRICES Cin US cents per US gallon) Current Domestic Prices World Prices World Prices (April 1990) (mid 1990) (end August 1990) Level (cents) Stuct. % Level (cents) Struc. % Level (cents) Gasoline 84 19.55 156.2 96.7 157.0 105.8 Gasoline 95 37.27 297.7 105.1 170 110.8 Kerosene 16.36 130.7 88.9 144.3 107.7 Diesel 2 16.18 129.2 75.1 121.9 97.6 Fuel Oil 9.65 77.0 43.9 71.3 56.9 LPG 9.67 77.2 78.9 128.1 - Average 12.52 100.0 61.6 100.0 Source: PETROPERU, PLATT'S and Study Group Calculations 2.8 In this table the imperfections of the current structure are emphasized: gasoline is too expensive (which is not a major problem but could produce an uneconomical dieselization) and LPG is too cheap. 2.9 These would be the only adjustments that should be implemented in the pricing structure of oil products, in addition to the obvious price adjustment. 2.10 To summarize, the pricing and tariff-setting proposal is as follows: (a) Electric power tariffs: at LRMC, that is, an average of approximately 8 US cents, as the sale price to the public and a reduction in taxes and additional charges which are currently levied on electricity consumption. Nevertheless, a total revision of the tariffs structure, which at present does not reflect the different levels of cost of electricity supply to the different types of consumer at all, should go ahead. (b) Oil product prices: setting the average price per gallon between US$1.00 and US$1.50 and the structure, close to international levels, would be the most logical.  Peru - Guideline Study 17 IMPACT OF THE PROPOSED MEASURES 2.11 The pricing ana tariff-setting policy recommended in previous sections of the study will exert an impact on the costs of other economic activities (more or less in proportion to the intensity of their energy use), on final consumption prices, on the finances of sector companies, and on public finances. To measure these various effects, several methodologies have been used, including mainly conventional financial analysis, analysis using macroeconomic models, and input-output models. Simulations and/or new studies were conducted, and the results obtained by other researchers (PETROPERU, MEM, universities, consultation firms) were used. The impact on different variables is described below. Impacts on the costs of other economic activities and on prices (that is, inflation) 2.12 All the studies conducted and/or queried were unanimous in concluding that, except in some highly energy-intensive industries or in the case of huge increases, the impact of increases in energy tariffs and prices is minimal. For example, a calculation done for this study shows that an increase in fuel prices equivalent to twice the financial costs (twice the world price for oil products) and equivalent to the LRMC for electricity would lead to an average increase of 3.8% in industrial costs (that is, 2.4% as a result of fuels and 1.4% from electricity). 2.13 The most affected sectors, that is, those which use energy more intensively in their production processes are: Industr Percentage cost increase Sugar 14.7% Chemicals and fertilizers 10.2% Non ferrous metals 10.4% Water (pumping) 11.3% Fishing, mining, fishmeal and oil,etc. 9% (approx.) 2.14 If increases were 150% for oil derivatives and 142% for electricity tariffs, the total impact on costs would be 5% (of which 1.8% for electricity). Impact on prices of final consumption goods 2.15 Regarding the effect on final consumption prices (that is, the effect on the cost of goods in the final consumption basket in addition to the direct impact on the purchase of fuel and power), the impact of 100% increases (fuel and electricity) is estimated at 4.7% (of which 2.5% accounts for direct impact, either from price increases in energy bought directly by the final  Peru - Guideline Study 18 consumer-families or households-and 2.2% accounts for indirect impact, that is, the cost increase for the energy input required to elaborate goods that enter into final consumption). 2.16 Moreover, a study carried out in PETROPERU in December 1989, using a slightly different methodology, confirms that the effects of an increase in energy tariffs and prices on general prices are minimal. In fact, this studyl/ estimates that the impact of the fuel price increases of December 2, 1989 (a weighted average increase of 17.1%) was 0.68%, that is, 2% of the December 1989 inflation. In the same study, the impacts of the following were researched: a) Price increases until the costs of PETROPERU are covered (about US$0.50 per gallon), and b) Price increases until economic costs are achieved (that is, world market prices, FOB or CIF, depending on the case). The results for the cases were: a) An impact equivalent to 3.80% of the January 1990 inflation (that is, 1.13% in absolute terms), and b) A price increase impact of 2% (that is, 6.7% of the January 1990 inflation). The author of this study concludes: 2.17 "The most important effects of this controlled pricing policy are: (A) subsidized fuel prices with a high sc-cial cost, as an inefficient redistribution mechanism and therefore highly burdensome for the country and PETROPERU; (B) absolute distortion in the structure of relative prices since, by mid-December 1989, it was more expensive for families to drink 'San Luis' table water (1700 intis per gallon) than LPG (1298 intis per gallon); (C) a setback in PETROPERU's business management and the country's hydrocarbons industry, diminishing the nation's development potential". And also 'the low incidence of the (energy) item on the family budget clearly reflects considerable subsidies, which are especially aimed at LPG and kerosene, and because they do not discriminate usually benefit poor and rich families...". And 2.18 "Controlled fuel price adjustments do not explain the origin nor the evolution of inflation and, therefore, their curtailment or delay is not an adequate instrument to combat current hyperinflation; but it could make the crisis affecting the hydrocarbons industry irreversible.... It is unfair to attribute to fuels the inflationary effects generated by expectations, inasmuch as they '/ TecnocooJ Magazine, June/July 1990, articlk entitlcd lpnpacto InJlacionario del incremento de lw Combustibks" by A. Hurtado Chiang, pp. 19-23.  Peru - Guideline Study 19 stem from unapplied or poorly applied economic policy measures.... The best way to combat inflation is steady growth of domestic production. The hydrocarbons industry could become one of the major driving forces behind the national development that is being forecast for the start of the 21st century. In principle, this would require the involvement of domestic and foreign capital, above all in risk exploration investment, and, in the very short term, the application of prices that would enable a margin for productive investment." It is evident that the ESMAP/CONERG Study Group accepts and supports these conclusions. Impact on the Residential Sector 2.19 (a) In many countries, average household energy spending (fuel and electricity) generally accounts for about 5% of total expenditures, although this figure is higher in the case of lower-income households and also in urban areas, where there is less possibility of usinz noncommercial fuels. In Peru, energy expenditure in 1985 accounted for only 2.2% of total household expenditure on a national level, with 0.9% for electricity and 1.3% for fuel (Annex 4, Table 15). In July 1990, it is possible that expenditure was even lower since energy prices had fallen by 400-500% although incomes had also fallen2/. Spending for services most affected by energy costs, such as public transportation and the use of private vehicles is not much higher (3.4% and 1.7%, respectively). In addition, for the poorest 30% of the population, energy spending is only 4;8% for the urban population and 2.9% on a national level. Finally, it has been observed that very poor rural population is not heavily affected by energy price fluctuations, mainly because their access to and consumption of commercial energy is lower. Likewise, goods and services with a high energy content do not play a large role in the budget of poor rural families, whose agricultural techniques are not very intensive in the use of commercial energy3/. The urban population belonging to the poorest 30% of total population, however, only accounted for 15% of total urban population in 1985. (b) Assessment of the impact of pricing policy on different socioeconomic groups also has to take into account incomes, energy sources and equipment used, and the possibility of energy conservation or substitution, which either enhance or mitigate the effects of these policies. The rapid drop in real prices of LPG during Z/ However, the major increase in energy prices in August 1990 along with the limited increase in earnings impls that nergy expenditure has risen considerably in the budget of households that have not changed their eating habits. / Asswning that criical poverty is notfarfrom of 30X of the population, provides us with an idea of the mmwber offamiies for which the inpact of the energy price rise possibty has to be remedied (for aamplk, with direcfinancial help).  Peru - Guideline Study 20 the last three years led to a drop in average energy spending, which in 1988 was only 2% for lower-income households and 1.2% for the highest-income households; this trend has continued up until now (that is up until August 8, 1990). In Lima, most lower-income households use kerosene for food cooking, and their transition to LPG is very slow despite its current more favorable price. This is even more apparent in other large cities, where, like Lima, there is no economical fuel substitute for kerosene. The result is that the LPG subsidy, which is 50% greater than the kerosene subsidy, favors higher-income households, although a rapid penetration of LPG is observed among the middle class. (c) In rural areas, kerosene is used almost exclusively for lighting, does not require very high spending nor does it have a more economical substitute, which forecasts a minimal reduction in its total consumption for this purpose. On- the other hand, in the cities of the sierra, the rain forest, and some parts of the coast, with favorable conditions for obtaining fuelwood resources, a large increase in kerosene prices is likely to provoke a return to the use of fuelwood or charcoal for food cooking for a substantial share of the lower-income population of these cities. (d) The informal sector, as well as the rest of the commercial sector, was affected by the poor quality of energy supply during the last two years (electric power outages and shortage of oil products) as a direct result of very low energy prices. The Freedom and Democracy Institute determined that, in 1984, 48% of Peru's work force had an informal activity and produced more than 30% of the country's GDP. In Lima, the two main types of activity that entail a high energy content are the sale of prepared food and refrigerated drinks (probably 2,000 to 3,000 stands) and informal transportation (which accounts for more than 90% of the public transportation motor vehicle fleet in Lima). An survey conducted in 1985 showed that, both in urban and rural environments, half of the households had at least one informal nonagricultural business. It should be noted that those household-based activities requiring electricity (manufacturing, refrigeration, etc.) benefit from the residential sector electricity tariff. In addition, informal business activities also benefit from subsidies granted to fuels for residential use. Effect of an increase in energy prices and tariffs on company sectorfinances 2.20 Before examining the effect of the proposed tariff and price increases in this study, it may perhaps be interesting to see what would happen to the sector companies if the prices and tariffs were not increased. At current oil prices, that is, an average 12 US cents a gallon, PETROPERU would have to cope with an annual loss of almost US$800 million (about 40 US cents per gallon with a daily volume of 125,000 barrels, equivalent to 4% of GDP).  Peru - Guideline Study 21 2.21 As for the electric power sector, if tariffs were not increased, total sales would remain at about US$160 million and losses, in rounded figures, at almost US$300 million, including more or less US$70 million for financial costs (equivalent to 1.5% GDP). With losses of this magnitude, the possibility that sector companies would come to a standstill because they would be unable to operate cannot be ruled out. 2.22 Finally, if these losses were covered by monetary emissions (at 120,000 intis per US$) it would generate 12 x 10"' intis, accounting for 5% of GDP or seven times the monetary emissions of May 1990 (1.7 x 1013 intis, according to the Central Reserve Bank). Using the June 1990 inflation rate of 50-60%, this issuance would be sufficient to maintain this pace of inflation for 17 months. This is much worse than the 3% or 4% that a drastic rise in energy tariffs and prices would add onto inflation, according to the indications shown in the preceding section. PROPOSED INCREASES 2.23 It should be taken into account that, with a drastic increase in prices and tariffs, the consumer reaction may be quite substantial in the very short term and small in the short/medium term, but that this increase could exert considerable positive effects in the long term, mainly because it would reduce the energy intensity of production and consumption. Although not many indications are available on price elasticities, in 1976 when Peru raised its fuel prices to international levels, in less than a year, there was a 209% drop in consumption of oil products. Electricity consumption is probably less elastic, but with the percentage increases advocated in this study, there is no doubt that there will be some elasticity. Besides elasticity, there is at the moment a considerable amount of smuggling of oil products, mainly to Bolivia and Brazil. The quantity is not known but the boundary areas (Madre de Dios, Puno, etc.) are always out of supply because incentives to sell outside the country are irresistible (prices of US$1-1.25 per gallon). It is clear that, with higher prices, smuggling would disappear to Peru's benefit. Thus, one of the first effects of a domestic price increase might well be a recovery of this contraband oil, which could easily be on the order of 5,000 to 10,000 barrels per day in the very short term (equal to Chainbira's production!, which will cost US$62 million and will take two or three years to enter into operation). This illustrates the overwhelming cost of mistaken economic policies for commodities like oil products. 2.24 Regarding PETROPERU's finances, the quantitative effects of a significant increase in consumer prices are shown in the following table. Assuming, for the time being, PETROPERU's stated current average cost (US$0.50 per gallon), a decision to increase fuel prices in the very short term to world levels (about US$0.62 per gallon), and sales of 100,000 barrels per day (a notable drop from current levels, which are 120,000 to 130,000 barrels per day), PETROPERU would generate earnings of about US$767 million and about US$386 million for the State (including the taxes currently levied and PETROPERU's surplus), that is, almost 2% of GDP. For each US cent decline on PETROPERU's costs, US$15.3 million would be saved. The main figures are seen in the following table:  Peru - Guideline Study 22 OIL: FINANCIAL EFFECT CALCULATED FROM VARIOUS HYPOTHETICAL PRODUCT PRICES Average Price (US$/g) 0.62 %GDP 1.00 %GDP 1.25 %GDP 1.50 %GDP Sales Value (US$M) 1153 (5.8) 1533 (7.7) 1916 (9.6) 2300(11.5) Tax (current system US$M, 326 391 approx. 17%) 195 260 PETROPERU Total costs ($0.5/g,US$M) 767 767 767 767 Surplus(US$M) 191 506 823 1142 Surplus (taxes + surplus) 386 766 1149 1533 Exportable Surplus (by country) 45 45 45 45 Total 431 (2.2) 811 (4.1) 1194 (6.0) 1578 (7.9) Notes: - Calculations based on consumer sales of 100,000 B/D The exportable surplus is estimated at 20,000 barrels per day with a margin of US$6 per barrel, which would be appropriated by PETROPERU and the government, assuming a world price of US$16-18 per barrel. - It is estimated that consumption of 100,000 B/D includes sales to large-scale mining. As sale prices to large-scale mining are higher, the last line, Total, is not strictly incremental. 2.25 The ESMAP/CONERG working group and IMF and IBRD missions made more detailed calculations of these items, for purely fiscal/stabilizationpurposes. Several circumstances, however, have made these figures obsolete: (a) The sudden increase in world oil prices as a result of Iraq's occupation of Kuwait. (b) The immediate and drastic fall in domestic consumption in Peru, from 130,000 barrels per day in early August to 60,000 barrels per day at the end of August and beginning of September.  Peru - Guideline Study 23 2.26 Consequently, in the short term Peru will earn more from its exports and less from taxes on domestic consumption. It is also clear that domestic consumption will not remain at 60,000 barrels per day and that an estimated consumption of 100,000 barrels per day is still reasonable in the medium term. However, the increase in the world prices for crude oil will positively affect the prices paid to the oil contracting companies, mainly Occidental. This situation, will in turn result in increased production in the short term. The additional income, between September and December 1990 could reach US$90 million. 2.27 The electric power subsector's financial situation is also very poor, and the possibility of putting utility finances on a sound footing is far less promising. Nevertheless, the following table shows the current situation and two hypothetical cases (tariff at 4 US cents, that is, the status quo for 1985, and a tariff at a long-run marginal cost of 8 cents in round numbers). ELECTIIC POWER SUBSECTOR: SITUATION AND FINANCIAL FORECASIS Current 1989 Tariff Tariff situation situation situation (tariff 1.24) 4 c. 8 c. & %GDP Sales (million US$) 162 310 617 3.1% With fin. expenses 448 448 448 Surplus (deficit) With fin. expenses (286) (138) 169 0.9% Without fin. expenses (216) (68) 239 1.2% Note: Sales based on 1989 volume (about 7717 GWh). Costs: Without financial expenses: 4.9 cents; with financial expenses: 5.8 cents (approximate figures based on the IDB-funded LRMC study and study group estimates). 2.28 Nevertheless, the attempt to return to the status quo prevailing before 1985 is not going to solve the financial problem, since with current sales volume the financial year will end with losses (probably higher than those calculated in the table, since the table does not take into account a reduction in sales volume as a result of a rise in tariffs). On the other hand, economic recovery could increase demand, possibly at the beginning of 1992. In this table, the largest surplus is without financial expenses, since if these expenses cover payments to the "Energy Sector Recovery Program" they would already be viewed as transfers to the central government. It is apparent that a tariff-setting policy based on LRMC entails more benefits than the short-term  Peru - Guideline Study 24 financial ones. This policy ensures that consumers are aware of the exact financial value of the energy they are using and so are able to make decisions without distortions. This tariff-setting policy would also help energy conservation, thus postponing the need to increase supply. This would provide more time to concretize those generating projects that have not yet been defined. REGULATORY AND INSTITUTIONAL ISSUES 2.29 In the last few years, the quality of the sector's support from regulatory, financial, and fiscal authorities has deteriorated. The National Electric Power Tariff Commission is losing the little autonomy it previously had, and this has virtually prevented it from maintaining a reasonable tariff-setting policy (both the level and the structure). The complete absence of a regulatory authority has been felt in the hydrocarbons subsector: there is virtually no technical authority that could act as intermediary between the managerial level (PETROPERU) and the political level (MEM, Office of the President). Sector companies, both power and oil, with the loss of their self-financing capacity have lost all their autonomy even with respect to current operations. So that in addition to physical rehabilitation operations (which are described in the first chapter), the following would have to be seriously rethought, with a view to rationalizing as well as reducing (i) the State's role in the energy sector, (ii) the role of state enterprises in the power and hydrocarbons subsectors and (iii) how to increase private sector involvement in the supply of energy. 2.30 For the purposes of this study, the discussion on institutional and regulatory problems is presented in Chapter V. In order to come up with practical and applicable recommendations on how to share energy sector responsibilities between the State, public enterprises, and the private sector, ESMAP intends to continue deepening its cooperation and dialogue with the energy sector and company officials. In general, joint efforts would be made to improve the quality of regulatory institutions and orient them toward mechanisms that reward efficiency using incentives, thus enabling better management of sector companies, either public or private, and facilitating the reorganization of public companies and the integration of new, public, semi-public, and private companies into the energy sector. 2.31 This study had several objectives, including taking a look at intra-subsectoral problems (Chapters VII to X), after viewing sector problems as a whole (in this chapter), and because of this, the discussion of specific measures for the liberalization, privatization, and promotion of private sector involvement is limited. As mentioned above, ESMAP intends to do this in the next phase of this study.  Peru - Guideline Study 25 m. INVESTMENT AND REHABILITATION NEEDS 3.1 For many years now neither public finances nor sector company finances have had any resources to tackle normal preventive maintenance, repairs, renovations, or new investments. Besides, with the end of access to foreign credit, turnkey projects also stopped. Likewise, stocks of spare parts and materials have almost disappeared from company stores. Stocks of finished products are well below their normal levels; for example, those of oil products are at less than 10 days consumption while their normal level is 20 days, to ensure that there is supply even when there is a breakdown in a refinery or deliveries by ship are delayed. 3.2 Sector officials are highly aware of the problem; despite this, however, there is almost no systematic information available on the need for funds to re-establish normal maintenance standards, repair what has been broken, and replace stocks of spare parts and materials which normal and necessary preventive maintenance programs rely upon. 3.3 In short, the following investments for rehabilitation and new priority projects are being proposed: ELECTRICITY 3.4 In electricity, there are projects and ideas for projects in the amount of US$873 million, requiring an additional net financing of US$610 million (in other words, there are already US$263 million in financing). The main components of the overall program are shown in the following table. Financing (USS million) Electricity Investments: Required Committed Total Supply increase in SICN 38.5 Rehabilitation (Hydro) 13.5 - Rehabilitation (Thermal) 43.5 - 95.5 Rehabilitation & Expansion (transmission, distribution substations, etc.) 404.8 211.0 615.8 Rural Electrification, distribution, provinces 90.0 52.0 142.0 Loss Reduction (SICN) 20.0 20.0 SUBTOTAL 610.3 263.0 873.3 200 MW Gas Turbines for n.a. n.a. 100.0 the SICN-Lima Source: ELECTROPERU; ELECTROLIMA; study group estimates.  Peru - Guideline Study 26 3.5 A more detailed study on investment needs, conducted as part of the World Bank's multisectoral mission (October/November 1990), reveals that US$328 million would be required for emergency investments between 1991 and 1993 (which essentially include rehabilitation and some small capacity increases, above all to improve supply reliability of the National Interconnected System). In addition, two other lower-priority, albeit important and profitable, investmnent programs were identified, for US$406 million and US$734 million, respectively. 3.6 Thus, the investment requirements over the next three years (1991-1993), assuming there were no financial constraints, could amount to US$1.468 billion (this would include all the projects listed in the preceding table). 3.7 An important consideration for electric power planning and for decision-making on the most immediate-term investments is uncertainty over the Camisea gas field development. The discovery and eventual development of the Camisea gas fields are a real alternative to the purely hydropower guidelines of the SICN expansion program. It seems clear that generation expansion based on natural gas is much cheaper than hydropower. There are at present major uncertainties about the time that this natural gas will be viewed as available for generation. Likewise, it is apparent that, by the end of 1991, there will be more information on the eventual availability of natural gas. In the very short term, the only urgent investments are some gas turbines for the SICN (especially Lima) which would be required anyway (that is, with or without gas). For obvious economic reasons, these turbines should burn fuel oil (since the opportunity cost of diesel is the CIF price while fuel oil is estimated at its least price plus FOB). 3.8 In order to avoid risks, it is suggested that any decision on the next hydropower station should be delayed for another couple of years or until more is known about the Camisea gas situation. If prospects of having gas, for example, in 1997 or 1998 are not very good, it is then likely that the hydropower alternatives should be considered or, perhaps, other thermal solutions. Lima-Callao Urban Area 3.9 Lima suffers from a large deficit and will be the first to suffer from an energy shortage, once the economy begins to stabilize, and therefore calls for greater attention. In the very short term, it is urgent that repairs be made to the Santa Rosa thermal power station (US$0.5 million) to increase its maximum firm capacity by 25 MW (from 75 MW to 100 MW) in five months and that the rehabilitation of Moyopampa be implemented (US$2.5 million), enabling the recovery of 6 MW in about one year. Obviously, starting the Santa Rosa turboelectric power station (which is not operating at present because ELECTROLIMA does not have the funds to purchase fuel) when electricity tariffs increase would help to increase the capacity available in Lima. Another idea that should be mentioned would be to replace 150,000 public street lights with other much more efficient sodium vapor lights. This would cost some  Peru - Guideline Study 27 US$20 million and (within a few weeks) could achieve savings of 19-20 MW (that is, about US$1000 per kW). Since the consumer pays for public lighting, this measure, besides saving capacity, would lead to financial savings for the consumer. HYDROCARBONS 3.10 As for hydrocarbons, the urgent rehabilitation and new project needs are summarized in the following table. The priorities are clear: First, it is essential to start a general rehabilitation process in the refineries (or better said, undertake the maintenance and/or repairs that should have been done in the last four-five years) and wharves, and to launch projects to recover production in the oil fields already being developed. Finally, new projects should be considered. Rehabilitation investments in the north and northeast rain forest could add 1,500 barrels per day to current oil production, almost US$10 million per year, at current crude oil prices (US$18 per barrel in July 1990). Chambira, however, could increase production by 5,000 barrels per day in the very short term (or in two years) and by 21,600 barrels per day in three years (a peak of 25,000 barrels per day would be achieved toward 1994 and a decline in production thereinafter). 3.11 A project for the rehabilitation of associated gas production in the northeast and continental shelf has been prepared by PETROPERU. However, investments of US$30 million seem high, bearing in mind the condition of PETROMAR installations, the decline in oil production, and the growing reinjection requirements. Tle most profitable aspects of the project should be focused on (for example, repair of compressors) and granted priority. The project could produce in the medium term some 6 million cubic feet per day of dry gas and 1,500 barrels per day of liquids. It should be noted that the increases in production mentioned as direct effects of the projects are not equivalent to net increases of total production since ongoing fields will continue current declining trends. In general, if all the aforementioned investments were implemented, total oil production could reach a peak of about 150,000 barrels per day towards 1992-1993 (starting from the current 130,000 thousand barrels per day) and then drop again immediately thereafter. Durable increases in production can only be based on the development of new discoveries.  Peru - Guideline Study 28 Hydrocarbons: Rehabilitation Requirements and New Projects (US$ million) Priority Investments 1991-1994 Rehabilitation of production projects (upstream) 148.0 Refinery and Wharf Rehabilitation 47.0 Subtotal 195.0 New and ongoing projects (small) (including north and central rain forest, etc.) 206.6 New large projects Camisea 965.0 Aguaytia 53.4 Financed by the private sector 1018.4 Total public investment in hydrocarbons 401.6 3.12 PETROPERU is not paying its suppliers or its contractors. An injection of funds for new acquisitions could provide it with the flexibility to negotiate an arrangement for its overdue payments (rescheduling). 3.13 With respect to refineries, for the moment no expansion seems necessary. Maintenance, small repairs, and substitution of small machines and/or equipment should be undertaken. The demand for products is sluggish because of the economic recession and will decline even more with the increase in prices (which will also discourage smuggling, which in turn will enhance the downward trend of demand). 3.14 Before making any kind of substantial investment in refining, a new exploration campaign should be launched aimed at determnining how much oil there might be and its condition. For this very reason (and for other technical ones-see the section on 'downstream' oil below), it is recommended that the catalytic cracking project not be implemented (either in Talara or La Pampilla). It would be advisable to wait before making any decision, so as to avoid unnecessary risks. This wait would not entail a higher cost, because in the next two-three years there will be excess capacity in refining activity. Likewise, just as there will be small exportable  Peru - Guideline Study 29 surpluses, the limited volume of oil products that could eventually be needed could be imported without any major difficulty. Oil Exploation and Development 3.15 A reasonable objective, that of achieving about I billion barrels of proven oil reserves in the next five-seven years (excluding the current reserves of 300 million barrels and those of Camisea), would require an investment on the order of US$1.5 billion in exploration and perhaps the same amount for development. It is recommended that PETROPERU (PP) virtually not get involved in exploration due to the high risks (except for certain cases in well-known areas and where risk is lower), that it take advantage of its purchasing prerogatives, for example, 20% of development fields identified by international oil companies (IOC), and that it reimburse the IOC for their share of exploration costs. On this basis, PETROPERU's financial requirements for exploration and development in the next six-eight years would amount to between US$400 million and US$500 million (that is, US$150 million for the reimbursement of exploration costs and US$250-300 million for its 20% share in development investment). CAMISEA GAS 3.16 As a result of the exploration campaign started in 1981, in the southeast Peruvian rain forest, Shell Company discovered important hydrocarbons reserves on the borders of the Camisea River. Estimates of proven and probable reserves in these two structures amount to 10.8 x 1012 cubic feet of natural gas and 725 million barrels of natural gas liquids (NGL), equivalent to more than 2.5 billion barrels of oil. If timely decisions are made, the Camisea project should generate, in four or five years, gas and condensates equivalent to 80,000 barrels of oil per day, a considerable volume of energy, which will gradually increase as new domestic and export markets open up for these resources. This report recommends that the project be implemented using private investments since the State does not have, nor can it obtain in the short term, the immense resources that would be required. The Projed 3.17 According to its current definition, the project includes the construction of pipelines towards the coast, through the Andes mountain range, towards the south and to Cusco, for the large-scale transport of gas and condensates. The initial investment is estimated at US$1.485 billion (1989). The project has been reviewed by national and foreign specialists, and they agree that it is feasible and should be developed as soon as possible. 3.18 The gas deposits will be developed through the recycling system of gross gas production, after separating the liquid fractions that the gas contains, to obtain two products: dry gas and natural gas liquids.  Peru - Guideline Study 30 3.19 The gas would first be used as a fuel for industry located in the central area and to generate electric power, thus resolving in this very economical fashion the shortage of generating capacity, until the beginning of the next decade. Second, the gas could have applications in decentralized industries like petrochemicals, fertilizer manufacture, and spongy iron production, if these activities turn out to be economical after being thoroughly studied. 3.20 The liquids will be fractionated in a 60,000-barrels-per-day capacity unit close to Lima, and LPG and condensates (gasoline, naphtha, kerosene) will be produced. These products, along with the substitution of fuel oil by gas, will generate exportable surpluses. 3.21 For supply of the southern region another fractionating unit of 7500 barrels per day should be installed, in Cusco, close to the southern railway network. If this were economical, it would enable PETROPERU to save the high cost of freight to transport fuel to this region. Once these first investments are implemented, the utilization of gas and its condensates could continue to be developed, through pipelines and additional fractionating units. Financial Analysis 3.22 A financial assessment of the project yields rates of return, in terms of constant dollars, which fluctuate between 16% and 29%, assuming that, during the project's lifetime, oil prices will vary between US$15 and US$25 per barrel on the world market. Sensitivity studies show that the project yields more than 15% in constant values, even when income is reduced or investment is increased by 20-30%. Elimination of the two pipelines towards the south of Camisea and the branches on the coast (project's planned extension) reduces the initial investment, but does not substantially improve the estimated return. On the other hand, by delaying earnings one year (which may happen if market penetration estimates are optimistic), the internal rate of return would drop by about 20% (that is, from 22.76 to 18.86). These calculations show that the project is technically feasible and promises a potentially high return. 3.23 Implementation of the project requires undertaking some prior work: (a) An assessment program of the structures that have been discovered, in order to establish the optimum development strategy. (b) An environmental impact study, including proposals for the development of the native communities who inhabit the area. (c) A study on the development of the Cusco-Quillabamba-Camisea road network in order to establish the most suitable logistics. (d) A plan to substantially increase the use of LPG on the domestic and industrial markets.  Peru - Guideline Study 31 (e) To determine up to what point lack of security could be a real threat to implementation of the project and see what solutions could be reached. 3.24 From the point of view of financing, the August 8 changes in domestic market energy prices aimed at making them compatible with the economic costs of energy are essential. For example, the gas produced in Camisea, transported and distributed in the industrial area of Lima, would cost less than US$2 per million BTU. At the domestic prices of fuel oil or diesel prior to August (at US$5 per barrel), that is, less than US$1 per million BTU, substitution on the industrial market would be impossible. However, compared to the opportunity cost equivalent to exporting these fuels, that is, more than US$14 per barrel (more than US$2.35 per million BTU), Camnisea gas would generate significant profits. 3.25 The experience gained in negotiating with Shell should not be lost. Along with the above-mentioned activities and pricing adjustment, it is important for Peru to reestablish relations with those contracting companies capable of being interested in a project of this size, particularly Shell and international financial institutions. As for any important project, Camisea requires bank financing (in addition to its own capital) to spread the investment risk. It is therefore essential that management of the foreign debt problem and reinsertion of the country into the international financial community be positive, as soon as possible.  Peru - Guideline Study 32 IV. ENERGY CONSERVATION AND SUBSTITUTON SITUATION 4.1 In view of the deficiencies and inefficiencies as well as the increased marginal costs of energy production and distribution in Peru, along with the scarcity of resources for investment in energy supply, energy conservation actions have to play an important role in the sector because they generally promote measures that are: (a) Low cost, compared to the equivalent increase in energy supply. (b) Financially very profitable. (c) Rapidly implemented. 4.2 In addition, these measures contribute directly and indirectly to improve the operating efficiency of the main economic sectors, supporting overall structural adjustment. Moreover, the attempt to facilitate and foster substitution possibilities between energy sources helps to minimize energy costs in the economy since it promotes the most economical energy source for a determined use. 4.3 Facilitating users' access to energy conservation or substitution measures enabling them to reduce their energy costs is also a very efficient tool to partly offset the effects of price adjustments. Energy conservation and substitution problems and prospects in terms of the user only will be assessed belowl/. ENERGY CONSERVATION CENERGIA 4.4 The Energy Conservation Center (Centro de Conservacidn de Energfa - CENERGIA) was created in 1985 as a nonprofit institution to implement a rational use of energy program. The CENERGIA program may be qualified as successful and advanced, compared to similar programs in Latin America. The institution's strength lies in a combination of three factors: The aspects of i&nproving efficiency and rehabilitating production, transporiation and energy distribution italaions are show" in chapter lI.  Peru - Guideline Study 33 (a) The active participation of private sector entities and the largest energy sector companies. (b) The broad availability of financial and human resources. (c) Political autonomy. 4.5 With a team of about 30 professionals and a large amount of metering equipment and instruments, CENERGIA conducts a wide range of activities but focuses mainly on two: (a) Performing energy audits in the major industries and companies in the mining- metallurgical sector. (b) Starting training, promotional, and information actions. 4.6 CENERGIA obtained UNDP financial support for three successive two-year periods (in the amount of US$452,000 for the last two-year period 1989-1990) and also from the CEC (in the amount of almost US$1 million for 1989-1990)2/. Ithas also relied on contributions from its four main partners (PETROPERU, ELECTROPERU, COFIDE, Banco Industrial) and managed to cover 16% of its operating budget in 1989 using earnings (US$33,000) for its energy auditing services. Several framework agreements were signed, particularly with the mining- metallurgical industry. 4.7 CENERGIA also prepared a draft bill of the Law for the Rational Use and Substitution of Energy, aimed at establishing responsibilities and obligations for companies, in particular energy audits for the largest companies, instructive labelling for energy machinery and installations, and review (by CENERGIA) of projects that involve large increases in company consumption. 4.8 Thus, CENERGIA has managed to identify and quantify the most interesting savings potential (a period of return on investments of less than two years); it has also gradually raised the awareness of technical experts and managers of companies, hUs gained credibility in the area of energy savings, and has been developing a market for audits (Table 1). Nevertheless, only a part of the recommended measures have been implemented, according to a recent evaluation of the 26 audits conducted between 1986 and 1989 confirms: 9% of the total consumption of these companies was effectively saved (equivalent to 23,000 TOE per year), compared with a total potential saving of 26%. In view of this situation, in 1990 CENERGIA 2/ Thisfinancing was obtained after a joinm project with PE7ROPERU, CENERGIA and the World Bank wa poswqoiu  Peru - Guideline Study 34 supported the creation of the Andean Fund for Energy Conservation (Fondo Andino para Conservaci6n de Energfa - FACE), made up of contributions from the CEC and CAF (US$1.8 million and US$0.75 million, respectively), to finance with nonreimbursable funds up to 25% of investment projects in energy conservation measures in Andean countries; in Peru, COFIDE will finance 75% of the remainder with soft loans. Table 1: Energy Saings Potential Implementation 1991-1994 1988 Energy Consumption Potential Saving Electricity Electrcity bbl (1) Fuels Total SECTOR kTOE % (2) kTOE Elect. (2) koE GWh % GWh PRODUCTION 1,821 31 7,070 62 27 500 10 707 561 Industrial 964 16 4,419 39 12 295 295 Mining-metal. 370 6 2,419 21 6 75 75 Agro 229 4 209 2 13 70 70 Fishing 258 4 23 0 11 60 60 TRANSPORT 2,670 45 0 0 12 320 320 RESIDENTIAL/ 1,426 24 4,267 38 9 130 8 341 159 COMMERCLAL & SERVICES TOTAL 5,854 100 11,337 100 16 950 9 1,048 1,040 Source: CENERGIA (1) Oil, gas, coal and bagasse products (2) In % consumption in 1988 (3) Potential saving with measure. without cost or with a period of return of less than 3 years Does not include technology improvements, procesm changes and high cost equipment. ITINTEC 4.9 The Institute of Industrial Technological Research and Technical Standards (Instituto de Investigacidn Tecnologica Industrial y de Normas Tecnicas - ITINTEC), created in 1970 and partner of CENERGIA, is in charge, among other duties, of elaborating and proposing technical standards for national products (recommended or obligatory) and granting quality seals3/. There are very few standards for the main energy equipment manufactured in Peru (kitchen stoves, refrigerators, washing machines, televisions), except for LPG cylinders and rTINAPEC does nt have prodst and equmnaent tesfitig stores, for whch if resorts to aoher research ceters.  Peru - Guideline Study 35 valves, batteries, incandescent lamps (which are the only products that entail obligatory standards), and fluorescent tubes4/. 4.10 The MNTEC budget comes mainly from the 2% levied on the profits of industrial companies that do not have a technological development project and, to a lesser extent, from earnings for services provided. Constraints and Hindrances for the Conservation Program 4.11 Several obstacles have slowed the energy conservation program implemented by CENERGIA and limited its possible impact on final energy consumption. The most significant constraints are listed below: (a) Basically, the low prices of all energy products and the distortions of relative prices. The first does not foster the efficient use of energy, and the second provokes the uneconomical substitution of selected energy products (for example, the use of household kerosene in other sectors); this situation aggravates the other obstacles to energy conservation. (b) Managerial and consumer priorities and motivations. Energy is generally not a major concern in the decision-making process of economic agents, whose investment priorities focus more on increasing market share, improving productivity, replacing equipment, increasing working capital, as well as speculative considerations. (c) The generally low impact of energy expenditure on production costs, especially in the case of companies whose profits are: (i) high compared to the value of forecast energy savings; and (ii) fixed or assured in the case of a protected market (limited budgetary pressure). (d) Lack of knowledge or understanding by managers or users of the practices or processes that lead to the inefficient use of energy, as well as the options and profitability of conservation actions. (e) The deficiencies of the regulatory and standard-setting framework: for example, efficient definition and application of standards and information for the user. The Ministy of Industy, an entity that should have bener coordinadon with rrNM C, is in charge of verying Lhe fu4flibnent of standards and approving industrial products.  Peru - Guideline Study 36 (f) The lack of innovative facilities to finance conservation measures to compensate for, in particular, the current lack of acquaintance, on the part of the domestic banking sector, with the importance and benefits of energy-saving measures (third-party financing, revolving funds, etc.) (g) The current limited capacity for providing advisory and promotional services. CENERGIA, for example, can only conduct 12 audits per year, although it has been estimated that there are about 150 auditable companies. Production sector 4.12 The energy consumption of the production sector is concentrated in a relatively small number of companies, especially in the case of the mining-metallurgical subsector, thus facilitating the application of energy conservation measures. Therefore, 170 companies account for slightly more than 70% of total consumption of the production sector, and the six largest mining-metallurgical companies account for more than 80% of total subsector consumption. In addition, for several subsectors, energy has a substantial impact on direct production costs (mainly mining-metallurgical, iron and steel, cement, bricks, paper, glass, chemicals). There is a great deal of variation in the figures that assess the impact of energy on production costs due to the absence of analytical accounting in many companies. 4.13 Moreover, there are only a few companies that have an energy conservation program; among them, however, there is the Southern Peru Copper Corporation (SPCC, a private company that accounts for about 50% of mining-metallurgical sector consumption) and CENTROMN. Within the current context of the economic crisis, it is more complicated to launch these types of programs. The following are the main obstacles: - Aging of the production infrastructure. - Inertia of state enterprises (which are the largest consumers, excluding SPCC). - Frequent arrears of state-owned enterprises in paying their energy bills. - Auto-generation of electricity by some companies in the mining-metallurgical sector, which neither facilitates nor justifies electric power savings. 4.14 Since 1987, CENERGIA has performed about 30 audits in the following branches of the industrial sector: fishing (PESCAPERU), milk products, glass, textile manufacture, sugar/paper (PARAMONGA), metal products, etc.; and also four audits in the mining- metallurgical sector (CENTROMIN and three of the four MINEROPERU companies). The results of these audits indicate the following levels of savings attainable, depending on the industrial process involved: operating improvements (20-40%); networks and steam consumption (15- 40%); combustion processes (15-30%); process improvements (5-50%); steam generation (15- 20%); electric power (5-15%).  Peru - Guideline Study 37 ranspoilation sector 4.15 This sector, which accounts for a substantial share of final energy consumption (almost 40%, of which 30% is for land transportation in the Lima-Callao area) and in which energy spending accounts for a large part of total expenditures (16 to 28% according to CENERGIA audits), offers a theoretically high potential for fuel savings due to its low energy efficiency, which stems from the following factors: - age of the motor vehicle fleet, - inefficient motor vehicle management, - lack of maintenance, - lack of technical training. 4.16 Besides the problem of the large number of entrepreneurs, there are structural obstacles that are difficult to eliminate and that restrict the scope of energy conservation measures, such as: - lack of capital, - low motivation of state enterprises (monopolies requiring minimal business and technical efforts), - instability of the private sector (more than 90% of the fleet), - type of service and routes (frequent stops and overloaded vehicles), - poor condition of the road infrastructure, except in Lima and on the coast. 4.17 CENERGIA audits have determined that, with only one driver training and motor vehicle maintenance and monitoring programn, a saving of up to 20% on the consumption of public transport companies participating in the program could be achieved. Apart from the necessary adjustment of fuel prices (a key element for obtaining the efficient use of light vehicles), several other measures would exert a considerable impact on total sector consumption: efficient renewal of the motor vehicle fleet with more economical vehicles; rationalization of routes and modalities for public transportation; improved maintenance of road infrastructure; eventual reestablishment of regular vehicle inspections. ResidentiallCommercial/Public sector 4.18 In the residential sector and, to a lesser extent, in the commercial sector, the users are numerous, dispersed, with low energy consumptions and a wide variety of rationales.  Peru - Guideline Study 38 Therefore, the price adjustment policy is the most efficient instrument to make these consumers reduce their consumption. In addition, awareness-raising and information campaigns will be necessary, but even so only a small percentage of these consumers will really be receptive to an energy conservation policy. In the public sector, however, despite the inertia of bureaucracies and the frequent existence of problems that have greater priority than energy saving (for example, in hospitals), there is a considerable potential for reducing the consumption of fuels (boilers) and electricity (lighting). 4.19 In the metropolitan area, CENERGIA has conducted 10 detailed audits in the commercial and public sector (hotels, hospitals, and buildings), as well as pre-assessments using surveys in 546 households, 116 businesses, and 76 government entities. These studies determined a potential saving in the LimalCallao area of about 8% for electricity consumption (mainly in lighting and water heaters) and 5% for fuel consumption (mainly in boilers), as well as a 5% reduction in electricity demand during peak hours. The measures recommended by CENERGIA include: - shift from incandescent lamps to fluorescent tubes or fluocompact lamps, - rational use of hot water, - improved use of household appliances (refrigerators, kitchen stoves), - lighting control in buildings, etc. 4.20 A study on electric power load shedding conducted in Lima in 1988 for ELECTROLIMA showed that the control of water heaters in households would be a very effective measure. A potential 40,000 households were identified where water heaters could be equipped with a remote-control turn-off system during the daily 4-hour peak demand period, including the option for the user to switch the heater on at a higher tariff (unit cost per house at US$120 in 1986). The total investment required by ELECTROLIMA was estimated at US$5.5 million, to save 18 MW of demand during peak hours (with a gradual implementation over eight years), with a negligible reduction in consumption. Implementation of the program would nevertheless require a prior user awareness-raising campaign:/. It was also estimated that, in the metropolitan area, the replacement of street lamps (about 150,000) by sodium vapor lamps would save about 20 MW for an investment on the order of US$20 million. 4.21 The improvement in energy efficiency of inefficient and most widely used household appliances (kitchen stoves, refrigerators, water heaters, lamps, etc.) is another possible action; a series of equipment tests would be needed to determine consumption. Efficiency standards also need to be defined and applied, with quality seals indicating consumption of the equipment. Imports should be limited to more efficient equipment. Finally, the design and A requestfor financing has been presentedgo the IDBfor the overallload reductionprograrn (TUSs20omilionfor a total reduction of about 100 MW)  Peru - Guideline Study 39 application of architectural standards and energy installations for large buildings also offers interesting potential savings. ENERGY SUBSTIUTION 4.22 The economic rationale behind energy substitution is the search for minimum cost and, therefore, there should be no distortion among prices. Also businessmen and users need to be informed and advised, bearing in mind their priorities and preferences. The main problem is often the cost of replacing equipment, due to the lack of capital, and frequent customs duty distortions. Residential sector Situation and consumption trends 4.23 For cooking food (which is one of the activities that consumes the most energy in the residential sector and offers scope for substitution), kerosene is the prevailing fuel. In urban areas (especially in the metropolitan area), however, a rapid substitution for LPG is taking place, while in rural areas fuelwood and residues are almost the only fuels used (Annex 4, Table 1 and charts). 4.24 In Lima, the progress made by LPG is notable: from 34% of households in 1986 to 48% in 1989 (part of them also using kerosene and being part of the transition group), while kerosene fell from 57% to 45% during the same period, electricity being limited to the highest- income households (frequently combined with LPG due to electric power supply problems). In other cities, kerosene has displaced fuelwood and coal (in about 75% of households), but LPG has not managed to penetrate due to a lack of distribution channels, except on the coast. 4.25 In rural areas, fuelwood and residues are and will continue to be, almost exclusively, the cooking fuels, whereas kerosene is used mainly for lighting. Comparative cooking costs 4.26 A comparison of useful energy costs helps to explain the trends observed (Annex 4, Tables 2 and 3). In terms of useful energy in Lima, the prices of LPG and kerosene (US$2 and US$3.4 per useful GJ, respectively) are clearly lower than the prices of electricity and coal (US$7.9 and US$8.3 per useful GJ), and much lower than the prices of fuelwood and charcoal (US$20 and US$22 per useful GJ), the use of the latter being limited to very specific applications (restaurants and barbecues). In terms of financial costs of cooking (including the cost of equipment), a fairly similar pattern is observed, and the impact of equipment cost is noted in the total cost, urging consumers to increase replacement time and contributing to energy inefficiency which is added to the inefficiency produced by low prices.  Peru - Guideline Study 40 4.27 Regarding economic costs, LPG and kerosene are at the same level (US$19.3 per useful GJ), that is, nearly 20% more than the approximate cost of cooking with coal briquettes (US$15.3 per useful GJ), which, bearing in mind the drawbacks of the latter fuel, strongly limits its marketing potential in Lima even in low-income households. 4.28 In the cities of the sierra, kerosene replaced fuelwood despite its higher cost (US$3.4 per useful GJ in contrast to US$1 8 per useful GJ for fuelwood). The cost of LPG is almost twice that of kerosene due to high transport costs (Annex 4, charts). If prices of modern fuels increase to their economic costs, kerosene would become eight times more expensive than fuelwood (US$14.7 per useful GJ), which will foster a return to the use of fuelwood and coal in the lower-income households, with a consequently greater pressure on the forest resource bordering these cities. This trend can be halted by progressively increasing taxes on the transport of fuelwood fuel to lessen the difference in prices between kerosene and fuelwood. Substituion 4.29 Substitution trends in the residential sector must cope with the problem of initial investment (in the case of cooking, which is the most important final use, the initial investment is 1.5-2 times higher for LPG than for kerosene, depending on the equipment used). The consumer intuitively applies a discount rate that reflects his access to capital. Besides, comparison in terms of cost per useful energy is only indicative, since the efficiency of cooking equipment used is not accurately known and does not include subjective aspects such as consumer preferences and motivations. Finally, the quantity of useful energy utilized is assumed to be constant for all equipment, regardless of changes in cooking techniques and culinary habits when the energy source is changed. 4.30 It is forecast, however, that LPG will be the prevailing fuel in urban areas of the coast in the medium term and possibly also in the sierra if demand and authorized distribution margins become sufficient for the private sector to develop a distribution infrastructure in the sierra, including the construction of bottling centers. In fact, with the development of the Camisea project, about 650,000 tons of LPG will be available every year starting with the latter half of nineties. Thus, the economic cost of LPG (part of which will be exported) will fall to its FOB price, which was on the order of US$11-12 per barrel in July 1990. Assuming a penetration of 70% in the metropolitan area and 30% in other urban areas, demand for LPG in the residential sector is estimated at 300,000 tons for the year 2000 (with an estimated consumption of 160 kg per household per year). 4.31 With increased kerosene prices, there are good prospects for developing a market for coal briquettes in the main cities on the northern coast. In fact, due to high transport costs, the cost of briquettes to supply these cities is estimated to be 30% less than the cost for the metropolitan area. In these cities, the economic cost of cooking with coal (US$10.7 per useful GJ) would be almost half the cost of cooking with kerosene (US$19.4 per useful GJ), which is  Peru - Guideline Study 41 theoretically sufficient for a substantial share of low-income households to shift to using coal. The design of efficient, safe, and cheap kitchen stoves is one of the preconditions for successfully developing this market. Regarding this, the lessons learned from the experiences of CENTROMIN (in La Oroya) and PROCARBON should be incorporated. Kerosene and LPG distribution systems 4.32 Distribution systems for kerosene and especially for LPG entail a series of major problems. The LPG market is already rapidly expanding (10% per year since 1986) due to its low price, nevertheless leading to serious financial difficulties for the distribution companies, in addition to the losses of PETROPERU. In terms of market size (160,000 tons in 1988, 85% of which in 24-pound cylinders for the household sector), there is a relatively large number of distributors (31, but two accounting for 63 % of the market). Insufficient distribution margins in July 1990 (Annex 4, Tables 10a, b, and c) impeded expansion, replacement of transport means, and the purchase of new cylinders. 4.33 The distributors are remaining mostly in Lima but keep going because of the prospect of the Camisea development and indirect help from PETROPERU (in the case of SOLGAS). Fraud is widespread in many phases of the distribution chain (cylinders with less gas than the quantity sold, use of colors from other brands). Marketing possibilities for small cylinders of 6 and 12 pounds (more accessible for low-income households due to lower equipment cost and lesser amount of money needed for each refill) seem very limited: consumers want kitchen ranges with two burners, which are difficult to adapt to small cylinders, and the distribution cost for small cylinders is greater than the cost of distributing the 24-pound cylinders. 4.34 The conditions of some bottling centers are distressing: for example, the SOLGAS plant in Lima is obsolete, inefficient, and dangerous, and should be moved. The poor quality of valves and pipes in cooking appliances enhances the risk of accidents, in addition to deteriorated cylinders, and standards need to be strengthened. Finally, there is a plethora of institutions in charge of the sector: an entity to control all the components of the distribution chain and to provide the user with information is needed. 4.35 As for kerosene, the margins granted by PETROPERU at authorized sale outlets were insufficient in July 1990. Nevertheless, margins for unauthorized distributors are probably higher (absence of competition in a small market), but impossible to control, with the consequent impact on consumer prices in rural areas. Finally, the constant increase in kerosene sales since 1986 (following a period of sluggishness since 1983), along with the probable decline in the number of households using kerosene both for cooking and lighting, cannot be entirely attributed to the effect of low prices (moreover, the elasticity of kerosene consumption to its price is low). It is very likely that there is smuggling towards Bolivia and certainly local fraud (household kerosene used in the industrial sector, and maybe mixed with gasoline or diesel for transportation).  Peru - Guideline Study 42 Transportation sector 4.36 The "dieselization" of the vehicle fleet is generally beneficial in financial terms, even when gasoline and diesel are at international prices. It should also be noted that the sale of diesel decreases as the age of the motor vehicles increases. The majority of informal transport vehicles (minibuses) use gasoline. 4.37 CENERGIA, has begun a study on the use of compressed natural gas (with the prospect of Camisea) for in-water fleets in Lima, freight vehicles on selected interprovincial routes, and for private vehicles which do not travel outside of Lima. Its technically feasible potential accounts for 10% of the motor vehicle fleet in Lima, which would enable substitution of 3% to 9% of total consumption, depending on the degree of acceptance. The economic feasibility remains to be seen, in a difficult situation: low cost of the substituted fuel (surplus gasoline), small market size, variety and age of the motor vehicle fleet, and high cost of the gas distribution infrastructure. Production sector 4.38 In the production sector, there are some interesting prospects, in economic terms, for the substitution of fuel oil by natural gas and, to a lesser extent, coal. Despite current uncertainties over the costs of large-scale production of national coal, this fuel could be competitive in industries close to production areas, mainly on the northern coast (Ancash and La Libertad). The possibility of modifying current equipment (involving the need for sufficiently large boilers) also enhances the substitution potential. In addition to its potential for generating electric power, Camisea natural gas may replace oil products in the production sector with significant economic, ecological, and technical advantages, especially in the case of large consumers that are concentrated geographically. Greater details are provided on the market potential of these fuels in the chapters focusing on coal and natural gas, respectively. RECOMMENDATIONS Energy conservation 4.39 Strengthening the ongoing energy conservation program is totally justified in terms of economic and social benefits. In fact, the energy conservation opportunities that are being proposed to consumers enable them to counteract the impact of energy price increases on their total expenditures. Nevertheless, one should be aware that, in view of the above, the total potential saving is relatively limited and could amount to 15% of total consumption over a period of four years (with investments with periods of return of less than three years). In view of expected GDP growth (3-4% in the next five-year period) and growth of urban population (3% per year), which is the largest energy consumer, expected savings would be absorbed in about  Peru - Guideline Study 43 three years, indicating the need to place greater emphasis on efficient planning and diversification of energy supply. 4.40 The success of a conservation program is based on the need for energy prices to reflect their real economic costs and to limit price distortions between energy products and/or sectors as much as possible. In this case, conservation and substitution measures are really possible, with a part of the users implementing by themselves the majority of measures without cost and some measures with very short periods of return. Depending on the sector, however, and the elasticity of consumption, savings will tend to fall after the initial pricing effect. And even more important, many consumers react neither suitably nor quickly to the signals provided by prices. This is partly due to the difficulty of identifying and implementing energy-saving measures. Energy audits therefore have to be conducted, as well as awareness-raising campaigns aimed at strengthening and maintaining the affect achieved by prices. In addition, loans at commercial rates should be available on a national level to finance the identified saving measures. 4.41 On the basis of these conditions, the government should seek foreign finandng to expand and strengthen the existing energy conservation program. The suggested actions are as follows: (a) Finalize a detailed evaluation of the results achieved by the conservation program up till now, especially regarding the extent of implementation of the measures recommended in the audits; to evaluate the behavior of users who are coping with energy price adjustments. (b) Establish degrees of priority for conservation actions: select the economically viable companies which rank at the top of their subsector and in terms of total national consumption, and also consider the share of energy expenditure in production costs, the level of margins, the nature of the company's capital, and all the other aspects which enable a company's expected motivation to be assessed. (c) In the companies selected, perform detailed audits and promote measures with a period of return of less than three years. Mechanisms must be established to bill the beneficiaries for these audits. (d) Develop technical capacity and enhance the motivation of company managers and technical experts (for example, by appointing a person in charge of energy saving in the companies). (e) As for the legal structure, joint review and update of the draft bill with the relevant entities and sectors are recommended, especially with respect to the eventual obligations of managers for energy audits and technical standards for  Peru - Guideline Study 44 equipment, and also regarding the responsibilities of CENERGIA concerning other companies. It would be equally important to include in the law a definition of the role of the private sector in the promotion and implementation of energy conservation and substitution, and their relation with CENERGIA. (f) Grant more responsibility to the private sector regarding promotion and marketing of conservation measures and substitution with managers and the users. Achieve an improved communication policy on the problem of saving (professional publicity, celebrity sponsorship, prizes for efficiency, etc.) (g) Inform and increase awareness of national financial institutions about the opportunities and profits stemming from energy conservation financing. (h) Foster the active participation of authorities and appropriate public/private entities in those regions where there is a large concentration of industrial activity (for example, Grau, Centro, Arequipa, Huari). (i) Define efficiency and quality standards for household electric appliances that consume the most, that is, LPG and kerosene kitchen stoves, refrigerators, lamps, etc. This implies the implementation of a series of tests, possibly in MTNTEC. Monitoring systems and the application of standards are needed, as well as strengthening CENERGIA's capacity to inform the consumer. (j) Continue assessment and auditing services, as well as training (manuals, seminars), dissemination Oeaflets, catalogues), and demonstrations and set up a data bank and an information center (in the charge of CENERGIA). (k) Broaden the capacity of the private sector (consultants) to perform audits, including financial facilities to acquire the equipment and instruments required (CENERGIA facilities are insufficient). 4.42 According to a CENERGIA estimate (Annex 2), program implementation over the 1991-1994 period would require about US$4.5 million, including technical advice, national specialists, equipment and instruments, promotion, information campaigns, and training. The maximum saving that could be achieved would be on the order of 950,000 TOE and 1,050 GWh per year (Annex 2, Table 1), equivalent to nearly US$200 million in July 1990. The investments needed to cover the cost of energy conservation measures in the production sector (with repayment periods of less than three years) were estimated by CENERGIA at approximately US$45 million. The total investment required for the three sectors (production, transportation, and residential/commercial) was estimated at about US$100 million.  Peru - Guideline Study 45 4.43 An assessment should be conducted as soon as possible to determine the program's detailed objectives and components, as well as the modalities of implementation, the organizational and managerial aspects, the costs, and financing plan, as well as the plan's benefits and impact. Substitution 4.44 To improve the potential for LPG and coal substitution