Ecuador - Third Power Project

(2-. a8(;,- Et1 FILE COPY RESTRICTED Report No.PU-73a Thds report is for official use only by the Bank Group and specifically authorized orpanizations or persons. It may not be pubised, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF THE THIRD POWER PROJECT EMPRESA ELECTRICA "QUITO" S.A. ECUADOR January 20, 197Z Public Utilities Projects Department  CU1RENCI BQUIVALENT Currency Unit = Sucre (S/) S3l.00 - 100 centavos - us$0.04 8/4,000,000 - US$4o, 000 US$1.00 a SJ25.00 U5$l,POO,O00 - S/25,000,000 Range of Sucre - S/24.75 - S/25.25 S$1.00 EEQ's Financial Year - Calendar Year UNITS OF EASURNEMNT = meter - 3.28 foet - kilometer n 0.621 mile R2 - square kilometer - 0.387 square mile - - cubic meter = 35.31 cubic feet 3/sec - cubic meter per second - 35.31 cubic feet per second 9 - kilogram = 2.2 pouxnd g/cm2 = kilogram per square centimeter 14.22 pounds per square inch W = kilowatt W= Megawatt = 1,000 kilowatt Wh = kilowatthour h= Gigawatthour = 1,000,000 kWh V = kilovolt V'A = megavoltanpere anual Load Factor = kWh generated in year maximum demand in kW x 760 ACRONYME CFN - Comision de Valores - Corporacion Financiera Nacional EEQ - Empresa Electrica "Quito" S. A. EMLEC - Empresa Electrica del Ecuador EPDC - Electric Power Development Company, Limited IESS - Instituto Ecuatoriano de Seguridad Social INQ - nfustre Municipalidad de San Francisco de Quito INECEL - Instituto Nacional Ecuatoriano do Electrificacion  ADDENDUM 1. This Appraisal Report was completed on the basis of additional information obtained from Empresa le6ctrica Quito (EEQ) during negotia- tions (July 1971). Figures for 1971 revenues shown in this report accordingly reflect a 35% tariff increase approved by the Government in April 1971 and introduced in May 1971. However, the new tariffs were charged only during May and EEQ and the Government subsequently agreed instead to raise tariffs in stages in such way that the previously agreed 35% increase would not be billed in full until January 1, 1972. 2. Preliminary financial inforrnation for 1971 indicates that this decision reduced revenue about S/12 million below the S/136 million estimated during the appraisal (Annex 11). The effect on EEQ's cash position during the year was minimal because the construction program was also delayed. The rate of return on net fixed assets in operation in 1971 was about 5", compared to the appraisal estimate of 7.6-ot. How- ever, the financial performance forecast for 1972 is not expected to differ materially from that estimated during the appraisal. The rate of return for that year should be over 10% and the substantive conclusions in the report on the merits of the proposed project remain unchanged. 3. The delays in construction will cause a slight change in the disbursement schedule (Annex 5) inasmuch as no disbursement can be made before the effective date of the credit, now assumed to be not later than May 1, 1972. Disbursements should be rapid thereafter and are expected to reach the forecast level by early 1973. January 20, 1972   APPRAISAL OF THE THIRD POWER PROJECT EMPRESA ELECTRICA "QUITO" S.A. ECUADOR Table of Contents Page No. SUMMARY AND CONCLUSIONS i-i 1. INTRODUCTION 1 2. THE ECONOMY 3 3. THE POWER SECTOR 4 Characteristics of the Sector 4 INECEL 4 Future Developments 4 14. ,THE BENEFICIARY 6 Organization and Management 6 Staff 7 Tariff Structure 7 Existing Facilities 7 EEQ's Investment Program 8 THE PROJECT 9 Description of the Project 9 Cost of the Project 9 Allocation of the Credit 10 Procurement and Disbursement 11 Engineering and Construction 11 Project Supervision 12 Ecology 12 6. JUSTIFICATION 13 Load Forecast 13 Project Justification 13 7. FINANCE 15 Past Record and Present Position 15 Financing Plan 18 Financial Forecasts 20 8. AGREEMENTS REACHED AND RECOMMENDATIONS 22 This report has been prepared by Messrs. W. F. Kupper and A. A. M. Onslow.   APPRAISAL OF THE THIRD POWER PROJECT EMPRESA ELECTRICA "QUITO" S.A. ECUADOR LIST OF ANNEXES 1. Electricity Statistics 1964 - 1969 Ecuador 2. Development of Main Generation and Transmission System in Ecuador 3. Historical and Forecast Electrical Data (EEQ) 4. Estimated Cost of Project 5. Schedule of Credit Disbursements 6. Justification of the Proposed Project 7. Electric Power Rates 8. Balance Sheets 1967 - 1970 9. Income Accounts 1967 - 1970 10. Estimated Balance Sheets 1971 - 1975 11. Estimated Income Accounts 1971 - 1975 12. Estimated Sources and Applications of Funds 1971 - 1975 13. Estimated Financial Ratios Map 1 Ecuador Map 2 EEQ's Generation and Transmission Systems   APPRAISAL OF THE THIRD POWER PROJECT EMPRESA ELECTRICA "QUITO" S. A. ECUADOR SUMMARY AND CONCLUSIONS i. This report covers the appraisal of the Third Power Project of the Empresa Electrica "Quito" S. A. (EEQ), a power agency owned by the Ecuadorian Institute of Social Security (56%) and by the Municipality of Quito (hi%). EEQ was established in 1955 as the successor to the Empresa Electrica Municipal and the Quito Electric Light Company, and is respon- sible for the generation and distribution of electricity in Quito and its environs. In the late 1950's it obtained two Bank loans (137-EC and 177-EC) totaling US$10 million for the first stage of the Cumbaya Hydro Project, some diesel plant and distribution. These facilities are operating satis- factorily. ii. The Project includes the construction of a 30 MW hydro-electric station at Nay6n on the San Pedro river; 18 MW of diesel-electric plant; 22 kV and 46 kV transmission lines and substations; and improvement and expansion of the Cant6n Quito distribution system. The Project also includes consultant assistance for management, administrative and tariff matters of EEQ and a study of its future power generation. iii. The cost of the Project is estimated to be US$18.7 million. It will be completed in 1974 and is about 85% of EEQ's US$22.3 million 1971 - 1975 expansion program. The Project's foreign exchange cost is estimated at US$12.7 million. Most of the foreign currency cost would be met by the proposed IDA Credit of US$6.8 million and by US$5.6 million from suppliers' credits. The balance of EEQ's requirements would be financed by a loan from the Corporacion Financiera Nacional of S/65 million (US$2.6 million), equity contributions of S/84.4 million (US$3.4 million) local bank loans and internal cash generation. iv. In the early 1960's EEQ's finances were in a deplorable state, mainly due to delay in increasing tariffs. More than two years were spent in attempts to raise EEQ's tariffs, during which time EEQ was in default on its two Bank loans, (Nos. 137-EC and 177-EC) which had to be serviced by the Ecuadorian Government under its guarantee. At the same time several other creditors had difficulty in collecting payments due. A tariff increase was ultimately allowed effective January 1, 1964. From 1964 to 1968, EEQ's financial conditions improved and the company was able to service its debt and to finance a 20 MW extension to the Cumbaya plant mainly from its own resources.  - ii - v. EEQ requested Bank Group assistance in financing the Project in 1967 and the first appraisal was made at the beginning of 1969. A 10% tariff increase found to be needed at that time was rejected by EEQ, and IDA was unable to consider financing the Project. With the appointment of a new Board of Directors and General Manager in the second half of 1970, EEQ again approached the Bank Group. However, the finances of EEQ had markedly deteriorated during the period when its expansion was delayed, and a 35% tariff increase was found to be necessary. This was granted effective May 1, 1971, and should put the Empresa in a satisfactory financial position to carry out its expansion program. vi. The Nay6n hydro plant is the least cost means of meeting Quito's electricity requirements for discount rates up to 15%. EEQ's consultants coipleted a study of the Project in 1966. Due to lack of funds major contracting was delayed until this year and Nayon is now scheduled for completion by the end of 1973. The diesel units have to be installed as the only means of expeditiously meeting interim demand. With these facilities generation capacity should be adequate until early 1975, when Instituto Nacional Ecuatoriano de Electrificaci6n (INECEL), the national electricity company, hopes to complete the first stage Pucara plant (65 MW) of its Pisayamnbo hydro development. The Inter-American Develop- ment Bank is presently considering financing this project. vii. Procurement for contracts to be financed by IDA is being carried out on the basis of international competitive bidding with a preference up to 15% for local bids on goods produced in Ecuador. Contracts for the main Nay6n civil works and for 9 MW of diesel plant were awarded in late 1970 with IDA approval. Up to US$1.4 million of retroactive financing is proposed. viii. EEQ's management and administration have been seriously deficient during the last decade, and for some years the position of Financial Director has been vacant. The present Board and General Manager appreciate EEQ.s shortcomings and have engaged the services of management consultants, which would be financed through the proposed Credit. ix. The rate of return on EEQ's average net assets in operation would rise from 7.6% in 1971 to 9.2% in 1975. The internal financial rate of return on the 1971-1976 time slice of EEQ's program would only be 8% because of the heavy backlog of construction to restore adequate service quality and the high operating cost of diesel plant needed to make up for the delay in completing the Nay6n plant. x. The IDA Credit of US$6.8 million would be made to the Government of Ecuador which would lend the amount to EEQ at an interest rate of 7 1/ES per annum for approximately 24 years including a grace period of 4 years. The Government would include interest during construction of about US$1.2 million in its loan to EEQ to bring the total loan amount to US$8.0 million equivalent which would be repaid in equal semi-annual payments commencing July 1, 1975.  APPRAISAL OF THE THIRD POWER PROJECT EMPRESA ELECTRICA "QUITO" S. A. ECUADOR 1. INTRODUCTION 1.01 The government of Ecuador has requested a Credit from the Associa- tion to assist in financing the 1971-1975 expansion program of Empresa Electrica "Quito" S. A. (EEQ). EEQ is responsible for the supply of electricity in Quito, the capital of Ecuador, and its surroundings. A Credit of US$6.8 million equivalent is proposed to cover part of the foreign exchange cost of the Project, the total cost of which is about US$18.7 million. The Borrower would be the Government of Ecuador and the Beneficiary EEQ. The loan from the Government to EEQ would be for US$8.0 million equiv- alent at 7 1/4% interest for a period of 24 years, with a grace period of 4 years, and would include interest during construction of US$1.2 million. 1.02 The Project would comprise the construction of a 30 MW hydro- electric plant at Nayon on the San Pedro River; an 18 MW diesel-electric plant in Quito; 46 kV and 22 kV transmission lines; the improvement and extension of EEQts distribution networks; engineering services; consult- ant assistance for management; a tariff study; a network study; a study over a period of time of the social cost and benefits attributable to village electri- fication; and complementary consultant studies and surveys for generation extensions. 1.03 The Bank made two loans to EEQ in the late 1950's for the first stage of the Cumbaya hydro-electric plant, some diesel plant and distri- bution. These works were completed by the end of 1961 and have been operating satisfactorily. In the early 1960's EEQ's finances were in a deplorable state, mainly due to delay in increasing tariffs. More than two years were spent in attempts to raise EEQ's tariffs, during which time EEQ was in default on its two Bank Loans, Nos. 137-EC and 177-EC, which had to be serviced by the Ecuadorian Government under its guarantee. At the same time several other creditors had difficulty in collecting pay- ments due. A tariff increase was ultimately allowed effective January 1, 1964. From 1964 to 1968, EEQ's financial conditions improved and the company was able to service its debt and to finance a 20 MW extension to the Cumbaya plant mainly from its own resources. 1.04 In 1967 EEQ requested IDA assistance in financing its develop- ment program and the Nayon project was appraised for the first time in early 1969. However, neither the General Manager nor the Manicipality of Quito (IMQ), which has an important voice on EEQ's Board, were prepared to accept the recommendations that tariffs be increased by some 10%, as was required at that time; and IDA was unable to consider financing the Project. EEQ's financial position deteriorated once more, and the company was unable to make the necessary further extensions of its facilities, resulting in the present deficits in capacity and energy capabilities and in overloaded networks.  1.05 After the appointment of a new General Manager to EEQ in August 1970, and a change of the Board of Directors following the election of a new Mayor of Quito, EEQ again approached the Association to assist in financing the Nayon project. The Government has since allowed EEQ to raise its tariffs by an average of 35% effective May 1, 1971, which, on present forecasts, is sufficient to enable EEQ to earn a reasonable rate of return on its net fixed assets in operation and to generate a reason- able amount of cash towards its construction program. 1.06 This report is based on a feasibility stuly,prepared by EEQ's consultants, Electric Power Developnent Co. Ltd., of Japan and on infor- mation supplied by EEQ to an appraisal mission, consisting of Messrs. W. F. Kupper and Alan A. M. Onslow, which visited Ecuador in January/ February 1971.  - 3 - 2. THE ECONOMY 2.01 Ecuador is situated in the north-west region of the South American continent. The Andean mountain system crosses the country from north to south, dividing it into three regions with marked orographic and climatic differences: (i) The coastal region is tropical. About 45% of the total estimated population of about 6 million lives in this area, where the port of Guayaquil, the largest and most industrialized city in Ecuador, is situated; (ii) The central region consists of two ranges of the Andes and a high valley between these ranges. About 50% of the population lives in this valley, which has a temperate climate. The city of Quito, capital and second largest city in Ecuador, is situated here; (iii) The eastern, largely undeveloped region of Ecuador which has a purely tropical climate, is formed by the upper Amazon river basin. 2.02 The economy of Ecuador depends to a large extent upon agriculture, which amounts to about one-third of the GNP. The two main crops are bananas and coffee which together accounted for about 77% of total 1970 exports. Industry is mainly concentrated around Gaayaquil and consumes about 40% of electric energy sold by the Empresa Electrica del Ecuador (EMELEC), a subsidiary of Boise-Cascade of the USA 1/; and around Quito where it accounts for about 25% of EEQ's energy sales. No substantial inflationary trends have been apparent in the economy in recent times. Over 1965-69 prices increased at about 3.7% per year, which is very modest by most standards. The higher price increase of 7% experienced in 1970 is largely attributable to the August devaluation. 2.03 Recent major oil discoveries in north-east Ecuador near Lake Agrio (see Map 1) may have a considerable impact on economic development in Ecuador in general and consequently on the development of the power sector. An oil pipe line, now under construction to the port of Esmeraldas, would have an initial capacity of about 250,000 barrels per day and is expected to be completed in 1972. Royalties on oil production are expected to amount to about US$18 million in 1973 and are expected to be higher in subsequent years. About 50% of these royalties have been earmarked for development of the country's power sector, for which purpose a National Fund for Electrifi- cation was created in May 1970. 2.04 Resources made available as a result of petroleum exports will enable Ecuador to achieve a much more rapid rate of growth than in the past. A recent Bank economic report projected the rate of growth over 1971-1976 at 8% per year. Manufacturing, the output of which has been growing at 10% per year, will grow even more rapidly. Andean integration should provide an additional stimulus for growth of the industrial sector. It is already evident that failure to expand electric power generating facilities in Quito is exerting a constraint on industrial growth. Unless the power supply situation is remedied, serious adverse consequence for development of the region could result. / Successor to American and Foreign Power Co.  - 4 - 3. THE POWER SECTOR Characteristics of the Sector 3.01 Except in Quito and Guayaquil, which are supplied by EEQ and EMELEC respectively, electric supply in the country is splintered and unorganized. Hundreds of plants, most of them small, cater to small communities and private industry. In general, maximum demand is not met and facilities are overloaded and badly maintained. Ecuador has some 60 companies with plants larger than 100 kW and an undetermined number of companies owning smaller plants. 3.02 Annex 1 shows national electrical statistics for the period 1964- 1969 in respect of plants of 100 kW and larger. Installed capacity increased from 175 MW in 1964 to 270 MW in 1969, or about 9% annually. Generated energy for the same period increased from 524 GWh to about 850 GWK or 10.2% annually. In 1969, EMELEC and EEQ together accounted for about 65% of the total generation. Annual per capita generation increased from 104 kWh in 1964. to 142 kWI in 1969 (or 6.3% annually) which is still low. In 1969 the average for Latin America was about 450 kli/capita. INECEL 3.03 As a result of discussions between Bank staff and Ecuadorian officials about how to improve the organization of the power sector, the Instituto Ecuatoriano de Electrificacion (INECEL) was created in 1961 but its assignment has been changed many times. Originally, INECEL's functions included those of a regulatory agency, but very early in its history these responsibilities were transferred to the former Ministry of Industry and Commerce and INECEL's role was primarily that of a State Power Company, with limited funds and powers, gradually taking over or associating itself with smaller electric utilities. In August 1970, however, INECEL was in addition redesignated the power regulatory agency under the Ministry of Natural Resources and Tourism (Annex 7). 3.04 INECEL has been preparing a master plan -- with the assistance of consultants -- with the object of integrating the many utilities in the country, first on a regional basis and then on a national basis. Due to lack of funds, and its inability to obtain Government approval for revision of tariffs, INECEL's effect on the power industry has been small. Future Developments 3.05 The oil royalties to be received by the National Fund for Electri- fication are expected to be made available to INECEL which is expected to finance, construct and operate from 1975 or 1976 onward practically all new generating and transmission facilities in the country. Gradually INECEL would interconnect most of the larger companies, and most of the small uneconomic plants would be put on standby.  3.06 INECEL would, in due course, thus become Ecuador's principal power company. However, plans for the integrated development of Ecuador's power sector have yet to be finalized by INECEL. A National Electrification Program, formulated by INECEL in 1966 and 1967 has not been revised since, though INECEL subsequently studied the market for both the northern and southern halves of the country and recently prepared a preliminary study on the development of the main generation and transmission systems in Ecuador (see Annex 2). 3.07 INECEL's present plans are to complete by 1975 its first major generating project, the 65 MW Pacara hydro plant of the Pisayambo Develop- ment (see Map 1). The Inter-American Development Bank (IADB) has recently appraised this project which would interconnect and supply electric energy to the main towns in the central region of Ecuador, including Quito (see paragraph 4.17). Subsequent requirements in this area would be met by constructing the Toachi hydro plant (see Map 1) and further extending Pisayambo. 3.08 By 1977 INECEL hopes to complete a 100 MW plant on the Paute River in southern Ecuador (see Map 1) for supply to Guayaquil. In the meantime EMELEC, the Wuayaquil power company, is expected to extend its all-thermal generating facilities by some 100-150 MW. INECEL would meet all EMELEC's generation and transmission requirements after 1977. 3.09 By 1985-1989 the whole country would be integrated and further generation requirements would probably be met from hydro facilities on the Paute and the lower Jubones River, which together have a hydro potential of some 1,400 MW.  - 6 - 4. THE BE'EFICIARf 4.01 EEQ was established in 1955. The company is the successor of the Enpresa El6ctrica 4Lricipal, established in 1934 as a department of the Municipality of Quito to supplement the generating and distribution facilities of the formner Qaito Electric ,ight ComparW, a subsidiary of the American and Foreign ?ower Company. In 1946 the Municipality bought all the fasilities of the Quito El1ectric Light Company. 4.02 At the end of 1970 EEQ had only two shareholders: the Municipality of Quito (IMQ) and the Ecuadorian Institute of Social Security (IESS), which respectively hJld 44% and 56% of the subscribed capital of S/221 million. A recenrt Governmellt Decree, however, opened the possibility of industrial companies as wiell as private investors obtaining shares in EQ. The Decree obliges industrial consumers to contribute an additional 10% of their monthly bills to FEQ as equity. Shares so acquired would be tradeable in the open market. Organization and Management 4.03 The Board of Directors, composed of five persons, is elected by the shareholcers. Two memabers are appointed by IMQ, two members by IESS and the fifth is elected by the other four. The Board elects one of its members as President of the Company (presently the Mayor of Quito). The members ser';e staggered terms not exceeding four years and are eligible for reappointment. The Board controls broad policy. It appoints the General Marnager - who is responsible for effective day to day operations of the conpany - the Auditor, the Technical Director, and the Financial Director. I4.04 For some time now, EEQ's managerial, financial and administrative development seriously lagged behind its technical development. The new Board and General Manager, who were appointed in the second half of 1970, are aware of shortcomings in the Em!resa and are taking active steps to rectify them, including an early appointment to the Financial Director's post, which has been vacant for some years. The Board has agreed to engage the services of consultants to improve management methods (paragraph 7.08) prior to the Credit being made effective. Although financial planning is poor, EEQ's accounting is generally good and information is produced promptly. During negotiations, EEQ agreed to: (i) cons-alt with IDA from time to time on actions it proposes to take on the consultants' recommendations; (ii) appoint as soon as possible but not later than six months after Credit signing, in consultation with IDA, a properly qualified and experienced Financial Director; and (iii) consult with IDA on any appointment to the posts of General Manager, Technical Director and Financial Director. 4.05 EEQ intends to update its charter (Estatutos), dating from 1955, to reflect present conditions and current law on such matters as shares and shareholders, tariffs and rate of return. The company will consult  - 7 - from time to time with IDA on its proposals. During negotiations EEQ and the Government have agreed to amend its charter after consultations with IDA prior to the Credit being made effective, and only to make further amendments after consultation with IDA. Staff 4.o6 EEQ's staffing situation is reasonable, and staff relations are satisfactory. The company employs about 850 regular staff (about one employee per ninety customers); its staff has been increasing by about 1% each year. The company's labor union is strong. Wages and salaries are considered to be above average for comparable work in Ecuador and have been increasing about 6.5% annually in real terms during 1965-1970. Tariff Structure 4.07 The structure of EEQ's tariffs has not been revised for many years, and the 1961, 1964 and 1971 tariff adjustments may have caused imbalances between the various classes of consumers. EEQ is aware of this and plans to engage consultants for a study of its tariffs. In view of its importance, the necessary funds for this study have been included in the proposed credit, (see paragraph 5.05 (iv) and Annex 7), and, as a condition of effectiveness, EEQ will appoint consultants for the tariff study, on terms and conditions satisfactory to IDA. Existing Facilities 4.08 Because of past financing problems and consequent delays in construction, EEQ's facilities are inadequate to meet demand which from time to time has to be reduced by lowering voltage during peak hours. Map 2 shows EEQ's principal power stations and its transmission lines, which consist of about 20 km of 46 kV lines and about 50 km of 22 kV lines. EEQ operates four hydro-electric plants totaling 52 MW on the San Pedro River, of which Cumbay'a with 40 MW is the largest. All the plants are run of the river type, although Guangopolo (9.4 MW) and Cumbaya. (40 MW) have daily pondage; thus supply is very sensitive to current hydrological conditions. 4.09 EEQrs hydro capacity is augmented by purchases from two small privately-owned hydro plants (1.2 MW). Additionally, EEQ owns and operates some 9.7 MW of diesel plant. Prior to 1969 the diesel plant was only used during the three dry season months of the year (July through September), but it is now operating at least six months a year in order to meet demand. 4.10 Historical demand, generation and sales of EEQ are shown in Annex 3. The total capability in 1970 was about 63 MW compared with a maximum demand of about 58 MW, i.e., demand almost reached installed capacity, which illustrates the necessity to install new plant as soon as possible. An estimated energy deficit of about 2 GWh (1.5%) occurred in 1969 and about 7 GWh (3.5%) in 1970. The system annual load factor is about 50%. Industrial sales are forecast to be proportionally higher by 1975, thus increasing the expected load factor to about 52% in that year.  -8- 4.11 In the past, losses have been as high as 30Q, but by 1968 EEQ had reduced them to about 19%. The main part of these losses is caused by the present poor condition of EEQ's network and the lo-wering of voltage at times of maximum demand. Losses are expected to approximate 18% by 1974 and may well be lower in view of EEQ's active program to reduce them. EEQ's Investment Program 4.12 EEQ's 1971-75 investment program (excluding La Mica (see paragraph 4.17)) totals S/557.7 million (US$22.3 nmllion) and would add 52 MW to EEQ's capacity. The major item is the 30 IMW Nay6n hydro plant on which construction was started in 1968 and is about 10 completed. This plant is the least cost next step in EEQ's generation program (Annex 6). The access roads, tunnel adits, a pilot tunnel, the penstock bed, and the power station platform are completed. Nay6n was originally scheduled for initial operation in early 1972, but when IDA was unable to consider lending (see paragraph 1.04) in 1969, EEQ was compelled to slow down progress because of a lack of funds. The station is now expected to be completed by the end of 1973. 4.13 The main civil works for Nay6n will be carried out by Mitsui of Japan, who was awarded the contract at the end of 1970, after international competitive bidding. Mitsui has a contract calling for cash payments; should the proposed IDA Credit be made, part of the proceeds would be applied to the foreign currency component of this contract. The electrical and mechanical equipment for Nayon is being provided by Mitsubishi under a supplier credit. 4.14 The program also includes 22 MW of diesel plant of which 4 MW were purchased in 1969 with suppliers' credits and are nlow being installed in the existing diesel station in the north of Quito. In order to meet the 1971 demand. international tenders for 9 SW of the remaining 18 MW were invited in 1970; the award was made to General Motors of the U.S. in January 1971 with IDA approval. The balance of 9 MW will be procured this year to meet the 1972 demand. A new diesel station is now under construction in the nerth of Quito to accommodate the additional 18 MW in diesel capacity. 4.15 A significant amoLut of distribution investment is being planned to strengthen, rehabilitate and extend the existing networks including some village electrification; a considerable improvement in Quito's street lighting is also included in the program. A large part of the distribution cost, except for the street lighting and village electrification, will be covered by the Mitsubishi supplier credit for the Nay6n equipment. 4.16 Jointly with the Emapresa de Agua Potable, EQ expects to complete in early 1972 the 4.5 MW rasachoa hydro project for which most of the expenditure has already been made. 4.17 EEQ's program also tentatively includes the construction of the La Mica hydro-electric davelopmaent, situated on the Amazon side of the Andes, which would divert water to the San Pedro River. In addition to its proposed installed capacity uf 16 MMW, the scheme would increase the capability of the existing plants by somo 12 MW during the dry season. if INECEL actually starts construction of the Pucara hydro project this year (see paragraph 3.07), La Mica should be postponed for at least three years.  - 9 - 5. THE PROJECT Description of the Project 5.01 The third power project consists of about 85% of EEQ's 1971-75 program and would comprise: (i) The 30 MW Nay6n hydro plant (see Map 2). This plant, with two 15 MW Kaplan units, will be the third power station in cascade, using waters of the San Pedro River (together with Guangopolo and Cumbaya). It will be essentially a run of the river plant operating under a head of about 97 m and connected to the Cumrbaya tailrace by means of a tunnel about 2.5 km long. The geological and hydrological conditions are similar to those of the existing plants. On average, Nayon will generate about 115 GWh annually. Firm power (i.e. minimum dependable capability during sustained extreme dry conditions) will be about 6.7 MW. To ensure continued operation when Cumbaya is shut down, a by-pass tunnel about 1.7 km long will be constructed for the Cumbaya plant. This would also increase Nay6n's average annual energy capability by about 6%; (ii) Construction of a new diesel power station, with 18 MW of diesel-electric plant; (iii) Transmission lines and substations to complete the 46 kV ring system for Quito to improve and extend the supply to the city, including conversion of some lines from 22 kV to 46 kV; (iv) Equipment, including transformers and street lighting components, to renovate, strengthen and expand the dis- tribution system for Quito; (v) Electrification of a number of small villages in the north- west part of Canton Quito. This part of the project will be carried out in conjunction with study over a period of time of the social costs and benellts attributable to electrification, to act as a guide to judging future village electrification schemes; and (vi) Engineering and construction supervision of the Nay6n hydro plant, studies for EEQ's next step in generation, a network study; and consultant assistance to EEQ for management and administration, and for tariffs. Cost of the Project 5.02 The estimated cost of the Project is about S/A72 million (US$18.7 million), as shown in the following table. A more detailed breakdown is shown in Annex 4.  - 10 - S/million or US$ million Local Foreign Total Local Foreign Total Nay6n plant i/ 70.1 98.7 168.8 2.78 3.91 6.69 Diesel plant 3.5 67.6 71.1 0.14 2.68 2.82 Transmission 7.5 36.6 44.1 0.30 1.45 1.75 Distribution 23.8 70.5 94.3 0.94 2.80 3.74 Engineering & Administration 15.3 4.6 19.9 0.61 0.18 0.79 Studies 4.3 14.0 18.3 0.17 0.55 0.72 Contingencies - physical 9.1 28.1 37.2 0.36 1.11 1.47 - price 18.4 - 2/ 18.4 0.72 - 0.72 Total 152.0 320.1 472.1 6.02 12.68 18.70 2 Does not include SA18,535,000 (US$741,400) spent prior to 1971. No price contingency is shown for the foreign exchange because most major contracts have already been placed (see paragraph 5.03). 5.03 The cost estimates were prepared by EEQ in conjunction with its consultants, Electric Power Develolment Co. Ltd., (EPDC) of Japan. The estimates are largely based on contracts already placed for civil works and electro-mechanical equipment for the Nay6n planlt (Mitsui and Mitsubishi of Japan); for 9 MW of the diesel plant (General Motors of USA); and for the supply of transmission and distribution equipment (Mitsubishi). To cover increases in cost due to any difficulties which might arise during the construction of the Project, and unforeseen extras, a physical con- tingency allowance of 9% has been included in the estimate. An additional allowance of 18% in local construction cost of the various works has been included to cover price escalation of 8% - 9% per year expected during the four-year construction period. 5.04 The total cost of the Nay6n hydro plant, including expenditures already made, but excluding interest during construction, would be about S/227 million (US$9.0 million)or US$300 per installed kW, which is reasonable. Allocation of the Credit 5.05 The proposed IDA Credit of US$6.8 million equivalent would finance the foreign exchange component of the following items of the Project: (i) Civil works of the Nay6n plant, and all works for the Cumbaya by-pass - US$1.5 million; (ii) Equipment and services for the 18 MW diesel power station - US$2.9 million;  - 11 - (iii) Transmission and distribution equipment totaling US$1.680 million comprising: line-switching and substation equipment, including transformers - US$230 thousand, some distribution line equipment comprising cement, steel and racks for con- crete poles, and equipment for the 1972-1973 streetlighting development program - US$1.0 million, distribution equipment, including transformers, for village electrification - US$450 thousand; and (iv) Consulting costs totaling US$720 thousand comprising: engineering of the Nay6n Project - US$170 thousand; drilling and surveying for the final feasibility study of La Mica - US$100 thousand, and a study of a thermal alternative Us$50 thousand; a network study - US$70 thousand; a village electrification social cost and benefit study - US$50 thousand; management assistance - US$230 thousand; and a tariff study - US$50 thousand. Procurement and Disbursement 5.06 All contracts for the works to be financed from the proposed Credit (except consultant services) have been or will be awarded on the basis of international competitive bidding. Forpurposes of evaluating bids on some locally produced goods preference to local bidders will be given up to the amount of any taxes on the importation of such goods or 15%, whichever shall be lower. EEQ is exempt from the payment of arn import duties on imported goods not produced in Ecuador. 5.07 Disbursements will be for the foreign currency cost of equipment and services only. For orders on locally produced goods placed with Ecuadorian suppliers, the Association would reimburse EEQ for 40C of the contract cost, this percentage being the average estimated foreign exchange component. Retroactive financing amounting to about US$1.4 million is pro- posed for those items which are of utmost urgency, and for which contracts have already been let, i.e., the 9 MW of diesel plant required by fall 1971 and the civil works part of the construction of the Nay6n plant. Annex 5 shows the estimated quarterly disbursements for the proposed Credit. The Project is expected to be completed in 1974; the closing date would be December 31, 1974. Should the foreign exchange cost to complete the Project be less than the estimate, any undisbursed amount of the proposed Credit would be canceled. Engineering and Construction 5.o8 Engineering design and the supervision of construction for the Nay6n plant, the Cumbaya by-pass, and associated transmission lines would be carried out by EPDC, which would continue to be engaged under its contract with EEQ. EEQ will continue to employ consultants acceptable to the Association and to the extent considered necessary by the Association for supervising the execution of the Project. The transmission, distribution and diesel plant would be designed andsupervisedby EEQ, which is competent to do so.  - 12 - Project Supervision 5.09 EEQ's management and financial control has been weak in the past but with the use of management and engineering consultants it should improve over the next few years. Supervision visits by IDA staff would be made to Ecuador at about six-monthly intervals. Ecology 5.10 The Nay6n plant is the third step in the development of the power potential of the San Pedro River. The earlier plants were constructed in 1937 and 1961. This area, which lies on a plateau with little vegetation, is only sparsely inhabited. No ecological problems were encountered in the past and none ,are expected from Nayon.  - 13 - 6. JUSTIFICATION Load Forecast 6.01 During the twenty-four years 1947 through 1970 sales in Quito increased at an average annual rate of about 9.3%, from 28 GWh to 211 GWh, while system maximum demand increased from 8.7 MW to 57.7 MW. However, during 1969 and 1970, demand was suppressed. After making adjustments for higher potential sales and maximum demand in these two years, growth rates for the years 1965-1970 would have been about 11.3% for sales and 10.9% for maximum demand. 6.02 The recent suppression of demand, the tariff increase of 35%, and the August 1970 devaluation of the sucre make forecasting of sales and demand over the next five years difficult. The forecast adopted in this report (see Annex 6) follows the basic approach used by EEQ and INECEL, modified during the appraisal and accepted by EEQ and INECEL for the tariff adjustment calculations. Sales are projected to increase annually by 10.5%, in 1971 and 1972, rising to 11.5% in 1973 and to 12% annually by 1974. The lower growth rates during the first two years reflect the possible effects of the recent tariff increase, and also the voltage reduction which will continue until overloaded substation transformers have been replaced. Transmission, distribution and other system losses are expected to account for 18-20% of total generation during the years 1971 through 1975. On this basis gross generation and maximum demand are forecast to increase 11.2% annually during the next five years reaching 440 GWh and 98 MW respectively in 1975. The forecast appears reasonable in view of the expected improvement of Ecuador's economy (see paragraph 2.04) which would result in increased electricity sales. 6.03 Annex 3 shows the forecast of EEQ's sales, gross generation and maximum demand, together with the required capacity, available capacity, and capacity additions, as well as a generation schedule. Project Justification 6.04 EEQ's decision in 1968 to construct the Nay6n station was taken after its consultants had made a cost comparison with alternative thermal plant which showed Nay6n to be the least cost means of expansion for discount rates up to at least 20%. The comparison was based on the then current price of US$4.96 per barrel for Bunker "C" oil, which did not include taxes. A revised calculation by the Bank using US$2.20 per barrel (which appears to be a reasonable price for oil from the new pipeline) shows that Nayon would still be preferred to thermal plant for discount rates up to 15% (see Annex 6). 6.05 Because the construction of Nay6n was delayed, EEQ is now forced into an expensive "crash" program of diesel generating capacity in order to meet requirements prior to commissioning of Nay6n. Gas turbines are not an economic alternative because they would operate at only 50-60% of normal  - 14 - (sea level) output at Quito's 2,800 m altitude. Load shedding, as an alternative to installing diesel plant, would be unacceptable because it would be even more costly to the economy in terms of lost industrial production. EEQ has estimated that in 1970 about 4 GWh could not be supplied to industry which had to curtail production by an estimated 7%. Lost production would be at least double this amount in 1971 and 1972 in the event no generating additions are made and would have serious secondary effect on the economy. 6.06 The internal financial rate of return on EEQ's 1971-1976 expansion program is about 8% (see Annex 6). This low return is not surprising be- cause: (a) EEQ has to install high cost diesel plant (although the capital cost is modest, the operating costs are extremely high due to the present fuel price, which EEQ will have to pay during this period, of US$6.12 per barrel or about US$1.10 per million Btu, excluding taxes); and (b) the present program is burdened with the additional investment required to restore adequate service quality. The calculation does not take into account, as a benefit attributable to the diesel plant, the avoidance of industrial production losses since from the data available in Ecuador, "value added to the economy" cannot be quantified. 6.07 The small program of village electrification included in the Project (see para. 5.01 (v)) does not appear to be justified on normal financial grounds. The basis for the inclusion of the program within the Project is that it is a pilot program, so far as the Association is con- cerned, for which the social costs and benefits would be carfully monitored over time. The social benefits are expected to include such items as the development of small industries, discouragement of population drift towards the towns, general improvement in living conditions, etc. EEQ has agreed to cooperate with the Association in carrying out such a long-term study and will appoint consultants for this study, on terms and conditions acceptable to IDA.  - 15 - 7. FINANCE 7.01 Since the Association first appraised the Nay6n Project in 1969, EEQ's finances have deteriorated, mainly due to the unwillingness of the former Mayor of Quito and EEQ's former General Manager to permit needed tariff increases. With the appointment of a new General Manager in August 1970, and a change of the Board of Directors following the election of a new Mayor of Quito last year, it is expected that substantial improve- ments will be seen in EEQ in the next few years, particularly in its financial planning. The Government has allowed EEQ to raise its tariffs by an average of 35% effective May 1, 1971. Past Record and Present Position 7.02 Balance Sheets and Income Accounts for 1967-70 are shown in Annexes 8 and 9. In 1967 the ratio of operating expenses (excluding depreciation) to revenue collected was 46%; by 1970 it had risen to 56%. During the last four years, operating costs have risen by about 18% per annum compared with a 10% annual increase in klns sold: one of the main increases being in wages. If wage rates continue to increase at the same pace further tariff increases will be needed to avoid renewed deterior- ation in EEQ's finances. 7.03 EEQ does not credit revenue with the actual amount billed to customers, but holds it in suspense as a deferred credit until a customer has paid his account. It is then taken into revenue. As of December 31, 1970, receivables from customers, other than IMQ and the Government, in- cluded about S/2.1 million, which have been outstanding since before 1970. EEQ has made a provision in its accounts of an amount equal to these old outstandinR receivables. 7.04 IMQ has also been in arrears with EEQ for some years. The reason given was that IMQ is a stockholder in EEQ and has received little or no return on its capital. Notwithstanding IMQ's refusal to permit timely tariff adjustments in the past, IMQ felt that it should receive some recompense and so did not settle its accounts with EEQ. As at December 31, 1970, IMQ owed EEQ S/23.0 million ($0.9 million) (see paragraph 7.11). 7.05 Prior to 1968, the Government also did not pay its accounts with EEQ, mainly because EEQ owed the Government some S/45 million on account of debt service paid on EEQts behalf. However, in 1967 and 1968, there was a settlement in which various debts were offset and assigned with the result that as at December 31, 1970, the Government owed EEQ only S/3.0 million. IMQ and the Government together account for about 8% of billed revenue. 7.06 Financial planning and control in EEQ is at a minimum: the Chief Accountant confines himself to the preparation of historical accounts, which are produced promptly. Any financial forecasting which may from time to time be required, is done by the Engineer in charge of Operations.  - i6 - 7.07 Until FY1970, EEQ did not employ an independent professional firm as external auditors, but instead relied on the services of two "Comisarios" to audit its accounts. These auditors were employees of such institutions as the Bank of Pichincha, a commercial bank, and the Social Security Institute and did not normally have the supporting staff, time or knowledge to carry out a professional audit. The international firm of Price, Waterhouse and Company has recently completed the audit of EEQ's accounts. During negotiations EEQ agreed to continue to have its accounts audited by external auditors acceptable to the Bank, and to send the Bank a copy of the annual accounts and auditors' report within four months of the end of the fiscal year. 7.08 The past record of EEQ clearly leaves much room for improve- ment, and the present Board of Directors and senior management are fully aware of this. To this end, EEQ has negotiated a contract (the foreign currency of which would be financed under the proposed IDA Credit), with Price, Waterhouse and Company for the study and implementation of improved management techniques, which will necessitate the appointment of a Financial Director (see paragraph 4.0h). 7.09 Annex 8 shows EEQ's Balance Sheet as at December 31, 1970, and can be sumnarized as follows: Millions Thousands of Sucres of US$ ASSETS Fixed Assets in Operation 558 22,320 Less: Depreciation 163 6 520 Net Fixed Assets in Operation 397 Other Fixed Assets (net) 39 1,560 TOTAL FIXED ASSETS 434 17,360 Net Current Assets 24 960 ZT ~~~ltS,320 LIABILITIES Equity 291 11,640 Long-term Debt a42 5,680 Deferred Credits 25 1,000 UN 15,320  - 17 - 7.10 The Debt/Equity ratio is 30/70. All long-term debt is due to be repaid by the end of 1977. Present long-term debt consists of: Balance Date Final Lender 12/31170 Arortization Due (thousands of Sucres) IBRD 121,629 1977 IESS 1,339 1972 INECEL 8,268 1975 IMQ 1,967 1971 Inter-American Conference 1,063 1973 Suppliers' Credits 7,316 1975 141,582 Debt service on existing loans over the five years 1971-1975 averages about S/27 million per annum, which is covered 1.6 times by the 1970 cash genera- tion (prior to dividends, which would be paid by issuing stock, see paragraph 7.12). 7.11 Since 1956, developers of new urban and other areas have been required to meet the capital cost of distribution networks necessary for such developments. These networks, which are used by EEQ, are not included in the assets in the books of EEQ. The Municipality has passed legislation claiming ownership of these networks and has recently transferred them to EEQ for S/28,088,000 (US$1.12 million), which is the estimated undepreciated original cost of the networks from 1956 to the end of 1970. EEQ would pay for this by offsetting IMQ's debt of S/23.0 million and issuing stock to IMQ for the balance of S/5.1 million. The networks will now be depreciated in EEQ's books by s/6.0 million, which is the estimated depreciation from 1956 through 1970. Effective January 1, 1971, IMQ will rent to EEQ all such networks completed after that date at a rental of 5-6% of cost; the networks would be maintained by EEQ. The execution of a satisfactory agreement on these lines is a condition of effectiveness of the proposed Credit. 7.12 As of December 31, 1970, S/44 million is included in current liabilities as unpaid dividends. This outstanding amount has now been settled by the issue of stock. 7.13 EEQ's fixed assets are undervalued as a result of the devaluation of the sucre in August 1970 from S/18 to US$1.00 to S/25 to US$1.00. At the time of the devaluation, a law was passed precluding entities from revaluing their assets except to the extent that their external debt was revalued; EEQ revalued its assets at that time to that extent. During negotiations EEQ agreed to a further revaluation of its assets in 197-, which is the earliest date allowed by this 1970 law. This valuation would then take into account the full effect of the 1970 devaluation of the sucre, and it is estimated that it will increase the gross value of fixed assets in operation by a further S/70 million.  - 18 - Financing Plan 7.14 The estimated sources and applications of funds for EEQ for the period 1971-1975 (Annex 12), are summarized below: Millions of US Dollars Percentage Financial Requirements Millions of Sacres (Equivalent) of Total Construction expenditure: IDA Project 472.2 18.9 58.2 Other expenditure (excluding La Mica) 85.5 3.4 10.5 La Mica 192.0 7.7 23.7 Increase in working capital 24.6 1.0 3.0 E.ployees' bonuses and cash dividends 37.0 1.5 4.6 TOTAL REQUIREMENTS 811.3 32.5 100.0 Sources Internal Cash Generation 494.0 19.7 60.9 Less: Debt Service 318.5 12.7 39.3 - 175.5 =7.' 21.6 Equity Contributions 84.4 3.4 10.4 Borrowings: Proposed Government Loan 1/ (Credit) 200.0 8.0 24.7 Local Loan 65.0 2.6 8.0 Suppliers' Credits 160.3 6.4 19.7 Future Foreign Loan 91.3 3-7 11.3 516.6 20.7 77 Other Miscellaneous Sources 34.8 1.4 4.3 TOTAL SOURCES 811.3 32.5 100.0 1/ Including interest during construction on these loans.  - 19 - 7.15 The cornerstone of the proposed financing plan is an increase in tariffs of approximately 35% to enable EEQ to earn a reasonable rate of return on its properly valued net fixed assets in operation and to generate a reasonable amount of cash towards its construction program. A tariff increase of this magnitude, effective May 1, 1971, has been approved by the Minister of Natural Resources and Tourism, and, during negotiations, the Government agreed not to reduce tariffs before June 30, 1974. 7.16 It is proposed that the Association make a Credit of US$6.8 million equivalent available to the Government which would lend the amount to EEQ at an interest rate of 7-1/b% per annum for approximately 24 years including a grace period of h years. The total anount to be repaid (US$8.0 million), would include interest on the Government loan during construction of about US$1.2 million equivalent and would be repaid in equal semi-annual annuities commencing July 1, 1975. During negotiations the Government and EEQ agreed to send to IDA for its approval, prior to presentation of this Credit to IDA's Board of Directors, a draft loan agreement, re-lending the proceeds of the Credit. This loan agreement will be signed at the same time as the proposed Credit. 7.17 Other loans recently negotiated, are: (a) Suppliers' Credits: (i) US$850,000 from Mitsui for some local currency expenditures of the civil works of Nayon. Interest will be at 11% per annum, payable i n cas h . Am ortization would start in September 1973 and would be in 16 semi-annual equal installments plus interest on the outstanding balance; (ii) S/122.5 million from Mitsubishi for plant and equipment for Nay6n and distribution. Interest during construction at 6.5% per annum on the amounts drawn down will be paid in one sum after 16 months. Amortization would commence in December 1972 and would be in twenty semi-annual annuity payments; and (iii) An additional loan of S/41.9 million from Mitsubishi with interest at 6.75%; amortization would commence in February 1972 and would be in eight semi-annual annuity payments. All three loans will be guaranteed by the Ecuadorian Government. During negotiations, EEQ agreed to submit draft loan agreements to IDA for its approval, prior to the presentation of the Credit to IDA's Board of Directors. (b) A local loan of S/65 million hab been made by Corporacion Financiera Nacional (CFN), with interest at 12% per annum and a commitment charge of 1% per annum on the undisbursed balance. EEQ has undertaken to submit to IDA a draft loan agreement prior to presentation of the Credit to IDA's Board.  - 20 - (c) A future foreign loan would be necessary to finance the foreign exchange cost of La Mica or its alternative. No action is necessary on this loan at this stage, and its amount will depend on the studies to be carried out for La Mica and future generation expansion by EEQ. Term of the loans in (a) and (b) above include the requirement that EEQ mortgage some of its assets as security. In order that the Bank may not be placed in an inferior position regarding loans 137-EC and 177-EC, it was agreed during negotiatiors that EEQ, as a coindition of effectiveness of the proposed Credit, will create a mortgage in favor of the Bank on so much of the property of EEQ as shall be necessary to secure the principal and interest outstanding on these two loans as of the date of the creation of the mortgage. The execution of the agreements referred to in (a) and (b) above are conditions of effectiveness for the proposed Credit. 7.18 During the period 1971-1975 equity will be provided as follows: Industrial consumers S/26 million IMQ-cash 50 INECEL 8 S3/84 million The industrial consumer's equity investment is the result of a recent decree which requires industrial consumers to pay an additional 10% of their monthly bill to EEQ as equity. The IMQ cash investment reflects a declaration by the Government to make payments of S/44 million to IMQ in connection with Quito's sesquecentennial celebrations for the purpose of EEQ's expansion program. IMQ will contribute this government grant to EEQ as equity. Additionally, IMQ has undertaken to provide SA/,500,000 annually for four years as its contribution towards EEQ's village electrification program. INECEL is also proposing to convert into equity the debt of S/8 million due from EEQ. 7.19 During negotiations, the Government agreed to provide EEQ, on terms satisfactory to the Association, any additional funds necessary to complete the Project. Financial Forecasts 7.20 As mentioned in p _:<.raph 7.15, the forecast income accounts (Annex 11) are based on the 1971 tariff increase of approximately 35k. Income is also based on the expectation that IMQ will include provision in its future budgets for electricity consumed and services obtained from EEQ, (other than street lighting), and that IMQ will promptly pay its accounts. This has not been the case in the past, but an undertaking to this effect has been given by IMQ to EEQ. Regarding street lighting, an amount to cover the cost of street lighting will probably be included in customers' bills; and as a condition of effectiveness, but in any case no later than January 1, 1972, EEQ has undertaken to submit arrangements, satisfactory to IDA, for the collection of its street lighting charges.  - 21 - 7.21 Estimated Balance Sheets for 1971-75 are shown in Annex 10. During the period 1971-75, the return on net fixed assets in operation will rise from an estimated 7.6% in 1971 to an estimated 9.2% in 1975 (Annex 13). In 1972, the estimated return on average net fixed assets would be 10.8% on unrevalued assets (see paragraph 7.13) and about 9.5% on revalued assets. The tariff increase of 35% should be sufficient through 1975, but circumstances could make a further tariff increase necessary. In order to assure that EEQ rakes a reasonable contribution to its expansion program from internal sources, EEQ should earn a minimum of 8% on its net fixed assets in operation. There- fore, during negotiations EEQ agreed to apply for an adjustment to its tariffs, whenever necessary, to enable it to earn a minimum of 8% on its average net fixed assets in operation, including distribution networks operated by EEQ, such assets valued in accordance with methods of valuation or revaluation acceptable to IDA. The Government also agreed to authorize such necessary increases promptly. 7.22 EEQ feels that it should pay modest dividends to its shareholders and has included in its financial forecasts dividends amounting to 1% of its net revenue, equivalent to less than 0.5% of paid-in capital. EEQ agreed during negotiations, to limit its cash dividends to this 1% of the annual net revenue, unless the Association should otherwise agree. 7.23 Over the five years, net fixed assets in operation will increase by 133% - i.e. from S/402.3 million to S/936.0 million (US$16.1 million to US$37.4 million), although about S/64.2 million (US$2.7 million) would be due to the 1973 revaluation (Annex 10). In 1974 and 1975, when interest on the relent proceeds of the Credit would no longer be financed, interest would be covered by net operating income 2.5 and 2.8 times, respectively, and debt service will be covered about 1.6 times by internal cash generation (Annex 13). At the end of the construction period, it is estimated that the debt/equity ratio will be 41/59. All of these financial ratios are satisfactory. To ensure that this improved financial position is maintained EEQ agreed during negotiations not to borrow without prior approval of the Association unless its net revenue for the fiscal year next preceding such incurrence or for a later twelve-month period prior to such incurrence, whichever is the greater, shall be not less than 1.5 times the maximum debt service requirement for any succeeding fiscal year on all debt, including the debt to be incurred.  - 22 - 8. AGREEMENTS REACHED AND RECOMMENDATIONS 8.0i During Credit negotiations, agreement was reached on the following points: (a) Empresa Electrica "Quito" S.A. will: (i) consult with IDA on the implementation of its management consultant's recommendations (paragraph 4.04); (ii) appoint a Financial Director within six months of the Credit being signed (paragraph 4.04); (iii) consult with IDA on future appointments to the posts of General Manager, Technical Director and Financial Director (paragraph 4.04); (iv) consult with IDA prior to making any further amendments to its charter (paragraph 4.05); (v) continue to employ consultants for supervising the Project to the extent considered necessary by IDA (paragraph 5.08); and appoint consultants to carry out a study for determining and comparing the economic, social and other benefits of its village electrification program (paragraph 6.07); (vi) employ external auditors acceptable to IDA and submit accounts and auditors' reports within four months of the end of the fiscal year (paragraph 7.07); (vii) revalue fixed assets in 1973 (paragraph 7.13); (viii) apply for an adjustment to its tariffs as and when necessary to enable it to earn a minimum rate of 8% on its properly valued or revalued net fixed assets in operation (paragraph 7.21); and not reduce its tariffs prior to June 30, 1974 (paragraph 7.15); (ix) limit its dividends to 1% of its annual net revenue, unless IDA agrees otherwise (paragraph 7.22); and, (x) not borrow, without prior approval from IDA, unless debt service is covered at least 1.5 times (paragraph 7.23); (b) the Ecuadorian Government will: (i) provide, on terms acceptable to the Association, any funds necessary to complete the Project (paragraph 7.19); and,  - 23 - (ii) authorize EEQ to adjust its tariffs to enable it to earn the agreed rate of return (paragraph 7.21); and not reduce tariffs before June 30, 1974 (paragraph 7.15). 8.02 At the time of signing the proposed Credit, the subsidiary loan agreement between EEQ and the Government should also be signed (paragraph 7.16). 8.03 Conditions of effectiveness of the Credit will be: (a) the appointment of consultants for a tariff study (paragraph 4.07) and management studies (paragraph 4.04); (b) the ratification of the subsidiary Loan Agreement (paragraph 7.16); (c) the amendment of EEQ's charter to reflect current law and conditions (paragraph 4.05); (d) the registration of a mortgage in favor of the Bank, on assets to an extent and on terms satisfactory to the Bank (paragraph 7.17); (e) the execution of contractual arrangements between IMQ and EEQ for the use of IMQ's distribution networks after December 31, 1970 (paragraph 7.11); (f) the provision for payment for street lighting provided to IMQ (paragraph 7.20); and (g) the execution of parallel financing for EEQ's investment program (paragraph 7.17). 8.04 The proposed project constitutes a suitable basis for an IDA Credit of US$6.8 million on the usual terms. September 2, 197)   ANNEX 1 APPRAISAL OF THE THIRD POWER PROdJCT EMPRESA ELECTRICA "jUITO" S.A. ECUADOR ELECTRICITY STATISTICS FOR ECUADORI' 1964 - 1969 Sales (GWh) Consumer Class 19641 1965 1966 1]967 1968 1969 Fixed 9.7 6.o 5.5 5.3 4.3 3.2 Residential 140.6 157.9 173.1 191.2 2l5.9 248.4 Commercial 44.6 52.5 58.6 70.2 81.5 93.0 Street lighting 18.3 19.0 20.2 23.2 26.6 29.4 Industrial 177.1 188.9 208.41 215.9 242.9 283.5 Others 51.7 57.6 42.2 56.2 67.9 71.1 Total Sales 442.0 481.9 508.0 562.0 639.1 728.6 Losses 81.6 88.5 100.4 98.1 111.7 121.8 Generation 523.6 570.4 608.4 660.1 750.8 850.4 Generation (GWh) Ei:EQ 155.7 166.7 1-78.5 196.8 219.2 238.9 EMELEC 189.3 211.2 228.1 246.9 287.3 317.6 Other Companies 105.7 120.3 136.4 134.9 145.3 188.2 Captive Plants 729 72.2 65.4 81.5 99.0 105.7 Total 523.6 570.4 608.4 660.1 750.8 850.4 Installed Capacity (MW) EEQ 40.3 41.9 41.9 61.8 61.8 63.1 EMELEC 52.4 52.5 52.5 52.5 66.o 66.0 Others 45.9 46.8 51.6 66.8 65.8 78.8 Captive Plants 36.1 41.2 40.0 40.7 44.9 61.9 Total 174.7 182.4 186.0 221.8 238.5 269.8 1/ Source: INECEL, EstadIsticas Electricas 1964-1969. Excludes plants of less than 100 kW. May 3, 1971   ANNEX 2 Page 1 of 2 pages APPRAISAL OF THE THIRD POWE PROJECT VEORESA ELECTRICA "QUITO" S.A. ECUADOR INSTITUTO NACIONAL DE ELECTRIFICACION (INECEL) Development of Main Generation and Transmission System in Ecuador 1. INECEL has preliminarily definel/ a development program for generation and transmission to meet main power requirements in the country through 1990, taking into account hydro potentials which have been sufficiently investigated to be considered as alternatives. This program comprises the following works: (a) Construction of the first stage Pucara power plant (64.5 MW) of the Pisayambo hydro project, to be completed in 1975. This project, which presently is being appraised by the Inter-American Development Bank,would also include 137 km of 138 kV line and 10 km of 69 kV line for supply to Quito and Ambato and intermediate towns in the northern half of the country. Total cost would be about US$30 million (US$465/kW). (b) Construction of the first stage Pulpito dam and Molino power plant (100 MW) of the Paute hydro project, to be completed in 1977, followed by an extension of 50 MW in 1979 and 50 MW in 1981. The project includes 160 km of 345 kV lines and 507 km of 138 kV lines for supply to Guayaquil and the main towns in southern Ecuador. Total cost would be about US$98 million (US$490/kW). (c) Construction of the first stage (54 MW) of the Toachi hydro project, to be completed by 1979. The plant would be connected to the Pisayambo system. The transmission system would be extended with 155 km of 138 kV lines and 40 km of 69 kV lines. Total cost would be about US$30 million (US$555/kW). (d) Construction of the second stage (San Miguelito plant 83.4 NW downstream from the Pucara plant) of the Pisayambo hydro project, to be completed by 1982. Total cost would be about US$32 million (US$384/kW). (e) Construction of the second stage (54 MW) of the Toachi hydro project, to be completed by 1985. Total cost would be about US$10 million (US$185/kW). (f) Integration of the country would take place between 1985 and 1990, for which the Molino power station would be extended 1/ Source: INECEL Proyecto Pieayambo, Vol. Anexo 10 Sistema Principal de Generacion y Transmission, Enero de 171.  AN~NEX 2 Page 2 of 2 pages by 200 MW (second stage) followed by the raising of the FiJpito dam and the addition of 375 MW in capacity (third stage). The fourth stage would comprise two additional dams in the Paute river, further additions (225 MW) to the Molino power plant which would reach its maximum capacity of 1,000 MW, and the construction of one upstream and one downstream hydro plant aggregating 260 MW. A 345 kV line would interconnect, the northern and southern system. 2. With the discovery of oil in the eastern part of Ecuador, the above program may have to be modified if it can be. shown that the construction of steam-electric plant in the northern part of the country near the oil pipe line (Which will pass somewhat south of Quito) would be justified. EEQ's consultants will study the location and justification of such plant in close cooperation with INECEL. Funds for this study have been included in the proposed credit for EEQ's Nayon project. Nay 3, 1971  APPRAISAL OF THE THIRD POWER PROJECT EMPRESA ELECTRICA "QUITO" S.A. HISTORICAL AND FORECAST ELECTRICAL DATA (EEQ) Sales (GWh) GENERATION SCHEDUIE (GWh) CAPACITY SCHEDULE (MW) (Average Hydro Conditions) Required Capacity System Capability Sales ~~~~~~~~Hydro iee Demand Hydro Calendar Sales Gross Generation EEQ Others Diesel Market Reserve Total EEQ Others Diesel Total Year Yea------------------------------------------------------------ --- -_---------i_------- _Historical------------------------------------ ---- ---- ------------------ --- ------------------------- ---- 1947 27.5 39.1 39.1 _ _ 8.7 4.0 12.7 10.1 - - 10.1 1955 61.5 75.3 75.3 - - 13.3 4.7 18.0 12.1 - - 12.1 1965 128.5 166.7 160.7 3.8 2.2 37.0 10.0 47.0 32.1 2J 2.0 7.8 g/ 41.9 1966 142.4 178.5 169.8 3.9 4.8 40.0 10.0 50.0 32.1 2.0 7.8 41.9 1967 159.6 196.8 184.1 4.5 8.2 45.2 10.0 55.2 52.1.3 2.0 7.7 6i.8 1968 177.2 219.2 201.8 5.9 11.5 49.4 10.0 59.4 52.1 2.0 7.7 61.8 1969 196.0 238.9 217.2 6.2 15.5 54.1 10.0 64.1 52.1 1.3 9.7 i/ 63.1 1970 / 211.3 Et 262.3 2/ 238.3 6.2 17.8 57.7 10.0 67.7 52.1 1.3 9.7 63.1