Mexico - Fourth Power Sector Program Project

Document of RETURN TO The World Bank FOR OFFICIAL USE ONLY V,j IT ONE WEEK Report No. 1775 ILE COP' PROGRAM PERFORMANCE AUDIT REPORT MEXICO: FOURTH POWER SECTOR PROGRAM (Loan 834-ME) October 26, 1977 Operations Evaluation 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 authorization.  FOR OFF AL USE ONLY PROGRAM PERFORMANCE AUDIT REPORT MEXICO: FOURTH POWER SECTOR PROGRAM (Loan 834-ME) Table of Contents Page No. Preface Program Performance Audit Basic Data Sheet Highlights Program Performance Audit Memorandum I. Introduction 1 II. The Bank and the Loan 2 III. Physical Execution of the Project 2 IV. Project Costs 3 V. Frequency Unification 4 VI. System Development and Service Quality 6 VII. Financial Performance 7 VIII. Operating Efficiency and Sectoral Development 10 IX. Re-estimated Return 11 X. Conclusion 11 Appendix A and B Annex Tables I - XIII Attachment: Program Completion Report Project Description Al Objective and Justification A2 Construction Schedule A3 Project Cost Estimate A4 Consultants A6 Financing A6 Financial Performance A7 Organization and Management A9 Plan of Action Al0 Insurance Practices of CFE A12 External Auditors A13 Financial Covenants Al3 Conclusions A3l Annexes I - VII 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.  PROGRAM PERFORMANCE AUDIT REPORT MEXICO: FOURTH POWER SECTOR PROGRAM (Loan 834-ME) Preface This report presents a performance audit of Mexico Fourth Power Sector Program, for which Loan 834-ME of US$125 million was fully disbursed in June 1975. The audit is based on the attached Program Completion Report (PCR), a review of project files and loan documents, and discussions with Bank staff and with officials of the Comision Federal de Electricidad (CFE) and the Government during a brief OED mission to Mexico in February 1977. The generous help given by the Government and by CFE officials in the prepara- tion of this report is gratefully acknowledged. The PCR is competent and covers the ground well; the audit memo- randum expands on aspects of the program experience which deserve special emphasis.  PROGRAM PERFORMANCE AUDIT BASIC DATA SHEET MEXICO: FOURTH POWER SECTOR PROGRAM (LOAN 834-ME) (Amounts in US$ m1n) As of 31 March 1977 Original Disbursed Cancelled Repaid Outstanding Loan 834-ME 125 125 nil 10.4 114.6 Project Data Actual or Original Plan Est. Actual First mention in files 12/30/70 Negotiations 1/72 5/23/72 Board Approval 6/20/72 Loan Agreement 6/23/72 Agreement Amending Loan Agreement 3/08/73 Effectiveness 12/31/72 4/13/73 Closing date 12/31/74 6/30/75 Total Costs 1,368 1,340 a/ Incremental Financial 14% 4% Rate of Return Borrower Comision Federal de Electricidad (CFE) Nacional Financiera S.A. (NAFIN) Executing Agency Comision Federal de Electricidad (CFE) Mission Data Month, No. of No. of Date of Item Year Weeks Persons Manweeks Report Identification 1/71 1/2 3 1 1/2 3/71 Preappraisal 6/71 1/2 3 1 1/2 6/71 Appraisal (a) 10/71 1 1 1 10/71 " (b) 12/71 3 1/2 3 10 12/71 Sub-total 5 1/2 14 Supervision I 3/73 1 1 1 4/73 Supervision II 9/73 1 1 1 9/73 Supervision III 3/74 3 2 6 4/74 Supervision IV 11/74 4 1/2 2 9 11/74 Supervision V 3/75 1 1/2 3 5 3/75 Sub-total 11 22 a/ On a substantially smaller program. The overall average cost of the actual program (i.e., of the components which were constructed) is estimated to be 30-40% in excess of the corresponding appraisal estimates.  PROGRAM PERFORMANCE AUDIT REPORT MEXICO: FOURTH POWER SECTOR PROGRAM (Loan 834-ME) Highlights This was the Bank's eleventh lending operation to Mexico's power sector. The loan was to finance a three year (1972-74) slice of a larger investment in generation, transmission, distribution, village electrification and frequency unification. The financing plan was a transition from joint financing, used in the three earlier programs, to parallel financing. The loan was not successful in help- ing the borrower realize the agreed objectives for the sector. The original program was substantially altered and was imple- mented with long delays and cost overruns. By the end of 1974, only about 30-50% of the planned facilities were operational, and the cost overrun is estimated at 30-40% in real terms. Only frequency unifi- cation was successfully completed about a year ahead of schedule and for lower than estimated costs in real terms. Construction delays resulted in extensive load-shedding in 1975, despite the actual growth in energy consumption being lower than forecast. Mainly because of inadequate tariff increases, the sector's financial performance was also unsatisfactory. Its entire investment program (whose costs had escalated) and a part of its debt service had to be financed by borrowings. The ex post incremental financial rate of return (4%) is substantially lower than the appraisal estimate (14%). The following points may be of particular interest: - reasons for delays in making the loan effective (paras. 8 and 9); - construction program: causes for delays and cost over- runs,and the consequences (paras. 11-16, 23 and 24, and PCR paras. 17.1, 17.2 and 18.1-18.3); - successful implementation of the frequency unifi- cation program (para. 21 and 22); - effects of inadequate tariffs on the financial perfor- mance (paras. 27-32 and PCR paras. 20.1-21.3); - changes in top management (PCR para. 22.2).  PROGRAM PERFORMANCE AUDIT MEMORANDUM MEXICO: FOURTH POWER SECTOR PROGRAM (Loan 834-ME) I. Introduction 1. Loan 834-ME, for US$125 million equivalent, to the Comision Federal de Electricidad (CFE) and Nacional Financiera, S.A. (NAFIN) was signed on June 23, 1972. It followed the general pattern of three previous loans to CFE and was designed to help finance that agency's 1972-74 investment program, the total cost of which was estimated at US$1,368 million equivalent, with a foreign exchange cost of US$650 million. Of the total cost, some 60% was for generation, transmission and substations, 23% for distribution, 6% for village electrification, 8% for overhead, and 3% for frequency unifica- tion, consultants and miscellaneous. 2. From 1965 to 1971 the Bank made three loans totalling US$325 mil- lion to help finance the programs of the power sector which consists in practice of two companies, namely CFE and Centro (formerly The Mexican Light and Power Company). It had previously made 7 loans, between 1949 and 1962, totalling US$255 million, net of cancellations, to finance specific projects of these two main power companies. The four 'sector programs' included installation of new generating, transmission and distribution facilities, under a long range expansion plan which was reviewed periodically by the Bank and SOFRELEC, one of CFE's consultants. 3. The financing plan for the Fourth Power Sector Program represented a transition from joint financing, used for the first three Mexico power sector programs, to parallel financing. Under the Third Power Sector Program Loan (Loan 659-ME) covering CFE's investment program for 1970-71, expendi- tures on equipment eligible for joint financing were covered on a 50-50 basis by the Bank and by loans from countries supplying equipment. Under the Fourth Loan, US$35 million equivalent was reserved for joint financing of further payments due after December 31, 1971, on orders placed before that date for equipment which formed part of the third program. The remainder was earmarked for the following components of the fourth program: a) equip- ment - US$73 million; b) civil works - US$15 million; and c) consultants - US$2 million. 4. The fourth power sector program followed the general pattern of the three previous sector programs in that it consisted of the investment programs expected to be carried out over a specific period. Major gen- eration equipment included 3,015 MW of hydroplant, 3,900 MW of steam- turbine plant, 670 MW of nuclear plant, and 500 MW of gas-turbine plant. The transmission program envisaged construction of 3,000 km of 400 KV lines, 2,900 km of 220 KV lines, and 5,600 km of 69-161 KV lines; further- more, 17,000 MVA of main stations and 300 MVA of small substations were to be constructed. The distribution networks, including village electrifica- tion, were to be expanded at an annual rate of US$120 million. Further details are given in Annex Table I. - 2 - II. The Bank and the Loan 5. Preappraisal of the Fourth Power Sector Program was carried out in June 1971, and the loan was signed on June 23, 1972. The Bank raised two main issues before sending an appraisal mission. 6. The first was the submission of a revised financing program for the years 1972-1974. The second issue concerned Government's approval for creating an entity which would carry out the frequency changeover (CUF). The Bank was concerned about the substantial delay which had occurred with the frequency conversion program, because the changeover of Centro's 50 Hz system to 60 Hz had long been recognized by Mexico and the Bank as an important sector objective. 7. The appraisal started in October 1971 and although it was pro- gressing smoothly in the fields of technical planning and frequency unifica- tion, it was interrupted because the Government had not prepared a suffi- ciently detailed investment and financing plan for the sector. The appraisal was resumed in December 1971. Financial projections were made assuming a proposed 17.5% electric power tariff increase would soon take effect. 8. In March 1972 the Bank informed the Mexican Government that it was ready to start negotiations for the loan but propcsed that tariff in- creases be introduced and a decree on frequency unification be issued be- fore presentation of the loan to the Executive Directors. However, it was eventually agreed that the loan would be approved and signed but that the Government would not request that it be made effective until after the 17.5% tariff increase had been approved. The Government undertook to increase the tariffs before December 31, 1972. Subsequently, the Government informed the Bank that it could not increase the rates as previously agreed upon. 9. As a result of discussions between the Bank and the Government, the Bank agreed to make the loan effective as of April 1973, but to allow the withdrawal of up to US$35 million only which was to be used for the pur- chase of equipment eligible for joint financing. The remaining US$90 million could be withdrawn only after the tariff increase. This increase was even- tually approved in October 1973 and the balance of the loan then made eligible for disbursement some 16 months after signature. III. Physical Execution of the Project 10. The Fourth Power Sector Program included facilities under construc- tion on January 1, 1972, or to be started before the end of 1974. CFE's in- vestment program comprised expansion of generating capacity on the order of 8,250 MW; more than half (about 4,286 MW) of this additional generating capa- city was expected to become operational during 1972-1974. As for transmission and distribution facilities, CFE's program for 1972-1974 included 11,500 km of transmission lines and 17,300 MVA of transformer stations; about 70% of - 3 - these facilities were to be operational before the end of 1974 (Annex Table I). 11. Procurement and construction work under the expansion program pro- ceeded more slowly than had been forecast. The actual construction of most major facilities took more than a year longer than the original schedule. Only 1,635 MW, or 38% of the planned 4,286 MW of additional generating capa- city, became operational before December 1974. Similarly, only about one-third of the transmission facilities and less than half of the distribution facili- ties planned for completion by the end of 1974 were actually operational by that date. 12. Delays in physical execution of projects under the Fourth Sector Program were not entirely unexpected. Experience with the previous three sector programs indicated that actual construction always took longer than the original schedules. The appraisal report did indicate that the borrower's construction schedule was optimistic. 13. According to initial Bank supervision missions, delays arose due to organizational problems in construction and procurement. Bank missions made recommendations regarding: (a) standardization of bidding documents; (b) clarification of technical specifications; and (c) reduction in the number of approval measures. The creation of the post of project coordinator in 1974, giving one person full responsibility for execution of a specific major project, led to more effective supervision of construction and expeditious follow-up on procurement. Although improvements in the implementation of the expansion program continued through 1974 and 1975, progress achieved fell short of the original goals. 14. The slower than expected progress during 1972-1974 on installation of generating equipment was reflected in the growth pattern of installed capacity in operation. By 1974, only 300 MW of additional hydro plant capa- city, as opposed to the envisaged 1,315 MW, became operational (23% of planned capacity). The installed steam plant capacity increased by 775 MW, as com- pared with the forecast increase of 2,399 MW (32% of planned capacity). By contrast, installed capacity of gas and diesel generating plant increased by 485 MW, as compared with the planned expansion of 497 MW. IV. Project Costs 15. Precise comparisons of actual versus expected project costs are only possible in the case of frequency unification. Since there were substantial changes in the construction program, there is no way of making a meaningful comparison of expected and actual costs of many project com- ponents. 16. The actual construction expenditures for 1972-1975 were Mex $30,652 million, as opposed to the forecast Mex $23,159 million, an increase of 32% in current terms. Table 1 below compares these expenditures with the esti- mates. -4- Table 1 Power Sector Construction Expenditures, Forecast and Actual - 1972/1975 (in Mex $ millions) 1972 1973 1974 1975 TOTAL Actual 4,440 5,481 6,835 13,896 30,652 Forecast 4,984 6,052 6,068 6,055 23,159 But there was no increase of construction expenditures in real terms since actual construction expenditures in constant prices were practically equal to forecast expenditures for the period 1972-1975, despite substantial con- struction delays in the major facilities of the expansion program. Lack of detailed information at this time makes it impossible to allocate cost overruns between design and quantity changes on the one hand, and price increases greater than the average on the other. However, the over- all average cost of the actual program, i.e.,of the components which were constructed, is estimated to be 30-40% greater in real terms, than the corresponding appraisal estimates. V. Frequency Unification 17. The crucial importance of frequency conversion goes beyond its modest share (3%) in the Fourth Power Sector Program. The frequency change- over program was essential to obtain all the benefits of a nationally inter- connected system. 18. Reports and reviews by CFE consultants in 1963 and in the follow- ing years confirmed the economic justification for converting the Central System from 50 to 60 cycles (Hz) and recommended that the conversion be started in 1965. As of 1964, the sector program included provisions for starting the frequency changeover. Although the Guarantee Agreement for Loans 436-ME and 544-ME included covenants providing for the timely initia- tion and completion of the first stage, no actual conversion of any of the connected load was accomplished under those Bank loans. Several successive plans were prepared but none were implemented. 19. In August 1969, CFE and its consultants, Bechtel, completed a new master plan which the Bank used for its project appraisal (Loan 659-ME, 1970-71 Investment Program). The plan concluded that, compared with the development of independent 50 Hz and 60 Hz systems, frequency unification and the subsequent development of a single 60 Hz system in Central and Southern Mexico was the least cost alternative for the continuing expansion of the power sector. The return on the investment was expected to be 14% - 20%. Any further delay in carrying out the unification was expected to reduce the - 5 - return by about two percentage points per year for the first 2 - 3 years of postponement. CFE agreed to carry out the first phase of the frequency unification to convert 300 MW of connected load by September 1972. Loan (659-ME) and the Guarantee Agreements included covenants to that effect. However, no actual conversion of consumer facilities had been carried out although inventories of frequency sensitive equipment had been largely com- pleted as a preparatory step. The construction of all the transmission lines and substations specified in the loan agreement was eventually completed, but there were considerable delays. As plans for converting Centro's 50 cycle power supply had not been implemented, Centro had to install additional generating equipment at 50 Hz to meet the growing demand. 20. Of the Sector's total installed capacity of 6091 MW in 1971, 2,380 MW in the Central System operated at 50 Hz, and 3,711 MW in the rest of the country operated at 60 Hz. CFE, assisted by its consultants, Bechtel (US), estimated that frequency unification was still the least cost solution for discount rates up to at least 12% at the time of appraisal of the Fourth Power Sector Program (1972-1974). In May 1972, two weeks before negotiation, the Frequency Unification Committee (CUF) was established as a decentralized public agency that would convert customer installations and coordinate all activities related to conversion. Actual conversion was to start in January 1973 and to be completed by 1977. During negotiations, agreement was reached on a timetable for implementing the first stage of frequency unification con- sisting of the changeover by September 1974 of frequency sensitive equipment corresponding to a maximum non-coincidental demand of about 600 MW. 21. CUF has proved to be an effective organization. Working under an accelerated schedule it completed the entire program by November 1976, one year ahead of schedule. Table 2 below shows the maximum gross demand (fore- cast and actual) through 1976, in the 50 Hz Central System. Demand declines toward zero as this system becomes integrated with other systems through fre- quency unification. Table 2 Central System (50 Hz) Maximum Gross Demand in MW 1973 1974 1975 1976 - Forecast 1,952 1,646 1,311 827 - Actual 2,248 1,971 1,380 - The changeover affected 2.8 mln. consumers (86% residential; 13% commercial; 1% other). The number of consumer installations converted in 1976 was equal to all those converted in 1973, 1974 and 1975. 22. The total cost of the frequency unification program was estimated at appraisal at Mex $1,600 million. Actual expenditures, in current prices, amounted to Mex $2,025 million, 26% higher than forecast, but in constant - 6 - prices they amounted to Mex $1,310 million, 18% less than forecast. The major benefits to be derived from frequency unification are minimization of total resources engaged in production and transmission and more flexible and economical operating and maintenance schedules. Huge savings will also be realized by manufacturers and suppliers of frequency sensitive electri- cal equipment who will no longer need to operate dual lines of production and maintain two different stocks of inventory. In view of the fact that: a) the program was completed one year ahead of schedule; b) the real cost was about 18% lower; and c) higher costs would have been incurred from al- ternative programs which would otherwise have been necessary, it can be concluded that the ex-post economic rate of return of frequency changeover was higher than the 12% estimated at appraisal. VI. System Development and Service Quality 23. The overall quality of service provided to CFE's customers deter- iorated considerably in 1975, and mainly during the 3-month period from April to June in which loads of up to 700 MW had to be shed on an average of 18 days per month in the interconnected system 1/. This load shedding arose mainly because of delays in physical execution of the construction program, which left the power system without the reserve capacity originally planned 2/. 24. Planned gross reserve in the interconnected system for 1974 was 1,495 MW, amounting to 27.3% of the expected peak demand. In fact, by 1974, the gross reserve was only 268 MW, or 5.3% of actual peak demand (at that time the size of the largest unit in service was 300 MW, see Annex Table III). Actual gross reserve increased to 1,068 MW by the end of 1975, of which 480 MW had been added in November and December. 25. For the system as a whole the actual consumption of energy was lower than the demand forecasts 3/. It grew by only about 10% p.a., during the period 1972-1975, as compared with the projected average annual growth rate of 13.4%. In 1975 the actual peak demand 4/ and gross reserve capacity 1/ Load shedding is estimated to have resulted in a loss of 195 GWh in energy production. This loss represents about 0.5% of energy sales in 1975. 2/ Probably because of the construction delays, additional gas generating capacity was installed in 1975. 3/ Delays in the envisaged construction program probably contributed to the lower growth rate in energy consumption. 4/ Probably non-coincidental. - 7 - were 1,270 MW and 1,576 MW lower than the respective forecasts. Had it not been for this lower growth of consumption, probably either more remedial changes would have been required or an even greater deterioration in ser- vice by CFE would have occurred in 1973-1975 (Annex Tables III and IV). 26. Delays in hydro plant construction had obviously also affected the growth pattern of gross production. In 1971 hydro plant capacity rep- resented about half of installed capacity and also half of gross genera- tion (Annex Table II). The increase in total gross generation amounted to 12,197 GWh in the period 1972-1975. Hydro plants provided only 6% of that increment, while steam plant supplied almost 70%. This higher than envisaged proportion of thermal generation increased operating costs and thereby aggra- vated the already deteriorating financial situation 1/. VII. Financial Performance 27. In the period 1972-1975 when the program was implemented, infla- tion 2/ in Mexico was much greater than could have been expected at the time of appraisal. In its attempt to cope with inflation, the Government introduced price controls on certain goods and services. In the case of electricity tariffs this control was particularly stringent and despite CFE's applications and Bank representations with the Government, the increases in electricity tariffs during the 1972-1975 period were inadequate; in fact, they turned out to be the lowest of the increases permitted on other goods and services. Annex Table X shows that, while the general price index increased by about 60%, electricity tariffs increased by less than 30% over the 3-year period. 28. Mainly as a result of inadequate tariff increases and, to a minor extent because of lower than expected energy sales, the Sector's financial performance deteriorated markedly during the 3 year period. On the other hand, the costs of the construction program had escalated so that the Sector's borrowings were substantially larger than expected. As a result, the Sector could not observe any of the major financial covenants in the Loan Agreement. (Details of tariff increases and unmet covenants are given in Appendix A.) 29. The following table summarizes the forecast and actual financing plan for the period 1972-1975. 1/ The adverse effect upon the country's resource utilization was even more serious considering that the domestic fuel price is substantially lower than its economic cost. 2/ Increase in General Price Index. - 8 - Power Sector Financing, Forecast and Actual, 1972-1975 (in Mex $ million) Forecast Actual Difference Financial Requirements 1. Construction Expenditures 23,159 30,652 7,493 2. Other applications 413 2,217 1,804 Total Requirements 23,572 32,869 9,297 Sources of Funds 3. Gross internal cash generation 21,362 12,785 (8,577) 4. Less: Debt Service 17,071 23,834 (6,763) 5. Net internal cash generation 4,291 (11,049) (15,340) 6. Contribution and transfers 1,894 6,336 4,442 Sub-total 6,185 (4,713) (10,898) 7. Borrowing 17,387 37,582 20,195 Total Sources 23,572 32,869 9,297 Actual financial requirements were 40% higher than forecast, but most of this overrun was the outcome of price increases which, during the period 1972-1975, amounted to about 60%. 30. The actual gross internal cash generation (before debt service) for the four-year period was 40% lower than the forecast. Lower revenues and higher operating expenses than those forecast resulted in lower cash generation (Annex Table V). Thus, whereas the appraisal had estimated that power sales would provide revenues of Mex $42,604 million (131,200 GWh at 32.5 cts/KWh) during the period 1972-1975, this source actually provided only Mex $38,881 million (122,200 GWh at 31.8 cts/KWh). This revenue gap represented 41% of the difference in gross internal cash generation. Re- garding operating expenses, increased labor costs alone represented 57% of the shortfall in gross internal cash generation. 31. The debt service for the period 1972-1975 was Mex $6,763 million higher than forecast and exceeded gross internal cash generation by about 100%. That was mainly because of increased borrowing which was required to compensate for the higher cost of the investment program and the lower net -9- internal cash generation. Thus, whereas the appraisal had envisaged that net internal cash generation would provide 18% of the planned financial require- ment, in fact, the net cash generation was negative to the extent of Mex $11,049 million. Under these conditions all investment outlays and service on some of the earlier debts 1/ had to be financed with borrowed funds during the period 1972-1975. 32. Therefore, to cover the financial gap, the borrowing undertaken by the Sector'during 1972-1975 amounted to Mex $37,582, as compared with the forecast borrowing plan of about Mex $17,387 million. The proportion between borrowing attributed to increased financial requirements and bor- rowing attributed to cash generation and contributions is nearly 50/50. The Sector's long-term debt-to-equity ratio, which had remained stable at 54/46 in the late 1960s and early 1970s deteriorated to 69/31 by 1975 (Annex Table VI) 2/. 33. Furthermore, the Sector's net internal resources would still have been negative by almost Mex $3,000 million, even if by 1975 it had been able to restore the real average revenue per KWh sold, prevailing in 1971. That would have required an additional rate increase of 32%, providing an increase in revenue of about Mex $3,500 million. Electricity rates would have required an additional 90% increase to meet the 25% self-financing target by 1975. 34. During negotiations it was agreed that in order to preserve a sat- isfactory liquidity position, the borrower would maintain a year-end current ratio of at least 0.95. The purpose of this provision was to ensure that short-term debt and other short-term liabilities would be used primarily for working capital requirements and only on a strictly interim basis for financ- ing capital investments. The actual year-end current ratio was well above 0.95 during the entire period 1972-1975, and even greater than forecast for 1974 and 1975, years in which all other meaningful financial coefficients showed deterioration (Annex Table VI). 35. No positive fiscal contribution was made by the Sector during the period 1972-1975. On the contrary, increased borrowing and government capital transfers had been substituted for shortfall in the Sector's internal cash generation. This happened at the same time as the position of the public sector as a whole showed a deterioration. The total public sector deficit, as a percentage of GDP, marked an increase from 2.2% in 1971 to 8.9% in 1976. The increased borrowing needs of the Sector occurred at a time when a major economic policy requirement was to increase public sector savings. 1/ Service on some debts was rescheduled. The large devaluation of Mex $ in 1976 would have increased CFE's debt service substantially, and thus caused additional strain on an already inadequate financial situation. 2/ This deteriorating trend was pointed out in the Project Performance Audit Report (No. 859) on Third Power Sector Program. - 10 - VIII. Operating Efficiency and Sectoral Development 36. The Sector's labor costs for the period 1972-1975 were Mex $16,995 million, as compared with the forecast Mex $11,938. The increase in labor costs, which amounted to Mex $5,057 million, accounted for 57% of the dif- ference between actual and forecast internal cash generation in 1972-1975. Therefore, labor cost increases not supported by tariff increases became the most important factor of the Sector's poor internal cash generation dur- ing the Fourth Power Sector Program (Annex Table XI). Had it been possible to restrain the Sector's real wages in line with inflation 1/ the resulting savings would have contributed Mex $1,500 million to internal cash genera- tion in 1975. These savings would have implied a contribution of about 11% to the Sector's construction expenditures during 1975. 37. The number of customers per employee (only permanent personnel), as indicated in Annex Table XI, increased from 183 in 1971 to 195 in 1975. While CFE served 221 consumers per employee in 1975, Centro had approxi- mately one staff member for each 150 consumers 2/. There were two major reasons for this. The first was Centro's restrictive labor contract; the second was that almost half of Centro's employees were working on construc- tion. The Bank supervision missions suggested that an analysis of the rela- tive cost of alternative construction procedures (i.e., use of outside con- tractors) would be a useful exercise to improve construction management. It is not known whether this analysis was carried out but an OED mission was informed that there is a growing tendency to execute the construction program using Centro's own labor rather than outside contractors. 38. In connection with the Fourth Power Sector Program, CFE had agreed to prepare and implement a program for improving the collection of accounts receivable. The receivables, as percent of annual billings, increased from 18% in 1972 to 26% in 1975. This increase implied higher working capital requirements of about Mex $900 million in 1975 (Annex Table XII). On the other hand, a program to reduce inventories achieved some positive results. Inventories as percent of annual requirements declined from 146% in 1972 to 125% in 1975 (Annex Table XIII). 39. The work on the study of replacement cost as a basis for depreci- ating fixed assets did not proceed as expected (PCR para 23.2). This issue has now become more important because of the inflationary trend and of the devaluation of the Peso in 1976. The fixed assets are now substantially un- dervalued in the Sector's accounts. I/ The average remuneration increased by 120% in current terms (about 31% in real terms) between 1972 and 1975. 2/ It would normally be expected that Centro, which operates in a concen- trated urban market, would serve more consumers per employee than CFE. - 11 - IX. Re-estimated Return 40. The Fourth Power Sector Program was justified in the appraisal report as the least cost alternative for meeting expected demand on the CFE system during the period 1972-1981. Whether or not any given project was to be included in the program at a given time was decided on the basis of the present worth of the total capital and operating costs, using a dis- count rate of 10%. The program details were not sensitive to small increases in the discount rate to reflect a higher estimate of the opportunity cost of capital. 41. The Appraisal Report calculated that the "internal economic re- turn" on the time-slice of investment for 1972-1974 was about 14%. 1/ This calculation was a "with time-slice" as compared to a "without time-slice" type of calculation based on four elements, namely, the annual additional investment costs, the annual additional operating costs of the new plant, the annual savings in operating costs through reduced use of old plant, and the annual increase in system sales and hence revenues. This return used re- venues as an approximate measure of benefits. It therefore illustrates only that electric power prices on the average were expected to exceed long run marginal costs. The Appraisal Report estimated that if revenue were to fall short of the estimates by 10% the return would decrease by 2.6 percentage points and if the costs of the program were to increase by 10% the return would decrease by 1.9 percentage points. 42. Since revenues were lower and costs higher than estimated, the actual incremental financial return is substantially less than 14% (conserva- tively estimated at 4%, Appendix B). X. Conclusion 43. The program made a useful contribution to the physical development of the Sector despite construction delays and lower than forecast growth rate in peak load and energy sales. Because of construction delays there was extensive load shedding in 1975. 1/ The Appraisal Report did not provide the computatiorn of the race cL return. Incidentally, because the revenues were used as a proxy for benefits, the 'internal economic return' was nearer to 'financial rate of return'. - 12 - 44. The Bank loan, though less than 10% of the total investment, may have enabled the Sector to obtain a substantial amount of foreign funds on terms better than would otherwise have been the case. Other achievements attributed to this loan are the completion of the frequency unification program and the reduction in the Sector's inventory levels. 45. The actual construction of the program was much slower than en- visaged. Of the facilities planned for completion by end 1974, under 40% of generating plant, about 1/3 of transmission lines and substations, and less than 50% of distribution networks were operational by that date. The overall construction schedule may have been somewhat optimistic, as indicated in the appraisal report. The delays were also due to organizational problems in construction and in procurement (para. 13), which were expected to be reduced as a result of the introduction, agreed between CFE and the Bank, of a compu- terized investment control system developed by CFE. However, CFE subsequently decided not to go forward with this system. Another cause which probably contributed to the delays was the turnover (three individuals in three years) in the position of the Director-General of CFE. 46. Substantial changes were made to the original program. It is not clear whether these changes were precipitated by construction delays or by changes in the expected regional demand for power, since relatively higher than originally envisaged proportion of thermal plant, particularly gas turbines, was commissioned by 1974. It is also not clear whether the actual program was and still is the least cost solution among alternatives, or whether it was a short term solution to problems (e.g., installing gas turbines to make up for the construction delays in the hydro plant). 47. The changes to the construction program and lack of detailed cost information on the individual components make it impossible to render a meaningful comparison between actual and estimated costs. It is also not possible to allocate cost overruns between design and quantity changes and price increases. However, the overall average cost of the actual program, i.e., of the components which were constructed, is estimated to be 30-40% greater, in real terms, than the corresponding appraisal expectation. 48. Construction delays with hydro plant were much longer than with thermal plant. These, apart from probably accelerating or advancing the investment in gas turbines, resulted in higher than envisaged proportion of the more expensive thermal generation. A more realistic construction sche- dule, together with other timely measures for reducing delays, might have led to a relocation of the Sector's efforts and consequently reduced the disproportionate construction delays in hydro plant. 49. One of the Bank's major objectives in making the loan was to strengthen the Sector's financial viability. This was almost wholly un- successful through 1975. As a means to achieve this objective a new per- formance covenant was introduced in the loan agreement, and financial covenants from the previous loan (659-ME) were retained. Mainly because the - 13 - assets had not been revalued, this rate of return covenant had not achieved the envisaged objective. It was therefore agreed to introduce the direct and more objective-oriented covenant. This required the government to grant tariff increases to the Sector to enable it to finance a specific minimum percentage of yearly investment from its internal resources. 50. Despite this, the Sector's financial performance deteriorated seriously, mainly because of inadequate tariff increases to compensate for increases in operating costs. Contributory factors to the deterioration were the increase in construction costs and the lower than expected energy sales. The rate of return on un-revalued assets in 1975 was 3.9% (instead of 8% covenanted), and the Sector's contribution to the construction expenditure from internal resources over the period 1972-75 was negative (instead of the covenanted 18% in 1973 and 25% thereafter). 51. The experience from this loan seems to point to the importance of focussing on the method of tariff adjustments as well as the target perform- ance. In this case, changes in the country's tariff regulations were neces- sary to enable the Sector to make more or less automatic adjustments to tariffs in line with increasing costs. 1/ 1/ The new electric power law, which came into effect in January 1976 seems to be a step in this direction.  Appendix A Page 1 of 2 Electricity Tariffs 1. The October 1973 tariff increase was designed to raise revenues by about 30%. The increase involved restructuring of tariffs and markedly favored the lower income groups. Residential tariffs became progressive since the price per KWh increased with consumption. The tariff increase per KWh for residential consumption in excess of 100 KWh/month was equal to 125%. The other consumer groups affected were commercial and industrial; those not affected were water, mining and agriculture. 2. Large industrial concerns are substantial consumers, and some of them had special contracts instead of being billed at standard industrial rates. The number of such special contracts increased sharply from 68 in 1969 to 1,404 in 1970, accounting for 14% of total energy sales but only 5.5% of total revenues. The October 1973 tariff reform eliminated these special contracts and replaced them by a new Tariff Class 12. This class applies to general service for at least 5,000 KW demand and at least 66 KV supply. Tariff 12 is based on kilowatt hours consumed per kilowatt of demand with a regressive schedule. 3. A new electricity tariff schedule was enacted on August 13, 1975, providing for an average increase in tariff levels of about 23% (10% for residential consumers, and 30% for industrial and other consumers). 4. Annex Table IX summarizes sales and average revenues, by cate- gory of consumer, resulting from the tariffs prevailing until 1975. The average revenue per KWh sold decreased by 25% in real terms during the period 1972-1975. The highest reduction in average revenue amounting to a 55% real decrease, was in agricultural tariffs 1/. This tariff class even shows a reduction in current terms since the average price decreased from 18.60 cents per KWh in 1971 to 14.10 cents in 1975, as a net result of the rate unification implemented in October 1973. Covenants 5. The complex debt limitation covenant of the earlier Loan (659-ME) was renewed in connection with Loan 834-ME. It consisted of two debt/asset tests and an interest coverage test; all three tests had to be met if debt was to be incurred without Bank consent. The Sector complied with only one of the two debt/asset tests (see PCR para. 26.2C). It failed to pass the 1/ Energy sales to agriculture constitute a small fraction of CFE's total sales. Appendix A Page 2 of 2 other debt/asset test from 1973 onwards (the sum of net fixed plant in opera- tion and work in progress was always less than 1.5 times the consolidated debt). I/ For this reason, in October 1974 the Bank required CFE to obtain its approval before incurring any new debt. 6. The Sector could not comply with the interest coverage test either. The coverage of interest payable by net income before interest, which had remained at a ratio of around 2 in the latter part of the 1960s, declined to 0.43 by 1975 (Annex Table VI, line 6). 7. The Sector did not comply with the cash-contribution covenant since actual self-financing was negative during the entire period 1972-1975 (Annex Table VII). The original financing plan for the Fourth Power Sector Program had envisaged an improvement in the debt service covered by internal cash generation from 0.89 in 1972 to 1.23 in 1975. Instead, the ratio deteriorated to 0.30 (Annex Table VI, line 1). 8. CFE also had an obligation to observe the covenant in the loan for the Third Power Sector Program which required an 8% rate of return on the rate base. At the time the Third Power Sector Program was appraised, this specific return was chosen to enable the Sector to contribute about 35% financing future construction. But while the Sector did comply with this covenant, less than 5% of its development was financed by net internal re- sources in the period 1970-1971. For the years covered by the Fourth Pro- gram (1972-1974), the Sector earned a return greater than 8% only in 1973. The trend shows a deterioration since 1970 (Annex Table VIII). I! Had the assets been revalued then the sector most probably would have complied with this test. MEXICO INCREMENTAL FINANCIAL RATE OF RETURN (All costs and revenues in Mex.$ million) Incremental Incremental Net Net Revenue FY Generation (GWh) Sales (GWh) Cost Revenue Defla- (Cost) Con- Hydro Thermal Total Capital Fuel Cther Total Revenue (Costs) tor stant Prices 1972 1,000 2,000 2,900 4,970 100 230 5,300 809 (4,491) 1.00 (4,491) 1973 1,800 4,000 5,400 6,500 220 370 7,090 1,577 (5,513) 1.12 (4,922) 1974 2,400 7,100 8,100 6,840 570 950 8,360 2,665 (5,695) 1.39 (4,097) 1975 2,400 7,100 8,100 - 570 913 1,520 2,665 1,145 1.39 824 ITI I I f g I 1 I I I I I I i If I I I I SI I I I1 I I I I f I I I I I I I f I I I 2002 2,400 7,100 8,100 - 570 950 1,520 2,665 1,145 1.39 824 Incremental Financial Rate of Return ^- 4% Uotes and Assumptions 1. Annual increase in energy generated and sold is attributed to the investment. 2. Fuel costs (in Mexican centavos) of the incremental thermal energy generated are: 5.0/KWh in 1972; 5.3/Kwh in 1973, and 8.0/KWh in 1974 and thereafter. 3. Other annual incremental costs are based on 2/3 of such cost (i.e.,1abor + other) per unit generated. They are (in Mexican centavos) 7.6/KWh in 1972; 7.8/KWh in 1973; and 10.2/KWh in 1974 and thereafter. 4. Incremental Annual Revenue is a direct function of incremental sales and average tariffs. These are (in Mexican centavos): 27.9/Kwh in 1972; 29.2/KWh in 1973; and 32.9/KWh in 1974 and thereafter. 5. General Index (see Annex Table X) is used as the Deflator. 6, The computation does not take into account: a) the benefits from frequency unification; b) the more than likely paisibility that the total invest- ment for the period 1972-74 generated incremental sales of more than 8,100 GWh in the subsequent years; and c) the savings in fuel and other costs derived from substitution (i.e. generation transmission, etc.,from new plant in place of those from older and lower efficiency plant). MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Construction Program, Forecast and Actual 1972-1974 iorecast to be Total included Completed by Actually Completed Percentage in the Program December 1974 by December 1974 Completed Type (MW - KM - MVA) (14J - KM - MVK) (MW - KM - MVA) Generating Plants 3250 MW 4286 MW 1635 MW 38 1. Hydro plant 3015 MW 1315 MW 300 MW 23 2. Steam-turbine plant 3900 MW 2399 MW 775 NW 32 3. Nuclear plant 670 MW 0 MW 0 MW - 4. Gas-turbine plant 500 MW 472 MW 460 MW 97 5. Geothermal plant 150 MW 75 MW 75 MW 10G 6. Diesel plant 15 MW 25 MW 25 MW 100 II - fransmission Lines 11,500 KM 8225 KM 2631 KM 32 1. 40G KV 3000 KM 1456 KM 318 KM 22 2. 220 KV 2900 KM 2401 KM 1142 KM 48 3. 69/161 KV 5600 KM 4368 KM 1171 KM 27 III - Substations 17,300 MVA 12,396 MVA 5729 MVA 46 1. Main substations 17,000 MVA 12,396 MVA 5729 MVA 46 2. Small substations 300 MVA - :D M MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Actual Growth of Installed Capacity and Gross Production, 1972-1975 I. Installed Capacity 1971 1972 1973 1974 1975 MMW W % MW 7 MW % M Inc. Inc. Inc. Inc. 1. Hydro plant 3227 3228 - 3446 6.7 3521 2.2 4044 14.8 2. Steam plant 2677 2698 0.8 3124 15.8 3490 11.7 4156 19.0 3. Other 594 987 66.2 1156 17.1 1360 17.6 1670 22.8 6498 6913 6.4 7726 11.7 8371 8.3 9870 17.4 II. Generation (gross) 1971 1972 1973 1974 1975 GWH GWH % GWH % GWH % GWH % Inc. Inc. Inc. Inc. 1. Hydro plant 14,269 15,246 6.8 16,081 5.4 16,602 3.2 15,016 (9.6) 2. Steam plant 13,321 14,780 11.0 15,623 5.7 18,575 18.4 21,727 17.0 3. Other 893 1,507 68.8 2,540 68.5 2,830 11.4 4,137 46.2 28,483 31,533 10.7 34,244 8.6 38,007 11.0 40,880 7.6 Annex Table III MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) National Interconnected System, Installed Capacity and Peak Demand, Forecast and Actual 1972-1975 (in MW as of end of year) a/ Forecast 1972 1973 1974 1975 1. Initial Gross Capacity 4,299 5,104 5,908 6,966 2. Plus, New Generating 805 900 1,100 300 Units 3. Less, Retired Generating - (96) (42) - Units 4. Total Installed 5,104 5,908 6,966 7,266 5. Peak Demand 4,388 4,370 5,471 6,093 6. Gross Reserve (MW) 716 1,038 1,495 1,173 as % 16.3 21.3 27.3 19.3 Actual Development 1972 1973 1974 1975 1. Initial Gross Capacity 4,299 4,599 4,958 5,347 2. Plus, New Generating 320 366 435 1,087 bi Units 3. Less, Retired Generating (20) (7) (46) (22) Units 4. Total Installed 4,599 4,958 5,347 6,412 5. Peak Demand 4,150 4,567 5,079 5,344 6. Gross Reserve (MW) 449 391 268 1,068 as 10.8 8.7 5.3 20.0 7. Largest Unit in Service 170 300 300 300 a/ It includes Oriental, Occidental, Central and Colotlipa-Acapulco. Inter- connection with Central (50 Hz) started through frequency conversion in January 1973 and was completed by September 1976. b/ Of which 480 MW was added by November and December 1975. Annex Table IV MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Power and Energy Balance, Forecast and Actual 1972-1975 Forecast 1972 1973 1974 1975 1. Sales (GWH) 26,700 30,400 34,800 39,300 2. Losses (GWH) 4,371 4,560 5,263 5,905 3. Delivered to System (GWH) 31,071 34,960 40,063 45,205 - CFE Plants (GWH) 30,881 34,684 39,841 44,897 - Purchased (GWH) 190 276 222 308 4. Load Factor (%) 55.1 55.3 57.7 57.7 5. Peak Demand (MW) 6,395 7,165 7,882 8,885 6. Transmission/Distribution Losses . of Sales 16.4 15.0 15.1 15.0 i Delivered to System 14.1 13.0 13.1 13.1 7. Sales Increase on Preceding 12.2 13.9 14.5 12.9 Year (%) 6. Sales Forecast Accuracy a/ 100.5 104.4 109.3 113.5 j. Load Forecast Accuracy a/ 109.0 110.9 109.4 116.7 a/ Defined by the rates, Forecast-Actual in 7. Actual Development 1972 1973 1974 1975 1. Sales (GWH) 26,574 29,128 31,835 34,624 2. Losses (GWH) 4,290 4,661 5,462 5,396 Delivered to System (GWH) 30,864 33,789 37,297 40,020 - CFE Plants (GWH-) 30,630 33,473 36,943 39,666 - Purchased (WII) 234 316 354 354 Load Factor (7) 60.1 59.7 59.1 60.0 5. Peak Demano (NW) 5,865 6,463 7,2G7 7,615 6. fransmission/Distribution ses i of Sales 16.1 16.0 17.2 15.8 I)elivered to System 13.9 13.8 14, 13. :ales increase un Preceding 12.1 9.6 9. 3.8 iear (.) ANNEX TABLE V MEXICO FOURTH POWER SECTOR PROGRAM (1972/1974) Power Sector, Gross Internal Cash Generation Forecast and Actual 1972/1975 (in Mex$ millions) Revenue Forecast Actual Difference 1. Power Sales 42,604 38,881 (3,723) 2. Other Revenues 304 380 76 Total Revenue 42,908 39,261 (3,647) Operating Expenses (excluding depreciation) 3. Labor 11,938 16,995 (5,057) 4. Fuel 5,311 5,758 (447) 5. Purchased Power 115 365 (250) 6. Other Expenses 4,478 3,947 531 Total Operating Expenses 21842 27,065 (5,223) (excluding depreciation) Net Income Before Depreciation and Interest 21,066 12,196 (8,870) 7. Other Income 296 589 293 Gross Internal Cash Generation 21,362 12(788,577) MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Power Sector: Key Financial Ratios, Forecast and Actual, 1968-1975 Financial itatios 1968 1969 1970 1971 1972 1973 1974 1975 1. Debt-service Covered by: Actual 1.32 1.25 1.4 1.07 0.75 0.49 0.75 0.30 Internal cash-generation Forecast - 1.3 1.4 1.5 0.89 1.37 1.46 1.23 (times) 2. Debt-service as a 1 of Actual 35.3 37.1 32.2 39.4 53.6 86.4 41.4 71.7 Revenue Forecast - 34.5 36.7 35.5 44.7 35.9 35.4 43.8 3. &ate of Aeturn Actual 9.8 9.8 8.8 8.1 7.5 8.1 5.7 3.9 Forecast - 10.0 9.2 9.2 6.7 11.8 12.6 13.2 4. Long-term Debt as a Actual 56.5 58.6 58.6 61.5 64.8 68.9 72.8 71.1 percentage of net Forecast - 54.9 55.1 53.6 62.3 60.9 60.2 55.9 fixed assets. 5. Current Ratio Actual 1.42 1.94 1.56 1.48 1.25 1.25 1.11 1.27 Forecast - 1.13 1.04 1.00 1.40 1.35 1.02 1.03 6. Coverage of Interest Actual 2.02 1.98 1.79 1.59 1.14 1.15 0.82 0.43 Payable by Net Income Forecast - 2.25 2.00 2.10 1.25 2.12 2.28 2.50 Before Interest. 7. Long-term Debt-equity Actual 54/46 54/46 55/45 57/43 57/43 60/40 64/36 69.31 Ratio Forecast - 54/46 54/46 52/46 57/43 55/45 52/48 48/52 rorecast figures: - 1969/1971, Appraisal Third Power Program (Loan 659-ME) - 1972/1973, Appraisal Fourth Power Program (Loan 834-ME) -3 M~ MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Power Sector Performance Under Self-financing Covenant (in Mex$ millions) 1969 1970 1971 1972 1973 1974 1975 1. Net Operating Income 1,857 2,039 2,075 2,140 2,510 2,030 1,545 2. Depreciation 610 669 757 856 963 1,060 1,160 - ross internal cash generation 2,467 2,708 2,832 2,996 3,473 3,090 2,705 Less. 3. Debt-service 2,030 1,986 2,632 3,983 7,347 4,409 9,095 :. Increases in Working Capital 267 181 934 501 1,117 694 (95) 5. NET INFERNAL RESOURCES 170 541 (734) (1,488) (4,991) (2,013) (6,485) 6. Construction Expenditures 3,382 4,331 3,949 4,440 5,481 6,835 13,895 7. Actual Self-financing - (5) x 100, % 5.2 12.5 (18.5) (33.5) (91.1) (29.5) (46.7) (6) 8. Self-financing Covenant, % - - - - 13 25 25 a/ Source: iigure supplied by CFE. Audited financial statements for 1975 did not contain sufficient information. (D FOURTH POWER SECTOR PROGRAM (1972-1974) Power Sector Performance Under Rate-of-Return Covenant (in Mex$ million) 1968 1969 1970 1971 1972 1973 1974 1975 1. Net Fixed Assets in Service 17,622 18,264 22,180 24,685 27,345 29,947 34,489 38,037 at beginning of year. 2. Notional 4% Additional 705 731 887 987 1,094 1,198 1,380 1,521 Completion of Plant. 3. Rate Base 18,327 18,995 23,067 25,672 28,439 31,145 35,869 39,558 4. 8% Return on Rate Base 1,466 1,520 1,845 2,054 2,275 2,492 2,870 3,165 5. Actual Operating Income 1,792 1,857 2,039 2,075 2,140 2,510 2,030 1,545 Attained by Power Sector (including Power consump- tion tax) 6. Actual Return on Rate Base (%) 9.8 9.8 8.8 8.1 7.5 8.1 5.7 3.9 7. Excess (or deficiency) with 326 337 194 21 (135) 18 (840) (1,620) Respect to 8% Rate-of-Return Requirement. 8. Forecast Return on Rate Base - 10.0 9.2 9.1 6.7 11.8 12.6 13.2 (M) - 1969/1971: Appraisal Third Program (Ln. 659-ME). - 1972/1975: Appraisal Fourth Program (Ln. 834-ME). F-1 MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Power Sector: Sales ana Revenues by Categories of Consumers - 1968-1975 Category 1968 1969 1970 1971 1972 1973 1974 1975 0WH Revenue GWH Revenue GWH Revenue GW11 Revenue GWH Revenue CWH Revenue GWB Revenue CWH Revenue A. Residential 17 27 16 28 17 28 17 29 17 29 17 29 17 30 17 29 B. Commercial 15 26 15 25 14 24 14 24 14 24 14 23 12 21 12 21 C. Industrial 52 37 54 38 54 39 54 38 54 38 55 39 56 41 56 42 D. Agricultural 6 4 6 4 6 4 6 4 6 4 6 4 6 3 6 3 E. Public Pumping 4 2 4 2 4 2 4 2 4 2 4 2 4 2 4 2 F. Public Lighting 4 3 3 2 3 2 4 2 4 2 3 2 4 2 4 2 C. Others 2 1 2 1 2 1 1 1 1 1 1 1 1 1 1 1 Total 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 c/ CWH 16,705 4,336 19,212 4,859 21,683 5,420 23,488 5,903 26,249 6,539 28,939 7,441 32,054 9,635 34,566 11,112 / Mex$ pesos (excluding sales taxes) Current and Real Revenues (including sales tax) in Mexican cents per kwh 1968 1969 1970 1971 1972 1973 1974 1975 Current 1968 a/ current 1968 Current 19b5 Current 1968 Current 1968 Current 1968 Current 1968 Current 1968 cents cents- cents cents cents cents cents cents cents cents cents cents cents cents cents cents A. Residential 47 47.0 47 45.4 47 43.2 47 41 47 39.1 48.5 36.0 58.3 34.9 60.2 31.3 8. Commercial 48 48.0 48 46.4 48 44.2 47.2 41.2 47.9 39.8 49.2 35.8 59.6 35.7 65.8 34.3 C. Industrial 21 21.0 21 20.3 20 18.4 20.4 17.8 20.2 16.8 21.1 15.6 25.4 15.2 28.0 14.6 D. Agricultural 18 18.0 18 17.4 18 166 18.6 16.2 17.2 14.3 18.0 13.3 17.2 10.3 14.1 7.3 E. Public Pumping 14 14.0 14 13.5 14 12.9 14.0 12.2 14.1 11.7 14.0 10.4 14.2 8.5 15.1 7.9 F. Public Lighting 16 16.0 16 15.4 16 14.7 16.2 14.1 16.2 13.5 16.2 12.0 17.0 10.1 19.2 10.0 G. Others 17 17.0 19 18.4 19 17.5 21.1 18.4 21.8 18.1 22.4 16.6 20.4 12.2 20.9 10.9 Total 28.7 28.7 28.2 27.2 28.2 25.9 28.1 24.5 27.9 23.2 29.2 21.7 32.9 19.7 35.5 18.5 fariff classes apply as follows: 31 A - Glass I ; b - Classes 2 and 3; C - Classes 8, 11, special and 12; D - Class 9; E - Class 6; F - Class 5; G - Classes 4, 7 and 10. a/ Deflated by National Consumer Price Index. A MEXICO FUURTH POWER SECTOR PROGRAM (1972-1974) Prices of Goods and Services Supplied by the Public Sector or Subject to Price Controls, 1968-1975 a (Annual rate of change) 1968 1969 1970 1971 1972 1973 1974 1975 Index % Change Index % Change Index % Change Index % Change Index % Change Index % Change Index 7 Change Index % Change 1. Postal Services 100.0 - 100.0 - 100.0 - 100.5 0.5 103.1 2.6 109.7 6.4 196.3 78.9 265.1 35.1 2. Gasoline 100.0 - 100.0 - 100.0 - 100.0 - 100.0 - 100.0 - 100.0 - 232.1 132.1 3. Maize 100.0 - 102.0 2.0 103.1 1.1 104.0 0.9 105.9 1.8 124.3 17.4 174.0 40.0 214.0 23.0 4. Tortillas 100.0 - 99.9 -0.1 100.0 0.1 100.4 0.4 102.1 1.7 118.5 16.1 175.3 47.9 207.8 18.5 5. Urban Bus Fares 100.0 - 100.9 0.9 101.9 1.0 107.8 5.8 115.7 7.3 121.4 4.9 158.6 30.6 186.7 17.7 6. Water 100.0 - 102.4 2.4 114.5 11.8 114.5 - 114.5 - 115.7 1.1 119.4 3.2 181.7 52.2 7. Telephone 100.0 - 100.0 - 100.3 0.3 101.7 1.4 100.0 -1.7 100.7 0.7 114.6 13.8 157.9 37.8 8. Railways Freight Rates 100.0 - 100.1 0.1 99.0 -1.1 98.3 -0.7 98.3 - 98.3 - 98.3 - 142.4 44.9 Passenger Fares 100.0 - 100.7 0.7 104.2 3.5 109.3 4.9 109.4 0.1 110.0 0.6 112.4 2.2 139.9 24.4 9. Domestic Gas 100.0 - 100.2 0.2 100.6 0.4 '100.6 - 100.7 0.1 102.3 1.6 124.4 21.6 135.2 8.7 10. Electricity (as defined 100.0 - 100.0 - 100.9 0.9 101.2 0-3 102-. 1.2 107.7 5.2 125.6 16.6 129.0 2.7 in the Nat'l consumers price Index 11. CFE: Average revenue 100.0 - 98.3 -1.7 98.3 - 98.0 (0.3) 97.2 (0.8) 101.7 4.6 114.6 12.7 123.7 7.9 by KWH sold GENERAL INDEX 100.0 - 103.5 3.3 108.7 5.0 114.6 5.4 120.3 5.0 134.8 12.1 166.8 23.7 191.3 15.0 a/ Components of the National Consumers Price Index. 1b Source: Bank of Mexico - (Table 8.4 Report No. 1110 - ME, March 23, 1976). 0 >e Annex Table XI MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Power Sector: Salaries and Wages, Forecast and Actual, 1972-1975 1971 1972 1973 1974 1975 1 - Forecast- 1. Salaries, Wages, Other - 2,617 2,865 3,102 3,354 and Social charges (in (Mex$ million) Ii. Actual Development- 2. Salaries, Wages, other 2,372 2,748 3,148 4,864 6,232 and Social Charges (in (Mex$ million) 3. Number of Employees, 31,446 32,238 34,154 36,076 37,565 Yearly Increase % 2.5 5.9 5.6 4.1 4. Average Remuneration 75,430 85,240 92,170 134,830 165,900 (Mexican pesos) 5. Average remuneration b/ 65,820 70,850 68,370 80,830 86,500 (1968 Mexican pesos) b Yearly Increase /. 7.6 9.6 18.2 7.0 6. Customers/Employees 183 190 192 190 195 a/ It includes only operating personnel. b/ Deflated by National Consumer Price Index. Annex Table XII MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Power Sector: Customer Accounts Receivable, 1972-1975 (as of December 31) 1972 1973 1974 1975 1. Billings in the Year 6,643 7,724 9,705 11,558 (in Mex$ millions) 2. Accounts Receivable 1,200 2,033 2,240 2,987 as of December 31 (in Mex$ million) 3. Receivables as . Billed 18 26 23 26 4. Average Period Outstanding (days) 65 94 83 94 5. Percent Distribution of Outstandings - Private Consumers 85 88 87 89 - Public Consumers 15 12 13 11 100 100 100 100 Annex Table XIII MEXICO FOURTH POWER SECTOR PROGRAM (1972-1974) Inventory Reduction Program (1972-1975) Actual Development a! 1972 1973 1974 1975 (Mex$ millions) 1. Inventories as of December 31 4,031 5,014 5,243 6,801 i) Construction materials 1,744 2,378 2,352 3,465 - CFE 1,670 2,310 2,284 3,386 - Centro 74 68 68 79 ii) Operations 2,287 2,636 2,891 3,346 - CFE 2,171 2,509 2,698 3,057 - Centro 116 127 193 289 2. Material Requirements 2,763 2,893 3,900 5,436 i) Construction Materials 2,456 2,546 3,489 4,827 - CFE 1,781 2,074 2,902 3,917 - Centro 675 472 587 910 ii) Operations 307 347 411 609 - CFE 246 269 299 444 - Centro 61 78 112 165 3. Inventories as % of 146 173 134 125 Requirements (1)* (2) a! Excluding fuel. Al Attachment MEXICO FOURTH POWER SECTOR PROGRAM, 1972-74 (Loan 834-NE) PROGRAM COMPLETION REPORT 1. Borrower: Comision Federal de Electricidad (CFE) Nacional Financiera S.A. (NAFIN) 2. Guarantor: United Mexican States 3. Loan Amountt US$125.0 million 4. Date Loan Signed: June 23, 1972 5. Effective Dates April 13, 1973 6. Closing Date: December 31, 1974; extended to June 30, 1975 7. Period of Grace: 5 years 8. Term of Loans 20 years 9. Interest Rate: 7-1/4% 10. Commitment Charge: 3/4 of 1% 11. Amortization: 30 semi-annual payments. First payment of US$2,370,000 on August 15, 1977 ending with last payment of US$6,665,000 on February 15, 1992. 12. Exchange Rate: US$1.00 = Mex$12.50 Mex$1.00 = US$0.08 (unchanged throughout the Deriod) 13. Appraisal Report No. and Date: PU-94a of May 30, 1972 14. CFE Fiscal Year: Begins January 1. 15. Project Descriotion 15.1 The project covered a three-year time slice (1972-74) of a con- tinuing investment program in Mexico's power sector. it was the fourth in a series of program segments financed b- the ank. The main project com- ponents were the construction of 8,085 Mw of generatinj canacity, 11,500 km of transmission lines and 17,300 MVA of substation f&cilities. A2 15.2 The facilities involved were under construction by January 1, 1972 or were expected to come under construction during the 1972-74 period. The total cost ol the project, including extension of the dis- tribution networks, conversion of the Central System frequency from 50 hz to 60 hz and village electrification, was estimated at US$1.368 million equivalent. About 75% of the facilities were expected to be completed and added to installed capacity by December 1974. 1/ The Bank loan was estimated to cover 9.1% of the total project cost. It actually covered 8.5% of the project. 15.3 It was used to finance: (a) 50% of foreign expenditures of equipment and materials financed under joint loans arranged under the previous Loans 659-ME and 544-ME and ordered by December 31, 1971; (b) 100% of foreign expenditures of equipment and materials other than (a) produced outside Mexico, and total expenditures of equipment and materials other than (a) produced in Mexico; (c) 35% of total expenditures of civil works;and (d) 100% of foreign expenditures of consulting services. Final List of Goods Category Appraisal Forecast Actual Disbursement US$ US$ I. Equipment and materials financed under joint loans and ordered by Dec. 31, 1971 35,000,000 40,229,944.50 II. Equipment and materials other than I 73,000,000 50,299,376.63 III. Civil works 15,000,000 33,559,074.15 IV. Consulting Services 2,000,000 911,604.72 16. Objective and Justification 16.1 The Bank loan was intended to help the Mexican power sector to finance its expansion program and, as a by-product, to serve as a catalyst to mobilize funds for -he project. The Bank's participation, according to the Mexican power s:ctor's officials, helped to generate the equivalent of US$1,h5 million ne% me-dium to long-term credit facilities (mainly suppliers credits and loans). The new credit facilities were nearly 80% more than had been fore:cast at appraisal and constituted Sh% of the total cash resources used oy CF:2 during the period. I/ See "Objective and Justification" below. A3 16.2 The investment program was designed to meet the increasing demand for energy from Mexicos rapidly growing semi-industrialized economy. The average growth in energy demand during 1969-72 was 12% annually. A 14% growth in energy sales (in GWh) had been forecast for 1973 and 1974. To meet the expected demand, construction of 4,286 MW of generating plant capacity, 12, 396 NVA of substation facilities, and 8, 225 km of transmission lines had been planned for commissioning during 1972-74. By December 1974, only 1,635 MW of generating plant capacity, 5,729 MVA of substation facilities and 2,631 km of transmission lines, had actually been completed during the period, although the construction expenditures had exceeded the forecast Levels. The slippages in construction schedules put heavy demands on the existing capacity causing localized blackouts and brownouts during 1974. Actual growth in GWh energy sales in 1973 and 1974 fell short of the forecast target - 9.6% in 1973 and 9.3% in 1974 compared with the forecast of 13.9% and 14.5% in each of the two years. 17. Construction Schedule 17.1 About the only phase of the program that was on schedule (and in fact, slightly ahead of schedule) was the frequency unification program. This segment of the program, which had been expected to be completed in 1977, is now expected to be completed by the end of 1976. The main construction program, however, lagged behind in every phase - generation, substation and transmission. The average slippage ranged between 18 to 24 months, with sone facilities, like the nuclear plant at Laguna Verde and the hydro plant at Aguamilpa, slipping by as much as 3 to 4 years. 17.2 While poor performance of contractors or suppliers contributed to the delay, the following causes also share in it: (a) during the three-year period, there were three changes in the top management of CFE. Since each new administration reviewed the state of CFE's program and made considerable changes in the personnel involved in overseeing the construction, delays were inevitable. (b) CFE's and the Mexican Government's slowness in raising tariffs in 1972, a critical condition of effectiveness of the Bank loan and a major mechanism for generating additional internal resources for the construction program, contributed to delays in procurement. The original forecast date of effectiveness was December 31, 1972. After an initial four months delay, the loan was declared effective to allow for disbursement of funds re- quired for Category I of the list of goods (which comprised equipment pi.rchased under the joint financing agreements of previous Bank Power Sector loans to Mexico). 3efore declaring the loan effective, the Bank obtained an amendment to the loan agreement r-quirng that disbursement of funds for Categories II, III and IV be held pending the raising of tariffs. 'ince US$35.0 million nad initially been allocated to Category I in the loan ag:-ee.ment, US$90 million of the loan was frozen until the tariffs were raised in October 1973 -- 16 :onLhs after the signing of the agreemenr,. Even then increases in operating costs (see Para. 21.3) effectively neutralized t-e increase in internal cash generation which had been expected at the time of appraisal. A4 (c) Another major reason was an apparent underestimation by both the Bank and CFE's construction divisiaiof the time factors associated with the procurement decision-making process in Mexico, although some of the problems, such as the delay in raising tarif could not have been foreseen at the time of appraisal. Decisions on much of the equipment took longer than had been anticipated (in part because CFE suspended preparation of bidding documents consistent with the Bank's procurement guidelines for items to be financed by the loan until late 1973. When loan funds finally became available for Categories II - IV, the procurement pipeline was empty). The result was that key equipment needed at critical phases of construction were not available as initially planned. (d) In a few instances, there was evidence that either a clear assessment of the ready availability of required equipment in the internat7onal market had not been made in advance or the specifications had not been clearly spelled out, causing a costly time-consuming search for potential suppliers after other parts of the equipment had already been received. A particular case in point involved disconnecting switches for 400 kV and 230 kV required for 15 substations. It took nearly a year before a supplier was located in Yugoslavia. In the meantime, construction on the affected facilities had to wait, and the commissioning of associated installations delayed. This type of problem can be anticipated when a sector, rather than the project lending approach is adopted, since under the former, the Bank has to rely to a much greater extent on the borrower for detailed scheduling. 18 Project Cost Estimate 18.1 The following table shows the estimated sector investment program as compared with actual expenditures for the years 1972-74: Appraisal Forecast Actual % Increase ---------in million Mex$-------- 1972 4,989 4,973 - 1973 6,052 6,503 7 1974 6,068 6,835 13 17j109 18,311 7 US$ equivalent _1368 6 A5 18.2 Although the actual investment expenditures exceeded the forecast by only 7%, they covered far less physical facilities than had been included in the Exhibit to Schedule 2 of the loan agreement. The exact extent and nature of the variation will not be known until the final construction progress report has been submitted by CFE. Nevertheless, the causes resulting in higher expenditures for smaller-than-planned physical program can be traced to: (a) low estimates of construction costs (only a small number of the facilities completed thus far came within budgeted amounts); (b) the need to improvise solutions that could be implemented quickly (capacity and energy deficits resulted in gas turbine and diesel units being installed in places where construction of initially planned facilities were substantially delayed); (c) high inflation, particularly in Me.xico's construction industry; (a government program to provide housing for workers competed for services of the construction industry, inevitably increasing construction costs during the period); (d).the effect of delays on cost escalation clauses (although there were ceilings to contracts, protracted discussions had to take place to redefine the final costs because the escalation clauses did not always cover the contractors' costs); and (e) inadequate control on expenditures (see Para. 23.2a). 18.3 Due to changes in the configuration of the original program (deletions, deferments, and additions were made throughout the period as a result of planning adjustments) it is not possible to make an accurate assessment of cost overruns. However, based on updated estimates of works under construction during the period, the average cost overrun is estimated to be in the range of 30 to 40%. Much of the cost over- runs were in the hydro construction component of the project. The program in the loan agreement had anticipated 1303 MW of hydro plants to be completed by 1974, instead CFE vas able to complete only 300 MW in spite of a 41% increase in expenditures over the forecast hydro construction costs. 18.b The low ratio of completed to planned facilities could be ascribed to the unrealistic scope of the original programvis-a-visCFE's capacity to carry it out. However, because of (a) the sector lending approach used for this loan, and (b) the agreement of the Mexican Government to provide "funds .needed to meet (investment) expenditures" whenever there was "reason- able cause to believe that the funds available .... will be inadequate" to meet estimated investment expenditures (Section 2.03 of Guarantee Agreement), the Bank had sufficient basis to believe that CFE would have the financial capacity to carry cut the program. As to managerial capacity, the discon- tinuities at the top management level (para. 17.2 (a)) could not have been foreseen at the time of appraisal or even during negotiations. A6 19. Consultants 19.1 A list of consultants whose -services were employed during the project is attached as Annex V. The list includes some manufacturers -- apparently CFE considered supervision of equipment installation by suppliers a consuitin service. CFE did not make any official complaint on the performance 20. Financing 20.1 The financing plan was based on an agreement in the loan documents that the Government would allow the energy sector to set power rates at levels enabling the sector's net internal resources (income before interest plus depreciation less debt service) to contribute 18% to investment in 1973 and 25% thereafter. The appraisal forecast sources of funds had estimated CFE's gross internal cash generation to provide 50% of CFE's cash requirements (including debt service) during the period. Government and other contributions, disbursements from what was left of IBRD Loans 5h-ME amd 659-ME and the associated joint and parallel loans, plus Loan 834-ME were expected to add another 15%, leaving 35% of gross cash needs to be obtained from new borrowings. 20.2 The sector's cash requirements during the period exceeded the forecast by the equivalent of US$13 million, or Mex$5.2 billion, i.e. 30.2% above the forecast. j1 CFE has not explained the increase satisfactorily, although the debt service on the additional funds which had to be borrowed because of CFE's inability to generate the planned internal cash generation contributed to it. The following table compares the actual cash generation with the forecast: (in millions Mex$) 1972-74 Forecast Actual % Variation Income before interest 11,32 6,999 (38.3%) Depreciation 2.839 2,879 1.4% Internal cash generation 1l.181 2 a 30 2.03 The 30.3% deficiency in gross internal cash generation indicated in above figures (amounting to Mex$h,303 million or the equivalent of US$344 million) meant that not only was the sector unable to make any contribution to the investment program, but that it could not even meet its debt-service obligations. The debt-service obligation for the period amounted to Mex$ Th,739 illion against the actual internal cash generation of Mex$9,878 million. The situation forced the sector to roll over some of its obligations, thus imposing a heavier debt-service burden on succeeding years. 1/ See Annex 1, Sources and Applications. A7 20.4 To meet its required contributions to the 1972-74 investment program therefore, CFE resorted to new borrowings much larger than had been forecast. It borrowed the equivalent of US$1,445 million compared to to the US$804 million new borrowings forecast at appraisal. 21. Financial Performance 21.1 The following indicators summarize the financial performance of CFE during the three years (forecast indicators are in parenthesis): 1272 12.73 12 Debt-service 1/ covered by internal cash generation (times) .75 (.89) .49 (1.37) .75 (1.46) Debt-service 2/ as a % of Revenue 53.65 (4.71) 86.4 (35.94) 41.40 (35.38) Rate of Return (%) 2/ 7.5 (6.67) 8.1 (11.81) 5.7 (12.57) New Borrowings as a % of cash resources required 47.61 (43.62) 56.65 (33.16) 54.24 (30.37) Debt as % of long-term capital- ization / 57.96 (56.88) 61.55 (55.58) 64.46 (53.47) 21.2 As the indicators.show, the modest improvements in CFE's finances anticipated at appraisal time did not materialize, worse, the financial performance of the sec;or is deteriorating. The following figures compare CFE's January to August 1975 results of operations with the same period in 1974. Comparative Income Statement January 1 to August 31 (Mex$ millions) 22iL 1975 % Increase Sales of electricity 6,238.4 6,781.9 9% Other operating income 59.4 92.9 56j Operating income 6,297.8 6,87.8 Operating costs 4,636.9 6,241.8 35% Depreciation 647.6 696.6 8% Net oDerating income 1,013.2 (63.5) Interest 1,589.6 2,109.3 33% Other Expenses i54.0 164.2 7% Net profit (464.8) (2,066.0) Wh? 1/ Only debt and interests actually paid. 2/ Rate base defined s beginning year's net plant in operation plus 4% national increase for plants commleted during the year. No allowance has been made for he effect of asset revaluation. / Excludes statutory obligations, e.g. workers' pension fund liability. A8 A preliminary review of results of operations for the remaining four months of the year did not indicate any appreciable improvements In spite of a tariff increase averaging 22% which became effective in September 1975. 21.3 The high increase in operating costs indicated above ;as a pattern running through the period of the loan. Operating costs in 1973 increased by 13%, and by 45% in 1974. Labor and fuel costs were accountable for most of the increases. Labor costs increased by 53% in 1974; the previous year's increase had been 15% (in real terms the increases were 29% and 24% respectively) Fuel costs which had increased by 21% in 1973, almost doubled in 1974, largely because of the worldwide increases in petroleum costs and the sector's shift to thermal plants as an interim solution for the delays in hydro plant construction. Sales revenue increased by 14.5% in 1973 against the 13.4% increase in operating costs, and increased by 25.6% in 1974 against a 45% increase in costs. 21.4 The deterioration will apparently not be stemmed in 1976. At the time of the mission,. the Government had approved the sector's 1976 preliminary investment program of acout Mex$11 billion. Forecast data indicate that it will not be able to riake any contribution to investment expenditures during 1976. Indeed, the sector's net internal cash generation is expected to be negative by Mex$6.1 billion as indicated below; i.e., it will have to borrow to meet debt-cervice obligations, unless it can reschedule them. Mex$ million Gross cash receipts 1/ 15,000 Less: operating expenses less depreciation (11,800) Gross internal cash generation 3,200 Lesst debt-service (principal and interest) 2/ (9,300) Net internal casa generation (6,100) Estimated Rate of Return Gross Internal Cash Generation 3,200 Less Estimated Depreciation 1/.00 Operating Income OO Estimated Plant in Operation at Jan. 1, 1976 1/ 59,091 Notional 4% for facilities to be completed in 1976 2.364 Rate Base(unrevalued) 61LT Rate of Return (1900 + 61,455) 3.09% Sources IBRD 1 Includes estimated Mex$800 million or US$64 million connection fees. Excludes Mex$2.2 billion or US$174 million debts owed to the Government and originally due in 1976 but not rescheduled. Depreciation expense has been grownirgat the rate of 10% per year in recent years. Derived by dividing Depreciation expense by the annual depreciation rate of 2.2%. A9 21.5 In fairness to CFE, some of its difficulties were unavoidable The government of Mexico, as the guarantor, had agreed (Section 3.03 of Guarantee Agreement) to tariff revisions that would have permitted CFE to provide 18% in 1973 and 25% thereafter of construction expenditures from its internal resources. The Government's reluctance topermit the revision, and the power sector's rising operating costs (especially for labor and fuel) effectively made it impossible for CFE to meet the obligations under this covenant. 21.6 There are presently some indications that the Mexican Government is taking measures to restore financial soundness to CFE. In approving the sector's investment program for 1976, the Government also committed an equity contribution of Mex$6.5 billion for the year, a substantial increase over the Mex.,218 million a year it has been contributing since 1968. In addition, Mexico's new electric power law effective January 1, 1976, for the first timne in the country's history recognizes the relation- ship between investment and operational costs, and internal resource generation, and allows the sector's board to annually "fix, adjust or restructure tariffs in accordance with criteria that result in an equitable social distribution of the costs of operation, financial obligations, and the resources needed for the investment program required for the development of the sector". The effect of this law on the sector's finances remains to be seen. 22. Organization and Management 22.1 CFE is an autonomous public sector enterprise with responsiblity for the power sector in M.exico. It is controlled by a Board of Directors. (The new law effective in January 1976 will change the composition of the Board). Administratively, CFE is divided into 14 divisions, and geographically into 10 regions. Centro, which is responsible for energy generation, distribution and sales in Mexico City and surrounding areas, is owned by CFE. Owned by Canadian interests till 1960, it was purchased by the Government when the whole sector was nationalized. Although the process of liquidation and le.al integration of Centro into CFE has been proceeding on schedule, operational integration has been effectively stymied by the existence of two competing labor unions -- CFEts and Centro's. The implementation of a unified system of accounts, common procedures, and integration of personnel begun early in 1975, has had to be suspended because of resistance by Centro's labor union. Under Mexican law, inte- gration would require the merger of Centro's highly independent union into CFE's, allowing for Centro's highly restrictive labor contracts (substantially responsible for the high increases in labor costs) to be renegotiated. The new law on energy makes provision for three members of whe labor unions to be represented on CFE!s board. CFE's management hopes that the presence of union members on the board will help the process of integration. 22.2 As noted in para. 17.2 (a), CFE's top management was changed three times during project pre,aration and inple;.entation. ne Present lLr=c;or - General is dnamic an: has improved the sectors perfor-ance ssntially, though as noted elsewhere in this report, further improvement would be desirable. The effort to improve CFE's operations, several of whiTh were incororated in the loan documents (see Plan of Action below), did not really get under A10 way in several important areas until 1974. Outside of the Plan of Action (described below) there have been two important changes with potential for improving operations. One of them is the.reorganization of CFE's Operations Department. The Department had been responsible for generation, transmission, distribution and sales. During 1975, it was split into two profit centers, one responsible for generation and transmission and the other distribution and sales. Indices on their various activities have been extracted from the previous Operations Department's activities and are being refined for use as per- formance indicators for monitoring the activities of the newly created profit centers. 22.3 The other irprovement effort has been the development and intro- duction by the Contro.ler's office of procedural mauals for the following: (i) Auditing of consumer accounts; (ii) Inventory control; (iii) Financial statements preparation; (iv) Personnel and loans for workers' housing; and (v) Budgeting. A manual on the auditing of investment expenditures is expected to be issued in January 1976. The staff of the Obntroller's Department has also been increased to implement the objectives of the manuals. 22.4 CFE's Director-General is usually replaced every six years when a new Government takes office. However, during the life of the loan, there were three Directors-General, each of whom made extensive changes in the top management. These changes had their share in contributing to delays in project execution. The current Director-General has been in office for just over two years. 23. Plan of Action 23.1 Recognizing its shortcomings, CFE had agreed during negotiationst (a) to adopt and implement, according to a timetable to be agreed between CFE and the Bank, a system of computer programs to produce adequate data for the control of its investment program as well as a system of computerized budgetary control; (b) to take such measures as shall be necessary to improve its methods for forecasting peak power demand and energy requirements; (c) to extend the development plans for its large urban aistribution net- works (such as Guadalajara and Monterrey) from the present two to three years to a minimum of five years; (d) to prepare and implement a program for the reduction of CFE's inventories, which program will involve, inter alia; (i) the use of older materials in rural installations; (ii) the introduction of analytical inventory control techniques in CFE's divisions; and All inventories between warehouses; (e) to prepare ,aLnd 'aplneent a progran for improvi:. the collection of receivables and for th:e writing off of unzcllectable accounts; (f) to furnish to the 'ank, beEinning March 31, 1973, semi-annual reports on the progress of the programs mentioned in paragraphs (d) and (e)hereof; (g) to undertake a stud.r of the replacement cost of CFE's fixed assets, such study to bv zonpleted and furnished to the Bank not later than one year after the Zffecive Date. 23.2 The above measures are at varying points of implementation. Summarized below is tie status of each one as of December 1975. (a) Investrent C rn :)l System A new computer system has been implemented, which produces monthly reports comparing each organizational units expenditure with its budget. However inere is no auditing of the work program on which the reported expenditures are based. The Controller's office plans to set up a special auditing unit in January 1976, when the manual on auditing of investment expenditures is issued, in order to ensure that the input data on investment expenditures are justifiably related to the work program. A software package that wuld monitor construction costs, progress and procurement status was added to the computer information system in December. CFI prcmised to send to the Bank a report on the program and how it is func;ioning. The program's objective is to provide management with data, at varying levels of aggregation, on the overall status of the construction program, and also to highlight areas of actual or potential problems. (b) Load Forecastin Load forecasting methods used by CFE's Planning Department are based on trend analyses for short- and medium-term system load forecasting. The procedures are under constant refinements, and studies that should lead to standardized rethodology to accurately forecast demand and energy requirements by individual systems, regions and the total sector are pre- sently being carried out. Models and studies developed in Japan and at the University of California are being studied for possible applications in long-term forecasting. (c) Distributicn Plnning A report or. the planning and design procedure currently applied by CFE in Mon-;errey and Guadalajara was ready in the iatte'r half of 1975. The report dealt with the feasibility of introducing a five-year horizon for distribution planning under Mexican circurn.tances. The reco=-mendations are c'rrently being studied by CFEIs Pnnin_ -_rr2r:t. (d) Inventory Rduction CFE's invenzory control wa3 a oubiect of the exter1 -,d-t_rs' qualifications for sev2ral years, but is now described by thn latter as A12 "tolerable". Materials at most of the warehouses have been reviewed, excesses and unwanted items have been segregated for sale, inter-divisional transfers have been made, and computerized inventory recording systems have been introduced in the warehouses. The manual on inventory control introduced by the controller's office in 1975 (see paragraph 22.3 above), should help reduce future acquisition of inventory close to actual needs. The above measures are expected to result in reduction of CFE's inventory (excluding fuel) from over 2 years' requirements at the beginning of 1975, to 1.5 years at the end of 1976, and should lead to reduction of CFE's cash needs. (e) Accounts Receivable Collections of consumer receivable have improved and these accounts had been reduced from 27.5% of sales in mid-1974 to 24.3% at year end (this is equivalent to a reduction of about US$31 million of CFE's borrowing requirements for the year). The initial effort had been focused on accounts receivable from the general public. Towards the end of 1975, CFE had begun taking action to reduce receivables (through disconnection of energy supplies - see Annex VI) from state and municipal governments. The billing system has also been improved to speed up revenue collection. (f) Progress Re'ports on Plan of Action on Inventory Control and Accounts Receivable Reduction The only progress reports on these two items came from Bank supervision missions and the long-form of the external auditorst reports. (g) Replacement Cost of Fixed Assets The work on the study of replacement cost as a basis for de- preciating fixed assets did not proceed as fast as expected. Preliminary results of the first approach - indexing of the book value of the fixed assets using 1939 as a base year - jem not ready till December 1975. The loan agreement had established a completion date of December 1973, An earlier evaluation by the Bank of Mexico, based on a general price level index, had been found unsuitable by CFE. CFE's depreciation is based on U.S. Federal Power Co:mission guidelines, and does not take into account the maintenance and life expectancy experience of equipment in Mexico. The adoption of a system reflective of Mexican experience should increase depreciation contribution to CFE's internal cash generation, now that Mexico, by legislative action, has tied tariff revision to production and investment costs. 24. Insurance Practices of CFE 24.1 Following completion of Loan 659-ME, CFE was urged to and has now established a reserve for self-insurance against fire and other risks for all thermal and nuclear plants. The decision to estblish th3 reser7es rather than use an outsice underwriter was based on cost-benefit analysis of past experience. The self-insurance does not cover hydro plants. A13 25. hxternal A,,ditors 25.1 CFE's external a-idL3rs qre Suarez del e il v Vale Crozco. They were a--ocinted ,: oe ec r e,.r del ?atr imonic. N.Z:ional, wch 1is the supervisory agency f0 &o'er .n-ownea enfcr-rises. The fir= of Suarez del Real y Valle Crozco ualiied and olows accP)ted accounting standards. They have been -,uditing CFE's accounts throughout the life of the Bank loan and hav6 been instrumental in getting CFE's management to focus attention on improving operational deficiencies. 26. Financial Covenants 26.1 The main financial covenant was the 181 CFE contribution in 1973 and 25% thereafter from net internal cash generation to the investment program, with which the sector did not comply. Debt Limitation 26.2 A debt limitation covenant provided that the sector would not incur debt without the agreement of the Bank if: (a) net income before interest is less than 1.6 times maximum interest on consolidated debt (debt with original maturity of one year or more) in any succeeding year; or (b) the sum of net fixed plant in operation and work in progress is less than 1.5 times the consolidated debt; or (c) the part of the consolidated debt with an original term of five years or less is more than one-tenth of the sum of net fixed plant in operation and work in progress. 26.3 The sector Lid not meet condition (a) in either 1973 cr 1974; net income before interest i.n 1972 was Mex$2,128 million against interest payable of Mex$2,299 in 1973, giving a ratio of 1.08. The 1974 net income before interest ratio to interest payable was 1.03. CFE has not provided data on consolidated cebt in 1973; but did provide them for 197h. The ratio of net fixed plEnt in operation and work in progress to the con- solidated debt for that year was 1.49 times. At 1974 year-end, the part of the consolidated debt with an original term of five years or less amounted to Mex$2,894.7 million; about 6% of the sum of the net fixed plant in operation and work in progress at 1974 year-end. 27. Conclusions 27.1 The Fourth ?ower Sector Program was not successful in Meeting the objective3 wnich the loan was neant to helP the sector achieve. Investment expenditur.s, while exceeding forecast levels, covered far less than the phrsicil f'clit i s included in the roram. Even the reduced prc-a was notva:tcd O:2gO ~ ~ d h .o responsibl2 for the &.1a,u, as pointed out 1= rara 17.2, ;ere ti) discontinuities at the top le7aa t level, (ii) poor perormace by contractcrs and supplira3, (iii) underestiiion of t "e tine fact:ors involved - In e '. ci.n-o2n3 -rocess in Mexico, and (iv) the .IMexican Goverr;ent's slowness in alowing tarifr inareases. A14 There was also probably some over-optimism at the time of appraisal about the capacity of CFE to carry out the planned program. It is true that some of the institution-building aspects of the program (Plan of Action - improvements in operations) made pr)gra3sa. But implementation of others were so delayed that they did not have th3 expected impact during the period (for exaple, the study of the replacement cost of CFE's fixed assets as a basia for depreciation which had been expected to be completed by the end of 1973, did not actually get under way till 1975). 27.2 CFE did not meet most of the financial covenants. In spite of a reduced program, it did not make any contributions to investment expenditures during the period as had been covenanted in the loan agreement. By the end of the project, CE's financial structure was weaker than at the time of appraisal. 27.3 Throughout the period of the loan, supervision missions had highlighted a pattern of actions, including the violation of the contribution-to-investment- expenditures covenant, which pointed to insufficient comitment on the part of the borrower and the guarantor to the program. The Bank's long and substantial involvement with the haxican power sector (11 loans totalling US$704.8 million since 1949 - Annex VII) was apparently not sufficient to hold the sector to the mutually-agreed covenants. Lessons to be Learned 27.4 While exogenaus factors such as delays by suppliers and inflation hampered program implxertation, inadequate commitment on the part of the sector and the guarantor is largaly responsible for the failures. In retrospect, it would have helped to have insisted on such measures ast (i) reasonably regular review of tariffs to raflect cost increases and investment goals; (ii) investment and inventory control; (iii) adequate mechanisms for project coordination; (iv) proper billing and quick collection of receivables; and (v) revaluation of assets, as additional preconditions for the graating of the loan. Latin America and the Caribbean Regional Office February 27, 1976 NEXICO - LOAN 834-NE SOURCES AND APPLICATION OF FUNDS 1972-74 FORECAST VS-ACTUAL (in millions Mex$) ------- 1972 -------1973 -------1974------- -------TOTAL------- SOURCES Forecast Actual Forecast Actual Forecast Actual Forecast Actual Net Income before Interest 2,141 2,128 4,168 2,644 5,033 2,227 11,342 6,999 Depreciation of Itn Cash 963 1 060 2839 2 8 Sutoalo Itenl as 2,9 2-9 510 3,607 "W7 37 ~ h T 1418 9,878 Federal Governmenb Conriibution 218 218 218 218 218 218 654 654 Other Contributions 242 1 250 701 260 1 080 752 2 332 Subtotal of Contributions 79 919 478 1,298 1,4o6 2,986 IBRD Loan 834-NE 85 - 750 736 728 642 1,563 1,378 Previous TBRD Loans 591 591 - - - - 591 591 Disbursement from other prior loanio (joint/parallel) 466 331 325 350 57 236 848 917 Disbursoments from new non-IBRD las(927)354 4,249 3_299 7 333 3 209 6 475 10 052 18 0571'/ Subtotal of Borrowings 5,8 tf 2 TOTAL SOURCES 81& 8.924 9949 12,945 lo,568 11,938 28,641 31807 APPLICATIONS Construction Construction expenditures 4,984 4,440 6,052 5,481 6,068 6,835 17,104 16,7562/ Debt Service: Amortization 1,633 2,113 1,750 3,894 1,970 1,438 5,353 7,445 Interest 1,707 1,870 1,970 3,453/ 2,207 2,971 5,889 7,294 Other applications Change in net current assets - cash (41) 180 24 43 108 115 88 338 Change in net current assets - other (257) (382) 130 328 210 (1,749) 83 (1,803) Other (net) 101 703 23 746 4 2 328 128 3,777 20 2_0_0 177 1,117 322 9 299 2j312 TOTAL APPLICATION 8124 8,924 9,949 1245 11,938 28,641 33,807 1/ Excludes NAFIN refinancing and short-tem borrowings. 2/ Figures for interest payments were supplied by CFE. Audited financial statements did not contain sufficient information on interest payments. 3/ Does not agree with total increase in fixed assets during 1972-74. Above figures provided by CFE. Audited figures not available. MEXICO - Loan 834-ME Estimated Cost of Construction and Forecast Expenditures (1972-74) vs* 1/ Actual Cost of Construction and Expenditures- (in 10b Mex$) 1972 1973 1974 TOTAL Forecast Actual Forecast Actual Forecast Actual Forecast Actual Hydro Generation 381 622.2 635 687.3 466 783.1 1482. 2092.6 Thermal Generation 1510 1507.6 1676 1598.4 1966 2161.5 5152 5267.5 Transmission 9711 385.9 1499 621.5 1227 802.3 3700 1809.7 Distribution 1195 1253.1 1290 1477.9 1390 1535.5 3875 4266.5 Village Electrification 350 689.1 350 625.8 350 377.2 1050 1692.1 Frequency Unification 19 13.4 30 42.2 70 49.9 119 105.5 Consultants 25 13.6 25 8.5 25 10.0 75 32.1 CFE overhead charged to Investment 428 401.6 437 550.9 454 597.0 1319 1519.5 Miscellaneous 102 86.6 110 890.2 120 8. 332 195. Total 28 4973.1 6052 6502.7 6068 6835.0 17104 1831C.E 1/ Actual construction expenditures for 1972 and 1973 do not agree with the construction expenditures in Annex 1. The figures were provided by CFE. Audited financial statement for the two years did not contain Statements of Sources and Uses of Funds. 11EXICO - LOAN 834-ME FORECAST INCOME STATEMENT vs. ACTUAL 1972-74 1972 1973 197 Years ending December 31 (in 106 Mexican $) Forecast Actual Forecast Actual Forecast Actual Percentage Sale Increase in GWh 8.59% 10.99% 13.86% 9.6% 14.47% 11.6 Sales (GWh) 26700 26314 30400 28841 34800 32055 Average Revenue (centavos/kwh) 27.7 27.91 33.8 29.16 33.7 32.95 Power Sales 7396 734i5.2 10275 8410.5 11728 10561." Other Revenues 74 84 -75, 92.7 7 9. Total Revenue 7470 7423.6 10350 8503.2 11805 1061. Operating Expenses Labor 2617 2746 286 3166 3102 4828 Fuel 908 816 131 984 1504 1708 Purchased Power 20 34- 28 39 29 110 Depreciation 837 855.8 939 963 1063 106C Other Expenses 1024 832- 1082 841 1149 _ - - Total Operating Expenses 5ho6 5283.8 6255 5993 68W7 8689 Operating Income 2064 2139.8 4095 2510 4958 2032 Other Income (Net) 77 (12) 73 134 197 Net Income before Interest 2141 2127.8 4168 25L4 5033 2227 Interest Payable 1870 1970 2299 2207 -722 Less Capitalized Interest (343) (306) (411) (417) (410) (1L4) Interest Chargeable to Operations 1364 1564 1559 1882 1797 280 Net Income 777 563.8 2609 762 3235 (353) MEXICO - LOAN 834-ME Forecast Balance Sheet vs. Actual 1972-7L As of December 31 (in 106Mexican $) 1972 1973 1974 Forecast Actual Forecast Actual Forecast Actual ASSETS Fixed Assets Plant in Operation 39839 38302 h316 43582 51009 48173 Less: Allowance for Depreciation 8259 _JLL 9198 9093 10261 10136 31580 29947 35113 34489 40748 38037 Work in Progress 6974 6962 8960 00 8 4 116 Total Fixed Assets 3755 36909 278 72389 9 9 Current Assets Cash 577 868 602 911 710 1026 Accounts Receivable 1700 1715 1920 2439 2200 2c6'6 Materials and Supplies 2200 2361 2200 2703 2200 29SC Other Current Assets 80 90 123 100 1 6 Other Assets _6939 2139 2512 2293 328 Total Assets 6077 43842 51029 5107 57016 59750 LIABILITIES AND EQUITY Equity 16937 16319 20015 17567 23728 18141 Long-term Debt (Ne.t) 22390 21434 24794 26494 25352 32424 Current Liabilities: Current Portion of Long-term Debt 1750 2458 1970 2742 3436 3748 Other Current Liabilities 1500 1520 1600 2203 1700 2 Total Current Liabilities 3250 3978 77730 7797 -T5E 3 9 Other Liabilities 2LOO 2111 265o 20)1 2800 3096 Total Liabilities & Equity 65077 43842 51029 51077 57016 59750 - - -M ANNEX V Page 1 of 2 pages List of Con.ultants Used During the Life of Loan 834-ME Consultant Project Phase Bufete Industrial, Designs and Projects, S.A. (Mexico) (i) engineering services for Tampico - units 1 and 2, 2 x 158 MW steam plants; (ii) Mazatlan II - 3rd Unit 300 MW steam plant; and supervision of construction of Valle 300 MW steam plant at Valle de Mexico Compania Electroconstructore S.A. Salamanca - unit 3, 300 MW steam plant - (Mexiuc) engineering services. Brown Boveri Mexicana, S.A. (i) Valle de Mexico - unit 4, steam, 300 MW, (Swi tzerland) supervision of construction (ii) El Humaya- hydro, 2 x h15 MW: supervision of constructk%a (iii) Monterey - units 4 and 5, 2 x 84 MW steam plants; supervision of installation and start-up. Babcock and Wilcox. Co. (U.K.) Valle de Mexico - unit 4, steam, 300 MW, supervision of installation and start-up. Dipian,S.A. and Companta Mexicana de (i) Campeche I - unit 3, 37.5 MW steam Consultores de Ingenieria, S.A. (Mexico) engineering services; (ii) Salamanca units 3 and 4, 2 x 300 MW, steam, design services; (iii) Cerro Prieto - units 2 and 3, geo- thernal, 2 x 37.5 MW, civil and electro- mechanical services, feasibility study and preparation of specifications. Bica, S.A. de C.V. (Mexico) Tuta - units 3 and 4, 2 x 300 MW, steam, engineering services. Constructors Hechos, S.A. (Mexico) Feasibility studies on hydro plants in and around Guadalajara. A.G. Siemens (West Germany) Supervision of installation of facilities at Infiernillo, La Villita, Guadalajara II, Nopala and Las Truchas C. Itoh and Co. de Mexico, S.A. de C.V. (i) P.H. Plutarco E Calles - 3rd unit, (Japan) hydro, 45 MW, supervision of installa6ion; (ii) Altamira - repairs of Icatec, S.A. (Mexico) Chicoasen - feasibility studies Geofimex, S.A. (Mexico) Chicoasen - Geological studies Ameron. Pipe-lining Division (U.S.) Masatlan, units 1 and 2 and Campeche I, units 1 and 2, lining of tubes Negociacion Electromecanica, S.A. Tula, units 1 and 2, installation (Spain) ANNEX V Page 2 of 2 pages Consultant Project Phase Corporacion de Planificacion, S.A. Feaaibility studies on village electrification Compania Mexicana Aero'oto, S.A. Aerial photography (Mexico) Cerey, S.A. (Mexico) Campeche II - 2 x 37.5 MW, steam Supervision of installation Pentec, S.A. de Houston (U.S.) Tula, units 1 and 2, 2 x 300 MW steam, supervision of installation Servicios Metalurgicos, S.A. (Mexico) Tula, inspection of welding and tubing Toshiba (Japan) Repair of generator covers Cablexport, S.A. (Italy) Supervision of installation and start- up of joint cables assembled from 400 kV isolated cables. ANNEX VI CONJO, CARBP11O CODORNI DIAR10 DE MEDIODIA CE S PRIMERA 1DCION c Nrote 5 5 -TOMO JUuIO SCHERER GARCIA MEXICO, D. .F-VIERNES 19 DE DICIJFMSRE Dt 1975 Z TORO NU RO 2.519 _ _ LJW\ -- ----- .- ------- 7 Por un Adeudo de dos Millones C- WUAN.Ak~KMU kTALK. a~.-n . 1.x. SALTILLO. Coah.. 19 de di iembre.--La ciudad de Torreön. donde viven mn dr 350,000 personas. est uvo anochr en tinichlas. La Comslån Federal de Ec<t riciad torti el mervicio de alumbrado públien por tina.dvuda de don millonis de pesos que tiene el mumi- cipio. La gerencia de la CFE en Cohumla s61(1 proporciona energia a lo hospitaleg y para ios semåform. AsImismo. Telé~fono dr México usvn- d1 el uervirin ala P.licia. ,Mimi,lerin Publirn, 'deugarim de Trinsitn y pau,dbm, por li - milma raión: falla de pago El gabernados del e 0.l. Os,nr Floren mTaplm. nianifeatt al re-lito que para sarar de la pnatrarion ernninnia al municipin le Torre6n -u-ituaciin atrilpnii; por et alvaj-le. J~å Snim Anarn, al al:nd p tio,n e I: anlerinr -administracien tal- "nada pottems ha- ~eer Denn hasta el primeroi dil afo proximn, euandn tnie posesitn el nuervo aldale, Fran <'4sro J. M:,lemV Cmna~. -9 .n,,td im N..s.. r .-.id. ...,,.. *Wl>. - thea t... ANNEX VII MEXICO Bank Loans to the Mexican Powcr Sector: 199-1972 Loan Amount Year Loan No. B ficiy (in millions of US$) 1949 12-NE CFE 24.1 1949 13-NE CFE - 1950 24-NE Mexlight 26.0 1952 56-ME CFE 29.7 1958 186-E Mexlight 11.0 1958 194-ME CFE 34.0 1962 316-NE CFE 130.0 1965 436-NE CFE 95.0 Centro 15.0 110.0 1968 544-ME CFE 78.0 Centro 12.0 90.0 1970 659-NE CFE 109.0 Centro 16.0 125.0 Subtotal $ 579.8 1972 834-ME CFE 125.0 TOTAL $ 704.8 1/ Loan 13-ME for US$13 million was made to CFE and relent to Mexlight pending its reorganization; the reorganization was concluded in 1950 and the loan was repaid from part of the proceeds of Loan 21-NE.