Mexico - Las Truchas Steel Expansion Project

Document of The World Bank FOR OFFICIAL USE ONLY AJ . J 5CA>t 0~ & Report No. 1060-ME MEXICO LAS TRUCHAS STEEL EXPANSION PROJECT STAFF PROJECT REPORT June 15, 1976 Industrial Projects Department This document has a restricted distribution and may be used by recipients only in the performance of | their official duties. Its contents may not otherwise be disclosed without World Bank authoriation. |  MEXICO STAFF PROJECT REPORT ON THE LAS TRUCHAS STEEL EXPANSION PROJECT CURRENCY EQUIVALENTS WEIGHTS AND MEASURES Except where otherwise indicated, all 1 Metric Ton = 1,000 Kilograms (kg) figures are quoted in Mexican Pesos (M$) 1 Metric Ton = 2,205 pounds and US dollars (US$). 1 Kilometer = 0.62 miles 1 Meter (m) = 39.3 inches M$1.000 = US$0.08 M$12.50 = US$1.00 M$1,000,000 = US$80,000 ABBREVIATIONS AND ACRONYMS AHNSA Altos Hornos de Mexico, S.A. AISI American Iron and Steel Institute (US) BANOBRAS Banco Nacional de Obras y Servicios Publicos BOF Basic Oxygen Furnace BSC British Steel Corporation CC Continuous Casting Plants CFM Comision de Fomento Minero C & F Cost and Freight CIF Cost, Insurance, Freight CNIHA Camara Nacional de la Industria del Hierro y Acero CONMSA Compania Minera del Estado de Michoacan de C.V. CRNNR Consejo de Recursos Naturales No Renovables db Decibel DWT Dead Weight Tons Fe Iron FOB Free on Board Fundidora Fundidora de Hierro y Acero, S.A. GDP Gross Domestic Product HYLSA Hojalata y Lamina, S.A. IDB Inter-American Development Bank IERI Industrial Economics Research Institute, Fordham University ISSA Inmobiliaria SICARTSA, S.A. Marina Secretaria de la Marina (Navy Ministry) NAFINSA Nacional Financiera, S.A. (National development bank) SICARTSA Siderurgica Lazaro Cardenas - Las Truchas, S.A. (the Company) SOFREMINES Societe Francaise d'Etudes Minieres TAMSA Tubos de Acero de Mexico, S.A. TPY Tons per year (metric) ' Trust Fund Fideicomiso Ciudad Lazaro Cardenas SICARTSA FISCAL YEAR January 1 - December 31 Industrial Projects Department June 15, 1976  FOR OFFICIAL USE ONLY MEXICO APPRAISAL OF LAS TRUCHAS STEEL EXPANSION PROJECT STAFF PROJECT REPORT TABLE OF CONTENTS Page No. SUMMARY .............................................. i - xii I. INTRODUCTION ......................................... 1 II. THE STEEL SECTOR IN MEXICO ........................... 1 A. Industrial Development ........................... 1 B. Historical Development of the Steel Industry ..... 3 C. tMajor Production Facilities and Problems Facing the Industry ..................................... 4 D. Future Plans ..................................... 5 E. Government's Steel Industry Policy .... ........... 6 F. Availability of Raw Materials .................... 7 G. Pricing and Import Systems ....................... 9 III. THE COMPANY .......................................... 13 A. Background and Plant Location ......... ........... 13 B. Ownership ................... ..................... 14 C. Organization and Management ........ .. ............ 15 D. Progress of Stage I Project ........ .. ............ 17 E. Recent Financial Position ......... .. ............. 20 F. Subsidiaries ................ 22 IV. THE MARKET ....................... 22 A. Recent Steel Consumption and Production .......... 22 B. Demand Forecasts for Steel through 1985 .......... 27 C. Supply of Steel Products through 1985 ............ 31 D. Supply and Demand Comparison for the Steel Sector. 31 E. Sales Forecast ................................... 35 F. Geographic Distribution of Sales and Transportation ................ .......... 36 G. Marketing Organization and Policies ............. 36 This report was prepared by Messrs. Nayar, Meunier, Cognet and Verdier of the Industrial Projects Department, in close cooperation with the Inter-American Development Bank. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  -2- Page No. V. PROJECT COMIPONENTS AND INFRASTRUCTURE ................ 37 A. Scope and Objectives ............. .. .............. 37 B. Project Description (Stage II) ......... .......... 41 C. Mining and Infrastructure Requirements ...... # .... 44 D. Ecology ..................... ..................... 49 E. Employment and Training ..... ..................... 51 VI. PROJECT COST AND FINANCING PLAN ...................... 52 A. Capital Cost Estimates ............. . .............. 52 B. Financing Plan ........... ........................ 56 VII. PROJECT IMPLEMENTATION .............................. 61 A. Project Management and Organization ............. . 61 B. Project Implementation ............ .. ............. 62 C. Procurement ................... ................... 64 D. Disbursement .......................................... 66 E. Allocation of Bank Loan ..... ..................... 67 VIII. FINANCIAL ANALYSIS ................................... 67 A. Raw Materials ...................................... 67 B. Production and Production Costs .............. .... 68 C. Projected Revenue ..... ........................... 71 D. Methodology Used in Financial Projections ........ 71 E. Futuire Profitability ..... ........................ 71 F. Financial Position ..... .......................... 74 C. Break-Even Point ..... ............................ 76 H. Financial Rate of Return ..... .................... 77 I. Major Risks ...... ................................ 80 J. Auditing Requirements ..... ....................... 80 IX. ECONOMIC ANALYSIS .................................... 80 A. Alternatives to the Proposed Project ............. 80 B. Economic Rate of Return ........... .. ............. 81 C. Foreign Exchange Savings ........... .. ............ 84 D. Regional Impact of the Project ......... .......... 84 E. Project's Impact on Employment ........ .. ......... 87 F. Transfer of Technology ............ .. ............. 87 K. SUMMARY OF RECOMMENDATIONS ........................... 88 ANNEX Additional Reports and Data Related to the Project Available in the Bank. MAPS IBRD 11930 - Mexico, Las Truchas Steel Expansion Project (Plant Location) IBRD 12021 - Mexico, Major Steel Production Centers  MEXICO LAS TRUCHAS STEEL EXPANSION PROJECT STAFF PROJECT REPORT SUMMARY The Industrial Sector 1. Over the last 30 years Mexico has come to place heavy reliance on industrial expansion to achieve its economic growth targets. The thrust of government industrial policies has been to promote employment opportunities to absorb surplus labor, save foreign exchange through import substitution and by expanding exports of manufactures, strengthen intra- and inter-in- dustry linkages to improve industrial efficiency, and intensify efforts at a wider regional dispersion of industrial investment. Since 1971, the gov- ernment has introduced policies which further emphasize investments in ex- port-oriented projects and the establishment of a geographically balanced industrial structure. 2. Although growth in manufacturing output slowed down in 1974 and 1975, partly as a consequence of the world recession, manufacturing industry has been one of the most dynamic sectors of the Mexican economy. In 1974 it accounted for 30 percent of GDP (as compared with 23 percent in 1940), and provided employment to almost a quarter of the total labor force. Both domestic and export markets have enabled the relatively rapid growth of manufactured output. The product groups which have shown the highest rates of growth of output in recent years have been textiles and wearing apparel, engineering goods, metals and metal products, chemical and petro-chemical products. The growth of output in the last three product groups points to a change in the structure of the industrial sector; consumer goods are losing ground to capital and intermediate goods. Nevertheless, measured in terms of the value of output in 1974, consumer goods industries still accounted for about 57 percent of manufacturing value added. The Steel Subsector 3. Mexico's iron and steel industry is one of the oldest in Latin America. Over the past 30 years it has grown rapidly, and in 1975 pro- duced 5.2 million tons of raw steel. Mexico is now the second largest steel producer in Latin America (after Brazil) and accounts for 29 per- cent of the region's output. There are five integrated steel companies, six semi-integrated plants and some 30 re-rolling plants at the present time. The government has almost complete ownership of the two largest plants and minority interests in two other integrated plants. 4. The Mexican steel industry still has a relatively low level of productivity. Pig iron is produced mainly in small blast furnaces, and only a small proportion of steel is produced with modern techniques. In addition most plants have unbalanced production facilities; installed  - ii - capacity to roll finished products is substantially in excess of steel- making capacity. Also, because of shortages of imported scrap iron and steel many semi-integrated producers have been operating at low capacity rates. The poor location of some plants in relation to raw materials sources and markets also contributes to inefficiency. 5. To improve productivity and satisfy growing domestic demand for steel, the industry in 1972 embarked on a rehabilitation and expansion pro- gram which is designed to increase raw steel production capacity to 9.2 mil- lion tons per year by 1980, or by about 85 percent over 1974 capacity, and to about 11.0 million tons by 1985. The Bank extended a loan 1/ in 1973 of US$70 million equivalent to SICARTSA to finance a new integrated plant at Lazaro Cardenas on the Pacific Coast, to produce raw steel pnd non-flat finished products as part of this program. The project now unler considera- tion constitutes the second stage of SICARTSA's program; it is designed to increase annual raw steel capacity by another 2.1 million tons for conver- sion into 1.7 million tons of flat steel products. Steel Demand and Supply 6. Steel consumption in Mexico increased at an annual average of 10 percent from 1955 to 1975 as compared to an annual growth rate of about 7 percent for the economy as a whole. Construction, manufacturing and the petroleum sector mainly accounted for the growth in steel consumption. In 1975, consumption of finished products reached 4.6 million tons, of which flat products accounted for 2.3 million tons (50 percent) and non-flat products for 2.3 million tons (50 percent). During 1967-1972, domestic steel production kept pace with Mexican needs and covered about 90 percent of requirements but thereafter steel imports increased rapidly, from 152,000 tons in 1972 to 520,000 tons in 1975, while exports decreased from 374,000 to 27,000 tons in the same period. 7. The present supply/demand forecasts are based on the assumption that all of the expansion projects now underway or planned will start on schedule and that the economy will grow at a rate of 4.5 percent per annum until 1980 and 6 percent thereafter. These forecasts suggest that, though there would be a small surplus of steel for export markets in 1980, equiva- lent to 4 percent of production, by 1985 (the first year of full production of the SICARTSA Stage II project) Mexico will produce some 11 million tons of raw steel as compared to a forecast demand of 13 million tons. Mexico would thus experience a production deficit in 1985 even if the economy were to grow at a somewhat slower rate than assumed. 1/ President's Report No. P-1307-ME dated August 21, 1973 and Appraisal Report No. 220-ME dated AuguSt 10, 1973.  - iii - 8. Supply/demand projections of flat steel products, which SICARTSA would produce as a result of this project, indicate that demand will in- crease to 5.2 million tons by 1985. This would result in a 0.2 million tons deficit by that year. Demand and supply comparisons for individual flat products further suggest that, if Stage II achieves full production in 1985, there would be a balance in supply/demand in the case of hot and cold-rolled products, but a deficit of some undetermined magnitude in plate and tinplate products even under the most pessimistic assumptions of demand growth. SICARTSA will study the economic feasibility of installing tinning lines in the early 1980's to supply such a market. Availability of Raw Materials 9. The availability of raw materials, with the exception of scrap, has not been a problem. Mexico has been almost self-sufficient in iron ore, importing only 1 percent of total needs. Proven reserves are sufficient for about 20 years production and domestic iron ore is about half the cost of imported ore. While coal imports for steel production have been less than 10 percent of total requirements, the higher ash content of domestic coals reduce their desirability for steelmaking. Exploitable reserves are sub- stantial, and would be sufficient for at least 35 years of steel production. The government is now planning to intensify exploration for additional re- serves and to determine the best commercial alternative for coal supply to the steel industry. It is, furthermore, undertaking a study of the mining sector as a whole to develop a strategy to encourage mineral exploration and exploitation. The recent discovery of new natural gas fields in the south- east appear promising and could encourage the future use of direct reduction technologies in steel production. Government's Steel Industry Policy 10. Growing dependence on imported steel at a time when Mexico is faced with increasing balance of payment difficulties, uncertain steel availability in international markets in the volume required by the 1980's and the basic nature of steel to industrial activity as a whole, have led the government to aim at national self-sufficiency. The achievement of this goal will re- quire investments of about US$10 billion (at 1975 prices) by 1985. The high capital cost of new plants, and the inability of the private sector to mobilize savings of sufficient magnitude, will result in a much higher government participation in the ownership and financing of the industry if self-sufficiency is to be achieved. While in 1975 the government owned on the average some 36 percent of installed capacity, its share by 1985 is ex- pected to be 60 percent. 11. The industry as a whole and the expansion programs of individual companies are coordinated by the Steel Coordinating Commission, which was created in 1972. The effectiveness of the Commission has been handicapped by lack of sufficient technical staff, late involvement in the review of expansion plans, and lack of independence, as its Board is identical to that of two major steel companies. In view of the substantial financial  - iv - resources that will have to be invested in the steel sector, there is urgent need for an independent body to determine priorities, and the op- timum location, size and technology for the new investments. The govern- ment has provided assurances that it will strengthen the Steel Coordinating Commission (Section 3.04 of the Draft Guarantee Agreement). Import and Pricing Policies 12. Imports of steel products are subject to licensing and import duties which average about 20 percent. The sales of steel products in the domestic market by the Mexican steel producers have been subject to price ceilings since 1956; these ceilings are established by the Price Commission, an Agency of the Secretariat of Commerce and Industry. Up to 1972 market prices were usually lower than ceilings and no distortions resulted from price controls, but during 1973-74 market prices reached ceiling levels and it became evident that the latter were too low. Ceil- ings were increased substantially in 1974 in recognition of increased pro- duction costs throughout the world. 13. The current price ceilings do not enable Mexican producers to benefit from available protection at the present time. In general, Mexican ex-factory prices for steel products are close to ceiling prices, which in turn are below the current CIF cost of comparable imports from Western Europe and Japan. For instance, in May 1976 the arithmetic average ceil- ing price of flat steel products (plates, coal and hot rolled products) was 5 percent below the CIF cost of imports from Japan and 15 percent lower than the CIF cost of imports from Western Europe. The overall re- lationship between domestic and import prices varies over time and may not hold for individual products. Mexican prices are generally in line with domestic prices prevailing within the main world steel markets, which are less responsive to short term fluctuation in demand than international prices. 14. At the occasion of the first Bank loan to SICARTSA, the govern- ment agreed to review steel prices from time to time and to maintain them at levels reasonably related to local production costs and world prices, while allowing steel consumers in Mexico to benefit from the anticipated decline in production costs. A similar assurance has been obtained for the proposed project. Price control procedures were altered in 1974 in order to make them more flexible; producers who now experience cost in- creases of 5 percent or more may apply for a compensatory price increase, and if the Price Commission does not object within 30 days the increase is granted automatically. Project Objective and Scope 15. The proposed expansion is the second stage of the SICARTSA proj- ect and is designed to increase annual raw steel production capacity from  1.2 million tons yearly - the capacity which will be attained on comple- tion of Stage I - to 3.3 million tons yearly. The Stage II project in- cludes facilities to convert all the increased raw steel production into 1.7 million tons of flat products. Stage II is to be completed by 1983 and has been designed to take the Stage III expansion into account; this is tentatively scheduled to be started in 1984 and would increase raw steel capacity to 6 million tons yearly. The Company 16. SICARTSA is a corporation established in 1969 under Mexican law. Its authorized capital was increased to US$528 million equivalent in February 1976. Except for 0.1 percent of the capital which is privately owned, all other shares are owned by the government or its agencies. Shares owned by the government itself (51 percent) may not be transferred since the government intends to maintain its controlling interest. 17. SICARTSA's Board of Directors and the Executive Committee are made up mainly of key government officials. Both the Board and the Execu- tive Committee played an important part in enabling the Stage I project to be carried out close to schedule. The Chief Executive is an experienced and highly competent engineer and the staff is capable, young and dynamic. Some of SICARTSA's top executives may be called upon to serve in other gov- ernment posts when the new administration takes office at the end of 1976, but it can be expected that their replacements will be equally competent. SICARTSA has provided assurances that it will maintain high standards in recruiting executive staff. 18. In the past there has been insufficient coordination amongst company departments and some lack of delegation of authority. Manage- ment is aware of these shortcomings and has recently introduced an im- proved organizational structure to make the start-up and subsequent oper- ation of Stage I easier while the Stage II expansion is being carried out. SICARTSA has a general know-how and technical assistance agreement with the British Steel Corporation (BSC) for design, construction and the ini- tial operation of Stage I; a similar agreement has been reached for the Stage II project and it can be expected to yield equally satisfactory results. In accordance with Mexican law, SICARTSA has external auditors appointed by the Secretariat of Patrimonio Nacional to independently re- view SICARTSA's accounts annually. Assurances were obtained that quali- fied auditors will review SICARTSA's accounts and that audit reports, of the scope and detail satisfactory to the Bank, will be provided annually (Section 5.08 of the Draft Loan Agreement and Section 3.06 of the Draft Guarantee Agreement). 19. Stage I is expected to come on stream in October 1976, a few months behind the original schedule. The delay was mainly due to (i) seis- mic code changes which made the design and execution of civil construction more complex; (ii) late delivery of some steel structures; and (iii) some- what slower than expected plant erection. The cost of the project is now  - vi - estimated at US$870 million equivalent, or 42 percent above the original cost estimate. The increase is of about the same magnitude as in Bank fi- nanced steel projects in Brazil and Turkey which are being carried out at about the same time. Considering that the SICARTSA project involves the erection of a totally new plant in an underdeveloped region of Mexico, that the staff is all new, and that project construction coincided with a period of unusua'lly high inflation throughout tbe world and with some supply con- straints, progress has been impressive. The experience gained in carrying out Stage I, with costs and time schedules as well as with management tech- niques, has been used to develop the Stage II project. Project Components 20. The Stage II project will result in a modern, well balanced plant with expanded ore beneficiation and agglomeration capacity, additional coke ovens designed to operate with indigenous coals, two new blast furnaces, a new basic oxygen steelmaking plant with two 220 ton vessels, a continuous casting plant with three twin strand slab casting machines, and the in- stallation of a new flat products rolling mill complex, including a hot strip mill and a cold reduction mill with related finishing facilities. Considering the longer learning curve associated with capacity build up in the rolling mill complex, in relation to the iron and steelmaking facilities, and to avoid premature investments the Stage II project will be carried out in two phases (Phase A and B). The entire steelmaking and hot-rolling capacity and half the iron making capacity will be installed under Phase A, which is to be completed by the end of 1979, and the remaining ironmaking, cold rolling and finishing facilities will be installed under Phase B, which is planned for completion in 1983. 21. Mines: Company-owned mines will supply both iron ore and lime- stone. As proven iron ore reserves in the vicinity of the plant as esti- mated by the Bank would be of limited duration, it has been assumed for the financial projections that the Company will import approximately 3.0 million tons annually starting in 1988. However, ore exploration is proceeding well and there are indications that economically recoverable reserves could be increased considerably, making ore imports unnecessary and improving the financial and economic desirability of the project. Local coal is of low quality and is located far from SICARTSA's plant; its use would be disadvan- tageous to the Company at present international coal prices. While due consideration is being given in project design to the possible use of local coal, assurances have been obtained that the government will require SICARTSA to use local coking coal only to the extent that it would not be economically or technically disadvantageous to do so (Section 3.03 of the Draft Guarantee Agreement). 22. Ecology: The project has been designed to conform to advanced pollution standards. Pollution control installations for Stage II are estimated at about 7 percent of total equipment cost. Though pollution  - vii - control provisions appear adequate, assurances have been obtained that the Company will carry out the project with due regard to environmental factors (Section 4.07 of the Draft Loan Agreement). Infrastructure Requirements 23. Housing: Construction of Stage I in a hitherto lightly populated region necessitated the development of a city (Lazaro Cardenas) to house and provide services for the employees of SICARTSA and ancillary industries. However, by the end of 1975 only 20 percent of Lazaro Cardenas was completed compared with a planned 80 percent. This delay was largely due to lack of coordination among various agencies. In order to overcome these deficien- cies, responsibility for the completion of the city has now been given to the Banco Nacional de Obras y Servicios Publicos, which has extensive experi- ence in housing development, and the Secretariat of the Presidency is giving its direct support to the project. While no further delays are anticipated, the Bank obtained assurances from the government that adequate support will be given to the city's construction program (Section 3.05 of the Draft Guaran- tee Agreement). The Bank is also considering an urban/regional development project in the Lazaro Cardenas area, and preparations for such a project are currently underway through a special team organized by the Secretariat of the Presidency. 24. Transport Facilities: One of the main advantages of SICARTSA's location is that it is adjacent to a port through which it could import raw material requirements and export finished products. The port is adequate for the Stage II project unless SICARTSA plans to ship a larger proportion than anticipated of its finished products by sea. Assurances have been obtained that SICARTSA will carry out studies with the government prior to the end of 1978, to determine future port requirements and that the government will take the necessary measures to meet project requirements (Section 3.02 of the Draft Loan Agreement and Section 3.02(a) of the Draft Guarantee Agreement). The best alternative to transport SICARTSA's products to Mexico City and the central part of the country is by rail through Nueva Italia. A 200 km rail connection, linking the plant with Nueva Italia, is now under construction and is due to be completed by the end of 1977. The government has agreed to take all necessary steps to complete this connection by the end of 1977 (Section 3.02(b) of the Draft Guarantee Agreement). The road network in the vicinity of the plant is also being improved and will link up with the national network by the end of 1977. Completion of these projects will enable SICARTSA to have satisfactory transport facilities. Capital Cost and Financing Plan 25. The capital cost estimates are based on experience gained on the Stage I project, quotations for equipment and civil works obtained in late 1975 and, for three important components, on actual bid prices quoted in May 1976. Total financing required for Phase A and B of the project, in- cluding working capital and interest during construction, is estimated at  - viii - US$3.6 billion equivalent, of which approximately 55 percent is in foreign exchange. Contingency provisions account for about one third of total proj- ect costs, with price contingencies alone accounting for about US$909 mil- lion. Contingency provisions are adequate and capital cost estimates are reasonable. Of the total financing requirements for Stage II, about US$3.0 billion (83 percent) are for Phase A and US$0.6 billion (17 percent) for Phase B. 26. Because of the long period required to carry out the entire Stage II project, a firm financing plan has only been prepared for Phase A. Proj- ect execution in two phases will enable SICARTSA to finance a significant portion of Phase B with internally generated cash. Financing for the Stage II project will be provided from the following sources, with those shown for Phase B being tentative: Financing Plan for the Project (US$ Million) Phase A Phase B (Definitive Plan) (Tentative Plan) Total % Equity: Gross Capital Increase 1,040.7 77.0 1,117.7 31 SICARTSA Cash Generation 185.1 159.8 344.9 9 Sub-Total 1,225.8 236.8 1,462.6 40 Loans: IBRD 95.0 95.0 3 IDB 95.0 95.0 3 Bilaterals 1,158.3 363.1 1,521.4 42 Local Loan (Govt. or NAFINSA) 409.6 37.5 447.1 12 Sub-Total 1,757.9 400.6 2,158.5 60 TOTAL 2,983.7 637.4 3,621.1 100 27. The proposed Bank loan of $95 million would be for 15 years, in- cluding five years of grace, at an interest rate of 8.85 percent per annum. NAFINSA would charge SICARTSA a fee on the Bank loan sufficient to bring the cost to 10 percent per annum. SICARTSA will bear the foreign exchange risk on all its foreign borrowings, including the Bank loan. The IDB loan would be at 8 percent per annum plus a 1 percent per annum NAFINSA service charge. Nine countries 1/ have agreed to open export credits to finance procurement from the respective country, and the aggregate of such offers is a little above 1/ Austria, Belgium, Canada, Fr-anc-s, Gerinyt ITLaly, Japan, U.K. and U.S.A.  - ix - $1.4 billion. With this magnitude of contingent financing assured, it should be possible for SICARTSA to procure equipment of at least $1.2 bil- lion at competitive prices. The terms of these credits vary somewhat as between supplying countries but on the average they provide credit to cover 85 percent of the value of equipment, including 15 percent for local expenses, with repayment over 10 years starting in mid-1979; the average cost is 9 per- cent per annum including a 1 percent NAFINSA guarantee fee. The government has agreed to increase SICARTSA's paid-in share capital to Mex$20 billion ($1.6 billion equivalent) according to an agreed time-table (Section 2.02 of the Draft Guarantee Agreement and Section 5.01 of the Draft Loan Agreement) and to provide whatever additional resources may be required to complete the project, subject to the requirement that SICARTSA's debt/equity ratio be no greater than 60/40. About $410 million equivalent required to finance local costs would also be provided by the government or one of its agencies in loan funds; these and other loan funds which might be provided by the government to meet SICARTSA's needs would be at terms and conditions satisfactory to the Bank (Section 2.03 of the Draft Guarantee Agreement). Project Implementation 28. The General Manager of the Planning and Development Department of SICARTSA, will be responsible for carrying out the project under the overall guidance of the Director General. While SICARTSA has gained con- siderable planning and project execution experience with the Stage I proj- ect, the Company has extended its technical advisory agreement with the British Steel Corporation (BSC) for engineering and procurement and for technical assistance, training, and know-how for flat steel product processing. Engineering and procurement for the project has commenced and tender documents have been issued according to Bank guidelines. It is anticipated that the Company will be able to place all major contracts by the second half of 1976. Procurement 29. Project financing will be on a parallel basis with separate single responsibility equipment packages for the Bank, IDB and bilateral lenders. These packages have been made as large as technically and economically fea- sible to avoid coordination problems and the administrative burden experi- enced during Stage I. The equipment, spare parts and building structures to be financed by the proposed Bank loan will be purchased through international competitive bidding according to Bank guidelines. A bidding and preference system has been adopted which recognizes that procurement must be in large packages with single contractor responsibility covering items which might otherwise be tendered separately. Since local suppliers are not expected to meet pre-qualification criteria for such overall responsibility, an in- centive to use Mexican resources will be given to non-Mexican bidders, as was done in the case of the Bank loan for Stage I, by way of a 15 percent margin of preference (or the prevailing import duty, whichever is lower) on the clearly identified Mexican components_of non-Mexican bids. For this  x purpose, a component is defined as Mexican when supplied by a company in- corporated in Mexico, and when the cost of local materials, labor and ser- vices used in its manufacture are not less than 50 percent of the total value of the component. In the event that Mexican companies prequalify to bid directly, and not simply as sub-suppliers, their bids would be con- sidered entirely Mexican if Mexican value added reached 50 percent. Such bidders would benefit from preference on the entire bid price. Procurement under the IDB loan will follow similar principles. Bilaterally financed items are likewise being procured under similar international competitive bidding procedures except that credit terms will be taken into account for purposes of bid evaluations. Civil works, which are to be financed out of local funds, will be procured competitively in Mexico as the domestic con- struction industry is large and competitive enough to service the project. Disbursements 30. The Bank loan would finance the cost of equipment and spares for a blast furnace, and the building structure, equipment and spares for the cold rolling mill. Disbursements would be on the basis of 100 percent of foreign expenditures or the ex-factory cost of goods manufactured in Mexico. It is estimated that about 39 percent of the value of contracts to be fi- nanced by the Bank would originate in Mexico. Disbursement would be com- pleted in 1980. Marketing and Prices 31. SICARTSA's overall share of the domestic market for steel products is expected to increase from 13 percent in 1980, to 30 percent in 1985. Even under conservative demand assumptions, the domestic market is expected to absorb the entire production by 1985, though some small surplus for ex- ports may develop between 1980 and 1984. SICARTSA has recently completed a comprehensive plan for marketing its products in the domestic market, which appears to be adequate. 32. For purposes of revenue projections, the average net price to SICARTSA (in 1975 terms) has been assumed to be the same as present market (and ceiling) prices for flat products and about 10 percent below present market (and ceiling) prices for non-flat products. The latter adjustment was made as long-term prices for non-flat products are likely to decrease somewhat as SICARTSA, which is expected to be more efficient than existing producers, enters the market and as temporary demand pressures ease. Financial Analysis 33. The financial projections in current terms are based on the assump- tion that steel prices and operating costs will increase by 5 percent and 7 percent per annum respectively; labor costs are assumed to increase by 12  - xi - percent yearly. Projections under these assumptions indicate that SICARTSA can remain financially viable even if its steel prices increase at a slower rate than the general level of prices in Mexico. While SICARTSA's long-term financial position can be expected to be strong, it is likely to experience cash shortfalls in 1976 and 1977, the first two years of the Stage I opera- tion, and in 1980, the first year of operation of Stage II. The government has however undertaken to provide sufficient resources to SICARTSA to enable it to conduct its operations and meet its obligations until project comple- tion and to ensure that its current ratio is at least 1.5/1 at the time of project completion (Section 2.03 of the Draft Guarantee Agreement). The Company is not expected to start paying dividends prior to 1984 based on the agreed dividend covenant for Stage I. A similar covenant, provides that no dividends will be paid until the debt/equity ratio drops below 50/50, or if the result would be to lower the current ratio below 1.5:1, or if cumulative dividends would exceed one half cumulative net income, (Section 5.03(b) of the Draft Loan Agreement). The Company has also provided assurances that it will not incur any new long term debt if the result would be to increase its debt/equity ratio above 60/40 and/or to reduce the debt- service coverage below 1.5 (Section 5.03(c) of the Draft Loan Agreement). SICARTSA also provided assurances that it would undertake additional in- vestments above US$25 million per annum up to project completion only after agreement with the Bank (Section 5.02(a) of the Draft Loan Agreement). 34. The incremental financial rate of return of the project is esti- mated at 12.5 percent, or 13 percent if the entire iron ore requirements of SICARTSA could be met from its own mines. Economic Justification 35. Since SICARTSA will be able to sell flat steel products at prices comparable to those of imports, the execution of the project is of high priority in view of the foreign exchange it would save (over $350 million per year when in full production), and the transfer of technology which would result from it. The incremental economic rate of return is 12.7 percent if benefits are calculated on the basis of conservative interna- tional steel price forecasts. The return would increase to 15 percent if foreign exchange is shadow priced by 20 percent. A recent Bank study suggests that international steel prices may increase in real terms in the near future and based on this more optimistic forecast, the economic rate of return would be 19.0 percent without shadow pricing foreign ex- change. 36. The SICARTSA project is a major step in carrying out the gov- ernment's policy of decentralizing economic activity from the Mexico City metropolitan area, which is suffering increasingly from congestion and environmental problems. The project is located in a relatively underde- veloped region of the country, with iron ore deposits close at hand and good transport facilities to both domestic and foreign markets; it is the  - xii - best alternative for expanding the domestic. supply of steel. The govern- ment intends to further develop the area in which the project is located by promoting the establishment of engineering industries so as to turn the region into a focus of future industrial expansion. Conclusions, Major Loan Conditions and Recommendations 37. The proposed Stage II project is part of the overall economic development plan for the country. In order to accelerate the development of the capital and consumer goods industries in Mexico, the government in- tends to achieve self-sufficiency in steel, at competitive prices, utiliz- ing local resources whenever possible. Decentralization of industrial activity around development poles in underdeveloped regions is another important goal of the government. The project has been developed to meet these two basic objectives. The Bank, together with the IDB, has played a major role in the Stage I project and, through it, the overall develop- ment of the Mexican steel industry. By providing limited amounts of fi- nancing for the proposed project and by acting as a catalyst for lending by other sources, the Bank will continue to play this role in the Stage II expansion. 38. The major risks inherent in the project relate to its large size, possible delays in receiving the required funds from the government, and the ability of the Company's management to carry out the project while Stage I is being constructed and subsequently operated. The government is fully aware of the magnitude of the required funds and it is expected to make every effort to provide them as promptly as needed since it attaches very high priority to the steel industry's development. The risk of the Company's management being overburdened is not great, since various meas- ures, including a reorganization and the extension of the contract with BSC, have been taken to strengthen management and prevent any interference -of Stage I with Stage II. 39. The most important of the recommended covenants are concerned with (i) strengthening the role of the Steel -Coordinating Commission; (ii) maintaining steel prices at levels reasonably related to domestic production costs and world prices; (iii) the timely payment of equity capital and the availability of local loan funds at satisfactory terms; and (iv) ensuring the Company's continued financial soundness by agreeing with SICARTSA that certain debt/equity and current ratios will be met and that borrowing, investments and dividend payments will be regulated. 40. Subject to the foregoing agreements, the project provides a sound basis for the proposed loan to SICARTSA and NAFINSA.  I. INTRODUCTION 1.01 This report appraises the proposed expansion proj-"t (SF 7 of Siderurgica Lazaro Cardenas Las Truchas, S.A. (SICARTSA), virtually wholly-owned by the Government and its agencies. SICARTSA is presently implementing an integrated steel plant (Stage I), to produce non-flat pro- ducts, with a capacity 1/ of about 1.2 million tons of raw steel equivalent per year (TPY), at Lazaro Cardenas in the State of Michoacan on the Pacific Ocean. The Stage I project, for which a Bank loan of US$70 million was approved in August 1973, 2/ is expected to be completed by the fourth quarter of 1976. The Company has already started work on the first expansion project (Stage II) with an additional capacity 1/ of 2.1 million TPY of raw steel equivalent in the form of flat products, for which Bank financing is being sought. The Stage II project, which will be implemented in two phases, is expected to be completed by 1983. Total financing required for Stage II, including additional working capital and interest during construction, is estimated at US$3.6 billion of which about US$2.0 billion is in foreign exchange. The proposed Bank loan would be US$95 million, about 3% of total financing requirements, and would be for equipment which is all to be inter- nationally bid. 1.02 The project is part of an overall economic development strategy of the country. In order to accelerate development of capital goods and consumer goods industries in Mexico, the Government strategy is to achieve self-suffi- ciency in steel, at competitive prices, utilizing to the extent possible local resources. Decentralization of industrial activities by creating future development poles in underdeveloped regions has also been an important goal of the Government. The project has been developed to meet, inter alia. these two basic objectives. The Bank together with the Inter-American Development Bank (IDB), has played a major role in Stage I project preparation and implementation, and through it, the overall development of the Mexican steel industry. The Bank will continue to play a similar role in the Stage II expansion program and in the Mexican steel sector. 1.03 The proposed project was approved by the Government in November 1974 and the formal application to finance the project was submitted to the Bank in December 1974. The project was pre-appraised in Mexico jointly with IDB in May 1975 and also jointly appraised between October 20 and November 10, 1975 by a mission consisting of Messrs. Nayar (Chief of IBRD mission), Meunier, Cognet, and Verdier of the Bank and Faria (Chief of IDB mission), Pokorny, Odinec, Palmer and Kelly of IDB. Messrs. Newman and Parker of the Bank re- viewed the port facilities and requirements for the Project. 1/ This capacity is 90% of installed capacity. 2/ IBRD report No. 220-ME dated August 10, 1973 - "Appraisal of the Las Truchas Steel Project Mexico".  - 2 - II. STEEL SECTOR IN MEXICO A. Industrial Development 2.01 Over the last 30 years, Mexico has been relying heavily on in- dustrial expansion to achieve its income, employment and economic growth objectives. The thrust of Government industrial policies has been to promote employment opportunities to absorb surplus labor, increase foreign exchange earnings through a rapid expansion of manufactured exports, strengthen intra- and inter-industry linkages and intensify efforts for a wider regional disper- sion of industrial investment. Since 1970, the Government has demonstrated an increasing commitment to investments in import-saving and export-oriented projects while striving at a geographically balanced industrial structure. 2.02 Industry today represents one of the dynamic sectors of the Mexican economy. In 1974, it accounted for 30% of GDP (as compared with 14% in 1940), about 26% of gross domestic investment and 23% of the total employment. The following table shows the sharp increase in the share of industry in GDP over 1965-1974: MEXICO - Gross Domestic Product at Constant 1960 Market Prices Billions of 1960 M$ % of GDP 1965 1974 1965 1974 Total GDP 212.3 375.1 100.0 100.0 of which: Agriculture 30.2 36.5 14.2 9.7 Services 124.1 223.9 58.5 59.7 Industry 58.0 114.7 27.3 30.6 2.03 Both domestic and export market demands have contributed to the rela- tively rapid growth of manufactured output, with the most important product groups in recent years (in terms of annual rates of growth) being textiles and wearing apparel, engineering goods, metals and metal products including steel, and chemical and petrochemical products. The growth of output in the last three product groups points to a changing structure of the sector and reflects the Government's policy to broaden and diversify the country's in- dustrial base. However, measured in terms of value of output in 1974, con- sumer goods industries led by processed food products still dominate the sector.  - 3 - 2.04 Although initially Mexican industry grew up under substantial pro- tection, growth of manufactured output from the mid-1960s onwards has been accompanied by rapidly increasing industrial exports without unduly high sub- sidies or export incentives. These exports increased from about M$3.3 billion in 1965 to M$16.3 billion in 1974 (excluding exports of assembly industries along the US-Mexican border), accounting for nearly 46% of total merchandise exports and representing about 6% of industrial production. Most notable gains in manufactured exports during 1970-74 have been in textiles, apparel and footwear (64%). Non-traditional items such as machinery, electronics, and automotive parts (55%) also showed a high growth rate reflecting the growing integration between Mexican part suppliers and the US industry and the success of the export promotion policies instituted since 1971. 2.05 The steel industry, which only accounts for 3% of GDP and an even smaller percentage of total employment, nevertheless plays a key role in the economic development of Mexico by supplying the industrial sector with a basic and critical raw material it needs for growth and development. Mexico has relatively large known reserves of two raw materials critical to the steel industry - iron ore and coal. There are indications that natural gas, another increasingly important input for the industry, may also become available increasingly in abundant quantities in the near future. This favorable raw materials situation is making it possible to develop a strong domestic steel industry. B. Historical Development of the Steel Industry 2.06 The Mexican steel industry traces its history back to 1900, when the first integrated iron and steel plant and a rolling mill for shapes and rails were established at Monterrey by Fundidora de Hierro y Acero, S.A. (Fundidora). It produced 11,000 tons of ingot steel in 1903, the first year of production, and by 1911 output had risen to 72,000 ingot tons. The next major development took place in 1941, when Altos Hornos de Mexico, S.A. (AHMSA) began to build an integrated steel mill for flat products at Monclova. The plant, commissioned in 1945, was conceived as a wartime measure to achieve a certain degree of independence from imports and was given special facilities for procuring new and used equipment from the US. In 1950, raw steel pro- duction was 333,000 tons and contributed less than half of apparent domestic consumption (42%). Since then, the industry has grown considerably and in 1975 it produced 5.2 million tons of raw steel which supplied about 83% of apparent steel consumption. Mexico is now the second largest steel producer in Latin America (after Brazil) accounting for 29% of the region's output.  -4- 2.07 The production profile of the industry in 1975 was as follows: MEXICO - Steel Production (1975) (1,000 tons) Non-Flat Primary Iron Raw Steel Steel Products Flat Products Products % of % of % of % of % of Company /1 Tons Total Tons Total Tons Total Tons Total Tons Total AHMSA 1,498 51 2,126 42 1,570 38 1,045 52 525 25 Fundidora 550 19 746 20 545 13 435 21 110 5 HYLSA /2 664 22 1,278 15 980 24 545 27 435 21 TAMSA /3 250 8 344 8 215 5 - - 215 10 Semi-Integ. Plants (4) - - 756 15 585 14 - - 585 27 Re-Rolling Plants (30) - - - 0 243 6 - - 243 12 TOTAL 2,962 100 5,250 100 4,138 100 2,025 100 2,113 100 /1 Ownership of the companies is as follows: AHMSA, 82% public; Fundidora, 64% private; HYLSA, 100% private; TAMSA, 83% private; and semi-integrated and re-rolling plants, 100% private. /2 HYLSA - Hojalata y Lamina, S.A. /3 TAMSA - Tubos de Acero de Mexico, S.A. In 1975, flat products represented 49% of total production while non-flat products and seamless pipe accounted for 46% and 5%, respectively. Companywise, AHMSA and Fundidora output was mainly flat products while HYLSA's products were about evenly divided between flat (55%) and non-flat (45%) products, TAMSA produced almost exclusively seamless pipes, and the semi-integrated plants produced only non-flat products. C. Major Production Facilities and Problems Facing the Industry 2.08 One of the major weaknesses of the Mexican steel companies is their relatively low productivity. Pig iron is still produced mainly in small blast furnaces and only a small proportion of the steel is produced using modern processes. For example, AHMSA's primary iron production is based on small and medium size blast furnaces. Its steelmaking facilities are evenly divided between the high cost open hearth and the more modern basic oxygen furnace (BOF). The rolling facilities include a plate mill, a hot-strip mill, cold-rolled mills, tin lines, wide-flange mills, bar and rod mills and two small mills for specialty and carbon steels. The main problem facing the operation of AHMSA is an insufficiency of pig iron capacity resulting in an underutilization of steelmaking equipment. The Fundidora primary iron production facility is based on the conventional process and comprises two blast furnaces, one of them built recently. All steelmaking facilities, even the most recent, have open-hearth furnaces  which adversely affect the productivity of the plant. The rolling facilities include a structural mill, a merchant mill, a hot-strip mill and a cold-rolled mill. In addition to the replacement of some obsolete facilities, the facilities require balancing of the steelmaking capacity with the rolling capacity. HYLSA's primary iron production is based on the direct reduction process and includes two plants in Monterrey (one started in 1974) and one in Puebla. Steel is produced in electric furnaces and in rolling facilities including hot-strip mills, cold-rolled mills, a tin line, and a rod and bar mill. TAMSA is the only seamless pipe producer in the country. It produces primary iron by the direct reduction process. Steelmaking facilities consist of electric furnaces, and rolling facilities are limited to seamless pipes. 2.09 Compared to the world average, the use in Mexico of the different processes for steel making is as follows: MEXICO - Steel Making Processes Used in the World and in Mexico Process Percentage of production (%) World Average Mexico Open hearth 17 42 Electric Furnace 20 45 Basic Oxygen Furnace 63 13 Other factors which affect productivity include imbalances among the capa- cities of the different facilities in most of the plants as already men- tioned in the case of AHMSA. The installed capacity for rolling finished products is substantially in excess of the steelmaking capability. Further- more, during 1974, the higher price and reduced availability of imported scrap forced semi-integrated producers to produce at low utilization rates. 2.10 Another problem facing the industry is the location of the existing plants, which in some cases, are relatively far from the main iron ore mines and consuming centers. The distances between the main plants and their iron ore deposits, coal mines and main markets are as follows: MEXICO - Distance Between Plant, Raw Materials Sources and Market (in miles) Company Iron Ore Coal Market AHMSA 250 and 950 220 750 Fundidora 410 and 290 250 Near HYLSA 650 and 940 - /1 Near TAMSA 650 - /1 80 /1 No coal used in process. D. Future Plans 2.11 To improve the productivity of the industry and satisfy the growing demand for steel, the steel companies prepared in 1972 extensive expansion  - 6 - programs, which were accepted by the Steel Coordinating Commission (para 2.16) in 1973. These expansion programs, including SICARTSA Stage I, are all well underway and they will increase raw steel production by 85% to 9.2 million tons by 1980. During 1974, the Steel Coordinating Commission accepted SICARTSA's Stage II project which, if implemented according to the present schedule, will achieve full production in 1985 and increase Mlexico's raw steel production to 11 million tons. 2.12 In terms of the individual expansion plans, the main items included in the AHMSA expansion program include the installation of a new blast furnace (1.5 million TPY), a new BOF shop (750,000 TPY) with a single vessel, a con- tinuous casting machine and additional rolling facilities for flat and non- flat products. Fundidora's expansion program consists of a new iron ore concentration and pellet plant, enlargement of the most recently completed (1969) blast furnace (450,000 TPY), and installation of a new BOF shop with two vessels (together 1.5 million TPY) to increase the steelmaking capacity to overcome a major bottleneck. It also includes expansion of hotrolling facilities and improvements to the cold-roll mills. The expansion program of HYLSA consists of a new direct reduction plant (500,000 TPY), installa- tion of a new electric furnace (100 TPD), a new cold rolling mill and minor improvements to the steelmaking, rolling and finishing facilities. TAMSA's expansion program includes minor expansions of the direct reduction plant, electric furnace and rolling facilities. SICARTSA's Stage II, the project under consideration, consists of the construction of a fully integrated plant for the production of about 1.7 million tons of flat product equiva- lent to about 2.1 million tons of raw steel. 2.13 Additional new investment programs are presently under considera- tion by the steel companies. AHMSA is considering the installation of a new greenfield plant of 4 million TPY of raw steel, although there seems to be still some room for expansion of the existing facility by adding another blast furnace and two vessels in the BOF shop which could increase its raw steel capacity by 1.8 million TPY. Lack of space available in Monterrey appears to be the main problem for further expansion of Fundidora in this location. SICARTSA has substantial scope for expansion of the existing facilities, in addition to the proposed expansion program. The many potential alternatives for growth and development of the sector under- line the importance of having a strong, capable and efficient coordinating body which will ensure that the expansion plans to be implemented are con- sistent with each other and with the economic development goals of the country. E. Government's Steel Industry Policy 2.14 The growing need to import steel, at a time when Mexico is faced with increasing balance of payment difficulties and uncertainty of longer range steel availability in the international market, had led the Government to aim at self-sufficiency in iron and steel in order to ensure availability of this basic input for the development of the country. This policy would necessitate major investments for expanding domestic steel production during the next decade. It is estimated that US$10 billion (in 1975 prices) will have to be invested by 1985 in the steel industry in order to meet projected domestic demand.  -7- 2.15 The very high cost of investment in new capacities, coupled with the inability of private sector to raise funds of such magnitude, is bringing about a much higher Government participation in the ownership and financing of the industry. The Government has almost complete ownership of AHMSA and SICARTSA, representing 36% of total projected production in 1976. It is ex- pected that, with the projects underway in both companies, this share will increase to 50% in 1980 and 60% in 1985. The Government is also part owner of Fundidora and TAMSA. 2.16 Coordination of the investment programs of the steel companies is exercised through the Steel Coordinating Commission. Created in 1972, after extended discussions with the Bank, the Commission's primary objec- tive is to optimize (from the country's rather than individual companies' point of view) the overall development of the industry. The Commission was placed under the responsibility of the Ministry of Patrimonio Nacional and serves as an advisory body to the Government in the formulation and appraisal of the production and expansion programs of the steel industry (IBRD Report 220 ME - Appraisal of the Las Truchas Steel Project, August 10, 1973). Up to now the effectiveness of the Commission in carrying out its function has been limited. The participation of the Commission in evaluating investment programs is often marginal; due to its limited budget (US$250,000 in 1975), it lacks the necessary expertise to fulfill its ob- jectives. Also, in the case of investment programs of Government-owned companies, the review of the projects is performed by the Commission after the Board of Directors of these companies has approved the programs. This is a very limiting factor in the effectiveness of the Commission, since the membership of the Boards of SICARTSA, AHMSA and the Commission are similar. In view of the substantial financial resources that will have to be invested in the steel sector and the critical decisions to be taken in the field of raw materials, the necessity of an independent body to decide on the need, location, size and technological process of new investments has become imperative. The Government is well aware of the situation and is develop- ing plans to strengthen the Steel Coordinating Commission. The plans, reportedly include the appointment of qualified staff in the Commission, the involvement of the Commission at an early stage of any project develop- ment and procedures to give more importance to the Commission's recom- mendations in the decision making process and a possible change in its Board composition. Moreover, the Government has agreed to take all reasonable action required to strengthen the role and expertise of the Steel Commission. F. Availability of Raw Materials 2.17 In the past, the availability of steelmaking inputs has not re- presented a problem to the industry, an exception being imported scrap which during 1973-74 was in very short supply. The problems facing the industry are more in terms of lack of adequate management and of development of these raw materials rather than their availability. In the near future, important decisions are expected to be taken by the Government relating to the existing raw material sources. The Ministry of Patrimonio Nacional is at present carrying out various studies, which are expected to be completed by late 1977, to establish national exploration policy, pricing policy, import policy,  - 8 - plant location, production incentives and systems to more efficiently exploit known potential reserves. 2.18 Iron Ore: Up to now, Mexico has been almost self-sufficient in iron ore, importing only about 1% of total consumption and it has been estimated that for some of the companies the cost of using domestic iron ore is about half the cost of importing it. The main iron ore deposits are located in the north, northwest, west, and on the Pacific coast. Identification of potential reserve zones is carried out by the Consejo de Recursos Naturales No Renovables (CRNNR) in the Ministry of Patrimonio Nacional; concessions for exploration and exploitation are also granted by this Ministry. Most of the iron ore mines are exploited by the subsidiaries of steelmaking com- panies, and the commercialization is very limited amounting to about 4% of total consumption. The presently known exploitable reserves are estimated at about 580 million tons, 1/ allowing for about 20 years of steel production, assuming that production would fully satisfy the increasing demand. The total iron ore reserves, including inferred reserves, are estimated to be about 950 million tons. The ownership of these reserves is mainly in the hands of a few companies. For example, Fundidora, which has no plans for large scale development, owns 35% of the measured reserves. The studies, which are carried out by the Ministry of Patrimonio Nacional, to develop an overall mining stra- tegy and to find ways to increase the exploitation and exploration of iron ore reserves are particularly important considering the relative concentration of ownership of reserves in a few companies. 2.19 Coal: Imports of coal for steel production have been low, less than 10% of total requirements. As in the case of iron ore, coal has been produced in mines owned by the steel companies mainly in the northern part of Mexico where the main deposits are located. The exploitable reserves of coking coal are estimated at about 350 million tons, 1/ enough for 35 years of steel pro- duction, if production follows estimated demand levels. This estimate is probably very conservative considering the huge amount of reserves (1,900 million tons) and the low level of present exploration. Mexican coal is high in ash content (17% vs 7% for imported coal) which substantially lowers its attractiveness for steel production. A study prepared by SICARTSA in 1975 concluded that given coal location, transport cost of domestic coal, prices and efficiencies of imported vs domestic coal, and other related technical and economic considerations, it would be more economical to import coal. However, if the present technical and economic relationships change in the future, the use of local coal in SICARTSA's operation can become attractive. In this regard, the studies mentioned earlier (para. 2.17) are to develop plans to substantially increase the exploitation of coal reserves, firm up estimates of existing reserves, the cost of their exploitation and their technical characteristics, establish the best alternative to supply coal to the in- dustry, and develop the necessary strategy and policies. 2.20 Gas: In recent years, Mexico has been increasingly facing a short- age of natural gas, particularly in the north of the country. However, it 1/ Taking 80% of the measured reserves, 50% of the indicated and 10% of the inferred reserves.  -9- seems that the situation has substantially improved with the recent discovery of new gas fields in the southeast and north of the country. These new discoveries appear promising for an increased use oll direct reduction techno- logies in steel production. In connection with the develoment of the steel sector, the Steel Coordinating Commission will study these alternatives (para 2.16). 2.21 Steel Scrap: Due to lack of availability of scrap in the country, Mexico imports considerable quantity of steel scrap and it will continue to do so in the future. Scrap is imported principally from the US for use in the semi-integrated steel plants which have electric furnaces and in the past five years, annual imports have ranged between 511,000 and 968,000 tons, averaging about 700,000 TPY. Rerollable materials, mainly rails and slabs, for the use of rerollers have also been imported to the extent of about 165,000 tons in 1974. G. Pricing and Import Systems 2.22 In Mexico, prices of steel products are subject to ceilings established by the Price Commission, an agency of the Ministry of Commerce and Industry. The price policy established in recent years by the Government takes into consideration domestic production costs, world price levels and the financial viability of steel producers. Official lists show ex-factory prices, and additional charges are levied for packing and handling. Apart from the base price, there is the usual range of "extras" for size and quality variations. Turnover tax is levied at 4%, 1/ but this is paid by the customer although, sometimes in the past, competitive conditions made it necessary for the producer of non-flat products to absorb this cost. Similarly, the transport cost, which is normally payable by the customer, is sometimes borne by the producer whenever competitive conditions make this necessary. 2.23 Ceiling prices were first established in 1956. These ceiling prices incorporated certain distortions in favor of non-flat products (prices of non-flat products at that time were equal to and, in some cases, higher than flat products), which reflected certain protection for the semi-integra- ted and re-rolling plants. In practice, however, this price control and its inherent distortions were nominal until the early 1970s, since ceiling prices had been fixed at levels seldom achieved in the market place. Also in 1969, flat-rolled product prices were increased on the average by 15% when the two main producers, AHMSA and Fundidora, demonstrated that their costs had risen sharply and that they would incur heavy losses at the old ceiling prices. 2.24 As late as January 1972, prices for the most important non-flat product in Mexico, reinforcing bars, were substantially lower than the permis- sible ceiling prices. They were almost at the ceiling level in 1969, but declined in 1970 and continued to be depressed in 1971. During 1972-73, prices 1/ In the case of SICARTSA, or any other industrial concern operating in an underdeveloped region, this tax is only 1.8% which gives them a small competitive advantage.  - 10 - climbed back to the ceiling level. In 1974, ceiling prices for flat and non- flat products were substantially increased as a result of a steep increase in the cost of raw materials throughout the world as well as a very tight international market for billets and scrap, which further increased the cost of production of the semi-integrated and re-rolling plants. These increases introduced distortions in the price relationship between flat and non-flat products. The evolution of official ceiling prices for major steel products is shown in Table 2-1. Furthermore, in the case of non-flat products, the demand increases due to the Government housing program as well as other public investments putting additional pressure on the price of these products and a temporary parallel market developed at the distributor's level, with prices for reinforcing bars reaching as high as US$500 per ton. 2.25 As a result of continuing inflationary pressures in the economy, the Ministry of Industry and Commerce introduced significant changes to the price control system at the end of 1974. Under the new procedure, pro- ducers who experience a 5% or more increase in the cost of production may request a compensatory price increase. If the Price Comission does not object to the petition within 30 days, the increase is granted automatically. In addition, a 5% to 15% margin was established for sales through distributors. The Government has confirmed that the assurances regarding pricing policy given for the Stage I project would also be extended to the life of the proposed loan for the Stage II project. This would mean that the Governmennt will review steel prices in Mexico from time to time and use its best efforts to maintain prices at levels that (i) are reasonably related to Mexican pro- duction costs and world price levels, and (ii) allow steel consumers in Mexico to share in any decline in production costs through reductions in steel prices. 2.26 Using the newly-established procedure for granting price increases, the industry was granted new higher ceiling prices during 1975 which further distorted the relationship between flat and non-flat prices. The new price ceilings for uncoated flat products which range from US$320 to about US$420, including average extras (US$260 to US$316 per ton without extras), appear to be reasonable in view of Mexican production costs, estimated capital costs of new plants and expansion and the Government policy of ensuring financial viability for steel projects, of which at least 50% (in terms of production) are Government-owned. 2.27 The price ceilings established for non-flat products which range from US$351 to US$374 per ton, including average extras, appear to be on the high side and were mainly the result of temporary internal demand pres- sures and international and domestic raw material cost increases. The slow- down in economic activity in Mexico during 1975 virtually eliminated the temporary parallel market that had developed mainly in non-flat products. It is also estimated that the increased supply of these products as of the end of 1976 (SICARTSA I production), as well as the anticipated more normal price situation for scrap and billets, will generate downward pressure on the prices of non-flat products and most likely keep them below the ceiling prices and thus somewhat correct the distortions. For purposes of the financial analysis of the project, the Bank adjusted downward the average FOB price of non-flat  MEXICO: LAS TRUCHAS STEEL EXPANSION PROJECT EVOLUTION OF OFFICIAL CEIIJNG PRICES FOR STEEL PRODUCTS PRICE TON FOB PLANT (US$) 19U5i 19 March June / September /2 March - October /2 /I /2 /2 /I /2- Plate 144.6 161.8 186.2 227.1 227.1 216.2 267.5 267.5 267.5 267.5 323.2 Hot-Rolled Products 166.7 178.7 205.6 257.1 257.1 242.5 305.3 305.3 305.3 305.3 344.3 Cold-Rolled Products 174.1 188.2 216.2 282.4 282.4 259.4 340.4 340.4 340.4 340.4 432.0 Total Flat Products (Avg) 163.7 176.2 202.7 255.6 255.6 239.4 304.4 304.4 304.4 304.4 366.5 Reinforcing Bars 184.2 184.2 184.2 184.2 184.2 208.6 208.6 355.0 310.2 355.0 374.1 Wire Rods 164.3 164.3 164.3 164.3 164.3 211.7 211.7 358.4 251.6 366.4 370.4 Light Sections 174.8 174.8 174.8 174.8 174.8 209.8 209.8 354.4 273.8 354.4 351.5 Solid Bars 172.5 172.5 172.5 172.5 172.5 207.0 207.0 354.4 271.0 354.4 368.1 Total Non-Flat Products (Avg) 174.0 174.0 174.0 174.0 174.0 209.3 909.3 355.6 276.6 357.6 366.0 Total Steel Products 168.8 175.1 188.3 214.8 214.8 244.3 256.8 330.0 290.5 331.0 366.3 /1 Base price FOB plant. /2 Base price plus additional charges for extra FOB plant. r13 Industrial Projects Department December 1975  - 12 - products to about US$320 per ton, which is US$35 below the ceiling price and which appears to more reasonably reflect long-term prices. 2.28 A comparison of domestic prices among major steel producing coun- tries is normally difficult because of their different classification, product characteristics and grades, their system of charging extras, and internal re- gulations of the industry including, in some cases, price control and other related systems. This comparison is even more difficult at present consider- ing that domestic as well as international prices have been substantially affected by the world economic recession, though not in a uniform pattern among the countries. In May 1976 the Bank, with the assistance of Industrial Economic Research Institute of the U.S., completed an indepth study of future international long-term steel prices. Based on the finding of this study, it can be said that at the present time base prices for uncoated flat products in Mexico, which were increased during 1975 and range from US$260 to US$316 per ton, are on the average in line with the present U.S. and Western European domestic prices as shown in the following table: MEXICO - International Comparison of Flat Steel Prices (In May 1976 US$ per ton) Mexican Estimated Import Prices Domestic Prices /1 Domestic Ceiling Western Long-Term /3 U.S.A. Western Europe Prices Japan /2 Europe /2 Estimate Plates 285 320 257 285 325 335 Hot Rolled Products 275 205 283 280 310 325 Cold Rolled Products 330 270 316 330 355 365 Average 297 265 285 298 330 342 /1 Base FOB prices, excluding extras. /2 May 1976 FOB export prices excluding extras and import duties in Mexico but including freight and handling charges to Mexico. /3 Based on economic price used in this report (para 9.05), but excludes extras and includes inflation between October 1975 and May 1976. 2.29 As mentioned earlier, Mexico imports a considerable quantity of steel scrap and re-rollable materials, as well as some steel products. All imports into Mexico are subject to licensing. The Ministry of Commerce and Industry has advisory committees (consisting of representatives of Government departments, industry and trade) to consider applications for import licenses. The committees' functions are within the guidelines regarding objectives and procedures and they are generally well regarded by the trade. Imports of scrap  - 13 - attract only an ad-valorem duty of 3%. Rails and axles imported for re-roll- ing attract somewhat higher tariffs, but the total charge does not exceed US$10 per ton. Other steel products are subject to higher levels of tariffs averaging about 20%. Prior to 1970, market prices for steel in Mexico actual- ly have been below ceiling levels, although generally higher than world market prices. Therefore, the system of protection through import tariffs and physical licensing has enabled Mexican producers to remain financially viable despite some inefficiencies caused by poor plant location with respect to raw materials and outdated technology. However, the protection granted is not a major factor at present. Mexican domestic prices for flat products at present are 5 to 15% lower than expected corresponding import prices, and 20% lower than expected long-term import prices as shown in the previous table. Therefore, given the substantial production cost increases all over the world and the ongoing expan- sion and modernization of the Mexican industry, the protection given to the industry in the past may not even be necessary in the future. III. THE COMPANY A. Background and Plant Location 3.01 In 1948, a Mexican Government commission began to study the pos- sible construction of an integrated steel works that would exploit the iron ore deposits of Las Truchas, adjacent to the Balsas River delta on the Pacific coast. A project based on direct reduction of the ore and electric furnace steelmaking was developed in the 1950s but never carried out, and little further progress was made until July 1, 1969, when SICARTSA was created by the Government and charged with formulating a specific plan for a modern steel plant. Overseas consultants were hired and a detailed fea- sibility study was completed in 1971. The Stage I project, which is designed to produce 1.2 million TPY of raw steel--utilizing modern conven- tional steelmaking facilities, was formally approved by the President of Mexico in September 1971 and the implementation was started in late 1972. The Bank has played an important role in developing this project; several project preparation missions, in close cooperation with the IDB, visited Mexico between December 1971 and August 1972 followed by appraisal missions in November 1972 and April and June 1973. The Stage I project was presented to the Board in August, 1973 and a loan of US$70 million equivalent was approved. The implementation of Stage I project is progressing well and is expected to commence operations in the last quarter of 1976. 3.02 The plant is located at Lazaro Cardenas (Map IBRD 11930), a town that in 1970 had a population of around 10,000 inhabitants who at the end of 1975 had increased to 60,000. This town is located between Zihuatanejo-- 100 km to the southeast--and Manzanillo--300 km to the northwest. The plant is well connected through the Pacific coastal highway to Zihuatanejo, from where a direct link with Mexico City is under construction, and through the highway to Morelia, the capital of the state of Michoacan. A railroad that will link Lazaro Cardenas with the national network is under construction and is expected to be completed by end 1977. A deep water harbor adjacent  - 14 - to the steel plant is already operating and is being expanded to accommodate even ships of up to 80,000 DWT. The Company's iron ore mines are located 20 km to the northwest of the plant site and the concentrated ore in the form of slurry will be delivered to the plant through a pipeline. Imported coal, as well as the limestone from the Company's own quarry, located about 100 km to the northeast of the plant, will be delivered through the harbor. Therefore, the plant is well located with respect to raw materials and prin- cipal markets--Mexico City, Guadalajara and Monterrey. The proposed Stage II expansion will be undertaken adjacent to the Stage I project. B. Ownership 3.03 SICARTSA is constituted as a "Sociedad Anonima" under Mexican law. SICARTSA's authorized share capital for Stage I amounts to M$3,750 million (US$300 million), of which as of December 31, 1975, M$3,583 million (US$287 million) had been paid in. In order to provide a sound equity base for the project and operation of the Stage I project, the share capital will have to be increased to at least M$20,000 million (US$1,600 million) by the end of 1980. The present and likely future ownership distribution are given below. SICARTSA Ownership /1 Present (1976) Future (1983) US$ US$ million % million % Federal Government of Mexico 269.3 51.0 816.0 51.0 Nacional Financiera, S.A. (NAFINSA) 132.0 25.0 400.0 25.0 Altos Hornos de Mexico, S.A. (AHMSA) /2 63.4 12.0 192.0 12.0 Federal Government - Trust Fund 62.8 11.9 191.5 12.0 Mr. Quintana (Private Industrialist) 0.5 0.1 0.5 * 528.0 100.0 1,600.0 100.0 1 Share capital was increased in February 1976 from US$300 million approved for the Stage I project. /2 Half of these shares are held by Minas de Hierro La Perla, S.A., wholly- owned mining subsidiary of AHMSA. * Less than 0.1%. 3.04 All but a very small percentage of the shares are being owned by the Government or Government agencies and companies. This situation is not expected to change in the future. The shares owned by the Government are not transferable, guaranteeing its continued majority ownership. The NAFINSA shares can be subscribed by other Mexican parties, but no plan exists for any to be sold off. Instead, it is intended that the Fideicomiso Ciudad Lazaro Cardenas (Trust Fund) shares--which NAFINSA holds on behalf of the Government-- will be offered to the general public at some future date. The share capital was increased to M$ 6.6 billion (US$528 million) in February 1976 to meet the needs of the revised capital cost estimates of Stage I project as well as the project (Stage II) requirements in 1976. The Government has agreed that it will approve the share capital of the Company to be further inreased in line  - 15 - with the fund requirements of both stages and that it will take all measures necessary to have the share capital paid up in accordance with an agreed timetable to maintain SICARTSA's debt/equity ratio below 60/40 at all times. According to SICARTSA's by-laws, AHMSA, the existing Government-owned steel company and its mining subsidiary together must subscribe 12% of SICARTSA's authorized capital. Since it was not possible to examine the financial con- dition of either of these companies, agreements were received from the Govern- ment that it will guarantee the obligations of all shareholders to subscribe and pay in capital as required by SICARTSA, this guarantee is similar to that obtained for Stage I. C. Organization and Management 3.05 The Board of Directors of the Company, the top decision-making body of SICARTSA, is composed of 9 directors. The Mexican Government elects all the Directors of the Board of the Company since the Government controls directly or indirectly virtually all of SICARTSA's shares. The Board is composed of the Secretary of Finance (Chairman of the Board), the Secretary of the Presidency, the Secretary of Patrimonio Nacional, the Secretary of Industry and Commerce, the Director General of NAFINSA, the Governor of the State of Michoacan, the Director General of Pena Colorada 1/, the Director General of AHMSA, and Mr. Quintana, the Mexican private investor. There have been no changes in the composition of the Board since 1972. The Board meets once every month to formulate policies and overall development programs for the Company. In order to expedite project implementation, an Investment and Finance Executive Committee was created in 1974. The Committee meets once a week and consists of 3 high-level members--the Undersecretary of Revenue of the Ministry of Finance, the Director of Investments of the Ministry of the Presidency and the Director of Project Programming of NAFINSA--of the Mexican Government. The Director General of the Steel Coordinating Commission also participates in the Board as well as in the Executive Committee meetings as an observer. Both the Board and the Executive Committee have played important roles in expediting and handling SICARTSA matters. The Company, in accord- ance with Mexican law must have an auditor who is appointed by the Ministry of Patrimonio Nacional to review the Company's accounts annually. 3.06 The organization of the Company is given in Chart III.1. The Director General of the Company, Ing. Adolfo Orive Alba, was appointed by the President of Mexico in 1969 when SICARTSA was founded. Prior to his present position, he worked for many years with the Government where he reached the position of Secretary of Hydraulic Resources. He is considered a good executive and has provided stability, maturity and motivation to SICARTSA management and has been largely responsible for pushing the pro- ject forward. The continuity of the present Director General of the Company will depend upon the new President of Mexico to be elected, who will take office in November 1976. It is not an uncommon practice in Mexico for a newly-elected President to bring his own men to run organizations of national importance. If the Director General is replaced by an outsider, it is quite possible that a few of the top management staff of SICARTSA may leave the 1/ Consorcio Minero Benito Juarez - Pena Colorada S.A. was created by the Mexican Government, together with AHMSA, HYLSA and Fundidora, to produce pellets from Colima iron ore reserves.  0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~1 > I A o Z g g Z g~~~~~~o tin~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I L 5: 9 fD  - 17 - Company along with him. It is hard to predict at present the chances of this occurring. However, if this happens, it can be reasonably expected that the new persons, who may be replacing the present staff, would be of the same high calibre. Nevertheless, the Company has agreed that it will pay considerable attention in filling management positions and will maintain the high standards in its recruitment for all management positions in SICARTSA. 3.07 The Company has acquired a capable, young and dynamic staff, who have been with the Company since the incorporation of SICARTSA. Although the calibre of the department heads is high, there has been a tendency in the recent past toward a lack of coordination among the various departments and lack of delegation of authority, mainly due to the transitionary period-- from construction type setup to operational setup. SICARTSA management has been aware of this and in an attempt to improve the situation and to minimize the interference between Stage I and II projects, is presently implementing a new organization structure developed by the Company in consultation with other large steel companies in Mexico. The basic objective of the new organization is to permit the smooth implementation and subsequent operation of Stage I project while the Stage II expansion is being carried out. In order to avoid disruption of the Company's activities, the new organization was established progressively. Under the new organization, which was fully established by the end of 1975, the Director General will have only six General Managers--as compared to 10 previously--reporting to him (viz: Stage I, Stage II, Finan- cing, Operations, Mlarketing and Administration). Once the construction of Stage I is completed Stage I department will merge with the Stage II depart- ment, leaving only five General Managers under the Director General. The new organization and procedures are expected to result in clearer functional responsibilities and improved control of current operations and management information systems. The new organizational setup appears to be functioning satisfactorily. 3.08 SICARTSA has a general know-how and technical assistance agreement with the British Steel Corporation 1/ (BSC) for design, construction and ini- tial operations of Stage I. Under this contract, SICARTSA has been receiving substantial assistance from BSC in all technical, financial, marketing and organizational aspects of Stage I project. This agreement has been extended to include BSC assistance in the design, construction and initial operation of the Stage II; a similar agreement with BSC has recently been concluded for the Stage II project as well. SICARTSA has been obtaining specialized assistance from Nederlandsche Hoogovens en Staalfabricken NV of the Netherlands for pelletizing and from Societe Francaise D'Etudes Minieres (SOFREMINES) of France for iron ore exploration and mine planning. D. Progress of Stage I Project 3.09 The Stage I project, is being satisfactorily implemented, first, to meet projected increases in domestic non-flat steel demand with a modern 1/ The BSC group includes subcontracted staff from W.S. Atkins & Partners and McLellan and Partners, both of the UK.  - 18 - conventional steelmaking works which will produce a full range of finished products at costs competitive by world standards; and second, to further the goal of directing public investments towards underdeveloped areas of Mexico and away from the concentrated wealth and economic activity of the nation's center. The Stage I project will have an annual rated capacity of about 1 million tons of light non-flat finished steel products with pro- vision for further expansions. 3.10 The project comprises the following main elements: (i) mining and beneficiation of the Las Truchas iron ore, with transport of concen- trate by slurry pipeline to the steel works, (ii) agglomeration of the iron ore fines to form self-fluxing pellets, (iii) conventional coke making based on imported coal, (iv) blast furnace ironmaking, (v) basic oxygen (BOF) steelmaking, (vi) continuous casting (CC) of billets, (vii) rolling of rod, bar and light sections in two finishing mills, and (viii) corresponding utilities and interplant services. The implementation started at the end of 1972 and the Stage I project is expected to come into operation in October 1976, about 6 months behind the original schedule. The delays have been mainly due to the seismic code changes recommended by the University of Mexico that initially delayed the civil construction work, delivery problems for the locally supplied structures, that have affected the erection schedule of the BOF and continuous casting plants and of the interplant fluids distribution system, the lower than previously expected efficiency of the local labor and some delays in equipment deliveries particularly of local supplies. A com- parison of original and present completion dates for major facilities is given below: SICARTSA - Comparison of Stage I Original and Present Completion Dates Completion Date Delay Major Facilities Original Present (months) 1. Mining and Raw Material Handling December 1975 May 1976 5 2. Pellet Plant December 1975 April 1976 4 3. Coke Plant December 1975 June 1976 6 4. Ironmaking Facilities April 1976 September 1976 5 5. Steelmaking Facilities March 1976 September 1976 6 6. Light Section Mill March 1976 July 1976 4 7. Rod Mill March 1976 December 1976 9 SICARTSA is planning to commission the light sections mill in July 1976 and to produce finished products based on purchased billets. The blast furnace and BOF and continuous casting shops may start producing iron and steel during the last quarter of 1976. They will be preceded by the commissioning of mining facilities, the coke ovens and the pellet plant respectively during the second and the third quarters of 1976. Since the commissioning of the plant is largely dependent on the completion of interplant services on time, SICARTSA is focusing specifically on the installation of the gasholders, the main gas and the pipe distribution systems (propane, oxygen, compressed air, fuel oil, water, etc.), the power plant and its control center and the main and unit substations.  - 19 - 3.11 The top management and the site supervision management hold regular monthly meetings with the erection contractors to discuss and agree on revised schedules whenever necessary. Long shifts and double shifts are being worked in the critical plant erection areas on short crash schedule as required to complete the project as presently scheduled. Bonus schemes have been intro- duced as an incentive to improve and maintain better efficiency of the present work force and to minimize the turnover that has been noticed specially among skilled workers like welders, pipe fitters and electricians. Moreover, the SICARTSA site construction organization has been complemented with the intro- duction of additional engineers from the Technical Department in Mexico City and with the increase of the BSC advisory staff. In addition, there have been some changes in the approach to erection. Originally, all major equipment suppliers' responsibilities included only supply of equipment and supervision of erection and startup. However, due to some problems with local erection contractors, the responsibilities of the equipment suppliers have been in- creased to cover also the erection of equipment using Mexican contractors to ensure timely completion and performance guarantees. The Company has also concluded contracts with an experienced foreign erection firm--Dillinger of the Federal Republic of Germany--to carry out the erection of complex and critical plant facilities. In view of the difficulties described above as well as the fact that this is a greenfield plant being erected in a region where there were no infrastructure facilities available and SICARTSA is a very young company, the progress of the project in the short period of time-- less than three years--is very impressive. 3.12 Due to a general inflation rate around the world much higher than expected in 1973, considerably higher increases in local costs and more ad- verse currency realignments than forecast, the total fixed asset cost of Stage I, excluding working capital and interest during construction, is ex- pected to be around US$870 million representing a cost overrun of about 42%-- about 21% due to price increases, 8% for scope changes and 13% as a result of an underestimate of quantities. The local cost will be about US$345 mil- lion (40% of total cost). The procurement for Stage I is virtually complete. Of the total value of all contracts, including IBRD financed contracts, thus far awarded, suppliers from the F.R. of Germany contribute 17.1%; the UK, 15.5%; Italy, 12.7%; Japan, 8.1%; Austria, 7.1%; France, 4.6%; and the remain- der would be from Canada, Australia, USA and Switzerland in descending order. The Mexican contribution, in value terms, of all the equipment procured under international bidding has accounted for about 20% of total equipment cost. Although the inflation of local costs was more than 55%, the local cost has increased by only 50% partly because of the lower than expected participation of local equipment suppliers bidding under the 15% preference rule. The foreign exchange requirements have increased by about 32% of which the transfer of equipment from local to foreign sources accounted for 16%. SICARTSA has recently developed a satisfactory cost control system which is being used for the Stage I project and will be fully implemented for Stage II from the very beginning of Stage II execution. Also, SICARTSA's cost control is being strengthened with a team, including BSC staff, which is working very closely with the project and site supervision management. 3.13 The experience gained in Stage I implementation with respect to efficiency of the local labor force, cost and time scheduling as well as  - 20 - other executory functions has been used in developing the Stage II project, particularly its cost and time schedules. E. Recent Financial Position 3.14 As Stage I will not start operations till the end of 1976, the financial statements for 1972-1975 reflect only the results of plant con- struction. A summary of the balance sheets of SICARTSA (Stage I) for the last three years and estimates for 1975 are given below: SICARTSA - Summary of Balance Sheets (US$ Million) /1 /1 /1 /2 As of December 31, 1972 1973 1974 1975 ASSETS Current Assets 6.2 2.5 8.0 17.2 Gross Fixed Assets 1.8 19.9 149.2 587.7 Deferred Charges 7.5 20.7 55.6 105.3 Other Assets 1.6 1.5 13.0 16.9 Total 17.1 44.6 225.8 727.1 LIABILITIES Accounts Payable 2.8 2.9 15.7 73.7 Current Portion of Long-Term Debt - - - 0.6 Total Current Liabilities 2.8 2.9 15.7 74.3 Long-Term Debt - 5.2 73.4 366.1 Paid-in Equity 14.3 36.5 136.7 286.7 Total 17.1 44.6 225.8 727.1 Debt/Equity Ratio 0/100 12/88 35/65 56/44 /1 Audited figures. /2 Unaudited figures. 3.15 Since there were some delays in project implementation, the finan- cial position as projected for December 31, 1974 in the Appraisal Report (Report No. 220-ME) of August 10, 1973, was reached only on April 30, 1975. In order to meet the increases in project cost the Company has concluded an agreement with NAFINSA in November 1975 for a loan of US$288 million equiva- lent at an average interest rate of 13.25% per annum for 14 years including 4 years of grace. This additional loan is expected to be sufficient to phy- sically complete the Stage I project. The Company has maintained a satis- factory financial position and at the end of 1975 the debt/ equity ratio of the Company was 56:44. However, in order not to exceed the agreed ratio of 60:40, additional funds, which will be needed in 1976 and 1977 for working capital and to meet initial operational losses and early maturities of loans, will have to be provided in the form of equity. These requirements will be adequately met by the Government's completion and overrun commitments obtained for Stage I project.  - 21 - 3.16 A summary of historical sources and applications of funds is given below: SICARTSA - Historical Sources and Applications of Funds (1972-1975) (US$ Million) 1972 1973 1974 1975 /1 Sources of Funds Depreciation - - - - Equity Paid-in 11.7 22.2 100.2 150.0 IBRD - - 22.3 36.1 IDB - - 21.2 16.9 Bilateral Credits - 5.2 24.7 240.3 Notes Payables 2.8 0.1 12.8 58.0 /2 Total Sources 14.5 27.5 181.2 501.3 Applications of Funds Investment in Fixed Assets 1.7 18.1 i29.3 438.5 Investment in Subsidiaries 1.6 (0.1) 11.5 3.9 Increase in Deferred Charges 5.1 13.2 34.9 49.7 Subtotal 8.4 31.2 175.7 492.1 Change in Current Assets: Cash and Marketable Securities 4.4 (2.4) 3.0 12.1 Debtors 1.7 (1.3) 2.5 (2.9) Total Applications 14.5 27.5 181.2 501.3 /1 Unaudited figures. /2 Commitments on equipment orders and civil works contracts. 3.17 Total investments in fixed assets of US$588 million, until the end of 1975 including investments made prior to 1972 represent about 80% of the total fixed assets investments required for the project. The total invest- ments including deferred charges, made until the end of 1975 are about 70% of total financing required for the project, including interest during con- struction. A major portion of the remainder of investments--about 84%-- will be made in 1976. As compared with the original projections the funds already invested as a percentage of total investment are somewhat lower mainly due to initial project delays. The contribution of equity funds and disbursements of long-term loans has consequently been delayed. The actual disbursement of the Bank loan until the end of 1975 was about US$58.4 million, which is slightly lower (6%) than the amount originally projected. The entire Bank loan will have been disbursed by the end of 1976.  - 22 - F. Subsidiaries 3.18 SICARTSA has two wholly owned subsidiaries: Inmobiliaria SICARTSA, S.A. (ISSA) and Compania Minera del Estado de Michoacan de C.V. (COMMSA). ISSA which owns the land where the SICARTSA complex is being constructed, was created in 1972 to carry out housing construction required for the Company. ISSA's share capital as of September 1975 was about US$1.1 million. One of ISSA's objectives is to construct and then sell or rent houses to the workers and employees of the Company in coordination with the Fideicomiso Ciudad Lazaro Cardenas (Trust Fund) which is in charge of developing the city of Lazaro Cardenas. COMMSA, established in 1974 with a total paid in equity of US$800,000, is in charge of exploring and exploiting all the mineral re- sources for SICARTSA. This subsidiary will supply a major part of SICARTSA's iron ore and limestone requirements. SICARTSA has established, as a general policy, that both these subsidiaries have to operate on a no-loss no-profit basis. The Board of Directors of both the subsidiaries is composed of top executives of SICARTSA. 3.19 SICARTSA also holds 49% (out of an equity of US$0.28 million) of Servicios Portuarios de Lazaro Cardenas, which has been operating all the port services in Lazaro Cardenas since 1972. The remaining 51% is owned by the Federal Government through the Ministry of the Navy (Marina). Only minor in- vestments in subsidiaries are anticipated over the next few years for housing construction and mine development. Until completion of the project, the Com- pany will not without prior consent of the Bank establish nor acquire any other subsidiaries each with an authorized capital not exceeding the equivalent of US$10 million. Moreover, the obligations of SICARTSA will equally apply to all its subsidiaries and the subsidiaries will observe and perform all such obligations. IV. THE MARKET A. Recent Steel Consumption and Production 4.01 Although consumption of raw steel in Mexico over the last 20 years (1955-1975) has increased by an average of about 10% annually, the growth rate has fluctuated substantially from year to year, in step with the econo- mic growth. Consumption exceeded one million tons of raw steel equivalent for the first time in 1951, by 1960 it had increased to about 1.9 million tons, rising to 3.2 million tons in 1967. Since then steel consumption has risen as shown in the following table.  - 23 - MEXICO - Supply and Apparent Steel Consumption (1967-1975) (1,000 tons) /1 /2 Total Flat Products Non-Flat Products Consumption Yearly App. Raw Steel Rate of Year Prod. Imp. Exp. Cons. Prod. Imp. Exp. Cons. Equival. Growth 1967 1,082 38 75 1,045 1,201 110 38 1,273 3,196 7.0 1968 1,240 41 108 1,173 1,307 93 44 1,356 3,438 7.6 1969 1,326 46 144 1,228 1,397 107 49 1,455 3,629 5.5 1970 1,443 82 158 1,367 1,532 77 69 1,540 3,965 9.3 1971 1,495 83 217 1,361 1,485 46 102 1,429 3,735 5.8 1972 1,742 59 216 1,585 1,657 93 158 1,594 4,276 14.5 1973 1,931 180 49 2,062 1,880 120 123 1,877 5,351 25.1 1974 2,126 305 11 2,420 2,047 168 124 2,157 6,205 16.0 1975 2,025 296 2 2,319 2,113 233 25 2,321 6,365 2.6 Annual Growth Rates of Steel Consumption (Percentage) Period Flat Products Non-Flat Products Total Raw Steel Equivalent 1967-1975 10.5 7.8 9.0 1967-1970 9.4 6.5 7.5 1970-1975 11.1 8.6 9.9 /1 Includes stainless and special steels. /2 Includes hollow bars, railway accessories and seamless tubes. 4.02 As a result of continued high rate of growth of the economy, total consumption of raw steel increased at a yearly rate of 9.0% in the 1967-1975 period. The 1975 total steel consumption level exceeded by 15% the consump- tion forecast at the time when the Stage I project was appraised. During the same period, flat products consumption increased at an annual rate of 10.5% which was approximately 35% higher than the 7.8% yearly growth rate of non-flat products. As a result, the proportion of flat products in total consumption increased from 45% in 1967 to about 50% in 1975. 4.03 During 1967-1975, production of raw steel increased at an annual rate of 7.0%. The production of finished products increased at a higher rate (7.8%) than raw steel as a result of productivity gains and changes in the product mix. During the same period, production of flat products increased at an annual rate of 8.2% compared to the 7.3% yearly growth rate of non-flat products. As a result, the proportion of flat products in the total domestic production increased from 41% in 1967 to about 50% in 1974. 4.04 The higher growth of consumption over production, specially during 1973-1975, resulted in an increase in imports (from 152,000 tons in 1972 to 529,000 tons in 1975) as well as in a reduction of exports (from 373,000 tons in 1972 to 27,000 tons in 1975).  - 24 - 4,05 Past apparent consumption of principal flat and non-flat products, their annual rate of growth and their major consuming sectors are shown below: MEXICO - Flat Steel Product Consumption Consumption (1,000 tons) Main Consuming Sector Annual Annual Growth % of % of Growth Rate % of Total Rate of Sector 1967 Total 1975 Total 1967-1975 Sector Consumption 1967-1975 Plate 294 28 735 31 12.1 Manuf. /2 70.5 7.0 Hot Rolled Prod. 193 18 415 18 10.0 Manuf. /2 93.3 7.0 Cold Rolled Prod. 394 38 874 38 10.5 Manuf. /2 98.0 7.0 Tinplate and Manuf. /3 100.0 7.0 Others /1 164 16 295 13 7.6 - Total Flat Prod. 1.045 100 2,319 100 10.5 Manuf. 90 - /1 Includes stainless and other special steels. /2 The main consuming branch within this sector was the Manufacture and Repair of Metal Products industries which grew at an annual rate of 8.3% during the same period. /3 The main consuming branch within this sector was the Food and Beverage industry which grew at an annual rate of 4.5% during the same period. MEXICO - Non-Flat Steel Product Consumption Consumption (1,000 tons) Main Consuming Sector Annual Annual Growth % of % of Growth Rate % of Total Rate of Sector 1967 Total 1975 Total 1967-1975 Sector Consumption 1967-1975 (%) (%) Concrete reinf. Bars 465 36 904 39 8.7 Const. 100.0 7.2 Wire Rods 219 17 448 19 9.4 Manuf. 74.1 7.0 Section Bars 155 12 248 11 6.1 Oil. Ind. 39.1 7.6 Const. 36.3 7.2 Solid Bars 87 7 268 12 15.1 Manuf. 97.4 7.0 Section Beams 114 9 213 9 8.1 Const. 65.6 7.2 Seamless Pipe and Others /_ 234 19 240 10 0.3 Oil Ind. 91.0 7.6 Total Non- Flat Prod. 1,274 100 2,321 100 7.8 - - - /1 Includes hollowed bars and railway accessories.  - 25 - 4.06 The high increase in consumption of most flat products can be attributed to the increasing intensity in the use of steel in the manufacturing sector, resulting from growth and development of heavy and consumer durable and non-durable industries. On the other hand, extensive Government spending in public works and housing, has been responsible for the growth of most non-flat products. 4.07 During 1967-1975, the composition by type of flat as well as non- flat steel consumption has remained nearly unchanged. Plate, hot rolled products, wire rod, and section beams have slightly increased their share of total consumption, while tin plate, cold rolled products, seamless pipe and special steel and railway accessories have slightly reduced their share. The share of concrete reinforcing bars has remained unchanged while that of solid bars .has increased substantially. 4.08 Steel production by type of products has increased as shown below: MEXICO - Steel Production in 1967 and 1975 (1,000 tons) Flat Products Non-Flat Product Production Production % of % of Annual % of % of Annual Product 1967 Total 1975 Total Growth Rate Product 1967 Total 1975 Total Growth Rat (X) (%) Plate 363 34 670 33 8.0 Reinf. 465 39 887 42 8.4 bars Hot Rolled 190 17 423 21 10.5 Wire Rod 219 18 414 20 8.3 Cold Solid bars 77 6 208 10 13.2 Rolled 529 /1 49 932 /2 46 7.3 Sect. bars 155 13 216 10 4.2 Sect. beams 95 8 173 8 7.8 Total Flat Seamless Products 1,082 100 2,025 100 8.2 pipe and Other 190 16 215 10 1.6 Total Non- flat prod. 1,201 100 2,113 100 7.3 /1 Includes the production of 131,000 tons cold rolled products for tinplate. /2 Includes the production of 198,000 tons cold rolled products for tinplate. 4.09 A comparison of consumption and production patterns on a per product basis during the 1967-1975 period, indicates that in recent years the production deficit has been concentrated in heavy plate, cold rolled products, tinplates, solid bars and section beams, while there has been a small surplus in reinfor- cing bars and nearly a supply and demand balance in hot rolled products and the remaining non-flat products, as summarized in Table 4-1.  MIEXI CO: LAS TRUCHAS STEEL EXPANSION PROJECT Mexico - Corparison between Production and Con gMtion of F'lat and Non-r4'lat P2roducts in 1967 and 1975 (009 tons) Surpluis Product:ion Consumption or Deficit) '35196t7 1975 -196'7 1975 17 Flat Products Plate 363 670 294 735 69 (65) Hot Rolled Prod. 190 423 193 415 (3) 8 Cold Rolled Prod. 398 728 394 874 4 (146) Tinplate 131 20tt 142 295 (U) (91) Others - - 22 (22) - TOTAL 1,082 2,025 1,045 2,319 37 (294) Non Flat Products Concrete Reinf. Bars 465 887 465 904 - (17) Wire Rods 219 414 219 448 - (34) Section Bars 155 216 155 248 - (32) Solid Bars 77 208 87 268 (10) (60) Section Beams 95 173 114 213 (19) (40) Seamless Pipes 156 215 160 240 ( 4) (25) Others 3 - 74 - -LO) TOTAL 1,201 2,113 1,274 2;321 (73) (208) Total Rolled Products 2,283 _4138 2,319 14640 4(50) CD Industrial Projects Department, December 1975.  - 27 - B. Demand Forecasts for Steel through 1985 4.10 Several market studies of the demand for steel in Mexico have been made over the past decade as part of the Government's efforts to develop the steel industry. The Bank of Mexico attempted the first major steel demand forecast when it made a projection for the period 1967-76, based on its experimental input-output model concerning 45 sectors of the Mexican economy. This steel demand forecast was part of a larger exercise for forecasting development of the Mexican economy. Since then, many other major studies have been undertaken by a number of different entities, including NAFINSA 1/ in 1969 and 1971, by Camara Nacional de la Industria del Hierro y Acero (CNIHA) in 1969, 1971 and again in 1974, by the Battelle Memorial Institute in 1973 (for the Steel Commission), and by the Steel Commission in 1974. At the end of 1975, the Steel Commission completed new projections using re- gression analysis and sector surveys. 4.11 After reviewing various studies prepared by others, SICARTSA in 1972 prepared its own forcasts, focussing on demand for non-flat products for the Stage I project and again in another demand forecast for flat and non-flat products upto 1985 on the basis of correlating each individual steel product with the growth of the corresponding consuming sectors. This fore- cast was updated in 1975. In addition, to firm up the forecast of future demand for flat products, SICARTSA and BSC prepared in July 1975 a demand projection based on sectoral surveys. 4.12 After an intensive analysis of the many macroeconomic and sectoral demand studies, it was felt by the Bank that the SICARTSA correlation analysis and sector surveys were the most relevant as a basis for the market analysis of the project. In addition, the Bank prepared alternative hypotheses using different assumptions and adjusting data used in the SICARTSA equations and modifying the sector survey methodology. The result of these studies including the alternative hypotheses prepared by the Bank were further tested by the Bank through an intensive set of new macroeconomic correlations and international comparisons. The main assumptions of these projections are discussed below. 4.13 The SICARTSA macroeconomic demand forecast was based on the correla- tion between the consumption of individual product and GDP in the main con- suming sectors. The regression analysis included 4 flat products (plates, hot rolled sheets, cold rolled sheets, and tinplate) and 5 non-flat products (reinforcing bars, wire rods, light sections, solid bars and heavy sections). The consuming sectors used in the analysis were manufacturing (including repair of metal products), construction, and food and beverage industry. The projections made for 1980-1985 were based on a set of linear equations and assumed a growth rate of 12% for the manufacturing sector, 9.4% for the con- struction sector and 6.7% for the food and beverage sector. These growth rates correspond to an overall GDP growth rate of 7% per annum during 1975- 1985. Although the equations developed give a good statistical test, the 1/ NAFINSA has a substantial interest in the three largest steel companies, ARMSA, Fundidora and SICARTSA.  - 28 - results obtained on a per product basis must be interpreted carefully, since GDP was considered the only independent variable. Also, the Bank considers the 7% GDP growth rate implicitly assumed by the major consumers as too high (para. 4.15). 4.14 The sectoral surveys were conducted on the basis of representative statistical sampling by visiting the major flat steel product consumers and subsequently carrying out various checks on the survey results. This sectoral study estimated the following growth rates in flat products consumption among the different consuming sectors. MEXICO - Growth Rates of Flat Steel Consumption by Sectors as assumed by SICARTSA 1975-1979 1980-1985 (X) (X) Oil and Gas 19 11 Packaging 12 8 Construction 10 9 Motor Vehicle 10 8 Machinery and Equipment 8 7 Railroad Equipment 10 5 Furniture and Fixtures 10 6 Other 12 9 4.15 The Bank made spot checks of the major consuming sectors and con- cluded after visiting PEMEX 1/ (which consumes 30% of total flat products) that the growth rate of steel consumption projected for the oil sector was not fully justified. Alternative new projections were prepared by the Bank on the basis of the SICARTSA macroeconomic and sector studies and assuming lower GDP growth rates, since a GDP growth rate of 7% is considered high; Bank's conser- vative projections assume lower overall GDP growth rates of 4.5% between 1975-1980 and 6% thereafter for medium and 4% throughout for low range. As a fast and conservative approximation, which may tend to underestimate steel consumption, the sector's growth rates as assumed in SICARTSA's above demand forecasts were reduced in direct proportion to the lower overall GDP growth rates, except for the growth rate for steel consumption in the oil sector which is assumed to grow at a rate of 12% for the high, 10% for the medium and 8% for the low projections. 4.16 To check SICARTSA estimates as well as the alternative projections prepared by the Bank on the basis of SICARTSA's equations, additional econo- mic analyses were carried out by the Bank. The set of equations that gave the best statistical results were double log linear equations which correla- ted overall GDP vs. raw steel consumption, GDP of the manufacturing sector vs. flat products consumption, GDP of the construction sector vs. non-flat products consumption and GDP of the oil sector vs. seamless tubes consumption. As in the previous cases, for each correlation, projections were developed using the three GDP growth rate alternatives mentioned above. 1/ State Oil Company.  - 29 - 4.17 Table 4-2 presents the demand estimates for 1980 and 1985 of the different projections classified on the basis of alternative GDP growth rate assumptions (for high, the continuation of 7% annual growth rate through the forecast period; for medium, annual growth rate of 4.5% from 1975 to 1980 and 6% thereafter; and for low, 4% from 1975 to 1985). On the basis of a review of all relevant demand forecasts, the additional tests performed and the great uncertainty surrounding the future level of the GDP growth rate, the Bank's best estimate range of the future demand for overall steel products is as follows. MEXICO - Projected Demand for Steel in 1980 and 1985 (1,000 tons) 1980 1985 1974-1985 Annual Rate of Increase (%) Low Medium High Low Medium High Medium Raw Steel 8,300 8,900 10,400 11,000 13,100 16,800 7.0 Rolled Products 6,100 6,510 7,620 8,110 9,650 12,380 7.0 Flat Products 3,280 3,530 4,110 4,370 5,180 6,680 7.2 Non-Flat Products 2,520 2,680 3,210 3,340 4,070 5,300 6.9 Seamless Pipes /1 300 300 300 300 400 400 6.4 /1 It is estimated that the exploitation and production of oil, which mostly consumes seamless pipes, will not be affected by the slowdown in economic activity. 4.18 The Bank's estimate for the demand of specific flat products which are directly relevant to the project under consideration are presented below: MEXICO - Projected Demand of Flat Products in 1980 and 1985 (1,000 tons) 1980 1985 1974-1985 Annual Rate of Increase (%) Low Medium High Low Medium High Medium Plate 895 975 1,145 1,180 1,405 1,890 6.2 Hot Rolled 680 745 855 970 1,180 1,420 8.9 Cold Rolled 1,320 1,400 1,655 1,730 2,015 2,725 7.6 Tin Plate 385 410 455 490 580 645 6.5 Total Flat Products 3,280 3,530 4,110 4,370 5,180 6,680 7.2 4.19 The low and medium demand forecasts for flat products presented above are probably conservative for two main reasons. First, the basic  MUEICO: LAS TRUCB STEEL EXPANSION PRO=CT fROJClD DEMAND FOR STEEL pR oUcTs (1,500tns Rev Steel ~ ~ ~ ~ ~ Iflol*ad Produts Fist on-Flat TSosu.ee Tube. 1980 1973R195 9 10 1985 - 1974-1985 1980 1983 1374-1985 1980 198o J 974-1985 1980 1985 1974-1985 Amnl Rate Annual Rats AnnuRI Rats Anual Rate Annual Rate IIIGH _css of 7ncr. f __ _ of Jn"s 4) - _ of le'.. a11 _ __ of Iicres e (1 __ __ of lecoss (71 SICARTSAMe ucralatloaIysli 10,342 16,812 9.' 7,608 12,362 9.5 4,108 6,675 9.8 3,211 5,308 9.0 289 379 5.8 Steel Cole.un'e t orrelatin- lysta 9,600 14,7no 8.2 7,055 10,829 8.2 3,740 5,824 8.3 3,009 4,608 8.1 306 397 6.3 SICARTSAes aloter etudy - - - - 4,701 7i326 10.6 - - - - 379 5.8 str so e Cter couvey 9,779 15,078 8.4 7,19 11,087 8.4 3,771 6,031 8.7 3,122 4,659 8.2 306 597 683 BSh' . eonelatln with ov r-ll GDP 9,614 15,047 8.4 - - - -- - - - - - BDons cen teLatiun ish CDP par * ctor 9,930 16,784 9.6 7,448 12,528 9.6 3,975 6,960 10.1 3,074 4,866 8.6 399 702 11.9 Inter-tional coapartoe 12,892 19,023 10.7 - - - - - - - - - - - MEDIUMI Revised 81ARSTA'e n nruatie slyesf 8,275 12,976 6.9 6,206 9,732 7,1 3,275 5,340 7.5 2,675 4,068 6.9 256 324 4.3 Revise-ad sitAit ector *tudy - - - - - 3.532 5,176 7.2 - - - - Rank* osroati Lth -vel"Il OY 8 119 11,944 6.1 - - - - - 8nko orrelatie v2th, CBi par sector 81235 13 456 7 4 6,176 10,077 7.4 3,219 5,218 7.8 2,599 4,285 7,0 358 574 9.9 Iotarutioaal loqleon 11,130 15,574 8.7 - - - - - - - - - R-loud SIOARSA' norralatlon aly.le 7,733 10,506 5.1 5,800 7,880 5.1 3,144 4,258 5.3 2,515 3,341 5.0 241 281 3.0 Rateed SV 7A'e mtor slod - - 3.281 4,365 5.5 - - - - - BRts: eonoelabtis with overall COP 7,670 9,877 4.3 - - - - - - - - - B-nk nowralatiee wth CDP per *cotor 7,680 10,430 3.0 5,767 7,823 5.0 3,000 4,154 5.0 2,443 5,194 4.6 324 475 8.0 Iona-atloua cori-ou 10,598 13,192 7.1 - - - - - Notn: Annal oocaoepttie prouth natas durtn8 1962 to 1974, in I: - ra eteel 10.7 - flotihad peduota 10.7 - 0let produta 13.5 - eon-flat prod cte 9 3 - se_1eswi tube. 358 Irduetri-l Prujote Departet ....6Ir 1975  - 31 - assumptions for the growth of the overall GDP can be considered as con- servative according to past experience and projections prepared recently by the Bank and other institutions. Second, it has been assumed that a slowdown of the economy would affect all the sectors equally. It could be argued that in such circumstances rationalization programs would be undertaken aiming at maintaining growth and reducing the scope of social programs including housing. This would in turn result in a higher demand for flat products which are mainly consumed by the industrial sector, and a possible lower demand for non-flat products whose main consumer is the construction sector. C. Supply of Steel Products through 1985 4.20 The Bank reviewed the production programs of all the projects pre- sently being built as well as SICARTSA II, which is the only additional project which has been approved by the Steel Commission. All projects under con- struction, with the exception of SICARTSA II, are expected to reach full pro- duction capacity by 1980. The overall estimated production by company in 1985 is given in Table 4-3. However, it is quite likely that new plants to increase capacity to meet growing demand may come into operation before 1985. If no expansion programs or new plants are considered to come into operation, a deficit of about 2 to 5 million tons of steel, in raw steel terms, is foreseeable in 1985. 4.21 The projected supply of specific flat steel products in 1980 and 1985 is presented below: MEXICO - Projected Supply of Flat Steel Products in 1980 and 1985 (1,000 tons) Hot Rolled Cold Rolled Total Flat Plates Products Products Tinplates Products 1980 1985 1980 1985 1980 1985 1980 1985 1980 1985 AHMSA 595 595 170 270 500 500 310 310 1,575 1,675 Fundidora 210 210 230 230 490 490 - - 930 930 HYLSA 85 85 180 180 340 340 45 45 650 650 SICARTSA 67 106 403 640 93 998 - - 563 1,744 Total 957 996 983 1,320 1,423 2 328 355 355 3 718 4,999 -~ ~~_ ... - = D. Supply and Demand Comparison for the Steel Sector 4.22 A comparison of the Bank's estimate of the demand forecast for the overall sector (para. 4.18) with the supply of steel products (para. 4.21) is summarized below:  MEXICO - LAS TRUCHAS STEEL EXPANSION PROJECT Supply of Steel Products in 1980 and 1985, (1,000 tons) - - _ - - - - 1 9 8 0- - - - - - - - - - - - - - - - - - - - 1 9 8 5- - - - - - - - - - - Raw Finished Flat Non-Flat Seamless Raw Finished Flat Non-Flat Seamless Company Steel Products Products Products Pipe Steel Products Products Products Pipe AHMSA 3,240 2,385 1,575 810 - 3,375 2,485 1,675 810 - Fundidora 1,500 1,080 930 150 - 1,500 1,200 1,020 180 - HYLSA 1,530 1,180 650 530 - 1,530 1,180 650 530 - TAMSA 500 320 - 5 315 500 320 - 5 315 SICARTSA I 1,125 1,000 - 1,000 - 1,180 10ooo - 1,000 - SICARTSA II 435 563 563 - - 2,110 1,744 1,744 - - Semi-Integrated 900 715 - 715 - 900 715 - 715 - Rerollers _ 255 _ 255 - _ 255 _ 255 _ Total 9,230 7,498 3,718 3,465 315 11,040 8,779 4,999 3,465 315 Note: These production figures are based on the assumption that the fully integrated plants will operate at 907 of L rate capacity and 80% for semi-integrated plants and re-rollers. The production buildup of new plants, with the exception of SICARTSA II, would be between 3 to 5 years. Industrial Projects Department December 1975  - 33 - MEXICO - Supply and Demand Comparison for Steel in 1980 and 1985 (1,000 Tons) 1980 1985 Low Medium High Low Medium High Raw Steel Demand 8,300 8,900 10,400 11,000 13,100 16,800 Supply 9,230 9,230 9,230 11,040 11,040 11,040 Surplus (Deficit) 930 330 (1,170) 40 (2,060) (5,760) Finished Products Demand 6,100 6,510 7,620 8,110 9,650 12,380 Supply 7,498 7,498 7,498 8,779 8,779 8,779 Surplus (Deficit) 1,318 988 (122) 669 (871) (3,601) Flat Products Demand 3,280 3,530 4,110 4,370 5,180 6,680 Supply 3,718 3,718 3,718 4,999 4,999 4,999 Surplus (Deficit) 438 188 (392) 629 (181) (1,681) Non-Flat Products Demand 2,520 2,680 3,210 3,340 4,070 5,300 Supply 3,465 3,465 3,465 3,465 3,465 3,465 Surplus (Deficit) 945 785 255 125 (605) (1,835) Seamless Pipe Demand 300 300 300 400 400 400 Suply 315 315 315 315 315 315 Surplus (Deficit) 15 15 15 (85) (85) (85) 4.23 The projected supply/demand balance for flat steel on a per product basis is summarized in the table below. However, it should be noted that there is some flexibility in the rolling facilities, particularly with respect to the production of light plate, hot rolled products and cold rolled products. Moreover, additional flexibility between the production of coated and non- coated products could be achieved with comparatively minor investments.  - 34 - MEXICO - Supply and Demand Comparison for Flat Steel Products in 1980 and 1985 (1,000 Tons) 1980 1985 Product Low Medium High Low Medium High Plate Demand 895 975 1,145 1,180 1,405 1,890 Supply 957 957 957 996 996 996 Surplus (Deficit) 62 (18) (188) (184) (409) (894) Hot Rolled Demand 680 745 855 970 1,180 1,420 Supply 983 983 983 1,320 1,320 1,320 Surplus (Deficit) 303 238 128 350 140 (100) Cold Rolled Demand 1,320 1,400 1,655 1,730 2,015 2,725 Supply 1,423 1,423 1,423 2,328 2,328 2,328 Surplus (Deficit) 103 23 (232) 598 313 (397) Tinplate Demand 385 410 455 490 580 645 Supply 355 355 355 355 355 355 Surplus (Deficit) (30) (55) (100) (135) (225) (290) Total Flat Products Demand 3,280 3,530 4,110 4,370 5,180 6,680 Supply 3,718 3,718 3,718 4,999 4,999 4,999 Surplus (Deficit) 438 188 (392) 629 (181) (1,681) 4.24 In 1980, there will be surplus for export in all major categories of products, if the economy grows at a substantially lower rate than in the past and plants under construction and expansion start production as scheduled. It is estimated that this surplus can be exported, given Mexico's substantially improved competitive position by 1980 and its prime location in relation to the US market which is expected to import in excess of 10 million tons in 1980. Considering the conservative nature of the projections (para. 4.19) and the possibility that there might be some production slippage in one or more of the projects, the quantities, if any, available for export could be substan- tially lower. In any case, these surpluses would be temporary and domestic demand is expected to exceed production in the early 1980s. 4.25 By 1985, first year of full production of SICARTSA II, the country, unless capacity beyond that presently projected is added, is most likely to experience moderate to substantial deficits in flat as well as non-flat products, which not only fully justifies the proposed investment in SICARTSA II from the market point of view but also indicates the need for additional pro- duction facilities. 4.26 The demand/supply comparison for individual flat products indicates that, when SICARTSA II achieves full production in 1985, there will be a deficit in plate and tinplate even under the most adverse assumptions. In the case of hot-rolled and cold-rolled products, it is most likely that there would be small surpluses or small deficits. Considering the high certainty  - 35 - of plate and tinplate deficits, future expansion programs in the country will take this into account. In the specific case of tinplate, SICARTSA will seriously study prior to 1979 the economic feasibility of installing tinning lines in the Phase B of the project. E. Sales Forecast 4.27 Sales for Stage I and II of SICARTSA are expected to develop as follows: /1 SICARTSA - Sales Forecast (1,000 tons) 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 Non Flat (Stage I) Reinforcing Bars 25 151 312 408 435 435 435 435 435 435 Wire Rods - 122 247 309 330 330 330 330 330 330 Solid Bars 11 43 87 117 125 125 125 125 125 125 Light Sections - 43 81 104 110 110 110 110 110 110 Subtotal 36 359 727 938 1,000 1,000 1,000 1,000 1,000 1,000 Flat Products (Stage II) Light Plates - - - - 67 100 100 95 100 106 Hot Rolled - - - - 403 606 609 578 600 639 Cold Rolled - - _ _ 93 406 670 900 995 997 Subtotal - - 563 1,112 1,379 1,573 1,695 1,742 Total Sales 36 359 727 938 1,563 2,112 2,379 2,573 2,695 2,742 /1 Assuming 90% utilization of installed capacity of both stages. These forecasts are based on the gradual production buildup for each stage. As discussed earlier, the domestic market is expected to absorb the entire production by 1985, while some surplus for exports could develop between 1980 and 1985 for some flat and non-flat products. The Government policy is to call upon SICARTSA to export a proportionately higher share than the rest of the steel industry, due to its favorable location for exports vis- a-vis other than Mexican plants. SICARTSA's marketing policy also con- templates the development of an export strategy to the extent of 10% of production volume. As a first step to implementing this policy, SICARTSA's sales manager is currently visiting potential customers mainly in North and Central America, and his first contacts have already indicated that SICARTSA could export to the western part of the US. At present, the US is annually importing about 15 million TPY of steel--5 millions from Europe to the East Coast and 10 million tons from Japan to the West Coast. According to a recent study conducted for the U.S. Deparment of Commerce, the United States is expected to import in excess of 10 million TPY of steel by 1980. Taking into account the project's advantageous location on the Pacific coast, SICARTSA might well be in a good competitive position to profitably  - 36 - export its products to the West Coast of the US. Therefore, it is believed that SICARTSA will be able to produce at full capacity. F. Geographic Distribution of Sales and Transportation 4.28 The consumption of steel products in Mexico is highly concentrated in the central and northern regions of the country. In 1973, the geographic distribution of flat and non-flat products production and consumption was as follows: MEXICO - 1973 - Geographic Distribution of Steel Products (%) Flat Products Non-Flat Products Production Consumption Production Consumption Pacific Region - 5 - 14 Central Region 24 48 67 57 Northern Region 76 31 23 7 Other - 16 - 22 Total 100 100 100 100 The geographic distribution of flat products significantly differs from that of non-flat products due to the differences in the location of major con- suming industries. For example, many important manufacturing industries con- suming mostly flat products are located in the state of Nuevo Leon in the northern region of Mexico. SICARTSA's marketing area will be mainly the central and Pacific regions. 4.29 It is planned that the central zone will be supplied by train, the Pacific zone by ship and the other zones by road. The railway link between the plant site and Nueva Italia is progressing satisfactorily and is expected to be completed by end 1977. The existing road to Mexico City is being improved and will be finished by mid-1976. It will not be possible to use it until the completion of the railway link and of the direct road to Mexico City from Zihuatanejo which is expected to be finished in 1977. This new road will shorten the transportation distance between Mexico City and Lazaro Cardenas by more than 200 km. The Pacific highway which connects Lazaro Cardenas to Manzanillo is expected to be completed this year. The port at Lazaro Cardenas has the necessary facilities to allow the shipping of steel products to the Pacific coast consuming centers. G. Marketing Organization and Policies 4.30 Due to the market conditions which prevailed in 1974 and 1975 -- seller's market -- the creation of a marketing department and development of sales strategy were delayed. The sales department of SICARTSA was created only recently. An indepth study of its future organization and policies was re- cently completed and was reviewed by the Bank. Based on this study, SICARTSA plans to sell 70% of its production directly to customers, using distributors  - 37 - only for small order quantities (less than 5,000 Kgs). Around 60% of the sales will be carried out through a network of six branches to be established in the central and pacific zones, the main one to be located in Mexico City, where consumption of SICARTSA's steel products is expected to be around 60%. The major function of branches will consist of taking orders, stocking pro- ducts, organizing transportation and collecting credit, in close conjunction with the head office. The Mexico city area will be mostly serviced by train and SICARTSA will absorb the cost of transportation in order to be competi- tive with existing producers. Until the completion of the railway link bet- ween Lazaro Cardenas and Nueva Italia by end 1977, road transportation will be used to service the central zone and this is not expected to pose any major problem. The coastal areas will be serviced by ship and the remaining areas by road. As part of its marketing policy, SICARTSA also plans to provide its clients with technical assistance services. 4.31 SICARTSA will be in a good competitive position, being located closer to the central zone than most of the other major steel companies, and benefiting from a merchant tax lower (1.8% vs. 4%) than that applicable to others, since unlike its main competitors, it is located outside the present centers of industrial production. V. PROJECT COMPONENTS AND INFRASTRUCTURE A. Scope and Objectives 5.01 To meet the growing demand for flat products, the Government's strategy is to expand Mexico's production capacity. By virtue of its location, SICARTSA's expansion is one of the best alternatives available towards this end, a coastal plant very close to iron ore deposits and not too far from the consuming centers. The project, which is to increase the capacity of the plant from 1.2 to 3.3 million TPY of raw steel, has been well designed in close cooperation between SICARTSA and BSC. It is intended to produce 1.7 million TPY of flat rolled finished products using modern conventional steelmaking technology and it is expected to start operations in early 1980 and reach full capacity by 1985. Project implementation has already started and procurement of major equipment items is underway. 5.02 Although the project involves an expansion of capacity, there is no technical inter-relationship between the Stage I and Stage II projects and both are in this sense, virtually independent as can be seen from the Process Flow Chart given in Chart V.1. Therefore, the overlap of the imple- mentation of stages is also not expected to interfere with the execution and subsequent operation of the Stage I project. The Stage II project will result in a modern well-balanced plant (Material Flow Diagram - Chart V.2) and consists of the following major facilities as described more fully in Section B below and Table 5-1: (i) expansion of the ore beneficiation plant;  -E Q11 -- r ,ll--"ffi - , 4--* _______________________________ I _l -S6't--fu01_ R13 /? ---- ----------- 1 I - ., bOreve NOejdfl 133ll fV,InS gl - O UC1W  SLIFICO-LAS TEUCIFAS STEEL ESEARSFSAJN PROJECT MATERIALS FLO- O-AGRA-S-TA-E 1 Fl ae r *F A 2 F 3 F 9F 5F F7 Y F CS F3 FE -------- -------- 1-1 2- = esa [ i s sxss Nes eose m , In n4 1FF FF FFI | llL$~lm IG IIII L _ _ > E 11M e5Y M F 1N fo-- - - - - - - - -- I | cnbl_ I r r~~~~~~~~~~~~~~~~--- ,,,.Ut SA 5._----------------- | YI I9M $VXPR^~~~-E S 1;S-r 5 ----I - ----------  - 40 TABLE 5.1 M3XICO: LAS TRUCHAS STEEL EXPANSION PROJECT DETAILS OF STAGE II FACILITIES FACILITIES PHASE A PHASE B Mining Mechanical Shovels, drilling machines, bulldozers trucks, Primary gyrotary crusher, blending yard enlargement, stacker reclaimer Concentration To be defined Agglomeration Sinter Plant 1.5 MT/y (to be finalized) Pellet Plant 1.85 Mt/y Limestone Crushing and Screening Equipment 200 T/hr - Two rotary kiln 325 t/d Goal Handling One Coal Unloader 1 ,000 tA One Coal Unloader 1,000 t/h (to be confirmed by further study) Coal Yard Conveyors, four storage beds - 2 stacker-reclaimers Coke Plant 70 coke ovens batteries 680,000 TPY 60 coke ovens batteries 580,000 TPY Iron Making One B.F. 9.5 m diameter 1,650 m3 working volume One B.F. 9.5m 1,650 m3 working daily output 3,300 t/d volume 3,300 t/d Steel Making Two vessels 220 tons Continuous Casting Three two strand continuous casting machine Hot Rolling Mill Semi Continuous HSM 60" 2 million TPY 2 slab furnaces 275 t/h each VSB reversing 4H stand 6 finishing stands, 2 downcoilers, conveyors Hot Finishing Mill One skin pass 2H single stand Hot Finishing Facilities One shearing line thickness 12.7 mm One slitting line - one shearing line thickness 4.75 mm Pickling Line One pickling line 1 million TPY One pickling line 1 million TPY Cold Rolling Mill One 4 high 4 stand tandem cold mill 1.1 million TPY One fifth stand 1.3 million TPY Batch Annealing 55 batch annealing furnaces - 120 bases 25 batch annealing furnaces 60 "bases" Cold Finishing Mill One Temper Hill 4 high stand 60" 0.6 million TPY One Temper Mtill 4 high stand 60"t o.6 million TFY Cold Finishing Facilities One high speed shearing line (240 m/min.) (thickness = 0.51/2.65 mm) One low speed shearing line (90 m/min - thickness 0.35/2 mm) One slitting line (thickness 0.4/3.4 mm) Oxygen Plant Two units 450 t/d each Electrical Services 4 transformers 220/34.5 kv 50/62.5 MVA Power Plant One turbo blower 225,000 Nm3Ar 4.5 kg/cm2 3 two boilers 200 tons/hr One turbo blower 225,000 Nm Ar one turbo alternator 10.5 MW 4.5 k/cm2 ~Wo bcilars 200 tnns/hr one turbo alternator 10.5 MW Industrial Projects Department December 1 975  - 41 - (ii) increase of the agglomeration capacity; (iii) addition of new coke ovens; (iv) installation of two new blast furnaces (v) installation of a new basic oxygen steelmaking plant; (vi) installation of a continuous casting plant of three twin strand slab casting machines, and (vii) installation of a new flat products rolling mill complex including a hot strip mill, and a cold reduction mill with related finishing facilities. 5.03 Considering the longer learning curve of the capacity buildup of the rolling mill complex in relation to the iron and steelmaking facilities, which are basically the same as those in Stage I, and to obviate the need for heavy investments prematurely, the Stage II project is to be implemented in two phases - Phase A and Phase B. Based on the above rationale, the entire steelmaking and hot-rolling capacity and half of the ironmaking capa- city will be installed under Phase A and the remainder of ironmaking, cold- rolling and finishing facilities will be installed under Phase B. Further details on the phasing of equipment installations are given in Table 5-1. 5.04 The overall strategy of SICARTSA is to expand capacity of its plant ultimately to 10 million TPY in two further stages. Therefore, the design of Stage II takes the expansion to Stage III already into account, which would bring raw steel capacity to about 6 million TPY. Stage IV, the final expansion (10 million TPY) possible at the present location, has only been considered very broadly mainly for determining space require- ments. Implementation of Stage III is tentatively planned to begin around 1984 and to include the following main plants: (i) installation of agglo- meration plants; (ii) installation of new coke oven plants, (iii) installa- tion of two new blast furnaces of 9.5m diameter, (iv) extension of the two existing steelmaking plants by adding the third 100-ton vessel and the third 220-ton vessel, (v) extension of the two existing continuous casting plants, (iv) installation of two new rolling mills (rods and light sections), (vii) extension of the semi-continuous hot strip mill to a three quarter continuous hot strip mill, and (viii) installation of a new tandem cold rolling mill and the corresponding finishing facilities. A tentative cost estimate of Stage III, based on the same assumptions as for Stage II, shows a total investment of about US$700/annual ton, in 1975 prices - this represents savings of about 35% with respect to Stage II, implying considerable economies of scale. B. Project Description (Stage II) 5.05 The material flow diagram and the plant layout are given in Charts V.2 and V.3 respectively. The project can be divided into five main producing facilities and services; (i) mining and raw material handling facilities, (ii) ironmaking facilities, (iii) steelmaking facilities, (iv) rolling and finishing mill facilities, and (v) utilities. 5.06 Mining and raw material handling facilities: In the area of iron ore mines, equipment necessary for the extraction and beneficiation of the annual iron ore requirements will be added. The existing blending yards will be enlarged to a total stocking capacity of 380,000 tons. The extension of the concentration plant will depend upon the findings of the laboratory work in progress and it is envisaged to introduce flotation processes to con- centrate the hematite fraction of the ore. The magnetic concentrate will be  MEXICO LAS TRUCHAS STEEL EXPANSION PROJECT PLANT LAYOUT THE THREE STAGE LAYOUT OF SICARTSA 1. SICARTSA WH4ARF 2. COAL STORAGE 3. COAL BLENDING 4. AIR COMPRESSED PLANT 6. LIME BURNING PLANT 7. SLAG TREATMENT AREA B. PELLET PLANT S. COKE & PELLETS EMERGENCY YARD 10. COKE OVENS PLANT 11. BY-PRODUCTS PLANT 12.BLAST FURNACE 13. POWER PLANT 14.GAS HOLDERS I5. TORPEDO LADLE CARS REPAIR SHOP 16. STEEL MAKING PLANT 17. CONTINUOUS CASTING PLANT 38, ~~~~~~~~~~~~~~~~~~~~~~~~~~~8. OXYGEN PLANT 1I.SCRAP YARD 20. ROLLING MILLS 21.FINISHED PRODUCTS WAREHOUSE c- ~~~~~~~~~~~~~~~~212. WATER TREATMENT PLANT 23. MAIN SUBSTATION 24. GENERAL MAINTENANCE WORKSHOP 4 25. MOBILE EQUIPMENT REPAIR SHOP 26. REFRACTORIES STORtAGE 27. GENERAL STORAGE 26. FUEL OIL STORAGE ________ ~~~~~~~~~~~~~~~~~~26. CUSTOM STORAGE 30. GENERAL OFEICES Liul PUERTO ~~~~~~~~~~31. WEIGHING STATION LAZABO ~~~~33. WORKERS CAMP 3.LUBRICANTS STORAGE 191 Z I ~~~~~~~__________GS TTON AND TRAFFIC AREA (1 2' 1 2 37. ~~~~~~~~~~~~~~~SINTER PLANT 3.EMERGENCY SINTER STORAGE 3.HOT ROLLING MILL t~~~~~o ~~~~~~l 40. ~~~~~~~~~COLD ROLLING MILL 4PIPE MILL 42 PLATE MILL ----------- ~ ~~~43. LIGHT SECTION MILL 4.BAR MILL O STAGE I 0 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~~<.STAGE 11 O STAGE III World Borrk-15349  - 43 - pumped in the form of slurry to the steel works through the Stage I pipeline which was designed with sufficient capacity for both stages. The major part of the additional 1.7 million TPY of coal required for Stage II will be received at the wharf and taken by a belt conveyor system to four storage beds (4 x 60,000 ton capacity) each served by a stacker reclaimer. One additional coal unloading system of 1,000 tons/hour nominal capacity will be installed at the dock, under Phase A, and another similar coal unloading system is planned under Phase B. However, SICARTSA will study the need for this additional unloading equipment for Phase B. The remainder of the coal will be received by rail and taken by conveyor belts to the same storage. The storage beds cover a total of nine weeks of coal requirements upon com- pletion of Stage II. 5.07 Ironmaking facilities: SICARTSA's present plan is to install a sinter plant, with a capacity of 1.5 million TPY, under Phase A based on the pilot work and the findings of earlier tests which have confirmed the pos- sibility of producing adequate sinter feed. Under Phase B, a pellet plant with a capacity of 1.85 million TPY will be installed. To produce the 1.25 million TPY of blast furnace coke, the coke oven plant will have 130 addi- tional ovens designed to operate with up to 20% indigenous high ash content coal. The Stage I by-product plant will be expanded in Phase A and a new by-product plant will be constructed in Phase B. Studies carried out by SICARTSA and BSC have shown clear advantages of installing two blast furnaces which allow the phasing of investment and provide greater security of supply. Each will have a nominal annual capacity of 1.1 million tons of pig iron. The corresponding fuel consumption per ton of pig iron would be 510 kg of coke 1/ plus 50 kg of fuel oil. Charging of the blast furnace and the operation of the stoves will be controlled by means of computer similar to that installed in Stage I. The pig iron will be transported to the steel plant in torpedo cars of 230-ton capacity. 5.08 Steelmaking facilities: Top blown oxygen steelmaking, which is a well proven and efficient process, was selected. Two converters, of 220-ton capacity each, will be installed under Phase A. This plant is designed to receive a third converter under Stage III. Allowing for interference between the steelmaking and continuous casting plant, it is calculated that 9,500 heats per year are required to produce 2.1 million tons of liquid steel in two vessels with a capacity of 220-tons. Three two-strand continuous casting machines will be installed under Phase A. Studies carried out to determine the optimum dimensions of slabs show that the mills would have maximum efficiency with a slab unit weight to give 20.4 kg/mm of width in the hot strip mill; this corresponds to a thickness and length of 250 mm by 10.4 m respectively. 1/ Based on 100% of imported coal. The consumption would increase to 570 kg of coke with a blend of 80% imported coal and 20% indigenous coal.  - 44 - 5.09 Rolling and Finishing Mill Facilities: The optimum width selected for the semi-continuous hot strip mill is 60 inches for a capacity of 2 mil- lion tons/annum. The product mix in a normal year of production, based on forecast market demand is expected to be: light plate 23%; hot rolled 20%; cold reduced 57%. The mill run out tables are designed to have sufficient length for the future installation of two additional roughing mill stands which will further increase the capacity of this plant up to 3 million TPY. The finishing mill will have electrically operated loopers, a fume and dust extraction system and a mechanized roll change arrangement. The installa- tion will have automatic strip gauge control with x-ray equipment and other necessary instrumentation and provision for full computer-controlled opera- tion in the future. The pickling lines will use hydrochloric acid and treat coils of 30 tons with a maximum thickness of 6.3 mm. A hydrochloric acid recovery plant will also be installed. The tandem cold mill will be installed with hydraulically driven screwdowns, load cells incorporated in each stand and work roll bending for shape control on the first and last stand. Automatic gauge and tension control will be installed with provisions for conversion to fully computerized control in Phase B. The furnaces of the batch annealing plant will be heated with coke oven gas and will have an inert atmosphere of HNX gas. 5.10 Utilities and Services: The oxygen plant will include two units of 450 tons/day of high purity oxygen with a proportion of liquid oxygen from 6% to 10%. In addition, 800 Nm3/h of nitrogen will be produced for other uses including pressurization of the blast furnace charging system. In the power plant, the two turbo generators driven by the steam produced by the boilers will generate about 10% of the total requirements of the Stage II plant. The maximum half hour electrical power demand for Stage II will be approximately 150 MW, which combined with Stage I demand totals 250 MW. The Comision Federal de Electricidad will provide approximately 220 MW (the rest is gene- rated by the power plant of SICARTSA) from La Vilita hydroelectric station through two existing 230 KV overhead lines interconnected to the Mexican general network. During negotiations assurances will be obtained from the Government that it will provide sufficient power to meet SICARTSA's require- ments. The total water requirements for both stages will be approximately 15 m3/sec which will be supplied from the Rio Balsas. Existing facilities for producing demineralized, soft and potable water, will be duplicated. The slag treatment plant will be expanded to recover the metal content from the additional blast furnace and steel plant slags. C. Mining and Insfrastructure Requirements 5.11 Mining: There are a number of small iron ore mines which SICARTSA is presently exploring or exploiting; the important ones are Ferrotapec, El Mango, El Volcan, El Venado, Santa Clara and Valverde. All these mines are located in the vicinity of the plant site, roughly about 20 km from the steel plant. Chemical analysis of the ore has shown an average soluble iron (Fe) content of about 50%. The main impurities are iron and copper sulphides, which largely disappear in the beneficiation process to yield a high quality  - 45 - concentrate of 67-68% Fe content. The primary ores are magnetic (Fe 304 ), but the northern deposits (El Mango and El Volcan) have been weathered and ex- posed to variable depths, the effect of which has been to convert much of the magnetite in the upper layers to hematite (Fe203). At present tests are being carried out by SOFREMINES of France and Comision de Fomento Minero (CFM) of Mexico to establish a process to concentrate the hematite ore. The selection of agglomeration plant will depend upon the results of these tests (para. 5.07). 5.12 A comparison of SICARTSA's assessment of iron ore reserves, based on the work done by Consejo de Recursos Naturales No Renovables (CRNNR) of Mexico in 1950 and recently by SICARTSA itself, and the Bank's estimates are given below. The basic difference between the Bank's and SICARTSA's figures stems from the fact that data used to calculate the quantities and categories of geological reserves have been interpreted by the Company in the most favorable way and also that a good deal of confusion exists con- cerning the terms used to describe different categories of reserves. SICARTSA - The Company-Owned Iron Ore Reserves (Million Tons) /1 SICARTSA Bank Measured Amenable Measured Workable Indicated Ferrotapec 9.9 8.2 9.9 8.2 - El Mango 24.0 24.0 24.0 22.0 - El Volcan 36.0 36.0 35.0 30.0 - El Venado 5.5 5.5 5.5 3.0 2.5 Valverde 3.0 1.0 - - 3.0 Santa Clara 5.0 5.0 - - 10.0 Float Ore 13.0 13.0 3.5 3.5 4.0 Total 96.4 92.7 77.9 66.7 19.5 /1 The basis for calculation of geological reserves of iron ore into categories are as per the definitions of USGS and USBM. 5.13 At full production capacity, Stage I will require about 2.3 million TPY of iron ore of 49% Fe content and Stage II about 4.2 million TPY of the same quality. The total requirements for Stages I and II projects for 15 years of production would be about 97 million tons. Therefore, since the proven workable reserves, according to the Bank's estimate, amount only to 67 million tons, the financial and economic analysis assumes imported iron ore of about 3.0 million tons per year starting from 1988. However, SICARTSA is proceeding well with its exploration work to find additional reserves and ensure the necessary iron ore reserves for the life of both projects. There is ample indication that economically recoverable reserves will increase to as much as 100 million tons by the end of the exploration program, which  - 46 - is expected to be completed by the end of 1976. This would undoubtedly im- prove the financial as well as economic situation of the project. The Company at present has a detailed overall mining plan covering Ferrotapec, El Mango and El Volcan. 5.14 Housing: The construction of the Stage I steel plant in a hitherto lightly populated region necessitated the development of a city to house and to provide services for the employees of SICARTSA and any ancillary industries growing up around it. For the concomitant development of the Lazaro Cardenas City--formerly known as Melchor Ocampo--a Trust Fund called Fideicomiso Ciudad Lazaro Cardenas 1/ was created at the end of 1972 under NAFINSA. The basic plans, based on the experience of Monclova, in Northern Mexico, where the nation's largest steel producer--AHMSA-- is located, were completed in 1973. However, the construction programs were considerably delayed due to the inability of the Trust Fund to carry out its responsibilities, and a severe lack of coordination among various Government bodies. Only less than 20% of the development works had been completed by the end of 1975 as against the originally foreseen 80%. This has already, to some extent, adversely affected the implementation of the Stage I project. Therefore, in order to minimize this effect and to meet immediate housing needs of Stage I, SICARTSA has set out on crash hous- ing programs, which are expected to cost about US$21 million 2/. SICARTSA has already constructed dormitories to accommodate about 11,000 construc- tion workers working for Stage I. These existing installations, with appro- priate reconditioning and modifications estimated to cost about US$ 1 mil- lion, will be used to accommodate Stage II construction workers and super- visory staff. 5.15 Of the total 5,000 houses required by the end of 1976 for SICARTSA's operational staff and workers, only about 1,100 houses were completed by the end of 1975. As a result of this considerable delay the Trust Fund was transferred in August 1975 to the Banco Nacional de Obras y Servicios Publicos (BANOBRAS), which has extensive experience in housing development in the country. Moreover, in November 1975 the Minister of Presidency was vested with full authority to carry out and complete a crash program of housing construction (in addition to the houses SICARTSA is presently constructing), urban infrastructure development--water, sewage, electricity, telephone, good roads, etc.--and social services--hospitals, schools, market, recreational facilities, etc.--before the end of 1976. 1/ Although SICARTSA has no financial obligation to the city, it is represented in the Trust Fund's Board. 2/ SICARTSA will be selling these houses through its own installment plan or through other agencies to its permanent workers to recover the initial investment. The possibility of obtaining long term mortgages through a financial institution is being explored to permit a longer repayment period and at the same time to allow SICARTSA to recoup its investments at a considerably earlier date.  - 47 - These arrangements are expected to rectify the problems thus far encountered in the development of the city. A mission recently visited Mexico to assess the actual progress being made. The necessary houses to accommodate opera- tional personnel are expected to be ready by the end of 1976, however, some delays in completion are expected with respect to social infrastructure facilities. 5.16 The project (Stage II) would require an additional 7,000 houses and related services by 1981. The total cost of this program is estimated to be about US$140 million including contingencies and price escalations. A detailed long term construction program is being prepared on the basis of a general scheme which the Bank has found satisfactory. The Bank is presently considering an urban/regional development project in the Lazaro Cardenas area and preparations for such a project are currently underway through a special team organized by the Ministry of the Presidency. With direct Bank involvement in the development of the Lazaro Cardenas area, timely implementation of a suitable development program, including hous- ing and related infrastructure facilities for ensuing operation of Stage II project can be reasonably expected. Nevertheless, the Bank has obtained assurances from the Government that adequate support would be given to the city's construction programs to suit the Stage II project. 5.17 Docks and Port Services: One of the main advantages of SICARTSA's location is that it is situated adjacent to a new port, making it possible to take full advantage of inexpensive sea transportation. The port was constructed by the Ministry of the Navy (Marina) during 1973-1975 for the Stage I project and further expansion of SICARTSA. For the present level of traffic 1/ the port appears to be well organized, adequately equipped and functioning efficiently. Hydrographic surveys show little evidence of any significant siltation of the dredged areas. By mid 1977, total investments in port facilities would amount to about US$35 million including a gantry crane for handling containers provided by SICARTSA as its equity contribution to Servicios Portuarios de Lazaro Cardenas, the operating company of the port. The port installation once completed in mid 1977 will include (a) dredging and fill (channel and basin 14 m deep), (b) two breakwater and channel entrances, (c) a 702m long SICARTSA wharf (600m usable), (d) a gantry con- tainer crane, (e) one 1,000 tons per hour coal unloader to be installed as part of Stage I project, (f) a 150m long public wharf with transit shed, and (g) necessary utilities and access roads. 5.18 The above installations will provide one 260m bulk berth for ships of up to 80,000 DWT and three general cargo berths assuming the bulk berth is reserved for coal, limestone and other bulk materials. With one 1,000-ton per hour unloader (15,000 tons per day) and 33% berth occu- pancy (120 days per year) the bulk berth could handle 1.8 million TPY with about 35 days of ship waiting time per year assuming arrivals are un- scheduled. With 50% berth occupancy and 750 tons handled per ship day at 1/ In addition to the present port, construction of a commercial port across the basin is underway and is expected to be completed by the end of 1977.  - 48 - berth, the three general cargo berths could handle 400,000 TPY with about 60 days of ship waiting time per year. With these installations, includ- ing a second bulk unloader to be constructed under the Stage II program, the port should be adequate to handle forecasted traffic. However, if SICARTSA plans to ship a major portion of its finished products by sea, an additional general cargo berth will be required for SICARTSA's use after 1981. Moreover, if ships larger than 80,000 DWT are expected after 1980, then the turning basin and bulk berth will have to be dredged to a depth of 16m. Therefore, studies to define future demand for port services and necessary future installations will be carried out by SICARTSA, in conjunction with the relevant Government agencies prior to the end of 1978 and the Government will take any necessary measures required for the efficient transportation of SICARTSA's products, in line with project requirements. 5.19 Railroad: Based on a comprehensive study carried out in 1973, it was concluded that the best alternative would be to transport SICARTSA pro- ducts by rail from the plant to Mexico City through Nueva Italia (Map IBRD 12021). Therefore, a rail connection--about 200km--linking Lazaro Cardenas and Nueva Italia was planned and is now under construction aiming at a completion by the end of 1977. By the end of 1975 about 25% of the work had been completed. Four major contracts will be issued in early 1976 for the construction of three bridges and two viaducts. Ferrocarriles Nacionales de Mexico, responsible for the completion of this railroad link, has already acquired the 50,000 tons of rails required to cover the full length of the extension. The construction of the railroad, including terminals and houses for operators, is estimated to cost about US$92 million. By the end of 1975 about US$26 million had been spent and about US$35 million will be required in 1976 and the remaining US$31 million in 1977. The Government has agreed to take all steps to complete this rail connection by the end of 1977. 5.20 Roads: Recognizing the need for the industrial development in the Lazaro Cardenas area, important expansions (for both freight movement and personnel transportation) in the road network that will link this zone with the rest of the country, are being carried out by the Ministry of Public Works. The most important programs are (i) a direct road from Mexico City to Zihuatanejo to be completed by the end of 1977; this will shorten the distance between plant and Mexico City (via Zihuatanejo) by more than 200km to about 550 km, (ii) improving the existing direct road from Lazaro Cardenas to Morelia by mid-1976; (iii) the completion of the Pacific Coast highway by 1977, which will connect the plant with Cuahuayana, and (iv) some extensions and improvements that are being made to secondary roads within SICARTSA's area of influence. With the completion of these road networks, SICARTSA will have satisfactory transport network for efficient operation. 5.21 Telecommunication: At present, communications between the steel works and the main office in Mexico City are achieved through SICARTSA's own radio equipment and a few telephone lines contracted from Telefonos de Mexico, which is at present installing a microwave system with a capacity of 120 channels to be completed by the end of 1976. As part u5 Stage I,  - 49 - SICARTSA will install in 1976 a telephone exchange having a capacity of 1,500 lines including 70 external lines. The Stage II project includes virtually the duplication of the Stage I facilities. The telecommunication program is considered satisfactory. D. Ecology 5.22 Although pollution control laws and regulations have been in ex- istence in Mexico for only a few years (the Sub-Secretaria de Mejoramiento de Ambiente was created in 1972), SICARTSA has recognized the need to exercise strict control over all aspects of environmental pollution from the beginning of the implementation of Stage I. The relatively new pollution control pro- gram of the Mexican Government is being carried out in three stages, the third of which will not come into effect until 1980. It is not until then that the Mexican standards will be comparable to those existing in other more indus- trialized countries. SICARTSA, therefore, decided to follow the same policy as for Stage I and to use standards established by some of the leading in- dustrial nations. (SICARTSA standards are based on IBRD report of Mr. Katz October 1972, United Nations 1970 report on problems of air and water pollutions arising in the Iron and Steel industry, and English and German Regulations). When specifying the Stage II facilities, SICARTSA issued a set of standards regarding the air, water and noise pollution with which contractors must comply. The air pollution controls apply to the dust emissions of the major facilities (pellet plant, sinter plant, coke ovens, lime plant, blast furnace, Iteelmaking plant, boilers); such dust emissions will be limited to 0.1 g/Nm . Furthermore, all stacks emitting gases con- taining SO2 will be controlled in accordance with the best standard avail- able (e.g. Coke oven tops-extraction equipment with wet scrubbing on coal charging car giving an emission level of 0.15 g/Nm ). The water pollution control standards specify that the effluent or industrial water discharged must comply with the limits indicated in each facility specification (Table 5-2). The general philosophy will be to treat liquids from each process and then to feed them into a large channel flowing to the southwest of the plant. In this channel any pollutant that escaped individual treat- ment will be sedimented before the liquids will flow into the sea. No water will be discharged to the local river. The noise level within working areas shall not exceed 85 dba, with the exception of all control rooms where the maximum permissible noise level will be 55 dba. Nevertheless, the Company has assured that it would continue to carry out the project and operate the plant with due regard to environmental factors. 5.23 The cost of pollution control installations for the Stage II project is estimated at about 7% of total equipment cost. This amount does not include the establishment of a "green belt" formed by a strip of native vegetation 50 m wide which will not only act as an acoustic barrier for the city's residents but will be capable of absorbing 70 to 100 tons of dust per year and thus help to create an attractive working environment.  - - Table 5-2 MEXICO: LAS TRUCHAS STEEL EXPANSION PROJECT LIMITS FOR THE TEIFERATURES AND CHEMICAL CONTENTS OF DISCHARGS INDUSTRIAL WATERS AND EFFLUENTS , I1 PLANT H o | F: 0 < W 2X x OH H CT 'x H4-) +)~ 4H + a,) CaH H) O+I H H +) H C w X U (a H 0 Ao XoH0 1) H CU 0 0 Max. Temperature 35