Mexico - Transmission and Distribution Project

Document of The World flank FOR OFFICIAL USE ONLY /-I .3 / s0 < 0 Repowt No. P-5210-ME MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAJ. BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$450.0 MILLION To NACIONAL FINANCIERA, S.N.C. (NAFIN) WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A TRANSMISSION AND DISTRIBUTION PROJECT MARCH 20, 1990 This decament has a restricted distribution and may be used by ripients only in the perfomance of dhdr offici duties Its contents may not otherwise be dbidosed withow World Bank authoriation.  CURRENCY EQUIVALENTS Currency unit Mexican Peso (Mex$) US$1.00 = Mex$ 2,718.00 (Exchange rate as of March 9, 1990. The exchange rate is currently being devalued by 1 Mexican Peso daily) UNITS AND MEASURES ton (T) - metric ton . 1000 kg Tcal - teracalories 98.04 TOE a 1012 calories TOE - ton of oil equivalent = 0.0102 Tcal kW - kilowatt 103 watts MW = megawatt 3 103 kW GW g gigawatt - 103 MW kWh . kilowatt hour - 103 watt hour MWh - megawatt hour - 103 kWh GWh gigawatt hour 106 kWh TWh - terawatt hour 1 0 kWh kV . kilovolt - 1 volts MVA - megavolt ampere - 106 volt-ampere bbd barrels per day ACRONYMS CFE - Comisi6n Federal de Electricidad (Government owned national electric utility) FRA F Financial Rehabilitation Agreement (Between Government and CFE) NAFIN - Nacional Financiera, S.N.C. (Government owned national development agency) FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY MEXICO TRANSMISSIOR AND DISTRIBUTION PROJECT Loan and Proiect Sumnary Borrowers Nacional Financiera, S.N.C. (NAFIN). Guarantor: The Government of Mexico. Beneficiary and Executing Agencyt Comisi6n Federal de Electricidad (CFE). Amount: US$450.0 million equivalent. Terms: Repayment in 17 years, including five years of grace, at the Bank's standard variable interest rate. On-lending Terms: The loan proceeds would be on-lent by NAFIN to CFE under terms and conditions which would include, inter alia, (i) the sub-loan would be denominated in US dollars, (ii) the onlending terms and conditions would be the same as the Bank loan, and (iii) NAFIN would charge a fee amounting to 1OZ of the interest charged by the Bank and an intermediary fee. US dollar to Hexican peso exchange and interest rate risks would be borne by CFE, and NAFIN would bear the US dollar to basket of currencies exchange risk. Financing Plan: US$ million Z (1991-92 Time Slice) CFE's own resources 3,969.3 56 Consumer contributions 154.4 2 Government contributions 198.0 3 IBRD proposed loan 450.0 6 IDB proposed loan 300.0 4 Bilateral sources (Eximbank Japan) 150.0 2 Loan 3083-ME (Hydro Development Project) 133.0 2 Turn-key contracts 560.0 8 Other loans and suppliers' credits 1,212.7 17 Total funds 7,127.4 100 Economic Rate of Return: 14Z on CFE's Ten-year Investment Program. Staff Appraisal Report: Report No. 8191-ME. Map: IBRD No. 21868 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MENORANDUM AND RUCO"ENDATION OP TUE PRESIDENT OF THE INTERRATIONAL BANK FOR RECONSTRUCTION AND DEVELORIENT TO THE EXECUTIVE DXRECTORS ON A PROPOSED LOAN TO KACIONAL VINANCIERA, S.N.C. (RAPIN) WITH TEE GUARATEE OF TEE GOVERNMENT OF )MICO FOR A TRANSMISSION AND DISTRIBUTION PROJECT 1. The following memorandum and recommendation on a proposed loan to Nacional Financiera, S.N.C. (NAFIN), for the equivalent of US$450.0 million is submitted for approval. The proposed loan would be guaranteed by the Government of Mexico and would have a term of 17 years, including five years of grace, with interest at the standard variable rate. The Loan proceeds would be relent by NAFIN to Comision Federal de Electricidad (CFE), at the same terms and conditions as the Bank loan except that (i) the sub-loan would be denominated in US dollars and (ii) NAFIN would charge a fee amounting to 10X of the interest charged by the Ba-k and an intermediary fee. The US dollar to Mexican peso exchange and interest rate risks would be borne by CFE, and NAFIN would bear the US dollar to basket of currencies exchange risk. 2. Background. CFE is responsible for the supply of electric service in all of Mexico. Until the early 70's, CFE's finances were sound and the Bank made 11 loans to help fund the development of Mexico's power system. Since the mid-70's a deteriorating trend qtarted as electricity prices decreased, reaching at times levels that did not even cover operating costs; to compensate for this situation, the power sector had to depend heavilj on Government transfers and fuel subsidies, which together peaked to 2.32 of GDP in 1983. In addition, CFE's dependence on foreign loans increased, reaching an accumulated debt of almost US$10 billion in 1986. As this situation was unsustainable, in 1986 a Financial Rehabilitation Agreement (FRA) was signed between CFE and the Government in which goals were set to improve CFE's finances through electricity rate increases and organizational and technical efficiency improvements. This agreement addressed several of the Bank's concerns on the power sector, and - after a 17-year lending hiatus - enabled granting of a loan in 1989 to finance a Hydroelectric Development Project. The conditionality in this loa-i provides for least cost investment planning and Bank annual reviews of CFE's investment program, and sets financial targets for CFE which will enable continuing the reduction of Government subsidies through further increases in the overall level of electricity rates and efficiency improvements; CFE's expected financial rate of return on revalued assets in operation is expected to improve from about 2? in 1989 to 3X in 1990 and to 4X in 1991. The Hydroelectric Development Project also includes substantial conditionality on environmental and resettlement practices for hydroelectric power projects. 3. Other sectoral issues still need to be addressed: tariff schedules have to be revised to reduce cross subsidies among consumers over time, transmission and distribution planning need to be improved, energy losses reduced and distribution metering expanded. Today there is a heavy backlog of unmet needs, particularly in distribution and in thermal power plant upgrading, due to the need in the past years to limit investments and reduce public sector expenditures because of macroeconomic reasons. CFE's Ten-year Investment Program includes special investment programs that would address these problems, the goals of which are to construct 7,500 km of high voltage lines, 12,500 of power transformers, 19,000 km of secondary feeders, 1,250 MVA  of distribution transformers and increase capacity by 1,100 MW by upgrading existing thermal plants. 4. Rationale for Bank Involvement. The Bank's country strategy is to support the Government's objectives of stabilization and structural change to the economy. The proposed project is in harmony with ongoing Bank's acjustment loans and with the Hydroelectric Development Project which seek to improve sectoral efficiency, introduce pricing policies based on economic criteria, reduce the reliance of public enterprises on Government funding and open procurement of goods and services to international markets. The continuation of the Bank's involvement in the power sector (which now accounts for about 15? of total public sector investment) would enable the Bank to expand the dialogue on pricing policy in the sector, review in detail the planning criteria for transmission and distribution and the sectoral investment programs and financial plans, and expand the focus of environmental issues. In addition, the proposed Bank loan and the mobilization of other resources, including the Inter-American Development Bank and the EXIMBANK of Japan, would allow CFE to undertake priority investments, without resorting to significant Government's budgetary transfers. 5. Project Obiectives: (a) Promote improvements and upgrading of thermoelectric power plants to reduce the investment requirements of the sector; (b) correct distortions in the tariff structure, reducing cross subsidies among consumers to improve end-user efficiency (c) strengthen CFE's internal capabilities to address environmental issues related to the operation of thermoelectric power plants and to the construction of transmission lines; (d) further pursue the improvement goals agreed under the Hydroelectric Development Project on management, technical, financial and energy conservation aspects; and (e) fund CFE's transmission and distribution program for 1991-92 with the purpose of meeting industrial and commercial demand and slightly expanding residential coverage, while improving the technical efficiency and reliability of electric service. 6. Project Description: The project consists of a two-year time slice (1991-92) of CFE's Ten-year Investment Program. The proposed Bank loan would help fund four basic components: (a) a transmission and substation program aimed at expanding and improving installations rated 400 kV to 115 kV (40? of the Bank's proposed loan); (b) a distribution program that would expand and improve CFE's distribution grid, including meters for customers presently connected directly without metering (34.5?); (c) a program to upgrade thermoelectric power plants to improve thermal efficiency and availability of CFE's main plants (25?); and (d) environmental and pollution control studies related to these components (0.5X). The two-year time slice is part of CFE's least-cost program; the engineering design for the programs to be financed by the Bank is at an advanced stage. The total cost of the project, including firancial charges (US$416 million) is estimated at US$7,127 million equivalent, with a foreign exchange component of US$3,100 million (43?). The executing agency, CFE, has the technical and administrative capacity to carry out the project. A breakdown of costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and of disbursements, as well as disbursement schedule are shown in Schedule B, a timetable of key project processing events and the status of Bank Group operations in Mexico are given in Schedule C and D, respectively. A map and the Staff Appraisal Report, No. 8191-ME dated March 20, 1990, are also attached.  7. Actions Agreed. During negotiations, agreements were reached on: (a) an action plan to modify by January 1, 1992 the electricity tariff structure to minimize cross subsides among consumers and promote consumer efficiency; (b) the increase of the price of residual oil ('combustoleo") used by CFE for thermoelectric generation, to reach international levels by June 30, 1992; (c) the execution, by September 30, 1991, of environmental studies and .raining programs related with transvission lines and thermoelectric power plants and the agreement by December 31, 1991 with the IBank on an action plan to implement the recommendation of the study; (d) CFE's proposed annual operating and investment budgets and financing plan for the upcoming year to be presented for Bank's comments, by October 31 of each year; and (e) financial rates of return on CFE's revalued net fixed assets in operation would progressively increase so as to achieve the following minimum targets: 42 in 1992, 52 in 1993; 62 in 1994, 6.52 in 1995 and 72 in 1996 and thereafter, to enable a contribution to investment from internally generated funds of not less than 402. In addition, during 1990 and 1991 tariffs would be increased in real terms by not less than 92 each year, as already agreed previously under the Hydroelectric Development Project. 8. Conditions of loan effectiveness are the signature of a subsidiary loan agreement between NAPIN and CFE and satisfactory progress in the implementation of commitments under Loan 3083-ME including the FRA and the execution of studies. 9. Proiect Benefits. The project would enable CFE to keep electric energy losses at low levels, improve the reliability of service and continue with the program of improvements in organizational, financial and technical issues initiated under the Hydroelectric Development Project; the project would also aid the Government in its program to improve the performance of public enterprises, reduce Government subsidies and achieve efficient allocation of resources. The economic rate of return on CFE's Ten-year Investment Program is about 14Z; if consumer surplus is not considered it would be 12X. 10. Risks. The main risk would arise from CFE's failure to continue increasing electricity rates, which would affect sector finances and result in a shortage of local counterpart funds and in project execution delays. However, the Government appears to be firm in its price policy reforms and has shown strong evidence of its commitment as reflected by the 5.5Z increase in real terms in 1989; in this context, the recent extension to the economic pact signals the end to a long period of price freeze, shifting instead to a more predictable and continuous process of regular public sector price adjustments. Another concern is the lack of access to external financing in the amounts required, to meet which the Bank would play an active role in putting together a cofinancing package. The project does not pose special technical or environmental problems. 11. Recommendation. I am satisfied that the proposed loan eomplies with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Washington, D.C. March 20, 1990  -4- Schedule A MEXICO TRANSMISSION AND DISTRIBUTION PROJECT Estimated Costs And Financing Plan Estimated Costs Local a/ Poreian Total 1991-1992 Time Slice: -------------Million US$------------- Generation Program 1,811.8 1,120.9 2,932.7 Transmission Program 624.3 366.2 990.5 Distribution Program 5a3.8 459.9 1,023.7 Equipment Upgrading 213.0 214.0 427.0 General Plant 82.9 36.1 119.0 Total Base Cost (June 1989 prices) 3,295.8 2,197.1 5,492.9 Physical Contingency 366.6 243.5 610.1 Price Contingency 365.0 243.4 608.4 Total Project Cost 4,027.4 2,684.0 6,711.4 Interest During Construction - 416.0 416.0 TOTAL FINANCING REQUIREMENTS 4,027.4 3,100.0 7,127.4 Financing Plan: CFE's own resources 3,675.0 294.3 3,969.3 Consumer contributions 154.4 0.0 154.4 Government contributions 198.0 0.0 198.0 IBRD proposed loan 0.0 450.0 450.0 IDB proposed loan 0.0 300.0 300.0 Bilateral sources (Eximbank Japan) 0.0 150.0 150.0 Loan 3083-ME (hydro Development Project) 0.0 133.0 133.0 Turn-key contracts 0.0 560.0 560.0 Other loans and suppliers' credits 0.0 1,212.7 1,212.7 TOTAL FUNDS 4,027.4 3,100.0 7,127.4 al Inclusive of taxes and dities estimated at US$576 million.  -5- Schedule B Page 1 of 2 MEXICO TRANSMISSION AND DISTRIBUTION PROJECT Procurement Method and DiLbuisement - ----------Procurement ttethod 11 - I C 8 21 LIB Other Total - - ~-31cost 6j Project Component ------(Million of current US Dollars)---- Generation Program 133.0 5S 0.0 3,450.3 3,583.3 [133.01 sI 0.0 1