Chile - Electric Power Expansion Project

/- f/ RESTRICTED Roport No. TO=445b This report was prepared for use within the Bank and its offiliatod organizations. They do not accept responsibility for its accuracy or completoness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCnON AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION INTERIM POWER PROGRAM EMPRESA NACIONAL DE ELECTRICIDAD, S. A. (ENDESA) CHILE January 29, 1965 Projects Department  CURRENCY EQUIVALENTS i U S. $ = 2. 3 Eacudoo (Esc. 9 IlEsc. = .43 U.S. $ 1 million Eec. = 463 ,73 U. S. $  TABLE OF CONTENTS Page S UMI4RY I. INTRODUCTION II. THE BORROWvERS 2 Management and Organization 2 III. POWER SUPPLY IN CHILE 2 Existing Power Facilities 3 Power Facilities Under Construction 4 IV. NEW PROJECTS PROPOSED FOR BANK FINANCING 4 A. Antofagasta Plant Capacity Addition 4 Present Facilities 5 Demand Forecast 5 Proposed Project 5 B. Punta Arenas Gas Turbine 6 Present Facilities 7 Demand Forecast 7 Proposed Project 7 Estimated Cost of Project 8 C. Submarine Cable to Chiloe Island 8 Present Facilities 8 Demand Forecast 9 Proposed Project 9 Estimated Cost of Project 9 D. Transmission and Distribution Expansion 10 Proposed Project 10 Estimated Cost 10 E. System Development Studies 11 F. Improvement of Central Office Functions 11 Summary of Estimated Costs 12 V. FINANCIAL ASPECTS 12 Tariffs 12 Past Earnings Record 14 Present Financial Situation 14 Proposed Financing Plan 15 Estimated Future Financial Position 16 VI. CONCLUSIONS 17  ANNEXES 1 - Total Installed renerating Capacity by Entities and Type of Plant 2 - Total Gross Generation by Entities and Type of Plant 3 - Installed Generating Capacity by Geographic Regions 4 - Gross Generation by Geographic Regions 5 - ENDESA Interconnected System - Forecast Maximum Demand and Proposed System Capacity Addition 1963-1972 6 - Income Statements 1959-1966 7 - Balance Sheets 1962-1966 8 - Sources and Applications of Funds 1964-1966 MAP - ENDESA Power Installations  INTERIM POWER PROGRAUI ENDESA CHILE SUMiARY il Empresa Nacional de Electricidad, S.A. (EIDESA), the Government- owned autonomous power company in Chile, which obtained Bank loans in 1948, 1956 and 1959 aggregating US$61 million for power system expansion is requesting another loan of US$4.4 million to finance the foreign exchange cost of several small power plant extensions and for system studies. ii. The small plant additions are needed to meet demands for power in several isolated areas in the country. The system studies will enable ENDESA to undertake improvements and studies essential to its future development and planning. iii. ENDESA is planning its next step of major plant and system expan- sion and expects to submit feasibility reports to the Bank next year with its request for financing. The present loan is for a small interim program to take care of needs until that time. iv. ENDESA's financial situation has been weak in the past due to the inadequacy and tardiness of tariff adjustments which did not fully compen- sate for cost increases due to inflation. Rates of return on revalued net fixed assets dropped from 5.9% in 1959 when the last loan was made to 3.1% in 1963. Since the Electricity Law provides the mechanism to compensate for inflationary cost increases when administered and applied promptly, the Government and ENDESA have in recent months taken a number of steps to improve ENDESA's earnings picture in absolute terms. Tariff increases totalling about 59% were approved during the beginning of 1964 which it is estimated will bring ENDESA's rate of return by the end of 1964 to about 5%. v. While the anticipated return (5%) in 1964 falls far short of that allowed under the Electricity Law, ENDESA considers that it is impractical to expect any further action by the Government at this time. However, it is ENDESA's intention to continue its efforts to improve its earninigs in the future. Vi. On this basis and considering the nature of the interim program the proposed projects would be suitable for a Bank loan of US$4.4 million, in- cluding interest during construction, for a term of 20 years including a grace period on amortization of three years.  INTERIM POWER PROGRAM EIDESA CHILE I. INTRODUCTION 1. Empresa Nacional de Electricidad S.A. (ENDESA) is the Government- owned autonomous power company in Chile. The Bank made loans to ENDESA in 1948, 1956 and 1959 aggregating US$61 million to finance generating plants totalling 589 MYW, of which 330 MW are still under construction. 2. The load projections made by ENDESA show that additional major generating capacity will be required by 1970 and studies are now being made by them of the alternative hydro and thermal possibilities. It is expected that ENDESA wJould again request the Bank to participate in financing this new construction. 3. In the meantime ENDESA has an urgent need for additional small generating units to serve several isolated towns and areas and the expansion of transmission and distribution facilities everywhere in the country. It has asked the Bank for a loan of US$4.4 million to finance the foreign ex- change cost of this Interim Program. 4. The proposed projects in the Interim Program are: (a) The reconstruction of the existing pipeline and penstock of the Salar del Carmen hydro plant and the addition of a 3.4 MW unit to increase power supnly to the town of Antofagasta. (b) The installation of a 5 MW gas turbine at Punta Arenas to burn natural gas to be supplied by a new pipeline from existing oil fields about 100 km awiay. (c) The installation of a transmission line and submarine cable to connect the island of Chiloe to the mainland. (d) Transmission and distribution system expansion and improvements in all regions of the country. (e) A program of system development studies requiring imported measuring and other equipment for hydrological and geological investigation and the services of consultants. (f) Improvement of central office functions requiring the assistance of consultants and imported equipment. 5. The appraisal of these projects is based upon information supplied by ENDESA and discussions held with them at the Bank alnd in Chile.  - 2 - II. THE BORROWERS 6. Corporacion de Fomento de la Produccion (CORFO) was created as a Government agency in 1939 to promote the economic growth of Chile. It acts as a planning and executing agency of the Government with the author- ity to lend or invest in public or private entities. Its funds are obtained by appropriation from the national budget, income from its invest- ments, borrowings and repayments of advances. 7. ENDESA was created by the Government in 1944 as an autonomous organization for the general planning of power supply in Chile and for supplying power where other companies were not able to meet the demand. It is a stock company with 99% of its shares held by CORFO. 8. ENDESA pays income and other taxes as well as customs duties on imported goods. It is also subject to tariff regulations by the Tariff Commission and must obtain its concessions from the Director General of Electric Services in the same way as all other utility companies. 9. The essential difference between ENDESA and private companies is that it receives substantial financial assistance through CORFO. This matter is given more detailed analysis in the financial section (para- graphs 81 and 86). CORFO and ENDESA have been co-borrowers in previous Bank loans and the same agreements previously made would apply again if the present loan is made. Management and Organization 10. In 1960 ENDESA adopted a new management structure which provided for a better delegation of responslbility and authority. This new organ- ization at the top management level is a definite improvement over the former organization but some of the changes to procedure have not been com- pleted yet. The French consulting firm of Paul Planus was retained by ENDESA in 1960-61 to study the budgetary and accounting practices with the view to recommending changes and bringing them into line with the new organization. 11. The recommendations by Paul Planus have now been presented and ENDESA wishes to implement them. Part of the financing now being requested is for this purpose, as detailed in paragraphs (65-67. 12. In the past ENDESA has used consultants for construction work on a lirited bcsis and for special purposes only. ENI\DS agreed during negotiations to nake more effective use of consultants in the future in order to improve its performance in plahnnng and construction (see paragraph 23). III. POWER SUPPLY IN CHILE 13. Annexes 1 and 2 show that at the end of 1963 Chile had a total installed capacity of 1,335 MTJ which generated 5,646 million kwh during that year. Hydro plants provided 60% of this energy while the rest came from steam and diesel plants. Public service companies accounted for 56%  of the total generated and private plants serving mines and industries contributed the other 44%. 14. For administrative purposes ENDESA has divided the country into seven regions as shown on the attached map. The installed capacity and the energy generated for these regions are shown in Annexes 3 and 4. The power systems of the four regions (2nd, 3rd, 4th and 5th), in the central zone containing 91% of the country's population, have been linked up through 15h-kv and 110-kv primary transmission lines to form the Inter- connected System where 97% of the total energy generated in the country for public service is consumed. On the other hand the largest block of captive power is located in the 1st Region in the private mines serving their own power needs. Existing Power Facilities 15. About two-thirds of the electric energy for public service in the Interconnected System is supplied by ENDESA and the remainder by several private power companies, among which the U.S. owned Cia Chilena de Electrici- dad (CCE) is the largest, and some power from captive plants. The several sources of power are tabulated below: Power Sources for the Interconnected System in 1963 Percentage Thermal Hydro Total of Total (millions of kwh) Generated by ENDESA 8 2,00 2,012 64 Generated by CCE U18 572 1,020 32 Generated by Other Companies 1 41 b2 1 Supplied by Captive Plants 16 69 85 3 473 2,636 3,159 100 16. ENDESA sells about 37% of its output to CCE, about 35% to other distributing companies and about 28% directly to large industries receiving power at high tension. CCE, as the largest distributor in the central zone, sells about 55% of all the retail energy in the Interconnected System, although its own power plants generate only 58% of the power it sells. 17. The graDh in Annex 5 shows the forecast maximum demand and pro- posed system capacity of the Interconnected System through 1970. The fore- cast demand is based on a load growth of about 9% up to 1965 and about 8% afterwards. It is seen that during 1964 system capacity is estimated to fall short of the demand by about 5%, which ENDESA plans to compensate by voltage and frequency control. These forecasts are considered realistic on the basis of past trends in Chile. 18. The situation is expected to improve at the end of 1964 when the 115 MW steam unit of the new La Ventana Station of CCE is due for service and in 1966 two 70 MW units at Rapel are scheduled to go into operation.  19. The three regions outside of the Interconnected System are sparsely populated and the towns are widely separated. Public supply of electric power is confined to a few towns which are served by isolated systems mostly without adequate generating capacity. The systems which ENDESA considers in need of imnediate improvement under the Interim Program and for which Bank financing is being requested are those at Antofagasta in the 1st Region, Chiloe Island in the 6th Region and Punta Arenas in the 7th Region. Power Facilities Under Construction 20, At the end of 1963 ENDESA owned and operated h60 MW of hydro plants and 35 MW of diesel and steam plants. It now has under construction the Rapel (280 !V) and Isla (34 1MW) hydro projects and the Huasco steam plant (16 MW). 21, The plants at present under construction have suffered delays of about 18 months due to very severe earthquakes in 1958 and 1960; land slides wnich destroyed some construction; strikes which caused a loss of three months at the Rapel project and some poor rock conditions encountered after tunnelling had advanced. However, work is now proceeding normally and new completion dates shown in Annex 5 should be met unless further events beyond ENDESA's control intervene. 22. The cost estimates for local currency expenditures for present construction have increased considerably due to inflation and construction changes caused by the above-mentioned problems. As an example the 1964 estimate for the local currency costs of the Rapel plant is 219% higher than the 1960 estimate. About 73% of this cost increase is due to infla- tion, 21% to changes in the project and 6% to other reasons. 23. The plants and installations of ENDESA are well maintained and operated. Construction work undertaken by ENDESA is in general satisfac- torily performed, but delays in completion of projects are characteristic of past performance in Chile. In the future ENDESA will take steps to improve this situation by mnaang fuller use of the services of consultants for its major projects to assist in construction program planning and supervision. IV. NEW PROJECTS PROPOSED FOR BANIK FINANCING 24. The Interim Program proposed by ENDESA consists of the following projects: A. Antofagasta Plant Capacity Addition 25. Antofagasta, the capital city of the province, is an important port in the 1st Region which is rich in mineral resources and produces 49%  - 5 - of the copper and 90% of the nitrates in the country. CORFO has started making important investments in industrial projects to initiate a develop- ment program to stimulate the growth of this region, which had been a depressed area. Present Facilities 26. Power facilities are owned and operated by ENDESA and consist of: (a) a 1,500 kw hydro plant; (b) 4,200 kw of diesel units; (c) an old diesel plant which is being reconditioned to provide 2,200 kw for peaking purposes until the proposed new hydro unit can be installed; there is also available 800 kw at the Air Force Base. These facilities combined give a total of 8,700 kw of effective capacity. Demand Forecast 27. The demand forecast made by ENDESA and the proposed system capacity are shown below: Estimated Increase in Available Demand Demand - Percent Capacity kw Over Previous Year kw 1963 (Actual) 7,360 11 8,700 1964 8,270 12 8,700 1965 9,010 9 8,700 1966 9,740 8 8n,700 1967 10,400 7 9,600 1968 11,100 7 12,100 1969 11,870 7 12,190 1970 12,690 7 18,130 28. The higher growth rates through 1966 are due to about 1,200 kw to 1,300 kw of load to be added by specific developments now under construction by CORFO and other private entities. After 1966 an annual growth of 7% is assumed wrhich is reasonable for this region based on past trends. The proposed additions of capacity in 1967-68 and in 1970 would meet forecast demands beyond 1970. During 1965-67, when the proposed plant addition would be con- structed, there will be rationing of power. Proposed Project 29. The existing hydro plant, Salar del Carmen, uses the potable water supply to the city, which was augmented in 1962 by the diversion of another small river so that sufficient water is now available to operate an additional 3.4 M1 generating unit which is being proposed by ENDESA. 30. The existing pressure pipeline and tanks have suffered extensively from corrosion caused by the mineral content of the water and are in need of immediate repair or replacement. ENDESA has agreed with the Ministry of Public Works on a plan to rebuild and reroute the pipeline. This work wrould  - 6 - consist of the replacement of h4 km of existing pipeline by an aqueduct and the use of the salvaged pipe along with 8h0 meters of new pipe to rebuild the remainder of the existing pipeline. 31. The repair and relocation of the pipeline can be done in stages so that the out of service time of the existing power plant can be kept to a minimum and the potable water supply continue uninterrupted. 32. It is proposed to install a new unit of 3.4 MW in an extension of the existing powerhouse. However, since the full amount of water will not be available during the reconstruction of the pipeline only a 0.9 M in- crease in capacity will be obtained initially. The full capacity increase will become effective in 1968, as shown in the tabulation in paragraph 27. 33. This proposed addition of a 3.4 MW unit and the repair and re- location of the pipeline is estimated by ENDESA to cost US$601,000 and Esc. 1,445,300. The major components of this cost are given below: Escudos US$ (in thousandsT Power plant including substation 275 189 Pipeline and associated civil works 1,205 313 Freight insurance and financing charges 165 99 Total 1,645 601 3a. The dollar cost estimate for the new unit and substation equipment of US$189,000 averages US$55 per kw which is reasonable for this size of unit. The cost of the civil work, part of which is attributable to the water system, is reasonable considering the extent of the work to be done and based on other actual construction costs in Chile. 35. The proposed addition to the existing hydro plant is the best next step of system expansion since it utilizes existing facilities and defers the construction of a new thermal plant until 1970. ENDESA has also shown that this proposed addition to the hydro plant would be 10.5% cheaper than the installation of equivalent diesel generating capacity. B. Punta Arenas Gas Turbine 36. Punta Arenas is the largest of the very small cities in the extreme south of Chile on the Straits of Magellan in the 7th Region. The main source of income of the area is sheep raising for wool export and during recent years the discovery of oil has added to the economic prospects of the region. In 1962 almost two million cubic meters of crude oil were produced, which gave enough gasoline for the entire domnestic requirements of the country. 37. The Government is very anxious to help this region to develop and in 1956 made Punta Arenas a free port to encourage industrial development.  -7- Present Facilities 38. The existing power supply owned and operated by ENDESA consists of two very old steam units of about 900 kw each and three diesel units of 1,400 kw each installed in 1958 and 1962. This combination of plants gives a total of about 6,000 kw which will barely be able to meet the pre- sent restricted demand until 1965 provided all units can be maintained in operation; new capacity is urgently needed. Demand Forecast 39. The demand forecast by MNDESA and the proposed system capacity are shown below: Estimated Increase in Available Demand Demand - Percent Capacity kw Over Previous Year kw 1963 (Actual) h,670 14 6,ooo 1964 5,150 11 6,000 1965 5,510 7 6,000 1966 5,910 7 10,200 0o. The higher growth rates of demand in 1963 and 1964 are due to the installation of the diesel uniLt in 1962 which allowed some previously sup- pressed demand to be met. An estimated 7% is assumed after 1964 and this is considered reasonable based on past trends in this region. 41. A 5 MWvJ capacity addition is proposed by ENDESA in 1966 which, after detating the old steam plant to 1,000 kw, would increase system caDacity to 10,200 kw, and provide sufficient capacity to meet the growth in power demand for several years. Proposed Project 42. In order to select the niost suitable type of plant ENDESA engaged the consulting firm of Kennedy & Donkin, London, England, to evaluate the alternatives. After considering the load characteristics of the region and alternative steam and diesel plants, the availability of an abundant supply of high quality natural gas which is now being flared and the problersof maintenance, the consultants reconmiiended the use of a gas turbine. This is the most satisfactory solution, from the economic as well as the operating point of view, to meet the local conditions where the evening peak load predominates and the annual load factor is only 36%. 43. The project would include the construction of a 100 km gas pipeline and compressor plant to convey the gas from the oil fields to Punta Arenas where it would be used to supply the gas turbine power plant and other in- dustries which the Government plans to establish.  - 8 - 44. The power plant would consist of the package type unit in its own housing, a terminal substation and two small buildings to house the control room and stores. Estimated Cost of Project 45. The installed cost of the plant and gas pipeline is estimated by ENDESA at US$ l5521,000 for the foreign exchange portion and Esc. 1,116,000 for the local currency. Of these amounts, the gas pipeline is estimated to cost US$402,000 and Esc. 466,ooo while the plant with one 5 MW gas turbine and terminal substation would cost US$1,119,000 and Esc. 650,ooo equivalent to US$280/kw installed. 46. The foreign currency component of cost is based upon bids received from gas turbine suppliers which have not been evaluated yet. The other com- ponents of cost are reasonable, The actual cost for the completed project may well be below the estimate when all equipment orders have been placed. ENDESA has invited bids on all the equipment and has been following procure- ment procedures acceptable to the Bank. C. Submarine Cable to Chiloe Island 47. The Island of Chiloe is situated immediately off the coast in the extreme north of Region 6, The 100,000 inhabitants engage in farming, fish- ing, canning of seafoods and some forestry. 48. The Government is anxious to raise the standard of living of this island and is plarning to improve road communications and arrange credits for agrlcultural and industrial development. Additional power facilities will consequently be needed in connection with the proposed general develop- ment. Present F'acilities 49. At the present time power for the island is provided by some very small isolated diesel and hydro units listed below: Location Type of Plant Capacity Ancud Diesel 660 Ancud Hydro 80 Castro Diesel 210 Castro Hydro 100 Other villages Diesel 48 1,098 kw 50. These plants are very old and in poor condition except for the 660 kw of diesel in Ancud which ENDESA installed in 1962. Rationing had been  - 9 - in effect prior to the installation of the new diesel capacity which will be rapidly absorbed by the suppressed demands and additional power is urgently needed to provide for future increased demand on a reliable basis. Demand Forecast 51. The demand forecast by ENDESA is shown below: Estimated Increase in Demand Demand - Percent kw Over Previous Year 196:3 (Actual) 1,030 8.4 1964 1,110 7.8 1965 1,200 9 1966 1,300 8.5 These estimated growth rates are reasonable in view of the present power shortage and anticipated development of the island. Proposed Project 52. In view of the proximity of the island to the mainland where power is now available, ENDESA proposes the installation of a submarine cable to connect the existing transmission system on the island with the nearest town, Puerto Miontt, on the mainland. 53. The entire project would consist of a 9 km extension of the present 66 kv transmission line at Puerto l[ontt to Puerto Redonda; two 23 kv sub- marine cables each 5e5 km long connecting a new substation at Puerto Redonda (66/23 kv) with a new terminal substation at the Chiloe end of the submarine cables. New additional 23 kv transmission lines and transformer stations would then carry the power from the delivery point to the consuming centers along the eastern shore of Chiloe Island. 54. Puerto llontt is in the 5th Region and is served by the central Interconnected System where power is available. The transmission line ex- tension and submarine cable would have a capacity of 2,000 kw which combined with existing installations, would amply rneet the needs of the island for a number of years. This connection to the mainland would provide a more economical power source than the installation of a thermal plant on the island. Estimated Cost of Project .55. The cost of the interconnection including transmission lines, sub- marine cable and substations is estimated by ENDESA at US$308,700 for the foreign exchange portion and Esc. 1,086,000 for the local costs. The local currency estimate is considered reasonable for the work proposed. The foreign exchange requirement is based on quotations already obtained by ENDESA for the submarine cable which they have already ordered after observing the pro- cedures of international competitive bidding.  - 10 - D0 Transmission and Distribution Fxpansion 56, ENDESA is proposing a program of transmission and distribution System expansion to meet the requirements for new facilities everywjhere in the country during the next three years. Their proposal would involve an investment of Esc. 25 million and US$3 million. Proposed Project 57. ENDESA has studied the needs of each region and from this infor- mation has developed a program which, in summary, includes the following items: (a) The construction of: 447 km of 66 kv lines 900 ka of 23 kv lines 1,200 km of 13 kv lines 2,100 km of low voltage lines. (b) The expansion of 100 urban distribution systems. (c) The construction of 9 primary substations and the expansion of 31 others. (d) The purchase of about 45,000 kwh meters. (e) The purchase of about 10 pick-up trucks. Estimated Cost 58. The present loan would be used to finance an interim program of small plants ard other items urgently required to meet specific power demands or needs and it is expected that ENDESA will present an application during 1965 to the Bank for financing its next major phase of power expansion. At that time the justification for additional transmission and distribution expansion will be predicated upon a more clearly defined program of power plant expansion and consequently will be more easily appraised and supported. 59. It appears reasonable, therefore, to consider including in the pro- posed interim loan about one-third or the equivalent of one year, of the pro- posed three-year program of distribution expansion. Loan funds allocated to this item would amount to US$1 million. 60. ENDESA has agreed to the inclusion of this reduced amount in the propozed loan and has submitted a correspondingly reduced list of goods for this part of' the progran.  E. System Development Studies 61. ENDESA is conducting a program for the study of system development to meet forecast load and the investigation of potential hydro and thermal si.tes for future develoDment. They will obtain the assistalce of foreign consultants in these studies. 62. The hydro site investigation deals particularly with the El Toro (280 15W) and Hlaule (300 14W) plant sites which have so far only received pre- liminary study. More exact hydrological and geological data are needed and imported equipment will be required for these studies. Stream flow measuring equipment, drills for geological studies, trucks and laboratory equipment are included in the request. Necessary data will also be collected on a long-range basis for other potential hydroelectric projects for future needs. 63. The proposed program is essential to the orderly development of a utility enterprise the size of ENDESA and the equipment requested is neces- sary to conduct the required studies. ENDESA also plans to examine the thermal alternatives of system development along with the studies of the feasibility for any proposed hydro possibilities. 64. ENDESA estimates the cost of the program at US$385,000 and Esc. 847,000. The local cost estimates are reasonable for the work to be done. About 40% of the foreign currency is being provided for consultants' services, the remainder is reasonable for the amount of equipment to be imported. F. Improvement of Central Office Functions As already stated under i4anage:nent and Organization, ENDESA has been studying its organization and implementing changes to procedures with the help of consultants. Further assistance is now urgently needed to implement the consultantst recommendations and to develop detailed procedures and to train stafj in the new methods. New office equipment and machinery will be required and incliudes equipment needed to utilize the computer at the University of Chile and to introduce perforated tape to store accounting data. 66. It is clear, after discussions in Chile, that these studies and improvements to ENDESA's organization are not only worthwhile but are essen- tial. Past efforts have shown good results and the general efficiency has improved. Therefore, the request for additional consulting services, parti- cularly in the area of budgeting and accounting controls is recommended as a fully justified expenditure. 67. ENDESA estimates the cost of the consultants' services at US$100,000 and imported office machinery at US$200,000, giving a total of US$300,000 for this item. Terms of reference for the consultants will be submitted for Bank approval at the appropriate time. This estimate is reasonable for the services and equipment required.  - 12 - Summary of Estimated Costs 68. The proposed investment in the interim program is summiarized below: Foreign Local Currency currency) US$ Escudos (in thousands) Antofagasta hydro unit 601 1,645 Punta Arenas gas turbine 1,521 1,116 Chi]oe Island cable 309 1,086 Transmission and distribution expansion and improvement 1,000 8,523 System Development Studies 385 847 Administrative functions 300 - Total 4,116 13,217 During negotiations it was agreed that the Bank would include about US$250,000 for interest and other loan charges during construction. The proposed loan would thus aLxautt to US,.44 i-illion. 69. -Z.IDESA has followed satisfc_ctcry procedures of international com- petitive bidding in the procurement-of goods for which contracts have already been placed and has made similar arrangements for the remainder of items to be financed under the proposed loan. V. FIiV'NCIAL ASPECTS Tariffs 70. Electric tariffs in Chile are regulated by the Direccion General de Servicios Electricos (DGSE) an agency under the Ministry of the Interior in conjunction with the Tariff Commission which is responsible to the Comptroller General of the Country. The regulations are based on the Electri- city Law (Ley General de Servicios Electricos DFL 4 of 1959) which in essence provides for a. rate of return of 10% to both public and private utilities based on their rate base consisting of (a) revalued net fixed assets in operation, (b) provision for worlkng capital not to exceed three months' operating expenses, and (c) intangi'ole assets not to exceed 5% of net fixed assets in operation. Net fixed assets in operation are adjusted annually in accordance with the cost of living index; this adjustment in 1963 amounted to 44%. Operating income is taken before interest and income taxes. 71. When.Loan 244-CH was made in 1959 ENDESA entered into a commitment on tariffs which provided that revenues would be sufficient to cover all operating expenses and debt service, and "leave a reasonable surplus for financing the expansion of its power facilities". At the same time ENDESA assured the Bank that it would take all steps required to adjust its tariffs before the end of 1962 so as to earn the full return permitted under the Law; the Bank was satisfied that this would meet the requirements of the  - 13 - tariff covenant. As of the end of 1959 this goal seemed attainable because a stabilization program of the Chilean economy had been instituted, the Electricity Law, which had just been passed, seemed to provide the neces- sary protection for future inflationary cost increases, and ENDESA was earning 5.9% during the year. 72. Subsequent events prevented ENDESA from meeting its connitment. In 1960 a disastrous earthquake caused a reduction in gross revenues and during subsequent years inflationary pressures on prices resumed again. The main reason for ENIDESA's poor performance, however, w.as that the provisions of the Electricity Law which could have remedied the situation, were not applied with the necessary expediency. There is little doubt that the regu- latory agencies acted purposely in order to moderate any price increase in the Power Sector. The maximum time required under the Electricity Law to process a fully documented tariff application should be roughly three and a half months. By objecting to applications as incomplete, the regulatory agencies wqere able to extend this period to one year and more. As a conse- quence. EIZDESAts rate of return at the end of 1963 was down to 3.1,%. 73. When ENIDESA applied for the proposed loan in early 1963 the problem of tariffs was forelaost in everybody' s mind. The matter was discussed with CORFO, ENDESAt s management, mermibers of the Tariff Commission and the head of DGSE in an endeavor to expedite the application of the Law and to improve ENDESA' s earningst picture in absolute terms. Since it was clear that the full recovery from the low earning levels would not be possible within a short time ENDESA proposed a number of measures which would bring about a gradual improvement. The discussions were continued and carried on at Cabinet level. The progress during 1963 was encouraging and it proved that the measures proposed by ENDESA were reasonable and attainable. 7h. In February 1964 ENDESA informed the Bank of the basic steps which it had taken during past months in order to obtain the legally allowed rate of return. It had set up an internal organization to formulate a procedure acceptable to the Tariff Commission and to speed up the preparation of its applications for tariff increases. Also, ENDESA obtained authorization to apply tariff increases as soon as they were approved instead of having to wait six months or longer, which was customary previously. All of ENDESA' s tariff applications were acted upon by the Tariff Commission within the time period provided in the Electricity Law. 75. The net result of the actions taken during past inonths should result in an increase of 59% in average revenues per kwh for the year 1964 which would raise the rate of return to about 5% instead of the previous estimate of 3.6%. If these increases in revenue continue through 1966, the rate of return is expected to rise to 6.5%, predicated upon additional increases in 1965 and 1966 (see par. 87). Although this is short of the desired rate of return of 10%o allowed under the provisions of the Electricity Law it is a marked improvement over the 1959-63 period. ENDESA is keenly aware of the need to further improve its financial  - 14 - position but stipulates that the actions taken during the past year were the maximum wihich could be accomplished under the prevailing conditions. However, ENDESA is planning to continue its efforts to obtain whatever rate increases might be feasible in 1965 and 1966 over and above any adjustments for inflation and to improve the administrative procedures for the appli- cation of the Electricity Law particularly with regard to the promptness of tariff action. Past Earnings Record 76. Actual income statements for the years 1959 through 1963 are shown in Annex 6. As mentioned in paragraph 72 the rate of return based on Electricity Law declined from 5.9% in 1959 to 3.1% in 1963 although tariff increases amounted to 74% during the same period. Operating ratios during the same period have risen from 66'% in 1959 to 75% in 1963 thereby reflect- ing the lack of adequate revenues to offset the inflationary trend in the cost of operations. 77. The low level of earnings in conjunction with the unavailability to ENDESA of long-term local funds have forced ENDESA in the past to depend heavily on equity funds from CORFO to meet its local currency requirements. As long as borrowings are limited to foreign exchange expenditures and long-term borrowings of local currency are not available on reasonable terms this situation will continue and can only be relieved by increasing ENDESA's own earnings through tariff increases or continuing to depend upon CORFO's contributions. Present Financial Situation 78. Sulrwary balance sheets for the years 1962 and 1963 are given in Annex 7. Although ENDESA operates on a fiscal year basis (July 1 to June 30) all tables in this report are based on the calendar year. Thus the most relevant factors, i.e. the annual tariff adjustments which occur at the beginning of each calendar year, can be illustrated more clearly. ENDESA s financial statements are audited by Price, Waterhouse, Peat and Company of Chile. 79. ENDESAts fixed assets in operation as of December 31, 1963 amounted to Esc. 449.40 million, which comprises actual investments in plant and the annual revaluations in accordance with the Electricity Law (see paragraph 70). As a starting point for 1964 this figure would have to be increased by L4% to Esc, 61h7,O8 million reflecting an inflationary increase in the cost of living index during 1963. The depreciation reserve at the end of 1963 was Esc. 92.86 million or 21% of fixed assets in operation. This reserve is also subject to revaluation.  - 15 - 80. ENDESA's capitalization as of December 31, 1963 can be summarized as follows: In M4illions of Escudos In Percent Equity Share capital issued 200000 Earned surplus and other reserves 26.67 Revaluation reserve 112l14 Contribution in aid of construction 3.33 CORFO advances 66.44 Total Equity 4o8-58 84.8 Long-term Debt (Exchange rate US$l = Esc. 1.80) IBRD Loan 5-CH, 4&o, 1948-68 9? 30 IBRD Loan 153-CH, 5%, 1956-76 22c95 IBRD Loan 244-CH, 6% ,1959-85 19.67 AID Loan, 2% ,1963-2003 14.44 Other loans and advances 6.62 Total Debt 72.98 15.2 Total Capitalization 481056 100% 81. About 99% of ENDESA's share capital is held by CORFO, the remainder is distributed among 30 different shareholders (municipalities, private enter- prises and individuals). The authorized share capital is increased from time to time and shares have been issued mainly against the accumulated revalua- tion reserve and CORFO advances. CORFO advances consist of (a) cash contribu- tions, (b) payment of debt service on IBRD loans, (c) budgetary appropriations under special laws, i.e. the Copper Law, (d) reinvested dividends and (e) reinvested interest at the rate of 8% on outstanding advances. It is quite evident that in the past CORFO has been the main source of funds for ENDESA's expansion. 82. The outstanding amount of the previous three IBRD loans at December 31, 1963 amounted to about US$28.8 million. The original amounts of the loans were (a) US$13.5 million for 5-CH, (b) US$15 million for 153-CH and (c) US$32.5 million for 244-CH, of which about US$21.3 million had not been drawn down as of that date. The AID loan was made available through CORFO; it carries interest at 2% and is repayable in 40 years including a ten year grace period, Other long-term debts consist of suppliers' credits and deferred customs duties. Proposed Financing Plan 83. Sources and applications of funds for the three years 1964-66 are shown in Annex 8. The forecasts are limited to a three year period because a number of important decisions regarding ENDESA's expansion plans beyond 1966 have not yet been taken; they are actually in part dependent on studies fi- nanced under the proposed interim loan.  -16 - 84. During the three year period 1964-66 ENDESA's construction expen- ditures would total Esc. 339 million of which the proposed interim program would represent about Esc. 23 million or about 7%. ENDESA would finance Esc. 105 million or 31% of its expansion requirements from its own resources. About Esc. 143 million or 42% would come from CORFO contributions, Esc. 22 mil- lion or 7% from contributions in aid of construction and other sources, and the balance of Esc. 69 million or 20% from other borrowings including deferred customs duties. 85. The borrowings during the period 1964-66 are assumed as follows: (a) The projects being financed by IBRD Loan 244-CH have a loan balance as of December 31, 1963 of US$21.29 million; (b) a Bank loan of US$4.4 million equivalent would be obtained at the end of 1964 to finance part of the proposed interim program, including interest during construction, at an assumed rate of 59a and for a term of 20 years including a three-year grace period for the amortization of the principal; (c) ENDESA estimated other minor foreign exchange loans of about Esc. 5.7 million equivalent would be incurred in 1965-66 for vari- ous small projects, including interest during construction. 86. Because of the importance of CORFO's estimated contributions toward ENDESA's expansion program,assurances were obtained from CORFO during nego- tiations that it will make available, as in the past, all funds required to complete ENDESA's specific expansion program and required working capital, if any0 CORFO's contributions would continue to be converted into share capital. Estimated Future Financial Position 87. Forecast income statements for the period 1964-66 are shown in Annex 6. The basic assumption for these forecasts is ENDESA's contention that they would be able to obtain tariff increases of 11% in 1965 and 16% in 1966 which would be over and above any upward adjustments for inflation. On this basis net income from operation before income tax and interest charges would increase from Esc. 24 million in 1964 to Esc. 38 million in 1966. Returns calculated on the basis of the Electricity Law would be 4.9g in 1964 and reach 6.5%, in 1966. ENDESA has stated its intent to apply for tariff increases which would enable it to obtain these return levels. 88. Internal cash generation would cover total debt service payable 3G7 to four times during the period under review. This illustrates mainly the low debt portion of ENDESA's capitalization which is also shown in the debt/ equity ratios in Annex 7, Balance Sheets, for 1962-66, which reflect a 9/91 ratio in 1962 increasing to a 14/86 ratio in 1966. 89. The contributions from earnings after meeting debt service payments would finance about 31% of capital expenditures during the three years ending 1966. This percentage would satisfy the stipulations of the existing tariff covenant as mentioned in paragraph 71.  - 17 - 90. In essence, the review of the financial performance of ENDESA since 1959 shows a deterioration because the company was not permitted to obtain adequate and prompt tariff adjustments. However, during 1964 there has been considerable change in the attitude of the regulatory agencies and tariff increases were approved more promptly and at more adequate levels. In view of this encouraging improvement and the declared intention by ENDESA to con- tinue applying for tariff increases which will result in further improving ENDESA's financial situation, the conclusion was reached that the proposed interim loan could be made without relating it to specific immediate tariff action. During negotiations it was made clear to the Borrower and the Govern- ment that the Bank would not be able to consider any further loans to ENDESA unless satisfactory tariff action is taken that would assure ENDESA of an acceptable rate of return on its investment, VI, CONCLUSIONS 91. The small new generating plants proposed for Antofagasta and Punta Arenas are urgently required to supply forecast power demands and are adequate for this purpose. The cost estimates are considered satisfactory and provide adequate contingencies. 92, The Chiloe Island submarine cable and associated transmission and distribution line extensions are the most economical method of providing power to the island and the cost estimates are based on bids by suppliers of material and knoam local costs; they are satisfactory. 93. The system studies and improvements to administrative functions are both well justified and necessary activities and the proposed investments are reasonable. 94. The transmission and distribution system expansion is justified by load growth and the amount of the proposed investment is reasonable in rela- tion to the size of ENDESA. However, since the requested loan would be for an interim program ENDESA has accepted the inclusion of only one third, or US$1 million of this program for Bank financing under the proposed loan. 95. ENDESA has agreed to make fuller use of consultants in future to improve its performance in system planning and construction work. (Paragraphs 12 and 23.) 96. Since 1959 ENDESA's earnings have been inadequate and its financial position has been weak. This was caused by a drop in sales after the earth- quake in 1960, inflationary increases in operating cost and deliberate delays in the approval of tariff adjustments by the regulatory agencies. During the last 12 months ENDESA has taken a number of constructive steps to improve the situation and the attitude of the regulatory agencies seems to have changed. In consequence average revenues per kwh for 1964 increased 59%. With further improvements in tariffs proposed by ENDESA the rate of return would reach 6.5% by 1966, which would be a satisfactory goal for the 2