Honduras - Fourth Power Project

LOqAAJ 6' XZ -HC FILE LJurC I Report No. PU-42a 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 publish-ed nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF FOURTH POWER PROJECT EMPRESA NACIONAL DE ENERGIA ELECTRICA HONDURAS May 28, 1970 Public Utilities Projects Department  CURRENCY EQ1TIVAIENTS Currency Unit - Lempira (L) Li * 100 centavos Li - 1US$0.50 Li, 000,000 US$500,000 1 centavo * 0.5 USp US$1 U US#1 2 centavos UNITS AND MEASURES kW kilowatt MW Megawatt - 1,000 kW k'Wh a Kilowatt hour G'di Gigawatt hour - 1,000,000 kih kV - kilo volt kVA 5 kilo volt-ampere MVA = Megavolt-ampere a - 3.28 fet km 0.621 mi ia2 - 0.386 Jq xi FISCAL YEAR ENEE's Fiscal Year Ends December 31  ABBREVIATIONS AND ACRONYMS ENEE - Empresa Nacional de Energia Electrica US AID - United States Agency for International Development CABEI - Central American Bank for Economic Integration  HONDURAS EMPRESA NACIONAL DE ENERGIA ELECTRICA APPRAISAL OF FOURTH POWTR PROJECT TABLE OF CONTENTS Page No. SUMMIARY AID CONCLUSIONS 1. INTRODUCTION 1 2. THE POWER SECTOR 2 General 2 ENEE's Market 3 La Ceiba and Aguan Valley 4 Tela and Sula Valley 5 Municipalities 5 Industrial Power Plants 5 Future Hydroelectric Development 5 3. THE PROJECT 7 Five-Year Program 7 Project Description 7 Estimated Cost 8 Engineering and Construction 9 Procurement and Disbursement 9 4. JUSTIFICATION 11 Forecast of Sales and Dbmand 11 Justification of the Transmission Extensions 11 5. ENPRESA NACIONAL DE ENERGIA ELECMRICA 12 Organization and Management 12 Tariffs 13 Capital Structure and Financial Position 13 Auditors 15 Earnings Record 15 6. FUTURE FINANCES 16 Proposed Financing Plan 16 Future Earnings 18 Future Financial Position 18 7. AGREEIENTS REACHED DURING NEGOTIATIONS 20 This report was prepared by Messrs. Hui Huang, Carel de Beaufort and Everardo W4essels.  LiST CF AIlTIEXZS 1. Installed Capacity of Power Plants (Interconnected System) Z.t.st m$ated Oosts of Proposed Transnission Extension Project 3. Energy Sales - Actual and Forecast 4. Energy Sales, Energy Generation, MYaximum Demand and Firm Capability (Interconnected System) 5. Actual and Forecast Balance Sheets 1965-l974 6. Long-Term Debt as of December 31, 1969 7. Actual and Forecast Income Statements 1965-1974 8. Forecast Sources and Applications of Funds 1970-1974 9. Actual and Forecast Financial Ratios 1965-1974 10. Incremental Financial Rate of Return MAP  HONDURAS EMPRESA MACIONAT, DE ENERGIA ELECTRICA APPRAISAL OF FOURTH POWER PROJECT SUMMARY AND CONCLUSIONS i. This report covers the appraisal of the Fourth Power Project for which the Empresa Nacional de Energia Electrica (ENEE) of Honduras has requested Bank Group assistance totaling US$11.0 million. ii. The Bank Group has provided major financial assistance in Honduran power development through three loans and one credit, totaling US$21.75 million, for three ENEE power projects. The first two projects have been successfully completed; the third project is under construction with satisfactory progress and is expected to commence operation by the end of 1970. iii. ENEE is a fully government-owned corporation responsible for the development and operation of power facilities in Honduras. The Bank Group's assistance has enabled ENEE to establish an interconnected system and to increase the energy production almost six times during the last six years. The total installed capacity of the interconnected system - predominantly hydro - and several isolated diesel plants, is 60 MW which represents 73% of the country's total capacity available for public power supply. ENEE's management has shown marked improvement since the re- organization in 1969. However, its engineering staff still needs strengthening. iv. The interconnected system presently encompasses only the narrow strip from the capital city of Tegucigalpa to the Caribbean port of Puerto Cortes. Under the Project ENEE proposes to extend the system: (a) to serve the important towns of Tela and La Ceiba on the northern coast which are now supplied by two fruit companies with inadequate diesel in- stallations (the concession of one company has expired), (b) to supply the Aguan Valley which is being develop- ed, and (c) to supply the southern zone presently served by E\EE's isolated diesel plants. v. The Project is a part of ENEE's five-year (1970-1974) ex- pansion program calling for a total investment of US$54 million. It would consist mainly of: (a) 138 kV and 69 kV transmission lines and substations, (b) subtransmission lines and substations, and (c) a gas turbine plant. The Project would also provide funds to cover communi- cations and maintenance equipment, training, and studies of future hydro- electric projects and tariffs. The total cost of the Project is estimated at US$14.8 million with US$11.0 million in foreign currency, which wouild be financed by the Bank Group.  - ii - vi. The design and supervision of construction of the principal items of the Project would be carried out by consulting engineers. Pro- curement would follow the Bank's guidelines. The Project is expected to be completed by the end of 1973. vii. Honduras is the least economically developed country in Central America. It is also lagging behind in the electric power field despite ENEE's achievements in recent years. The Project would lay a sound foundation for further development. Extension of the transmission lines would replace the inefficient diesel installations by the more economical power of the interconnected system and would also help open up new areas for economic development. viii. ENEEts financial condition and earnings are satisfactory and are expected to remain so. ix. The Project would form a suitable basis for a Bank loan of US$5.5 million equivalent with a term of 20 years including 4 years of grace, and for an IDA credit of the same amount. As in the case of the Rio Undo Project (Loan 541-HO/Credit 116-HO) the loan and the credit would be made to the Republic of Honduras which would relend the proceeds to ENEE on the terms of the Bank loan.  HONDUPLAS ETMPESA NACION.L DE ENERGIA ELECTRICA APPRAISAL OF FOURTH POWER PROJECT 1. INTRODUCTION 1.01 This report appraises the Fourth Power Project for which Bank Group assistance totaling US$11.0 million equivalent oas been requested by the Empresa lNacional de Energia Electrica (ENEE), the Government-oined authority which is responsible for the development and operation of power facilities in Honduras. A Bank loan of US$5.5 million equivalent and an IDA credit of the same amount are proposed. The Borrower would be the Government of Honduras, which would relend the proceeds to ENEE to cover the foreign exchange costs of the Project, the total cost of which is US$14.8 million. 1.02 The Project would extend ENEE's main interconnected system to important areas in the north and the south, replacing diesel engines, and would permit, sooner than would otherwise occur, full utilization of the power to be produced by the Rio Lindo hydroelectric scheme under construction (being financed by the Bank Group) and other future projects. 1.03 The Bank Group has helped finance three power projects in Honduras, providing major financial support for power development in addition to loans from US AID and the Central American Bank for Economic Integration (CABEI), and enabling ENEE to increase its investment in plant during the last ten years more than twelve-fold. In 1959, Loan 226-HO for US$1.h5 million was made to ENEE for a project to provide a 2.5 MW diesel generating plant at the capital city of Tegucigalpa and to improve the city's distribution system. The following year, Loan 261-HO for US$8.8 million was made to ENEE for construction of the 28.5 MW Canaveral hydro station (the first stage of Lake Yojoa-Rio Lindo Develop- ment) and associated transmission facilities. Both projects have been successfully completed. In 1968, Loan 541-HO for US$7.5 million and Credit 116-HO for US$4.o million were extended to the Government, mainly to assist ENEE in the construction of the 40 MW Rio Lindo hydro station as the second stage of the Lake Yojoa-Rio Lindo Development. Construction progress of this project is satisfactory, and the first generating unit is expected to be commissioned by the end of 1970. l.o4 This report is based on a feasibility report prepared by ENEE's consultants, R.W. Beck & Associates, and on the findings of an appraisal mission composed of Messrs. Hui Huang, Carel de Beaufort and A. Bouhaouala which visited Honduras in February 1970.  2. THE POWER SECTOR General 2.01 A mountainous country with an area of some 112,000 km2, of which only about one-sixth is arable, Honduras is the second largest of the five Central American countries and ranks third in population. Its population of about 2.5 million is growing rapidly at a rate of over 3% per year. In recent years, Honduras has experienced a reasonable degree of political stability and has achieved satisfactory economic progress. The annual rate of growth of the gross domestic product (GDP) has averaged 6% in real terms. With the per capita gross national product (GNP) estimated at only about US$260 the country is still the poorest among the Central American countries. 2.02 Agriculture accounts for about 40% of the GDP. Bananas have long been the leading export, but coffee and lumber have gradually assumed importance. Recently there has been a rapid expansion in manu- facturing, especially in the area of San Pedro Sula, the principal city in the north. The manufacturing sector now contributes about 15% of GDP. Several large industrial projects have been proposed for imple- mentation in the near future, the most important being a large pulp and paper project near La Ceiba to exploit the abundant forest resources in the Aguan Valley. The International Finance Corporation is partici- pating in the pilot project and is expected to participate in the full project. 2.03 Since ENEE embarked on the Canaveral hydro project in 1962, Honduras has made great strides in power development with an almost six- fold increase in electricity production during the last six years.l/ Further progress will be realized when the Rio Lindo hydro station com- mences operation by the end of 1970. As of now, however, the per capita annual electricity generation is only 104 kWh and less than 20% of the total population is estimated to have electrical service. 2.04 Public electrical service in Honduras is provided by ENEE, private companies, and municipalities. As shown below, the present installed capacity totals 82 MW and the total energy generation in 1968 is estimated at 225 GWh (excluding captive industrial plants - see paragraph 2.17). Present Installed Capacity Generation in 1968 ENEE 6o vw 194 GWh Private companies 20 YI 29 GWh lunicipalities 2 14W 2 GWh Total 82 MW 225 GWh 1/ In 1964 energy sales increased 94% over 1963 due to the coming into operation of Canaveral, the acquisition of the San Pedro Sula system and a tariff reduction.  -3- ENEEIs Market 2.05 ENEE is the principal supplier of power. Its main system (the interconnected system) serves the most populous and important zone including the capital, Tegucigalpa, the new industrial center of San Pedro Sula in the north, and Puerto Cortes on the Caribbean coast (see rriap). It also supplies the country's two major industries -- the silver mines at Pochito and the cement factory at Bijao. Under the proposed Project ENEE would extend the interconnected system to the north and the south to encompass new power markets. 2.06 The interconnected system presently consists of 229 km of 138 kV transmission lines and 50 km of 69 kV lines connecting seven hydro and diesel power plants with a total installed capacity of about 54 MW. The 28.5 MW Canaveral hydro station is the major source of power. The 40 MW Rio Lindo station and a 15 MW gas turbine at San Pedro Sula are under construction and expected to be commissioned by the end of 1970. Details are shown in Annex 1. In addition, ENEE operates 14 isolated plants totaling 6.2 MW. The largest is the 2.2 MW diesel plant at San Lorenzo which was recently installed to meet the increasing power demand of the southern zone. 2.07 Tegucigalpa, the political and commercial center, is served with a long transmission line coming from the Canaveral station and does not have an adequate local back-up power source to cope with any interruption of the line. Under the proposed Project, a gas turbine would be installed at Tegucigalpa to ensure reliable supply. 2.08 San Pedro Sula has had an extremely rapid economic growth in recent years and has become the most important industrial center of Honduras. Puerto Cortes is the largest seaport in the country, and its development has been financed by a recent Bank loan. Power to these im- portant areas is presently supplied with a single 138 kV line from Canaveral to San Pedro Sula and a single 69 kV line from San Pedro Sula to Puerto Cortes. To provide economical means of delivering reliable power to these areas, ENEE proposes to construct, under the proposed Project, another 138 kV line from the Rio UIndo station to San Pedro Sula viaEl Progreso and Bufalo, and another 69 kV line from San Pedro Sula to Puerto Cortes. 2.09 Outside of the interconnected system ENEE serves 13 other towns including the newly industrialized town of San Lorenzo in the south and the largest southern town of Choluteca by means of isolated diesel plants. Under the proposed Project, the interconnected system would be extended with a 69 kV line to these towns. The southern zone is a potentially rich region whose rapid development the Government has been promoting in recent years. A large cotton ginnery at San Lorenzo and a silver mine on the route of the proposed line have been in operation for a number of years with inefficient power installations; they would be served by ENEE. Several industrial projects are planned. The merits of improved port facilities in the area are being investigated by a Bank financed feasibility study.  2.10 E12EE plans to supply important areas which do not yet have electric service, either by installing diesel units which are no longer needed in the interconnected system or, if the distances are not too great, by linking these areas to the main system with 34.5 kV subtrans- mission lines (in some cases to be operated at 13.8 kV initially). Under the proposed Project the latter method would be used to supply the Tamara Valley near Tegucigalpa, the Comayagua Valley, and La Masica near La Ceiba. Santa Barbara, the center of a large rural population presently served by ENEE with an isolated diesel plant, would also be connected to the inter- connected system. La Ceiba and Aguan Valley 2.11 Of the ten private companies supplying power to the public, the most important are the two fruit companies - the Standard Fruit Company and the United Fruit Company through its subsidiary, the Tela Railroad Company. The former supplies La Ceiba, the largest town on the north coast and the third largest town of Honduras, with a diesel plant of 5.5 I4. Inadequate facilities and high costs have inhibited the increased use of electricity. With Standard's utility franchise at La Ceiba having expired, EIEE plans to purchase the power properties from the company and, as part of the proposed Project, to extend the interconnected system with a 138 kV line to serve this city. A new highway is being constructed from San Pedro Sula to Tela and La Ceiba. New pineapple plantations have been established near La Ceiba, and an international airport as well as the large pulp and paper mill mentioned in paragraph 2.02 is proposed to be built nearby. These various projects will stimulate economic activity in this area. 2.12 The Standard Fruit Company also operates irrigation pumps driven by diesel units at its banana plantations at Isleta (total about 3,000 hp) and Coyoles (total about 8,000 hp) in the Aguan Valley. For the most part these units are old and inefficient and the operating cost is high. ENEE would be prepared to extend a 69 kV line as part of the Project from La Ceiba to the valley if the company converts its pumps to electric drive. However, ENEE willonly construct this extension if it is financially and economically justified. 2.13 Through the National Agrarian Institute, the Honduran Government recently launched a land reform program to develop the lower Aguan Valley. Included in this large-scale program are new settlements and the establish- ment of packing and processing plants for agricultural products. An Inter-American Development Bank loan of US$7.5 million is helping to finance the undertaking, in which many public agencies including ENEE are partici- pating. Thus, in addition to electrifying the irrigation pumps, the extension of ENEE's transmission system to the valley would meet the power requirements of this important agricultural development program and thereby contribute to its implementation.  -5- Tela and Sula Valley 2.14 The Tela Railroad Company owns two diesel plants in the north coast area - one at La Lima with a capacity of 7.4 MW and the other at Tela with a capacity of 2.6 MW. Each of these plants provides energy to the company's employees and industrial establishments as well as to the respective municipalities. As part of the Rio Lindo project, ENEE has under construction a 69 kV line from San Pedro Sula to La Lima and El Progreso. The city of Tela is the second largest town on the north coast and the third most important port of Honduras. The proposed Project would extend a 138 kV line from El Progreso to Tela, thereby enabling ENIEE to serve both La Lima and Tela directly and also the company's facili- ties in these municipalities on a wholesale basis. 2.15 The company also operates a number of diesel-driven irrigation pumps in the Sula Valley with a total capacity of about 22,000 hp. If the company converts these pumps to electric drive, ENEE would supply power to them wholesale, provided a satisfactory contract can be concluded. Minicipalities 2.16 Some twenty municipalities provide public electrical service by operating diesel or hydro units of small capacity. These units are inadequate and the power costs are high. Whenever the interconnected system reaches these municipalities, ENEE will take over their electrical services completely and increased consumption can be expected because of a more adequatepower supply and lower rates. Industrial Power Plants 2.17 A few industries in Honduras have their own power facilities. The total capacity of these facilities is estimated at 23 IW. Their energy generation in 1968 is estimated at 35 GWh, whichl together with the estimated output of 225 Gdh for public electrical service brings the country's output for 1968 to 260 GWh. The most important of the industrial power facilities are the diesel plants owned by the sil ver mines at Mochito (5.6 MW) and the cement factory at Bijao (2 Nd). As noted heretofore, these two industries receive their primary power supply from ENEE and maintain their power plants as standby. Future Hydroelectric Development 2.18 Honduras is rich in hydro power resources. Potential sites on the Humuya River are particularly attractive because of favorable technical features and proximity to the power market. Motor-Columbus of Switzerland is carrying out feasibility studies for projects on the river financed under the loan/credit for the Rio Lindo project. From their preliminary findings, it appears feasible to build a high dam (about 220 m) at El Cajon creating  - 6 - a very large reservoir which could produce a considerable amount of power (of the order of 400 1W) and effectively control the floods in the Sula Valley. The cost of energy would be low and it might be economic to export part of the output to neighboring countries, particularly to Nicaragua, which otherwise would have to resort to more expensive thermal power generation in the future. However, since such a large multi-purpose project requires intensive studies of various technical and economic aspects, which take time, it may be preferable to first undertake a smaler hydro project o.n the Ulua River which has been explored previously. ENEE has agreed to continue employing consultants acceptable to the Bank and the Association for studies on the two rivers. The decision on the priority of development would be ma d e only after sufficient information on both projects has been gathered. 2.19 Because neither the El Cajon project nor the Ulua River project can be expected to be completed by the end of 1974 when additional generating capacity would be required (see Annex 4), ENEE would have to construct an interim thermal plant. On the other hand, there is the possibility of Nicaragua supplying ENEE's needs during this interim period as an initial phase of interconnection between the two countries. In any event, this matter would be resolved by EwEE and the Bank before the middle of 1971 in order to allow sufficient time for the construction of the thermal plant, if the supply from Nicaragua cannot be arranged.  3. THE PROJECT Five-Year Program 3.01 The proposed Fourth Power Project, which is essentially the ex- tension of the transmission facitities, is a part of ENEE's five-year development program for the period 1970-197a. The program calls for a total investment of about US$5 million and would consist of the following works in addition to the Project: Under Construction (a) Rio Lindo project; (b) Gas turbine at San Pedro Sula; (c) Second 34.5 kV line to the I4ochito mines. Future Works (a) Interim thermal project to be started in 1971 (at La Ceiba - two 30 MW units) for initial operation by 1974 (paragraph 2.19); (b) Major hydro project to be started in 1974 for initial operation by 1977 (paragraph 2.18); (c) Improvement and expansion of existing distribution systems; (d) Supply to additional towns; (e) Feasibility studies of future power projects. 3.02 The Drogram is adequate to meet the needs, but the generating projects in (a) and (b) above are subject to review and revision after the completion of the feasibility studies of future hydro power projects (paragraph 2.18). Project Description 3.03 The proposed Bank/IDA transmission extension Project would comprise the following: (a) 138 kV transmission lines from Rio Lindo station to Bufalo (near San Pedro Sula) via El Progreso and from El Progreso to La Ceiba via Tela, total- ing 227 km; 69 kV lines from San Pedro Sula to Puerto Cortes, from La Ceiba to the Aguan Valley, and from Tegucigalpa to the southern zone, totaling 331 kmn; 138 kV and 69 kV substations with a total capacity of 103 MVA;  - 8 - (b) 34.5/13.8 kV subtransmission lines totaling 184 km; and 34.5/13.8 kV substations with a total capacity of 20 MVA; (c) One 15 MW gas turbine at Tegucigalpa (paragraph 2.07); (d) Communications and maintenance equipment; (e) Training; and (f) Consulting services for feasibility studies of future hydro power projects and for a tariff study (paragraphs 2.18 and 5.o8). 3.04 The voltages adopted are the most suitable for the distances involved and the amounts of power to be transmitted. All lines will have single-circuit structures. The 138 kV and 69 kV lines will be on steel towers, while the 34.5/13.8 kV lines will be on wooden poles. 3.05 The communications equipment would consist of a carrier tele- phone system installed on the 138 kV lines, similar to that in use on the existing 138 kV lines. It is required for centralized dispatching. The maintenance equipment is required for work on the transmission and distri- bution systems. 3.o6 ENEE's engineering staff needs to be strengthened by employing some more experienced and competent engineers (paragraph 5.05). Since no such persons of Honduran nationality are knownto be available at the present time, ENEE has agreed to engage 4 or 5 experienced and competent expatriates, on three-year contracts, to assist the existing staff in carrying out the Project and at the same time to give additional training to the ENEE staff. ENEE has also agreed to send selected engineers and technicians from its present staff to foreign power companies for on-the- job training. The foreign currency funds required for these purposes would be met by the proposed loan/credit. Estimated Cost 3.07 The Project is estimated to cost US$14.8 million with a foreign currency component of US$11.0 million. Ihe estimates of the cost of the transmission lines and substations and the gas turbine are based on recent experience with similar works in Honduras and other Central American countries. A contingency allowance of approximately 12% (8% to cover in- creases in quantities and 4% to cover price escalation) of the estimated costs of the lines and substations has been included which should be adequate. Details of the cost estimates are shown in Annex 2. The following is a summary:  - 9 - Estimated Cost of the Project Lempiras (millions) US$ (millions) Foreign Local Total Foreign Local Total a. Transmission Lines and Substations 12.72 4.70 17.42 6.36 2.35 8.71 b. Subtransmission Lines and Substations 1.42 1.17 2.59 0.71 0.58 1.29 c. Gas Turbine Plant 2.82 0.05 2.87 1.41 0.03 1.44 d. Communications and Maintenance Equipment 0.60 - o.60 0.30 - 0.30 e. Training 0.40 0.10 0.50 0.20 0.05 0.25 f. Feasibility Studies of Future Hydro Power Projects and Tariff Study 0.80 0.40 1.20 0.40 0.20 0.60 g. Engineering and Supervision 1.48 0.52 2.00 0.74 0.26 1.00 h. Contingencies 1.76 o.66 2.42 0.88 0.33 1.21 Total 22.00 7.60 29.60 11.00 3.80 14.80 Engineering and Construction 3.08 Construction of works under the Project would be done by contrac- tors. Engineering design and supervision of construction for the 138 kV and 69 kV lines and substations as well as procurement of communications and maintenance equipment would be carried out by consultants acceptable to the Bank and the Association. Motor-Columbus would continue with its existing assignment on the Hnumuya River feasibility studies and would also carry out the studies on the Ulua River. During negotiations ENEE confirmed that it will continue to employ qualified consultants, acceptable to the Bank and Association, to do the above work. ENEE's own staff would design and supervise the construction of the subtransmission lines and substations, with which it has previous experience. Preparation of specifications and tendering for the gas turbine plant also would be handled by the Empresa based on its recent experience with such an installation. 3.09 The Project is expected to be completed by the end of 1973. Procurement and Disbursement 3.10 Procurement of equipment and selection of contractors would follow the Bank Group's international bidding procedures. Except for the engagement of the consultants and individuals (paragraphs 3.06, 3.08 and 5.08) contracts are not expected to be awarded before the signing of the loan/credit.  - 10 - 3.11 Disbursements from the loan/credit accounts would be made for the CIF cost of imported equipment and materials and for the foreign cur- rency cost of contractors' erection work, consultants' services, and train- ing. Disbursements are expected to be completed by mid-1974. In the event the Project costs less than estimated, any savings from the loan/credit should be canceled.  - 11 - 4. JUSTIFICATICN Forecast of Sales and Demand 4.01 The forecast of energy sales through 1980 in ENEE's market is shown in Annex 3. ENEE's forecasts which have been remarkably accurate in the past are based on an analysis of historical trends and on forecast economic and population growth in the different areas served by ENEE. Sales to large existing customers were projected on the basis of load estimates furnished by these customers. New major industrial, agricultural and mining loads were included only for well advanced projects; the pulp and paper project mentioned in paragraphs 2.02 and 2.11 is not among these and was not included in the forecast. 4.02 The average growth of energy sales in the areas presently served by ENEE's interconnected system is forecast at 15%, considerably below the 24% observed during 1965-1969, because of the expected slower industrial growth in these areas. However, including the forecast sales for areas to be added to the interconnected system, total sales are expected to increase at an average annual rate of 21% through 1974. Maximum demand in the interconnected system which was 44.5 MWJ in 1969 is expected to increase to 121 MW by 1974 (Annex 4). These forecasts which have been reviewed by ENEE's consultants are satisfactory. Justification of the Transmission Extensions 4.03 The principal component of the Project is the proposed extension of transmission lines to important northern and southern towns and to the Aguan Valley, in line withl the Government's policy of economic diversifica- tion by developing these potentially rich areas. The important towns of Tela and La Ceiba in the north and San Lorenzo and Choluteca in the south are presently served by isolated diesel generating units which are inadequate to meet their expected growth in demand. The proposed transmission line extensions to these towns would ensure reliable service at lower cost, as small inefficient diesel units would be replaced by the more efficient hydro and thermal plants of ENEE's interconnected system. The economy would also benefit from the substitution of the small diesel units used to drive irrigation pumps in the Aguan and Sula Valleys. 4.04 ENEE's consultants have examined alternative methods of supplying the areas to be included in the interconnected system and have concluded that the proposed transmission extension is the most economical way of supplying power to these areas. Isolated units could continue to be used to supply these areas, but this would result in a higher cost operation of the country's power sector. 4.05 T7he incremental financial rate of return (see Annex 10) on the investment needed for the north coast interconnection from El Progreso to the Aguan Valley is about 10%. The incremental financial rate of return on the investment needed for the southern zone interconnection is about 14%. These incremental financial rates of return are based on conservative sales forecasts and the actual returns could be higher.  - 12 - 5. EMPRESA NACIONAL DE ENPiGIA ELECTRICA Organization and Management 5.01 The Empresa Nacional de Energia Electri-ca (ENEE) was established in 1957 by law as an autonomous authority wholly owned by the Government and responsible for developing and operating power facilities in Honduras. It is a reasonably well-managed utility. 5.02 ENEE is governed by a Board of Directors composed of five members: the Minister of Communications and Public Works, as Chairman; the Minister of National Resources; and representatives of the National Economic Planning Council, the Development Department of the National Development Bank, and the National Chamber of Commerce and Industry. The two Ministers are appointed ex-officio. The term of office of the other three representatives is three years and they are eligible for reappointment. 5.03 A General Manager, appointed by the Board, is responsible for all managerial and admlnistrative functions. The ENEE Law stipulates that the appointment of the General Mqanager shall be reserved to persons with technical and administrative ability, experience and academic qualifications in the power sector. The present General Manager, a civil engineer, is a capable executive. He was appointed in October 1965. Under the previous loans and credit ENEE agreed to carry out its functions under the direction of a qualified and experienced General Manager mutually satisfactory to ENEE and the Bank Group. This provision was confirmed during negotiations and incorporated in the loan and credit agreements. 5.04 When the financing of the Rio Lindo project was under considera- tion, the Bank found ENEE's organization weak and its operating procedures too cumbersome to cope with its heavy expansion program and, consequently, suggested that ENEE engage a management firm to help improve its management and organization. In 1968 ENEE retained the services of R.W. Beck & Associates to make a study of ENEE's organization and operating procedures and to recommend any needed improvements. After the Beck report was submitted and reviewed by ENEE and the Bank in 1969, work on the reorganiza- tion commenced with Beck's assistance and is still in progress. As part of their assignment, the Beck firm formulated the By-laws delineating the General lvianager's authority and specific duties in order to facilitate day-to-day operations. The Board recently adopted these By-laws, essentially as recommended by the Consultants. ENEE's management is already showing a marked improvement, especially with regard to decision- making on operational matters.  - 13 - 5.05 ENEE's engineering staff has always been weak resulting in lack of sound development planning and causing frequent delays of construction work. A competent expatriate engineer with considerable experience was recently engaged as a Technical Adviser to the General Manager to deal with planning and engineering matters. ENEE has also recruited a number of young Honduran engineering graduates, but they lack experience. The engineering staff still needs strengthening and training (paragraph 3.06). Tariffs 5.o6 The ENEE Law gives the Empresa the authority to establish power tariffs; however, it does not stipulate the basis for determining the tariffs. In the agreements for the previous loans and credit, a minimum rate of return of 10% on fixed assets was specified. Thi-s provision is continued in the new agreements. In recent years ENEE's rate of return has been well above this level. 5.07 ENEE's tariffs have remained practically unchanged since 1964t. The overall average revenue per kILXl sold is now about 7.2 centavos (US