Chile - Lota and Schwager Coal Mine Modernization Projects

RESTR ICTED 13113. CUI'1 Report No. P-378 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED READJUSTMENT OF THE LOANS TO LOTA AND SCHWAGER GUARANTEED BY THE REPUBLIC OF CHILE June 5, 1964  Report and Recommendations of the President to the Executive Directors on t'ie pronposed readjustment of Iota and Schwager Loans 1. INTHODUCTION 1. On July 24, 1957, the Bank made Loans 172-OH and 171-CH for 3S$9.6 million to lat&. (Oumpafl{a Carbon{fera e Industril de Lota) end U5$12.2 million to Schwager (Compaflla Carbon{ifera y de Fundicion Schwager S.A.) tc assist in financing the rehabili:ction, rnoderriaation and eroansion of -heir two ooal mil.as stuated near each other south of Conce,ci6n, Chile. The Chilean Government development corporation (CORFP)- was co-borro*rer on both loans and also undertook to lend to the tw-o Companies funds to assist in financirg local currency costs of the projects whenever funds availrble to the Companies from tncir own resources were inadequate. Both loans had a tern of 15 years (with a 5-year period of grace) and were guaranteed by the Chilean Government. 2. Nwaerous factors, such as the earthquake of 1960 and a three-month strike at the coal mines, served to delay completion of the project and weaken the financial position of the Companies. A fundamental factor was the failure of the coal market to develop as had been forecast. (Instead of rising to ebout 2 million tons by 1963, as had been fcrecast, annual sales of the two Conparniesremained belcw the 1557 level of' I.3 million tons') This, together with the inability of the Companies for a psr,iod of t..me to adjust coal prices, made for cashl si&ortages which causec the Companies to slow down work on the projncts and to increase the amounts they were required to borrow from COR7O. In the cane of the Schwager Project, the effect of these factors was aggravated by weakness of thle top management and the fact that the Scliwaper Project was physicall1-y more difficult tnan that of Lota. Nei ther project was coipl.;leted uhen anortizotion on the loans began (October 15, 1962 for Lota and: April 15, 19963 for Schwager); and consequently both Companies ihave hnad to obtain from CORFO funds to rmeet loan payments (aggre- gating just under $3 nillion for the two Companies combined) in addition to fuinds required to meet a portion of the local currency costs cf the Proj ects. 3. In an attempt to reduce operatinrg costs ar:d avDid duplication of eff-ort, the Companies reached an arreement in October 1961 to merge by havringr Iota absorb Schwager and oecome Compa.Ma Carhonlfera tota-Schwager S. A. (Lota-Schwager). The ability, of the Companies to complets the merger wsas substantialLy delayed ty a finding on the part of the Chilean A ti- Ilonopoly ConnnissiE ot that the merger wiould give thae nerged company a monopoly position and could be legally undertaken only if authorized by Presidential decree. Although it was politically difficult for the President to authorize the .merger, a decree, the terms of which were accepted by the Companies, was pub- *iisMd on October 183 1963, after which the Comnpanies were in a position to work Dut the details of the -merger agreement. * RLefarred to in the Documents as "Fomrento"  4. By early 1963 it was apparent t'lat sorme time would be required to complete the revised project and that in the interim the merged Company would not be able to provide from its own resources the funds needed to cover the local cur ency cos-s of the remaining investment and to service its debts to the Bank and to CORFO. COXFO and the companies asked the Bank to reschedule amortization in order to postpone payments falling due during the additional period needed for the completion of the project. In reply they were told that the fresident would be prepared to consider such an adjustment, and possibly to recommend its approval by the Executive Directors, only if our appraisal of the revised project and the prospective financial position of Lota-Schwager were to indicate a reasonable prospect that when the revised project was comjleted, Lota-Schwager would be able to service its debts to thle Bank and to CORFO out of its own resources. The Chilean government then -oern4tted a substantial upward adjustment in the price of coal and, together with the Bank, began an energy study to enable it to formulate a more adequate policy for the balanced utilization of alternative sources of energy. Meanwhile the Bank prepared an appraisal of the revised project. This appraisal (TO hlOa presented as Attachment No. 1 hereto) indicates the b2;sis onl which Lota-Schwager would be able to complete the project and thereafter repay its obligations out of its own resources. 5. l'Negotiations with officials of Lota-Schwager, COQ--O, and the Chilean Government took place in Washington during April and M-lay of this year. The negotiators for the Lota-Schwaaer were Messrs. G. deHeeckeren, (President), P. Edwards (Vice-President), A. Searle(Financial Manager), T. Tocornal (legal Counsel) and Ii. Kelly (Chief Engineer). Messrs. R. Fresard and J. Zabala, respectively General Counsel and New York Represen- t.itive of CORFO, represented both the Government and CORFO. In addition to the Appraisal Report, other documents are attached herewiith: Draft Supplem-ental Agreement (Attachment No. 2) Draft Supplemental Guarantee Agreement (Attachment No. 3) Letter from the Chilean Government concerning future pricing policy for coal (Attachment ho. 4) IT. PR1CGIPAL POINT? DT TM R?W VISED I IPAlTG- ENTS 6. A>part from changEs in language to accommodate the loan and Guarantee Agreements to the fact of the merger, the principal readjustments to be made in the arrangements would be as follows: A. The Descriptions of the projects would be revised to provide for the integrated operation of the mines and, in -view of the failure of the coal market to develop as had been forecast, to scale down ultimate capacity from 2.2 to 1.9 million tons a year. B. A new financial plan wiould be adopted under whidh the cost of completing the revised project would be financed by the  undisbursed balances of the Lota and Schwager loans ($17,000 and $4,950,000 respectively) and by E