Guatemala - Third Power Project

DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use RETURN TO REPORTS DESK WITHIN No. PU-102a ONE WEEK ' Rt ' APPRAISAL OF THE THIRD POWER PROJECT INSTITUTO NACIONAL DE ELECTRIFICACION GUATEMALA November 1, 1972 Latin America and the Caribbean Projects Department I This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY A) EQUIVALENT Currency Unit = Quetzal 0Q) US$l.00 Q1.00 Q1.00 - 100 centavos a US$1.00 TNITS AND, MWSURES kW Kilowatt MW * Megawatt - 1,000 kW kiWh Kilowatt,hour GWt Gigawatt hour = 1 million kWh kV = Kilovolt kVA Kilovolt-ampere MVA - Megavolt-ampere - 1,000 kVA mile - 1.609 km square mile 2.590 km2 IlDE s FISCAL YEAR January 1 to December 31 AC1RNYMS CACM - Central American Common Market EEG - Empresa Electrica de Ouatemala (S.A.) INDE - Instituto Nacional de Electrificacion  APPRAISAL OF THE THIRD POWER PROJECT INSTITUTO NACICNAL DE ELECTRIFICACICI GUATEMALA Table of Contents Page No. SUMMARY AND CCNCLUSIONS ....................,.i - iii 1. INTRODUCTION ........................................... 1 2. THE SECTOR ............................................. 2 The Economy ............................................ 2 The Sector ................... 2 System Expansion and Planning .......................... 4 3. THE BORROWER ...............---.- 6 4. THE PROJECT............................................ 8 INDE's Expansion Program .. 8 The Bank Project ....................................... 9 Engineering and Construction.. . 11 Procurement ............................................ 11 Disbursements .......................................... 12 Ecology ................................................ 12 Project Supervision --........... 12 Operation of the Project ------.---... 12 5. JUSTIFICATIC -.. .. ........ 14 Forecast of System Requirements . . 14 Justification of the Two 50 MW Units -. ..1 Transmission System .................16 Economic Return ........................................ 16 6. FINANCE .. 17 Past Record and Present Position . . 17 Financing Plan . ........................................ 19 Financial Forecasts .............-. 21 7. AGREMNTS RSACHED AND RECoMMENDATIONS .... ... 22 This report was prepared by Messrs. S. Astrain and A.A.M. Onslow  I I I  LIST OF ANNEXES ANNEX3S 1. Historical Market Data 2. Description of the Third Power Project 3. Estimated Schedule of Loan Disoursements 4. Historical and Forecast Maximum Demand and Installed and Firm Capacity (Chart) 5. Proposed Plan of Operations 6. Justification of the Project 7. Income Accounts 1969 - 1971 8. Balance Sheets 1969 - 1971 9. Estimated Sources and Applications of Funds 1972 - 1977 10. Estimated Income Accounts 1972 - 1977 11. Estimated Balance Sheets 1972 - 1977 12. Estimated Financial Ratios 1972 - 1977 MAP  I I 0 1  APPRAISAL OF THE THIRD POWER PROJECT INSTITUTO NACIONAL DE ELECTRIFICACION GUATEMALA SUMMARY AND C(ICWCJSIONS i. This report covers the appraisal of a project that forms part of the 1972-77 expansion program of Instituto Nacional de Electrificacion (INDE), an autonomous agency of the Guatemalan Government, responsible for installing all new generating capacity for public service. A Bank loan of US$24 million has been requested to cover the foreign exchange cost of the project, the total cost of which is estimated to be US$33.1 million. The principal comp)nent of the project is two 50 MW steam units at the existing Escuintla plant. ii. This would be the Bank's third loan to INDE. Loans 487-GU and 545-GU, signed in 1967 and 1968, have assisted INDS in financing previous system expansion. Loan 487-GU covered the foreign currency component of the cost of the 60 MW Jurun-Marinala hydroelectric scheme, of a 12.7 MW gas turbine and of some diesel sets; all of these are now in satisfactory operation and, except for some retention payments to contractors, the loan has been completely disbursed. Loan 545-Gu included the foreign currency component of the cost of a 33 MW steam plant, commissioned in July 1972, and of consultants' services for pre-in7estment studies of future system expansion; it is expected to be completely disbursed by its present closing date of June 30, 1973. iii. INDS's six-year expansion program is estimated to cost US$12h.1 million equivalent and comprises ongoing works included in previous Bank loans, the project proposed for Bank financing, a village and rural electrification project--to be partially financed by USAID--and some additional works to be undertaken during the period, to meet subsequent needs of the system. iv. The present installed capacity of the Guatemalan system will be able to supply the growing system requirements only until 1973, with an adequate reserve margin; the December 1974 peak will have to be met without sufficient spare capacity. The proposed Bank project would provide 100 MW of additional capacity and associated transmission facilities starting in early 1975, which should be enough to supply the system require- ments until 1978, when a new hydroelectric scheme is expected to be in operation. The project would also include a feasibility study of a new hydroelectric scheme on the Chixoy river and a long-range Master Plan for the development of the Guatemalan system. The proposed addition of two 50 MW steam units at Escuintla and associated transmission facilities constitutes the least cost solution to the expansion of the system. v. The loan would finance only the foreign currency component of the project cost. International competitive bidding would be used to contract for all work, other than consultants' services. Except for the  - ii - engagement of consultants, no contracts are expected to be awarded before the signing of the loan. INDE has requested tenders for the major items of equipment on both a cash and supplier credit basis to ensure financing in the event the Bank loan is not made. vi. INDE will require the services of consultants satisfactory to the Bank for the design work and supervision during construction of tne proposed steam plant, for the feasibility studies on the Chixoy river and for the preparation of the Master Plan. It is proposed that INDE be permitted to undertake tho design work and supervision of construction of the transmission line and of the substation expansions. vii. Included in the amount of the proposed loan is US$2.0 million equivalent to cover the foreign currency component of an oil transport facility to bring Bunker C oil from the port of San Jose to the plant site. This expenditure may not be required if it is determined that it is more economical to buy Bunker C oil from a nearby refinery owned by Texaco, which has expressed its interest in this supply. As a condition of disbursement of this part of the loan it is proposed that INDE submit justification satisfactory to the Bank for this investment. viii. INDE has been in default on the abeve loans, under their tariff covenants, for the years 1968, 1970 and 1971. INDE's main customer is Empresa Electrica de Guatemala S.A. (EEG), which, until the Government bought 96% of the stock in May 1972, was a subsidiary of Boiso Cascade (USA). EEG has been earning a minimum of 14% on its net fixed assets, but, because EEG said it would pass on to the public any increase in the amount it had to pay for power purchased from INDE, both the Government and INDE havs been unwilling to increase the bulk charges to EEG sufficiently to meet the covenants. The Government, for political reasons, is unwilling at this stage to permit INDE to increase the amount it charges EEG for electricity. Until the end of 1974, the Goveirnment will pass on to INDE out of tne dividends which it receives frc,m EEG, after the Government has serviced the debt which it created to purchase EEG, such sum as is necessary to enable INDE to meet its revenuei commitment. ix. INDE's collections from a number of municipalities and Government departments have been slow in the past. New contracts have recently been signed with many of the municipalities, which provide for the collection of the arrears over a period of years, which should help improve the situation. x. With the increased income mentioned in paragraph viii and with' an improvement in the arrears situation, INDE's financial position should be satisfactory and enough funds should be generated internally to cover debt service and to contribute a reasonable proportion towards the expansion plan. INDE would then provide 24% of the total cost of US$124 million of its 1972-77 expansion program from internal resources, 59% would be covered by foreign loans and 17% would have to be contributed by the Government.  - iii - xi. The proposed project is a suitable basis for a Bank loan to INDE of US$24 million equivalent, for a period of 20 years, including a grace period of about 3-1/2 years.  i: I  APPRAISAL OF THE THIRD POWER PROJECT INSTITUTO NACIONAL DE ELECTRIFICACION GUATEMALA 1. INTRODUCTION 1.01 The Government of Guatemala has requested the Bank to assist in the financing of a project which is part of the 1972-77 expansion program of Instituto Nacional de Electrificacion (INDE), the autonomous agency responsible for the installation of all new electric generating capacity for public service. During this six-year period, INDE expects to invest about US$124.1 million in this program. 1.02 The project proposed for Bank financing comprises the addition to INDE's system of 100 MW of steam generating capacity and associated transmission facilities, the studies necessary to define the next step in the expansion of the system and the elaboration of a Master Plan for the long-range development of the system. The estimated cost of the project is US$33.1 million equivalent and includes a foreign currency component of US$24 million, which would be financed by the loan. The addition of 100 MW generating capacity and associated facilities will provide for the system growth until 1978. 1.03 This would be the third Bank loan to INDE. Loan 487-GU of US$15 million equivalent, signed March 10, 1967, assisted INDE in financ- ing the construction of the 60 MW Jurun-Marinala hydroelectric project and associated facilities, the installation of a 12.7 MW gas turbine and some diesel sets--all of which are now in satisfactory operation. Actual construction costs were within the estimates prepared at the time the project was appraised. Except for some retention payments to con- tractors, the loan has been completely disbursed. Loan 545-GU of US$7 million equivalent, signed June 28, 1968, covers the foreign exchange component of a 33 MW steam unit, and the Consultants' services, site investigations, studies and design of the first stage of the Atitlan project, then considered to be the next step in the Guatemalan system development. The 33 MW steam plant started cammercial operation in July 1972, about a year and a half later than the originally estimated date, due mainly to the relocation of the plant to Escuintla, after the original Guacalate site was destroyed by a flood in 1969. Closing date of the Loan is June 30, 1973, at which time the presently undisbursed portion of it-- mainly contractor's retentions and Consultants' services--is expected to be totally disbursed. 1.04 An appraisal mission, composed of Messrs. S. Astrain and A.A.M. Onslow visited Guatemala in November/December 1971 but could not finalize its work because it was necessary to revise the load forecast and reduce the size of the generating units. Following revision of the Consultants' report, the above mission completed its field work during a second visit in June 1972.  2. THE SECTOR The Economy 2.01 Guatemala is the nortLhernmost of the Central American countries; with a population of over 5 miLlion and an area of 110,000 kmi2, it is also the most populous and the third largest. Its population, presently grow- ing at an annual rate of 3.3%, is concentrated mainly in the higthlands and the Pacific lowlands. About 1 million peopl6 live in Guatemala City, the capital, located in the central highlands, which is also the adminis- trative and commercial center of the country. 2.02 During 1968-70 real GDP grew at an average rate of 6% per annum and reached US$338 per capita, in 1970. Agriculture is the most impor- tant sector, accounting for 27% of the GDP in 1970; it grew at a rate of 5%, mainly because livestock production has increased at 14% yearly, while the traditional crops, coffee and corn, have increased at a much lower rate. Manufacturing has been the most dynamic sector; the real value added has grown at a rate of 9% per annum during the period. The Sector 2.03 Public electric service in Guatemala is provided by INDE, b its principal customer, the Empresa Electrica de Guatemala S.A. (EEG)_/ a former subsidiary of Boise Cascade, U.S.A., recently purchased by the Guatemalan Government, by a few smaller private enterprises and by nu- merous municipalities. Some utilities of these last two categories have their own generating capacity, and are not interconnected with INDE and EEG systems; the remainder purchase bulk energy from INDE or EEG for distribution in their franchise areas. 2.04 In 1971 the installed capacity and energy generated were: Installed capacity Energy generated _ W GWh INDE 123.9 386.7 EEG 51.5 256.9 Private enterprises 3.9 13.cL/ M4unicipal enterprises 7.9 19.02/ TOTAL 187.2 675.6 1/ EEG purchases about 88% of INDE total sales. See paragraph 3.05. 2/ Estimated figures.  -3- 2.05 For operational and administrative purposes INDE has divided its service area into four regions, the Central, the Eastern, the Western and the Atlantic regions (see map, inset 1). 2.06 The Central Region coincides, approximately, with EEG's con- cession area, which includes the departments of Guatemala, Escuintla and Sacatepequez. This is the most developed area of the country, with an annual per capita consumption of 361 kWh in 1970 (national average: 124 kWh per annum); with only 29% of the total population, it has 88% of the country's total installed capacity and consumes 88% of the total energy. Distribution in this area is almost entirely done by BEG to which TDEE sells in bulk an increasingly large percentage of the required energy (57% in 1971 and expected to increase to 93% in 1976). All of EEG's generating capacity is concentrated in this region. 2.07 The Eastern Region is served by the Rio Hondo hydroelectric plant (2.4 MW) and was interconnected with the Central Region in June 1970. The Western system is fed by the hydroelectric plants at Santa Maria (5.9 MW) and El Porvenir (2.2 MW) and by the diesel plant at San Felipe (2.4 MW); this region will be interconnected with the Central Region in 1974, when the Escuintla-Mazatenango-Retalhuleu transmission line-- included in a rural and village electrification plan being partly financed by USAIM--is put in operation. The Atlantic Region comprises the area around Puerto Barrios and Puerto Matias de Galvez on the Atlantic coast and has diesel generation (1971 peak was 1.3 MW); there are at present no plans to interconnect this region with the main system. In these outlying regions INDE sells about 44% of the energy in bulk for dis- tribution by others; the remainder is distributed by INDE directly. 2.08 It is estimated that about 24% of the Guatemalan population now enjoys public electric service; after the program referred to in Chapter 4 is completed, this figure will increase to about 30%. 2.09 EEG's 50-year concession was due to expire in May 1972. Shortly before, the Guatemalan Government and EEG's parent company-- Boise Cascade,, U.S.A.--concluded an agreement whereby the Government bought 96% of ERG's common stock, thus obtaining full control. A new Board and a new General Manager have since been appointed and a five- year extension to the concession has been granted, making use of a clause to this effect contained in the original 1922 contract. This will give the Government the necessary time to develop a plan for the future reorganization of the electric power sector. During negotiation-, the Government agreed to consult with the Bank before any major decision is taken in this regard. 2.10 EEG is INDE's principal customer and the contract between them which expired in April 1972, shortly before the Government acquired its interest in EEG, resulted in an average selling price of 1.72 centavos per kWh during 1971. Over the last few years EEG has been able to finance its capital expansion program from its own internal cash gener- ation and still provide cash dividends of increasing amounts (20% in 1967 on its common stock rising to 25% in 1971). There is no outstanding long-term debt. Over the five years 1967-71, it is estimated that EEG  -4 - has earned the following rates of return on its average net fixed plant in operation: Average Net Operating Percentage Year Plant Revenues Return (in thousands of Quetzales) 1967 24,555 3,525 1h.4 1968 25,343 3,819 15.1 1969 26,213 3,816 1h.6 1970 27,052 3,797 14.o 1971 28,093 3,972 14.1 2.11 If the financial information available for fIND and EEG is com- bined for 1971, it is estimated that their joint average net fixed assets in operation for that year amounted to Q69 million, and the joint net operating revenues to Q6.3 million, giving an average return of 9.1%. However, since the Govenment only recently acquired its interest in EEG, it has not been possible to assess whether EEG's assets are properly valued. Its annual depreciation charge is slightly over 2% of its gross assets, which is considered low for an undertaking of EEG's nature. Consequently, a higher depreciation charge may be more appropriate in future years. On the other hand, EEG should be able to reduce some of its operating expenses, e.g. inter-company consultation fees of about Us$4OO,000 - US$500,000 annually. It would be preferable if the power sector as a whole were to earn an agreed rate of return on its investment, but in view of the number of municipalities and small electric companies involved,such a requirement would be impracticable. However, since INDE sells over 80% of its output to FEG, it is desirab:Le to ensure that KE is financially sound, so that it can pay INDE promptly for the power it purchases, and, at the same time, expand its distribution system to keep pace with demand in its franchise area. Therefore, during negotiations the Government agreed to review EEG's and INDE's earnings as a whole and to maintain tariffs to the public at a level sufficient to earn an overall rate of return, which would be mutually agreed with the Biank; meanwhile tariffs to the public would not be reduced below their existing levels. System Epansion and Planning 2.12 Electric power consumption in the interconnected system has increased at an average annual rate of 12.2% from 1957 to 1971 (see Annex 1), due to the general increase of economic activity in the country and the expanding impor- tance of industrial loads; in 1957 33% of the total energy was consumed by industry, but by 1966 the proportion had reached 42% and has since remained at about this level. 2.13 Installation of new generating capacity has not always kept pace with the growing needs and there have been periods of service interruptions and deliberate load shedding in the interconnected system. Present installed capacity, including a new 33 MW steam unit commissioned in 1972, will only be enough to cover the expected demand with a reasonable reserve margin until 1973. As additional capacity will not be available until early 1975, the December 1974 peak will have to be supplied without sufficient reserve.  - 5 - 2.14 Long-range system expansion planning has been concentrated over many years on the study of the Atitlan hydroelectric project which, when fully developed, could add about 400 MW and 1,100 GWh to the inter- connected system. The feasibility study of this project, financed under Loan 545-GU, has recently been completed and it shows the project to be economically attractive, especially with the fuel prices prevailing now. 2.15 Because of possible adverse ecological effects and objections by local farmers, the Government and INDE have decided not to take any action on the Atitlan project until an alternative hydroelectric project has been studied. INDE is now concentrating its efforts on the medium reaches of the Chixoy river, about 100 miles northwest of Guatemala City, where some exploration and a prefeasibility study were made some time ago. Consultants for a new feasibility study were appointed in June 1972 and their report should be completed in the second half of 1973.1/ 2.16 The Bank has expressed its opinion that, in addition to the Chixoy study, a general survey of the country's hydroelectric resources should be carried out as a matter of priority and that a Master Plan for the long-range development of the Guatemalan system should be pre- pared. The Government and INDE have concurred and INDE will shortly select the Consultants to be entrusted with this work. 1/ The Consultants selected are LAMI, a consortium formed by Lahmeyer, Germany, Motor Columbus, Switzerland and International Engineering, U.S.A.  - 6 - 3. THE BOBROWER 3.01 The Borrower would be the Instituto Nacional de ELectrificacion (IXDE), which is an autonomous agency of the Guatemalan Government, created by law and charged with the task of developing the electric power resources of the country. 3.02 INDE's Board of Directors is composed of five directors and three alternates. Three directors must be engineers, one must be a lawyer and the fifth an economist. The alternates must each be one of the three mentioned professions. All members normally attend Board meetings but only five can vote; in the absence of a director, he is substituted for by the alternate of the same profession. Alliembers are appointed by the Chief of Government for indefinite terms. 3.03 Administration is entrusted to a General Manager and two Sub- Managers, one responsible for technical operations, the other for administrative and financial matters. The main problem with INDE's man- agement has been its lack of continuity. The General Manager and the higher officials are normally changed each time a new Government takes office (Presidential term is four years). Under the present administration, which took over in July 1970, INDE's organization has shown marked improvements in some areas. For example, sore attention is now paid to the long-range planning of the system and to the programming of ongoing works; and operating results, quarterly reports and financial information are issued more timely than before. While there is still room for improvements in these areas, as well as in all others, no specific action from the Bank--other than that to be exercised through regular supervision missions--is considered necessary. 3.O4 As of December 31, 1971, INDE employed 2,760 people. This is a large number considering that INDE distributes only a small fraction of the energy sold (see paragraph 3.06) and, while this number is heavily influenced by the fact that INDE has undertaken all of the civil works related to the Escuintla No. 1 steam unit on a force account basis, this is not the only example of overstaffing within the organization. With the completion of the civil works at Escuintla, INDE should reduce its con- struction personnel materially. During negotiations the general staffing level was discussed, and INDE agreed within six months of loan signing to exchange views with the Bank concerning its proposed staff requirements for the next five years. 3.05 INDE now owns and operates generating facilities totalling 157 MW, of which 96 MW is hydro, 33 MW steam, 24.7 MW gas turbines and 3.6 MW diesel. 145 MW of this generating capacity is in the interconnected syster and constitutes 73% of the installed capacity of the INDE-EEG system. Under the terms of the interconnection and supply contract between INDE and EEG, the interconnected systez is operated under a joint operating and coordinating committee, which formulates the generation programs, the standards for frequency and reactive power control, and the maintenance schedules for all major components of the system. In setting up the  -7- generation programs and maintenance schedules, the committee has to abide by the rules established in the contract which are designed to achieve the most economical operation of the interconnected system as a whole. As INDE's generating capacity has become predominant, daily operation of the system is now controlled by INDE's dispatcher at Guatemala Sur substation, guided by the generation schedules agreed upon by the joint committee. 3.06 During 1971 I1DE generated 387 GWh and sold 370 GWh of which 344 GWh were bulk sales to distributors and 26 GWh were sold to the ultimate consumer. Of the bulk sales, 324 GWh or 88% of total sales, wers to EU for distribution in the Central Region and this accounted for 76% of INDE's 1971 gross revenues.  - 8 - 4. THE PROJECT INDE's Expansion Program 4.01 INDE's expansion program for the period 1972-77 comprises the completion of ongoing works financed under previous loans (paragraph 1.03), the Third Power Project (paragraph 4.05), a Rural and Village Electrification Project (paragraph 4.02), construction of a future hydro project (paragraph 4.04), miscellaneous extensionts to the existing system and further studies to identify subsequent system additions. Tne program is estimated to cost US$124.1 million, as shown below: 1972-1977 US$-(or Quetzales) thousands Local Foreign Currency Currency Total a) Ongoing works 994 4,649 5,643 b) Third Power Project 9,100 24,000 33,100 c) Rural and Village Electrification Project 4,625 7,000 11,625 d) Future hydro project 24,200 38,800 63,000 e) Miscellaneous extensions 8,217 - 8,217 f) Expansion studies 1,350 1,200 2,550 TOTAL 48_486 75,649 124,135 4.02 During the last few years, under instructions from the Govern- ment, INDfl has been studying a Rural and Village Electrification Plan, in order to accelerate the expansion of its outlying systems to hitherto unserved villages and rural areas. The Rural Electrification Project, included in the above table, will be the first stage in the execution of the Plan and will be financed partly by a US$7.0 million USAID loan to the Government under concessionary terms, and will be relent to INDE on concessionary terms (Annex 8). The proceeds of this loan will finance part of the foreign currency component of the project cost (US$4.3 million) and part of the local currency component (US$2.7 million). The project will bring electricity to the three top priority regions of tne five included in the Plan: Las Verapaces, Huehuetenango-Quiche and San Marcos (see map, inset 2). 565 km of 69 kV transmission lines, 213 km of 33 kV lines and 5,860 km of distribution lines will be built and, when completed, will serve about 30% of the urban and rural population in those regions (1971 population estimate: 1,040,000). The project will be carried out during a minimum period of five years and it is expected that INDE will spread it over a longer period, if necessary, so that resources--physical and financial--will not be strained. 4 03 Even if INDE intends to charge in these regions the same tariffs now in effect in the existing system, their low-density loading will not generate revenues sufficient to cover operating expenses and  depreciation during the first years and the revenues will not, in the foreseeable future, enable INDE to earn a rate of return comparable to the rest of INDE's system. In view of the favorable terms of the USAID loan and the pressing social needs that the project will satisfy, the Bank has not objected to the borrowing, even though INDE was not able to meet the debt limitation provision of Section 5.11 of the current loans. 4.04 Item (d) of the above table represents the investment to be made through 1977 on the construction of a new hydro plant which, accord- ing to present forecasts, should be commissioned in time to meet the 1978 December peak. The hydro plant is tentatively assumed to be a development on the Chixoy river with a total investment through 1979 of US$84 million. Feasibility studies for this hydro plant are now only in the initial phase and results will not be known until mid-1973. If a thermal plant proves to be the most economical solution for the next expansion of the system, investments will be lower and future borrowing and future Government contributions (see paragraphs 6.01 and 6.09)will decrease correspondingly. The Bank Project 4.05 The Third Power Project, proposed for Bank financing, would consist of: (i) An extension to the existing Escuintla power plant (33 MW steam and 24.7 MW in two gas turbines) with two 50 MW oil fired steam units and auxiliaries. (ii) Extensions to the existing 138 kV and 69 kV substations at Escuintla and Guatemala Sur. (iii) A 45 km double circuit 138 kV transmission line from Escuintla to Guatemala Sur substation. (iv) Consultants' services and field investigations for pre- investment studies on the Chixoy river and Consultants' services for the preparation of the master plan for the long-range development of the Guatemalan system. 4.o6 A detailed description of the Third Power Project is given in Annex 2. The attached map shows the location of the Project and its relation to the existing system. 4.07 The 50 MW units will be commissioned early in 1975 and will help to meet the growing system requirements until 1978. The bulk of the generated power will be transmitted to Guatemala Sur substation, the main substation supplying the capital city.  - 10 - 4.08 Funds for the initiation of the feasibility study on the Chixoy river and the preparation of the Master Plan are included in Loan 545-Gu; the new loan would provide the necessary funds to finance these studies to their completion. 4.09 The Project is expected to cost the equivalent of US$33.1 million. The foreign exchange component, excluding interest during construction, is estimated to be Us$24.o million equivalent, which is the amount of the proposed Bank loan. A cost summary is given below: Estimated Cost (Quetzales or US$ Thousands) % of Total Local Forei Total Expenditures Steam Plant Site and foundations 150 163 313 0.9 Buildings 800 865 1,665 5.0 Steam generators and auxiliaries 1,950 6,600 8,550 25.9 Turbo-generators and auxiliaries 485 3,900 4,385 13.2 Electrical equipment 640 1,600 2,240 6.8 Cooling water 536 745 1,281 3.9 Fuel transport facilities 1,175 1,780 2,955 8.9 Spare parts - 335 335 1.0 Freight and insurance 400 1,300 1,700 5.1 Engineering and supervision 170 690 860 2.6 Sub-total 6,306 17,978 24,284 73.3 Transmission Line 344 630 974 2.9 Substations 456 1,570 2,026 6.2 Sub-total 7,106 20,178 27,284 82.4 Contingencies Physical (10% on local 5% on foreign currency) 711 1,008 1,719 5.2 Prices (7~9) 533 1,514 2,o47 6.2 Sub-total 8,350 22,700 31,050 93.8 Consultants' Services Chixoy Studies 500 650 1,150 3.5 Master Plan 250 650 900 2.7 TOTAL 9,100 24,000 33,100 100.0 The cost estimates for the steam plant, transmission line and substations, as prepared by INDE and its Consultants and revised by the appraisal mission, are based on recent procurement for similar equipment in the international market and on recent experience in the cost of civil works both in Guatemala and in other Central American countries, with the foreign currency component adjusted to cover the recent currency revaluations. A contingency allow- ance has been included to cover possible increases in quantity of work  (physical) and price escalation. The physical contingency figure is 10% for the local currency component and 5% for the foreign currency component; the price escalation figure is 7-1/2% for both components (5% per year, three-year constructioan period). The resulting overall contingency allowance of 13.8% to cover cost increases is considered adequate. 2hgineering and Construction h.1o INDE has retained the Kuijian Corporation, U.S.A. to provide engineering services and supervise the construction of the steam plant. During negotiations INDE agreed to continue to employ experienced consultants for this part of the Project, under terms and conditions acceptable to the Bank. As it is considered that INDE now has sufficient experience in 138 kV transmission line and substation work, it is proposed that the engineering design and supervision of construction of the trans- mission line and substations be done by INDE itself. h.ll Tenders for the electromechanical equipment for the steam plant were opened on October 26, 1972 and are being analyzed. Preference has been indicated for the award of a single contract to cover the steam generators, the turbine-generator sets and the electrical equipment but INDE has reserved the right to award separate contracts for each of these three main components. In addition tro cash bids, alternative supplier's financing has been requested, whih would be used if the Bank loan is not made. Contract award is expected to be made by the end of the year. The estimated construction schedule for the plant requires 27 months from the time of firm order of the electromechanical equipment to initial operation of the first unit. Thus, the first unit sho-uld be in operation around March 1, 1975; the second around June 1, 1975. This is a tight, but manage- able,schedule. Since the site is already developed and valuable experience has been obtained from the recent installation of the 33 KW steam unit, no unusual problems are foreseen, This schedule means, however, that the new units will not be available to meet the December 1974 peak, which will have to be met without a reasonable reserve margin. Procurement 4.12 International competitive bidding in accordance with the Bank's Guidelines will be used to contract for all work, other than Consultants' services, financed by the proposed loan. Except for the engagement of Consultants, no contracts are expected to be awarded before the signing of the loan. 4.13 A preference of either 15% of the CIF price or 50% of the import duty, whichever is lower, would be given to manufacturers from the Central American Common Market (CACM), in view of the Central American Agreement on Fiscal Incentives to Industrial Development (1969). It is expected that CACM countries could be competitive under this arrangement for the supply of conductors for the 138 kV transmission line, which amount to approximately US$200,000 CIF.  2 2 - Disbursements 4.14 Diabursmient would be for the foreign currency cost of imported equipment and sarvices only. Disbursements are expected to be completed by mid-1976 (see Armex 3). In the event the project cost is less than the estimated amount, any savi.ngs from the loan should be cancelled. Ecology 4.15 The thermel power plant is located in an unpopulated area some distance away from the city of Escuintla and adjacent to an oil refinery owned by Texaco. No apacial pollution problems have been experienced from the operatior of these facilities. Project Supervision 4.16 Seai-arnuaZ supervision missions by Bank staff are recommended for this Project. Operation of the Project 4.17 By the time the first of the two new steam units is put in operation, UIDE will hnave had zlmost three years experience in the oper- ation of the 33 1W steam unit recently commissioned at the same site. Some additional trUinirig, related to the larger size and higher steam conditions of the new units will be necessary to enable INDE's personnel to operate and maintain the ner units. This additional training will be included in the contracts with the equipment suppliers. Operation and maintenance of the three steam units, plus the two gas turbines, at Escuintla will be performed by a single, integrated group. This is the most important advantage of the Escuintla site over the alternative sites considered fhr -The new units (see paragraph 5.08). 4.18 Cooling water for the 33 MW steam unit is being brought by gravity pipelinri from the Monte Maria springs, located about 14 km a-ay and 500 xa higher than the plant site. The springs have enough water, even in the driest years on record, to supply the additional require- ments of the two new units. Measurements recently made have shown that the pipeline will also be capable of transporting the additional amount. Only an alternate emergency supply is required, to assure continued oper- ation in case of a pipeline breakdown. The rehabilitation of the Guacalate wells--drilled at the original plant site before it was destroyed by a flood--and a 3 Pan long pipeline to Escuintla have been found to be the most economical -way to provide this emergency supply. 4.19 Bunker C oil (see Annex 10 for prices) will have to be trans- ported from the port of San Jose, on the Pacific coast, to the plant site, about 40 km away. 'Two alternatives are possible here: (a) INDE wo-uld buy the fuel oil in the international market and would build and operate the Bunker C oil transport facilities or, (b) INDE would buy tho Burner C oil from the nearby refinery which,in turn, would buy it in the international market and would build and operate the transport facilities.  - 13 - INDE feels that the first alternative will prove to be more economical but no final comparison can be made at this time because scme information, including the location of the new port at San Jose, will not be available for some time. Under these circumstances, the Bank has been requested by the Guatemalan Government to include in the proposed loan the necessary funds to enable INDE to proceed with alternative (a), the disbursement of such funds to be conditioned to the justification of this alternative in a manner satisfactory to the Bank. A provision of US$3.4 million equivalent, including US$2.0 million in foreign currency, has been made in the Project cost estimate to include this alternative. If alternative (b) proves to be more economical, US$2.0 million would be cancelled from the loan.  5. JUSTIFICATION iForecast of System Requirements 5.01 Historically (see Annex 1) the interconnected system maximum demand has grown at an average rate of 10.8% per annum from 1957 to 1971, in spite of the fact that, with the exception of a few years, the system capacity has been barely enough to meet the demand (see also Annex 4). The system energy requirements have grown at a faster rate-- average 12.2% per annum over the period--and the system load factor has correspondingly increased from 49.8% in 1957 to 59.6% in 1971. Until about 1966 this increase in load factor can be attributed to the increased proportion of industrial loads, which that year amounted to 42% of the total energy consumption, up from 33% in 1957. The continued increase in load factor during the last five years can only be imputed to insuf- ficient installed capacity. 5.02 Several studies have been made in the recent past to forecast the demand and energy requirements of future years. One of the latest is included in the Atitlan Feasibility Report, prepared in 1971 by Electro- watt, Switzerland, to cover the long range development of the system. After comparing the system historical development--modified to take into account the effect of insufficient installed capacity--with the evolution of the country's main demographic and economic indicators and taking into consideration the actual development; of systems in other countries in a more advanced stage of growth, Electrowatt came to the conclusion that the system energy consumption would increase at annual growth rates starting at 12.5% in 1970, decreasing to 9.6% in 1990. 5.03 The Kuljian Corporation, entrusted in 1971 with the feasibility study of the proposed Project, reviewed the above study, as contained in the 1970 preliminary report, taking advantage of one more year in the historical series and of the informLtion available at the Consejo Naclional de Planificacion regarIding past and expected industrial output and appli- cations of new industries seeking fiscal incentives. Kuljian came to the conclusion that maximum demand on the interconnected system should be projected at a growth rate of 12% per annum and that of the Western system, up to its interconnection in 1974 with the Central system, at a rate of 10%. Included in these rates are the several new industries expected to be connected during the next few years, as well as many existing loads now served by captive plants, which will very likely prefer to buy energy from INDE as soon as the power system is extended to their locations. As for the energy requirements, Kuljian expects the system gross load factor to remain for some years at the present 60% value. 5.04 After some discussions with INDE and Kuljian, and especially after the low load growth of 1971 (2.8%) was known, it was agreed that for the purposes of the proposed Project, maximum demand would be pro- jected with an 11% rate of growth over the 1971 value and that the system gross load factor would be maintained at 60%, in view of the expected  - 15 - increase in steam generation--with higher auxiliary services consumption-- during the next few years. Justification of the Two 50 MW Units 5.05 The next hydroelectric scheme--to be defined when the results of the feasibility studies on the Chixoy are known in mid-1973--is assumed to be commissioned in 1978. The study of the optimum solution to provide the power and energy requirements up to that year, was made by Kuljian. 5.06 Kuljian in its original report (October 1971) recommended the. installation of two 66 MW steam units (1,250 psi and 9500 F) at the same site, Escuintla, where the two gas turbines (24.7 MW) and the new 33 MW steam unit are now in operation. 5.07 The present size of the system, the existing amount of hydro and gas turbine capacity, the high plant factor under which the new units will operate (see Annex 5) and the short time available for instal- lation (see paragraph 4.11) justify the installation of steam turbine generators. The 66 MW size recommended by Kuljian is the result of an economic comparison of different sizes of units (33, 44 and 66 MW) to make up the same total installed capacity of 132 MW, originally deemed by the Consultants as necessary to supply the system needs until 1978. 5.08 The recommendation of the Escuintla site, likewise, is the result of an economic comparison of five different sites: (i) Puerto Barrios, on the Caribbean coast; (ii) Lake Amatitlan, close to Guatemala City; (iii) Lake Izabal, close to the Caribbean coast; (iv) San Jose, near the port of the same name, on the Pacific coast; and (v) Escuintla, 50 km south of Guatemala City. The main advantage of the Escuintla site is the fact that it is an established operating center and the lower installation and operating costs resulting therefrom outweigh the advantages of the coasial sites-- where fuel would be cheaper and cooling water would normallyY be more economical--or of Amatitlan--where transmission costs and losses would be minimal. 1/ In the present case, however, the cooling water supply built for the 33 MW unit will also be capable of supplying the two new 50 MW units (see paragraph 4.18).  - 16 - 5.09 With the new load forecasts, formulated after the 1971 operating results were known, two 50 MW units are sufficient to carry the system growth until 1978, when the new hydro plant is assumed to be commissioned. In fact, a carefully scheduled maintenance plan of the existing units will even allow a delay of one year in the commissioning of the new hydro plant. Annex 5 shows the recent past and expected future system operation through 1978, with two 50 MW units added. As it can be seen in this table, through 1978 no base load is carried by the gas turbines or diesel units, which are only called upon to operate during peak hours. Since the two 50 MW units would cost about 17% less than the two 66 MW units and, with the same steam conditions, would have the same or better heat rates for loads up to 100 MW, they constitute a lower cost solution to provide for the system growth than the two 66 MW units. 5.10 Annex 6 gives details of comparisons made between two 50 MW steam units and other practical alternatives, which prove that the instal- lation of two 50 MW steam units is the least cost solution to provide the required system growth. The selected steam conditions (1,250 psi and 9500 F) are standard for this size unit and appropriate for the expected fuel prices. 5.11 As mentioned in paragraph 4.11, the first 50 MW unit is expected to be in operation March 1, 1975; from the system demand point of view, commissioning of the second unit could be delayed until September-October 1976, thus postponing investments about 15 months. However, it is more economical--for discount rates up to 18%--to put the second unit into operation as soon as possible after the first one, due to the savings that accrue from lower installation costs and from the reduction of system fuel costs. Iransmission System 5.12 The choice of 138 kV for the double circuit transmission line to transport the bulk of the generated power to Guatemala City (Guatemala Sur substation) is correct, since 138 kV is an existing voltage and INDE's personnel has experience with it. The other possibility for the line would be a single circuit at 230 kV. However, this solution would be less reliable than a double circuit 138 kV line, would be considerably more expensive--due to the special or larger size conductors that would have to be used to prevent corona effect on account of the altitude--, would unnecessarily and prematurely introduce a new voltage into the system and would complicate the tying of the new installations with the existing system both at Escuintla and at Guatemala Sur substation. Economic Return 5.13 The proposed Project would have a minimum economic return of about 16% (see Annex 6). If fuel prices 25% higher than those expected are assumed,the minimum value of the Project's economic return would drop to approximately 13%. If investment costs 25% higher than those expected are assumed, the minimum value of the Project's economic return would be 12.6%.  - 17 - 6. FINANCE 6.01 Ever since INDE started operations in 1961, its financial position has been weak. Moreover, INDE has been in default under the revenue covenants of Loans 487-GU (March 1967) and 545-GU (June 1968), for the years 1968, 1970 and 1971; present forecasts indicate that INDE will continue to be in default in 1972. BEG, which takes over 80% of INDE's output, had previously said that it would pass on to the public arn increase in the amount it had to pay for power purchased from INDE, even though ERG's minimum earnings during the last five years have exceeded 14% on average net fixed aasets.. In view of the fact that the Government now owns 96% of EEG1s stock, it would be possible for INDE to revise its contract with EEG to enable INDE1 to meet its tariff covenant. However, for political reasons this is unaccept- able to the Ouatemalan Government, but it was agreed during negotiations that as a condition of effectiveness of the proposed loan, a new contract satisfactory to the Bank would be signed by INDE and EEG for the sale of electricity. Until the end of 1974 the Government will pass on to INDE out of the dividends which it receives from EEG, after the Government has serviced the debt which it created to purchase EEG, such sum as is necessary to enable INDE to meet its revenue commitment. With this increase in income IND1 should be able to finance all the local costs of the Project from its own resources. However, substantial Government contributions will be required for the next stage of I111D's development. Past Record and Present Position 6.02 Income Accounts and Balance Sheets for 1969-1971 are shown in Annexes 7 and 8. In 1969 the ratio of operating expenses to revenue was 77%, but in 1970 it was reduced to 66%, reflecting the conmissioning of the Jurun-Marinala bydro development in that year. The ratio increased to 68% in 1971, due to an increase in thermal generation. These ratios are high for the type of system and reflect INDE's low tariffs. 6.03 The following table sumnarises INDE's Balance Maeet as of December 31, 1971: Thousands of Quetzales or Dollars ASSETS Fixed Assets in Operation 49,331 Less: Depreciation 7,296 Net Fixed Assets in Operation 42,035 Work in Progress, Studies, etc. 10,785 TOTAL FIXED ASSETS 52,820 Current Assets 6,278 Less: Current Liabilities (including current portion of long-term debt) 243735 Deferred Assets (Michatoya interest) 724 577279  - 18 - Thousands of Quetzales or Dollars LIABILITIES Equity 38,868 Long-Term Debt (excluding cturent portion) 18.411 I7.279 The Nichatoya hydroelectric system was valued at Q3,164,000 when it was purchased from EM by the Government in 1966 (at no cost to INDE) and was included in INDE's books at this figure. On instructions from the Government auditor, the asset value was increased during 1970 by Ql,224,000--the total amount of interest which the Governiment (not INDE) will pay over a period of ten years to F3M in connection with the purchass of this asset. The logic of this accounting is not understood, nor could any satisfactory explanation as to its purpose, be obtained. As this does not follow normal accounting practices, INDE shows the balance as a deferred asset, which is not included in the rate base for tariff covenant purposes. Similarly, it amortizes the deferred asset over the life of the loan from EEG to the Government, and such amortization is not included Eas an expense in calculating the rate of return, which is logical, if the Government auditor's requirements are to be met. 6.04 Included in current assets are accounts receivable for the sale of electricity and services amounting to Q1,537,000, less a bad debt reserve of Q84,000, giving a net figure of Ql,453,000. Of this amounts Q496,000 is due from EEG for December 1971 and was paid in January 1972. The balance of Ql,O4l,OOO is due from retail sales and bulk sales to Government, munici- palities and other electric companies. While this balance of Ql,OSl,OO0 represents an average of about seven months of INDE's billings, excluding EEG's sales, some of the municipalities have not paid their accounts since INDE was formed. INDE has recently signed new contracts with many of the municipalities and electric companies. These new contracts provide that current consumption be paid monthly and the arrears be paid off in installments; or, in some cases, the municipalities have authorized INDE to make a surcharge on retail sales within the municipality to cover current accounts of the municipalities and public lighting, and also to cover an installment on the old arrears. Sometimes, however, the surcharge is so small that it may take another ten years to collect the arrears. The Government accounts include sums due by hospitals and other departments, where no provision has been included in the departmental budgets for the payment for electricity. During negotiations, the Government agreed to include all its outstanding accounts in its next budget and make adequate provision for prompt payment of future accounts. Additionally, INDE needs more active support from the Central Government in collecting the old arrears due from municipalities and other electric companies; and, during negotiations, INDE and the Government agreed to present further proposals which would ensure prompt payment of current accounts due from these entities. It would seem, moreover, that  - 19 - the reserve for doubtful debts, which is based on 2% of current billings, ls insufficient; this will be reviewed by INDE, and the Bank advised of the results of the review. 6.05 INDE's accounting system has materially improved over the past four years. There is still room for further improvement, especially in the more speedy preparation of accounts, although this aspect has been better following the appointment of a new Chief Financial Officer in 1971. INDE's accounts have been audited in the past by Lizarralde Y Ayestas, Asociadas, a Guatemalan firm of public accountants and auditors, which has been re-appointed for the current year. During negotiations, INDE agreed to continue to employ the services of an independent auditor acceptable to the Bank. Such appointment will be made within four months of the cormencement of any financial years and IIIDE will 2orward to the Bank a signed copy of the annual accounts and auditors' report within four months of the end of the fiscal year. Financing Plan 6.06 The estimated sources and applications of funds of INDE for the six-year period 1972-1977 (Annex 9), are summarized below: 1972 - 1977 Thousands of US$ Percnntage or Quetzales of Total Financial Requirements Construction Expenditure Proposed Project 33,100 25.9 Existing IBRD Projects 5,643 h.4 Other Expenditure (excluding future hydroelectric project) 19,842 15.5 Future hydroelectric project 63,000 h9.2 Expansion studies 2.550 2.0 124,135 97.0 Increase in working capital _ 3835 3.