Mexico - Las Truchas Steel Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 3478 PROJECT PERFORMANCE AUDIT REPORT MEXICO--LAS TRUCHAS STEEL PROJECT (LOAN 934-ME) May 28, 1981 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. COUNTRY EXCHANGE RATES Name of Currency - Pesos (Mex$) Year Exchange Rates Appraisal (1973) - US$1.00 = Mex$ 12.5 Completion (1978) - US$1.00 = Mex$ 22.7 Intervening Period: 1974 - US$1.00 = Mex$ 12.5 1975 - US$1.00 = Mex$ 12.5 1976/a - US$1.00 = Mex$ 15.4 1977 - US$1.00 = Mex$ 22.6 /a In August 1976, the exchange rate was raised from Mex$ 12.5 to Mex$ 22.6 per U.S. dollar. FOR OFFICIAL USE ONLY PROJECT PERFORMANCE AUDIT REPORT MEXICO--LAS TRUCHAS STEEL PROJECT (LOAN 934-ME) TABLE OF CONTENTS Page No. Preface ....................................*.......................... i Basic Data Sheet ...................................................... ii Highligths ............................................................ iv PROJECT PERFORMANCE AUDIT MEMORANDUM I. Project Identification and Preparation ................... 1 A. Origin of the Project ................................ 1 B. Project-related Issues ............................... 2 C. Steel Industry Planning and Policies ................. 4 II. Project Implementation and Early Operations .............. 6 A. Project Construction ..................................... 6 B. Project Operation ........................................ 9 C. Financial Performance ................... ........... 11 III. Sectoral and Regional Planning ............................. 12 A. Sectoral Planning ...................................... 12 B. Regional Planning ...................................... 14 IV. Conclusions ............................................. 17 ATTACHMENT 1: COMMENTS RECEIVED FROM THE GOVERNMENT ............... 21 ATTACHMENT 2: COMMENTS RECEIVED FROM THE BORROWER ...... ......... 25 ATTACHMENT 3: COMMENTS RECEIVED FROM THE IRON AND STEEL COORDINATING COMMISSION (CCIS) .................... 27 ATTACHMENT 4: PROJECT COMPLETION REPORT I. Project Description and Implementation .................. 33 A. Project Background and Description ................... 33 B. Project Construction and Completion .................. 34 C. Project Scope and Cost ............................... 35 D. Financial Plan and Cost Overrun Financing ............ 38 E. Procurement, Allocation of Bank Loan, and Disbursement ............................... ....39 F. Infrastructure ................................ ...... 41 This document has a restricted distribution and may be used by recipients only in the performance of their offcial duties. Its contents may not otherwise be disclosed without World Bank authorization. TABLE OF CONTENTS (continued) Page No. II. Political and Economic Environment ....................... 42 III. SICARTSA--the Company ................................... 43 A. Ownership and Control ............................... 43 B. Organization and Management ..........................44 IV. The Steel Market ........................ ............. 46 V. Project Operation .................................... 49 A. Production Build-up .................................... 49 B. Sales ................................................... 52 C. Financial Performance ...................... ........ 57 D. Financial Rate of Return on Investment ............... 60 E. Economic Benefits of the Project ..................... 60 F. Labor and Social Aspects ............................ 61 C. Environmental Aspects ...................... ........ 62 VI. The Bank-s Role ......................................... 62 A. Project Formulation and Supervision .................. 62 Annexes 1. Production Facilities ...................................... 64 2. Actual and Planned Project Completion Schedules .......... 65 3. Reasons for Delays in Project Completion ................. 66 4. Capital Cost Summary ....................................... 67 5. Equipment Financed by IBRD Loan ............................. 68 6. Disbursement Schedule ...................................... 69 7. Evolution of Share Capital Structure ........................ 70 8. Organization Chart ......................................... 71 9. Production Performance ..................................... 72 10. Historical Profit and Loss Statements ...................... 73 11. Historical Balance Sheets .................................. 74 12. Projected Balance Sheets ................................... 75 13. Financial Rate of Return Calculations ...................... 76 14. Savings in Foreign Exchange ................................ 77 15. Economic Rate of Return Calculations ....................... 78 16. Exchange Rates and Price Indices ........................... 80 17. Ecology ..................................................... 81 Maps: No. IBRD 10485: Mexico--Siderurgica Lazaro Cardenas - Las Truchas General Location Map No. IBRD 12021: Mexico--Major Steel Production Centers PROJECT PERFORMANCE AUDIT REPORT MEXICO--LAS TRUCHAS STEEL PROJECT (LOAN 934-ME) PREFACE This report presents a performance audit of the Las Truchas Steel Project in Mexico supported by loan 934-ME. The loan, for US$70 million, was approved in September 1973 to Nacional Financiera, S.A. (NAFINSA), the Govern- ment development bank, and Siderurgica Lazaro Cardenas-Las Truchas, S.A. (SICARTSA), a Government-owned company, as joint borrowers, the Government acting as guarantor. The project represented the erection, from the green- field stage, of an integrated iron and steel works in an hitherto undeveloped region of Mexico, and included the development of iron ore mines and installa- tion of steel making equipment (following the blast furnace/BOF route) and rolling facilities. The plant was to have an annual capacity of one million tons of light non-flat finished steel products. A project completion report (PCR) was prepared by the Bank-s Indus- trial Projects Department on the basis of information provided by SICARTSA. It provides a detailed factual review of project implementation. The audit memorandum was prepared, following a mission to Mexico by OED staff in June 1980, on the basis of discussions held with representatives of the Govern- ment, NAFINSA, SICARTSA and Siderurgica Mexicana (SIDERMEX), the Government's holding company for the steel industry. The audit memorandum is also based on discussions with Bank staff and a review of project files and other relevant documents. The project was erected slightly behind schedule and with a sub- stantial cost overrun. The company has since experienced severe teething difficulties in building up production to rated capacity. The audit memo- randum relates these difficulties to the high staff turnover which resulted from the inadequate development of social infrastructure in relation to the needs of the population drawn to the area by the project; it further suggests that the project would have gained from being analyzed in a wider, multi- sectoral framework encompassing an analysis of the development of the area as a whole. Comments were received from the Government, the Borrower and the Iron and Steel Coordinating Commission (CCIS). They have been taken into account in finalizing the report and are reproduced as Attachments 1, 2 and 3 to the audit memorandum.  - ii - PROJECT PERFORMANCE AUDIT REPORT MEXICO--LAS TRUCHAS STEEL PROJECT (LOAN 934-ME) BASIC DATA SHEET Amounts (in US$M) As of 02/28/81 Original Disbursed Cancelled Repaid Outstanding Loan 934-ME 70.0 70.0 - 13.1 56.9 CUMULATIVE LOAN DISBURSEMENT FY74 FY75 FY76 FY77 FY78 (i) Planned 16.2 59.1 64.7 69.0 70.0 (ii) Actual 6.5 40.8 64.6 68.9 70.0 (iii) (ii) as % of (i) 40.1 69.0 99.8 99.8 100.0 PROJECT DATA Original Loan Date Actual or Re-estimated Board Approval 7/23/73 9/04/73 Loan Agreement 7/31/73 9/12/73 Effectiveness 12/20/73 10/29/73 Loan Closing 12/31/77 11/22/77 Physical Completion 3/76 11/76 Total Project Cost (US$M) 635.6 962.8 Economic Rate of Return 12-13% 9-9.5% MISSION DATA No. of No. of Date of Month, Year Weeks Persons Manweeks Report Identification December 1971 1 1 1 12/21/71 Preparation Jan./Feb. 1972 1.5 2 3 2/16/72 Preappraisal March 1972 0.5 2 1 3/16/72 Preappraisal Follow-up July 1972 1.5 2 3 8/07/72 Preappraisal Follow-up August 1972 1 1 1 9/06/72 Appraisal November 1972 3 5 15 7/12/72 Appraisal Follow-up February 1973 0.5 1 0.5 2/22/73 Appraisal Follow-up March 1973 2 5 10 4/25/74 - 111 - No. of No. of Date of Month, Year Weeks Persons Manweeks Report Supervision I February 1974 1.5 1 1.5 4/25/74 Supervision II May 1974 0.5 1 0.5 5/13/74 Supervision III June 1975 2 4 8 6/12/75 Supervision IV November 1975 3 4 12 11/18/75 Supervision V February 1976 0.5 1 0.5 3/11/76 Supervision VI June 1976 1 2 2 6/22/76 Supervision VII August 1976 1 1 1 9/04/76 Supervision VIII January 1977 2 1 2 2/10/77 Supervision IX October 1977 1 2 2 11/11/77 Supervision X March 1978 1 2 2 4/05/78 Completion December 1978 2 3 6 6/14/79 TOTAL 72.0a FOLLOW-UP PROJECT Loan 1308-ME for US$95 million approved in July 1976 but cancelled before being declared effective. /a The number of man-weeks shown for supervision may be a substantial under- estimate, as, from 1975 onwards, supervision of Stage I was combined with the preparation of the Stage II project. - iv - PROJECT PERFORMANCE AUDIT REPORT MEXICO--LAS TRUCHAS STEEL PROJECT (LOAN 934-ME) HIGHLIGHTS The project was Mexico-s largest development project of the seven- ties. It represented the erection of an integrated steel works with a capa- city of one million tons per year (tpy) in terms of (light non-flat) finished products in a hitherto undeveloped and sparsely populated area on the Pacific Coast, which met the physical requirements for such a project, including the proximity of iron ore deposits and the availability of a good natural harbor. The project was conceived as the first stage of a large-scale plant whose capacity could eventually reach up to 10 million tpy. The decision to build the plant also reflected the Government's intention to promote the development of the area, using the project as an instrument to spark the engine of growth. The project was implemented by a new company set up by the Government for the purpose, Siderurgica Lazaro Cardenas-Las Truchas S.A. (SICARTSA); the company had contracted the services of a team of expatriate advisors for assistance in implementing and commissioning the project. The project was physically completed in three and a half years-- about nine months behind schedule. Given the tightness of the original schedule, this was a remarkable achievement which demonstrated the decisive- ness of SICARTSA's management, the positive role played by its technical advisors, as well as the Government's will to back up the project. The project was implemented during a period of high domestic and international inflation; moreover, the objective of meeting completion deadlines seems to have taken precedence over cost control considerations. As a result, total project cost amounted to US$96.3 million, i.e., 51 percent over the appraisal estimate (PPAM, paras. 17 to 22; PCR, paras. 1.06 to 1.22). SICARTSA has experienced major teething difficulties in building up the production of its plant to capacity; in 1980, the fourth year of commer- cial operation, capacity utilization (in terms of finished products) had only reached 60%. This poor production showing has had two principal causes: (i) SICARTSA-s decision to terminate its contract with its operating advisors - shortly after start-up (in violation of its loan agreement with the Bank, which the latter did not endeavor to enforce); and (ii) SICARTSA-s high man- power turnover as a result of very difficult living conditions in the area (PPAM, paras. 23 to 28; PCR, paras. 5.01 to 5.09). Production shortfall was compounded by difficulties for SICARTSA in establishing its share of the market as the economy was going through a deflationary period. This resulted in substantial losses in 1977, 1978 and 1979 and a deterioration of the company-s financial structure. Recent measures taken by the Government have helped considerably in placing SICARTSA on a sounder financial footing (PPAM, paras. 29 to 32; PCR, paras. 5.10 to 5.23). - V - An important factor behind SICARTSA-s difficulties has been its inability to maintain continuity among its middle management and operating and maintenance staff. In turn, staff turnover reflected the dissatisfaction of SICARTSA-s management and labor force with the living conditions in the town of Lazaro Cardenas, as the development of housing and social infrastructure required to meet the needs of a rapidly growing population failed to be implemented as expected. With the benefit of hindsight, a case can be made that the project would have gained from being analyzed in a wider perspective encompassing all aspects pertaining to the development of the area, a develop- ment which the project was intended to initiate and foster. Other points of interest are: - the ambiguity created by analyzing the project's transport needs without explicit reference to the development of the area as a whole (PPAM, paras. 7 to 9); - SICARTSA-s decision not to include erection as part of its equipment contracts (PPAM, paras. 18 to 21); and - the slow development of steel sector planning despite the Bank-s urging (PPAM, paras. 34 to 37). PROJECT PERFORMANCE AUDIT MEMORANDUM MEXICO--LAS TRUCRAS STEEL PROJECT (LOAN 934-ME) I. Project Identification and Preparation A. Origin of the Project 1. The possibility of setting up a steel plant to exploit the iron ore deposits of Las Truchas in Mexico-a State of Michoacan was first studied as far back as 1948. The history of the Las Truchas Steel Project proper, which the Bank supported in September 1973 with a loan of US$70 million, is of more recent origin, dating from 1969, when the Mexican Government created Siderurgica Lazaro Cardenas--Las Truchas, S.A. (SICARTSA) as a "Sociedad Anonima" under Mexican law. The company was set up with the specific purpose of carrying out the preparatory work for a large, integrated, coastal steel works, which it would eventually install and run. As the name of the com- pany indicates, one of the very early steps in defining the project was the decision to set up the plant at the mouth of the Rio Balsas on the Pacific Coast, close to a small town newly named after Mexico-s former President Lazaro Cardenas. 2. A major consideration behind the choice of this location, charac- terized as it was by undeveloped and sparsely populated surroundings, was undoubtedly the relative proximity (19 km) of the ore deposits, as also the availability of a good natural harbor, water from the Rio Balsas and electric power from upstream hydroelectric plants. This decision, however, also clearly reflected the Government-s intention to use the project as a first step towards, and to an extent as a catalyst for, promoting the emergence of a new pole of development around Lazaro Cardenas. The mouth of the Rio Balsas indeed satisfied the requirements for the construction of a deep-sea port to service industries to be developed on the basis of the areas promising mineral resources. As such, the project fitted well within the Government-s objective of directing productive investment towards underdeveloped areas of the country so as to bring about a more balanced development of the economy, away from major urban centers. 3. The decision in 1969 to promote the development of the area had an earlier background. As early as the 1930-s, Lazaro Cardenas, then President of Mexico, had envisioned and, through land reform measures, promoted the area as a future growth pole. During the 1960's, the construction of the La Villita Dam on the Rio Balsas, with its related power plant and irrigation works, had created additional impetus to the development of the region. The steel project reviewed herein has to be considered in the context of this progressive development process, of which it was to be an essential element. It indeed represented the establishment of a first industrial concern in the -2- area and was expected to trigger the development of other industries, through either formal industrial linkages or demand for services resulting from employment creation. The parallel development of an industrial harbour at the mouth of the Rio Balsas was intended to promote and otherwise support further industrial development. A fertilizer complex is now under construction close to the site of SICARTSA's steel plant; other industries in the process of being developed include a pipe plant and a casting and forge plant. A grain terminal and a container terminal are almost completed. B. Project-related Issues 4. The project was an ambitious one, not so much because of its size-- one million tons per year (tpy) in terms of (light non-flat) finished prod- ucts, which incidentally was making it the largest industrial project ever undertaken in Mexico at the time--, but because of the combination of three crucial factors: (i) firstly, the project aimed at setting up a "green field" plant without the support of an existing corporate structure with operating service and administrative facilities; (ii) secondly, the project was to be prepared and executed by a newly-established company essentially conceived as an instru- ment for promoting the project and headed by an executive team with very little operating experience; (iii) finally, the plant was to be erected in a remote and virtually undeveloped area lacking most of the infrastructure needed for such a complex; overall the project was to require the construction of a port, township, transport infrastructure and complete support equipment. On the plus side, however, the project appeared to benefit from the strong support of the administration in charge of the country for the six-year period 1970-1976. 5. The Bank's involvement with the project dates back to early 1970. By September 1970, SICARTSA had, with the active support of overseas con- sultants, completed a pre-feasibility study which provided the basis for the Government-s decision to proceed with the project. When the Bank was formally approached in August 1971, it found this study inadequate as a basis for appraisal and project implementation and recommended, as a next step, the engagement of a team of international engineering to review the project proposal. SICARTSA agreed to this suggestion and appointed a team of overseas technical and operating advisors whose first task was to prepare a revised pre-feasibility report, including a detailed analysis of capital costs and a definition of the critical path for implementing the project. The Bank found the revised report acceptable as a basis for considering a request for finance. - 3 - 6. It was not until 1973, however, that the Bank approved its loan to SICARTSA and work started on the site. This relatively long lead-time resulted from the Bank's insistence on addressing thoroughly a number of issues on which the viability of the project was seen to hinge. Considering the rapidity with which the initial investment program had been conceived and adopted, the Bank concentrated its appraisal effort on the task of determining the technical, financial and economic viability of the project, focusing on issues which appeared to have been until then, if not ignored, at least given perfunctory treatment, and insisting on their solution as a condition for its support. These included notably: (i) confirmation of the existence of suffi- cient ore deposits in the area to warrant the project--i.e., sufficient to cover the requirements of the future plant for at least fifteen years, and (ii) choice of, and official decision to undertake, the best-suited transport infrastructure to provide appropriate linkage between Lazaro Cardenas and the future plant's market outlets, in the first place the Mexico City metropolitan area. At the Bank-s urging, SICARTSA-s consultants sub-contracted a team of geologists to supervise an intensive drilling program of the Las Truchas ore deposits to be conducted by SICARTSA. This program eventually confirmed the existence of iron ore reserves far in excess of the amounts previously quoted by the project sponsors. 7. The transport issue remained confused for some time by the differing attitudes in Mexico towards the regional role of the steel project. To those sharing the vision of an evolving agricultural/industrial complex in the area, the early undertaking of proper transport connections was essential. Opponents to the construction of a railway link appeared not to accept Lazaro Cardenas as a major new opening to the Pacific insofar as considerable invest- ment was already going into developing the port of Manzanillo some 300 km to the north; they considered that construction of a rail link should await sufficient traffic to justify the investment. 8. The transport issue was complicated by the need to demonstrate the economic viability of constructing a railway link (if this was to be the final decision) on the basis of expected traffic--a stipulation of Government commitments to the Bank as part of a past railway loan. A study of transport alternatives was undertaken by the Secretary of Communications and Transporta- tion. This study concluded that a railway link to Lazaro Cardenas would not be economical unless there was a guaranteed transport demand of 2 million tpy of freight, and that consequently the project was insufficient to justify its construction. The Bank then suggested that SICARTSA undertake its own study of the problem. The Bank never acknowledged, however, that once a best solution from SICARTSA-s point of view had been identified--i.e. one minimiz- ing the present value of both investment and operating costs--the economic viability of such solution could not be demonstrated on the basis of the project alone. As the Bank looked at the project in isolation, it did not perceive that the infrastructure requirements should have been assessed in a wider regional perspective. -4- 9. SICARTSA-s study eventually concluded the desirability of a two phase solution: using a road/rail combination on the basis of existing infrastructure (with some road improvement) during the first two years of steel production, and constructing a railway link for 1978, by which date SICARTSA-s production would be shipped directly by rail. This two-phase transportation solution was desirable only insofar as it acknowledged the inevitability of a railway link to service the plant, as there was never any doubt that road transport could not provide the long-term solution. In August 1973, the Mexican Government submitted to the Bank a letter of intent whereby it committed itself to implement the aforementioned plan. The railway link was completed in 1979, one year behind schedule, and became operational in 1980. This delay was not too consequential as SICARTSA's production build-up, and hence the growth in transport needs, was much slower than anticipated. Looking at transport requirements on the basis of project needs thus led to some ambiguity in the way these were analyzed, but in itself was not detri- mental to the project, although road transport have clearly involved higher transport charges for SICARTSA. 10. As regards the construction of the port of Lazaro Cardenas, the situation was somewhat different as the Government was bound by an agree- ment in principle with the Bank to set charges for the use of any new port constructed in Mexico on full cost basisl/. Lest charges detrimental to the project-s financial performance should be levied for the use of the port, in case non-SICARTSA freight did not progress as expected, the Bank suggested that port facilities be reduced to the absolute minimum required by SICARTSA-- i.e., 250 meters of quay as opposed to the 600 meters originally planned. Further expansions to the port are now being planned. 11. The Bank was thus thorough in its assessment of technical issues having a direct bearing on production although, by limiting the framework of its analysis to the project, it introduced indirectly an element of ambiguity in the Government-s capital budgeting process, as it was impossible to justify the necessary infrastructure investment on the basis of the project alone. In sharp contrast, the Bank failed to account adequately for the green-field nature of the project in the sense that it devoted only limited attention to socio-economic factors, such as the development of housing and social facili- ties, which were to prove critical to project performance (see section III below). C. Steel Industry Planning and Policies 12. During its appraisal of the project, the Bank emphasized that its involvement would be predicated upon its being satisfied that the project constituted an appropriate next step in expanding Mexico-s steel industry. Aside from a number of small, private, semi-integrated (re-rolling) plants, 1/ In comparison, railway rates are set country-wide on an average per kilometer basis. most of which are located in Mexico City, Mexico-s steel production capacity was confined to three fully-integrated producers: Government-owned AHMSA, privately-owned HYLSA, and Fundidora (of mixed ownership) which was at the time undergoing a 0.5 million tpy capacity expansion. To be in a position to demonstrate the economic viability of the project, the Bank indicated that it needed to have a comprehensive knowledge of Mexico-s steel market and of the cost structure of existing companies. The Bank also stressed that it needed to obtain assurances from the Government that a national coordination effort of the whole sector would be undertaken. 13. At the Bank-s suggestion, the Government established in June 1972 an Iron and Steel Coordinating Commission (CCIS) to formulate a national steel policy and prepare a long-term program for the overall expansion of the industry. This commission took the form of an Interministry Secretariatl/, operating alongside a Technical Committee composed of representatives of the largest steel companies. Its composition, as also the mechanisms imbedded in its structure, reflected the search for compromise between institutionalizing a planning process and respecting the autonomy of the companies, whether privately or publicly owned. One of the first tasks undertaken by CCIS was to commission a team of foreign consultants to carry out a study of the Mexican steel industry. Major elements to be covered were: (i) a review of the demand and supply situation for steel in Mexico over the next one to two decades; (ii) an analysis of comparative costs of the existing steel com- panies; (iii) a judgment on the various plant expansions contemplated in Mexico; and (iv) an analysis of the domestic price structure in relation to that of steel available from abroad. The Bank had emphasized that it needed the answer to such questions before it could commit itself to the project. 14. In suggesting that the Mexican Government develop progressively a strategy for future capacity expansions in the steel sector--an effort which the study commissioned by CCIS was expected to help initiate--, the Bank was particularly concerned with the eventuality that unilateral and unconcerted investment decisions on the part of the steel companies could result in overcapacity by the late 1970's. In a more immediate horizon, the Bank wished to induce the development of an analytical framework, covering both sectoral and macroeconomic issues, to assess the rationality of the project in the context of the long-term needs of the economy and the production and invest- ment programs of existing production units. 15. Because of delays in completing CCIS-s steel industry study, the Bank eventually appraised--and agreed to participate in the financing of-- the project without the benefit of its conclusions. In particular, for lack of detailed cost data on the existing industry, the issue of the general appropriateness of the project was addressed in mostly qualitative terms. Feasible alternatives to the project were clearly identifiable, be it (i) to postpone the expansion of raw steel making facilities and concentrate on the creation of re-rolling capacity on the basis of imported billets or (ii) to 1/ CCIS is formally composed of the Secretaries of Government Properties and Industrial Development, Program and Budget, Treasury and Public Credit, and Commerce. - 6 - expand existing steel producing units instead of creating an entirely new plant. Alternative (i) would have entertained some advantage in terms of employment creation; alternative (ii), in terms of capital and start-up expenditures per ton of additional capacityl!. The Bank, however, agreed that the project, conceived as the first stage of a plant whose total capa- city, after successive expansions, would eventually reach 10 million tpy, constituted an appropriate first step for a vast, though yet to be planned, expansion program covering the following two decades. Despite subsequent difficulties in implementing the project and the postponement of a Stage II Expansion project27 for financial reasons--and therefore that of potential economies of scale--, there are good reasons at this point for endorsing the validity of the Bank's judgment. II. Project implementation and Early Operations A. Project Construction 16. The project aimed at creating a fully integrated steel complex with an initial capacity of about 1.2 million tpy of rau steel corresponding to 1.0 million tpy of finished products. It consisted of the development of iron ore and limestone mines and the construction of an ore crushing and concen- trating plant, a pelletizing plant, a battery of coke ovens, a blast furnace for the production of pig iron, a steel making plant with two basic oxygen (BOF) converters, three continuous billet casting machines and two rolling mills for the production of light, non-flat steel products (rods, reinforcing bars and light sections). Ore transport from the concentrating plant (located close to the mines) to the steel works was to be effected by way of a slurry pipeline--at the time, a new but tested method of ore transportation. 17. The attached PCR provides a detailed review of project implementa- tion (paras. 1.06 to 1.22). The project was completed in three and a half years--about nine months behind schedule. Given the tightness of the original schedule, this was, as the PCR notes, a remarkable achievement which demon- strated the decisiveness of SICARTSA-s management, the positive role played by its technical advisors, as well as the Government's will to back up the project. The project was implemented during the period of high inflation resulting from the oil crisis, and completed after the peso devaluation in the second half of 1976. Moreover, the objective of meeting completion deadlines seems to have taken precedence over cost control considerations. As a result, the project was completed at a total cost of US$963 million, i.e., with a cost 1/ Alternative (ii), however, would have exacerbated the difficulties of supplying iron ore to the Monterrey/Monclova area, which involved long rail hauls. 2/ Which the Bank intended to support with a loan for US$95 million (Loan 1308-ME) approved in July 1976 but cancelled before becoming effective (para. 1.03 of the PCR). - 7 - overrun of 51% over the appraisal estimate. The US$330 million cost overrun was financed in part from additional loans from Nacional Financiera (NAFINSA), one of SICARTSA-s shareholders, and an additional equity share issue sub- scribed by the Federal Government of Mexico (para. 3.01 of the PCR). 18. The erection and commissioning stages accounted for half of the nine months average composite delay in completing the project and 54% of the overall cost overrun. SICARTSA-s original intention had been to carry out the project on the basis of turnkey contracts for each of the twelve separate units constituting the project. Each package was to include all of the infrastructure and civil works, in addition to the equipment and erection works related to one particular unit of production. The Bank questioned this approach and inquired whether foundations, civil works and utilities should not be carried out on a functional basis rather than integrated within each package. Such an approach was expected to allow for a more detailed breakdown of equipment orders and eventually to result in lower capital costs!Y. 19. Mostly at the Bank-s urging, SICARTSA eventually undertook to restructure its procurement arrangements. In doing so, SICARTSA was also influenced by pressures from the Mexican construction industry which did not favor contracts being awarded to foreign suppliers2/. SICARTSA-s expatriate advisors suggested that, insofar as SICARTSA as a company had little experi- ence with Mexican erection sub-contractors, it would be better for it to allow each equipment supplier to choose the construction company it wished to work with. Despite this warning SICARTSA eventually entered into (27 separate) equipment contracts, without making suppliers responsible for the erection and start-up of equipment. However, on the positive side, it refrained from breaking down large units into several packages--an arrangement which has in other cases had poor results--, and passed single contracts for the slurry 1/ Having erection works contracted separately from equipment was the solution adopted by the experienced sponsors of the three large steel projects in Brazil to which the Bank had approved loans in 1972. This clearly was an important factor in the Bank-s preference for this ap- proach to implementation. An additional consideration was that packaging orders along the lines suggested by SICARTSA was thought not to be fully consistent with the parallel financing package which SICARTSA intended to follow. In this regard, the Bank indicated that it was not in a position to finance the erection portion of equipment contracts and that this might make bid evaluation and disbursement overly complicated. 2/ The contracting of civil engineering work was also conditioned by a presidential instruction that none of Mexico-s (two) leading engineering contractors were to be contracted, but rather that the project should help the development of a number of medium-size contractors. Although, in reality, this served as a training exercise and did not work out too badly, it gave rise to a number of otherwise avoidable problems. - 8 - pipe, the pelletizing plant, the coke ovens, the blast furnace, the steel making plant, the continuous casting machine and each one of the two millsl/. 20. SICARTSA became progressively aware that its lack of construction experience severely limited its ability to supervise the erection of the plant. Accordingly, it later proposed that each of its suppliers enter into additional contracts covering the installation of equipment. Work had to be sub-contracted to a Mexican construction company while suppliers were to remain responsible for supervision work in exchange for an agreed fee. A number of suppliers declined to accept this proposal, which led SICARTSA to appoint an overseas company to supervise the erection of the remaining portion of equipment. This procedure permitted SICARTSA to minimize difficulties in the course of erection and allowed for a relatively tinely project implementa- tion, although it obviously placed the company in a more difficult position to negotiate supervision contracts on advantageous terms than if it had kept with its original procurement arrangements. 21. The lesson of these difficulties appears to have been well taken by both SICARTSA and the Bank. All contracts under SICARTSA-s aborted Stage II project were to include the erection and commissioning of equipment. For its part, the Bank now gives more thorough consideration to its borrowers' engineering and supervision capabilities before commenting on and giving its approval to their procurement arrangements. 22. All contracts with Mexican construction companies were entered into on a cost-plus basis. This resulted in a large cost overrun on erection expenditures for lack of effective cost control. A typical example may be found in the case of the blast furnace: whereas the supplier had provided an indicative figure of 1.5 million man-hours as erection manpower requirement, the actual figure turned out to be 4 million man-hours. Such a large differ- ence points to the inefficient control procedures followed in erecting the unit, as also certainly the unrealistically low original estimate to which the supplier was not committed. Higher actual construction costs also reflected the failure of domestic wages to compensate for low labor productivity in relation to international standards on which original cost estimates were based. To that extent, a substantial portion of the US$187 million local cost overrun on civil works and erection can be seen to represent an element of social transfers and the price of developing local construction capabilities. Erection contracts on a cost-plus basis have repeatedly been found to be a major cause of cost overruns in Bank-financed steel projects. In cases where there is a lack of construction experience in the country, such contracts are difficult to avoid entirely. The Bank should endeavor, however, to have construction contracts entered into, inasmuch as possible, on the basis of a schedule of rates to induce greater efficiency. 1/ The electrical equipment for the two rolling mills was not included in the mechanical equipment but, for reasons of standardization, pro- cured from a common supplier. 9- B. Project Operation 23. SICARTSA was initially expected to reach full production in five to six years from start-up, which at the time the Bank considered prudent. In the course of project appraisal, however, the expected learning curve was shortened to three years, as the Bank was forecasting large cash shortages in the first 2-3 years of operation when preparing financial projections for SICARTSA on the basis of the former assump tioni!. SICARTSA's Technical and Operating Advisers indicated that a three-year build-up to full production was indeed feasible but would require a major training effort at all levels of responsibility with special emphasis on departmental and managerial positions to ensure that highly trained plant operators became available rapidly. 24. SICARTSA has experienced major difficulties in building up the production of its plant to capacity, as shown in the following table: Capacity Utilization (%) 1977 1978 1979 1980 Pellets 44 54 57 67 Pig Iron 47 52 58 68 Raw Steel 23 50 55 68 Billets 19 44 50 63 Finished Products Actual 15 44 50 60 Expected 50 80 100 100 In 1980, SICARTSA's fourth year of commercial operation, capacity utiliza- tion--in terms of finished products--had only reached 60%. As the PCR notes, SICARTSA was handicapped mostly by difficulties in coordinating the operation of the BOF converters with that of the billet casting machines, especially in the absence of operating advisors who could have been relied upon to expedite the establishment of a stable operating practice. Continuous casting was a new technology for Mexico and one which has proved difficult to master by inexperienced steel companies in other countries. Three factors have been responsible for SICARTSA's poor production record: (i) its decision to terminate its technical assistance contract shortly after start-up; (ii) its high labor turnover; and (iii) some deficiencies in its organizational structure. 1/ As part of preparing financial projections for SICARTSA, the Bank carried out a sensitivity analysis of the impact of changes in sales buildup assumptions on cash shortages in the first two to three years of opera- tion. - 10 - 25. In 1977, despite its lack of technical experience, SICARTSA took the decision to terminate its contract with its expatriate advisers--a decision which in retrospective proved particularly damageable and upon which the Bank did not comment at the time. It was initially expected that every process department would be assigned one manager, two assistant. managers and from four to six shift foremen from the expatriate group of consultants appointed by SICARTSA. While such an arrangement could have provided for effective on- the-job training, the company in effect quickly decided to rely on its own resources, sending a number of engineers and technicians abroad for training. All of these, however, unfortunately left SICARTSA quickly thereafter. 26. SICARTSA-s production performance has suffered chiefly from an unusually high staff turnover at all levels of responsibility. This in turn has resulted from the difficult living conditions in Lazaro Cardenas, and the company-s uncompetitive pay scale which failed to compensate for themil. Staff turnover was for a number of years in excess of 30% p.a. It reportedly dropped to 11% in 1980. 27. The project being a greenfield one, SICARTSA-s organizational structure was naturally geared primarily to construction--although even then it was never capable of rigorous capital expenditure control and regular project cost analysis and re-estimation as implementation proceeded. After start-up, frequent personnel changes in SICARTSA-s management made it diffi- cult to implement the structural modifications essential to the smooth running of the company as a productive entity. Despite the Bank's early warning about the need for timely measures, necessary changes to transform the structure of the company into one geared to production were only belatedly introduced. 28. SICARTSA also experienced difficulties in establishing its share of the market, as the Government's deflationary measures in 1976-1977 led to a reduction in overall demand, thus hindering SICARTSA's entry into the market. Technical and marketing difficulties resulted in a financial setback for SICARTSA and a natural circular effect ensued: cash shortages further under- mined the company's production performance. Low profitability was one of the factors, though not the main one, in SICARTSA's decision to terminate its technical assistance contract, curtail wages and not to maintain adequate stocks of spare parts--three factors which contributed to depress its level of output further. SICARTSA-s poor production showing had, however, causes of its own; in particular, management capability at the foreman level and main- tenance programs were deficient since the outset of operations, and have only recently started to receive more adequate attention. 1/ To an extent, low wages (in relation to the suoply of labor in Lazaro Cardenas) were meant to compensate for SICARTSA's excessive labor force and very low labor productivity. Total employment now exceeds 7,000 persons, compared to less than 4,000 estimated at appraisal. This corresponds to an average labor productivity of about 100 tons/man-year, compared to 800 tons/man-year in large, modern plants and 250 tons/man- year expected at appraisal. - 11 - C. Financial Performance 29. Since SICARTSA-s beginning of operations in 1977, its financial performance has been extremely poor. By 1979-end, the company had accumulated losses in an amount equivalent to US$200 million despite government subsidies for US$148 million equivalent. In comparison, projections made at appraisal showed losses for the first 18 months of operation with the company turning an overall profit during its third operational year. 30. The PCR lists the factors which contributed to SICARTSA's poor financial performance (para. 5.19). These include: (i), on the expense side, shortfall in production, low labor productivity and higher financial charges; and (ii), on the revenue side, the Government-s control over steel prices. Each of these factors is relevant in explaining SICARTSA's lack of profitability in the past. However, to make a viable case for the project--a small plant as modern steel mills based on blast furnace technology go--, some optimistic assumptions had to be made at appraisal. Besides expecting that full production would be reached within 2-1/2 yearsl, the appraisal was based on operating cost projections suggesting a break-even point below 60% - an unrealistically low level2/. 31. The appraisal report mentioned that operating cost projections were low by world standards but asserted that they were realistic in view of the savings to be obtained by basing the project on local iron ore. The project permitted low cost production of iron ore pellets. At a unit cost of US$20/ton equivalent, these are about US$10-15 below comparable costs of European or Japanese producers--a substantial margin, offset however by the lack of economies of scale at the pig iron stage compared to the more modern steel plants in other countries. Hence, overall, more conservative assumptions would have been appropriate, and therefore (as suggested below) a less leveraged capital structure. 32. By 1978-end, as a result of operating losses, SICARTSA-s debt-equity ratio was as high as 68:32, in excess of the 60:40 ceiling covenanted under its loan agreement with the Bank23. SICARTSA-s liquidity position was also 1/ This was based on the assumption that operating advisers would parti- cipate actively in the start-up and initial operations of the plant. 2/ The Bank staff views the low break-even point calculated at appraisal as illustrating the many advantages associated with the site and the exis- tence of a domestic market for the full output of the plant. 3/ The US$330 million cost overrun on the project had been financed by part from additional loans from NAFINSA and increases in the Government's equity share, in such a proportion as to maintain SICARTSA-s debt:equity ratio within its 60:40 contractual ceiling. - 12 - poor, as reflected in its 0.70 current ratio, less than half the contractual minimum of 1.5. This prompted the Government to take two important measures to help place SICARTSA on a sounder financial footing: the Government agreed (i) to take over the debts to NAFINSA that SICARTSA. had entered to cover the project cost overrun; and (ii) to increase steel prices in real terms (paras. 5.20 to 5.22 of the PCR). As of 1979-end, the debt equity ratio was down to 43:57 and the current ratio up to 1.19. Moreover, steel prices are now more or less in line with international prices. Unaudited accounts for 1980 show a profit of M$245 million (US$10.7 million equivalent) and suggest a debt/equity ratio of 36:64 as of end-December 1980. III. Sectoral and Regional Planning a 33. With total investment nearing US$1 billion, the project was Mexico-s single largest development project of the seventies. As such, it was a venture of critical importance for the steel sector, the Lazaro Cardenas area where it was implemented and, indeed, for the Mexican economy as a whole. To what extent the project was coordinated to appropriate sectoral and regional planning exercises is a relevant question to ask for two separate reasons: first, to assess the impact which such planning effort (or the lack thereof) may have had on the conception and implementation of the project; conversely, to evaluate the contribution of the project to the strengthening of Mexico-s administrative apparatus, as the country engages in increasingly ambitious development programs. A. Sectoral Planning 34. It was mentioned earlier that institutional aspects of the steel industry-s growth and its relationship to the project had been central to the Bank-s discussions with SICARTSA and the Government during the appraisal. In particular, the Bank considered it important that, in connection with the project, steel industry planning be initiated to rationalize future develop- ment policy and investment decisions related to the sector. In line with this general objective, CCIS was created in 1972 and a study of the steel sector commissioned shortly thereafter (paras. 14 to 17 above). The objective of the study was two-fold: first, to minimize the ovErlapping of development projects in the sector by encouraging the exchange of information regarding operational and investment matters between the various steel companies with CCIS acting as advisory body; second, in the longer run, the study was meant to be a first step towards the development of a national steel plan by CCIS. 35. The study did not bring the expected results and failed to provide the analytical basis on which a strategy for the future growth of the sector could be based. The Government never demonstrated any enthusiasm for CCIS and the work of the consultants hired by CCIS at the prompting of the Bank was hindered by lack of information. Apart from the project under review, little investment in the steel sector took place after 1973, so the overlapping of - 13 - projects has not been an issue. For one thing, low demand in the intervening years, coupled with price controlsl/Y , have deterred private investment. Moreover, operational coordination of the three government-controlled steel companies has been firmly enhanced through the creation in 1978 of a holding company, SIDERMEX, under which the Government regrouped its interests in the steel sector with the objective of rationalizing the operations and develop- ment of the three parastatal steel companies ( ara. 3.02 of the PCR). Among the functions now centralized under SIDERMEX3/, a common sales department caters to the marketing needs of AHMSA, SICARTSA and FUNDIDORA. 36. CCIS has not developed into the strong advisory body it was expected to become. Its role in the decision making process of the steel sector has also remained minimal. Headed by an able administrator but suffering from severe understaffing as a result of its limited budget, CCIS has remained a weak institution engaged, as a matter of procedure, in the review of expan- sion projects formulated by the steel companies--usually after projects have been approved by their respective Board of Directors4/. Partly for lack of technical staff, CCIS has not been carrying out the type of analysis necessary to be in a position to formulate the coordinated steel policy, encompassing both project-specific factors (location, scope, process) and socio-economic factors, which could now help in optimizing--from the country's, rather than individual companies point of view--future investments in the steel sector within the larger framework of economic development in Mexico. 1/ Slow-down in the growth of demand between 1976 and 1978 did result in a temporary overcapacity in the non-flat steel sub-sector where SICARTSA is engaged; this, however, was impossible to forecast at appraisal and does not call in question the project. 2/ During the period when a "trigger price" mechanism was enforced by the US Government, controlled steel prices in Mexico were consistently set below comparable trigger prices. While this was meant to help control domestic inflation, this was also in line with the Bank-s objective that the project result in a significant lowering of steel prices in real terms to encourage export of manufactured goods. 3/ Sales, Finance and Control, Legal, Purchasing, Planning and Technical Departments are common to AHMSA, SICARTSA, and FUNDIDORA, and placed directly under SIDERMEX. Production and labor relations are areas handled directly by each plant. 4/ The Director General of CCIS also serves as Director General of Para- statal Basic Industry within the Secretariat of Government Properties and Industrial Development. To an extent, the staff of the Directorate of Parastatal Basic Industry is meant to provide CCIS with technical support. Moreover, in his capacity as Director of Basic Industry, the Director General of CCIS participates in the board meetings of SIDERMEX, AHMSA, FUNDIDORA and SICARTSA. - 14 - 37. The development of economic planning has thus lagged behind sector growth in output terms. Today, as the Government contemplates large addi- tional investments in the steel industry over the coming decade to meet the growth of domestic demand and achieve self-sufficiency, it lacks the analyt- ical framework, encompassing both macro-economic and sector issues, necessary to analyze the various options at hand and devise an optimal growth strategy. To meet the growing demand for steel products, a steel sector plan has been prepared, which covers the future growth of the sector. This plan is based on market studies aimed at measuring the evolving supply-demand gap for various steel products and is coordinated with the Industrial Development Plan and the Global Development Planl. However, no overall steel sector review, cover- ing such issues as the choice of technology, plant location, input and output pricing policies and trade policies, has yet been prepared in Mexico. Since 1979, CCIS has been reinforced by the appointment of specialized technical staff; it is now involved in the preparation of a Steel Program for the period 1981-90.2/ B. Regional Planning 38. The decision to set up a new steelworks in Lazaro Cardenas reflected techno-economic considerations--the proximity of iron ore deposits and the advantages of a coastal site--as well as the intention to promote the economic development of the area, with the project acting as ignitor of the engine of growth. The vast amount of indirect investment necessitated by the project, in the form of infrastructurel/ and social equipment, suggests that both rationales were indeed called for to make the project a worthwhile enterprise. No attempt was made, however, to integrate the prcject within a regional development program. Infrastructure needs were analyzed without the benefit of a long-term strategy for the area. As discussed earlier (paras. 8 to 13), this led to some ambiguity in the way the project's infrastructural require- ments (in particular the need for a railway link) were analyzed. Because these requirements were essential to the operation of the plant, appropriate investment decisions were eventually taken and implemented. In sharp con- trast, social investments, possibly because these were not seen at the time as having a direct bearing on the project, suffered from the lack of a coordi- nated approach to regional development. 39. Population Growth and Urbanization. The conStruction of the project in a hitherto lightly populated area necessitated the concomitant development of existing urban centers to provide housing and other social services for the employees of SICARTSA and any ancillary industries which were to grow around it. It was generally expected at appraisal that urbanization would take place 1/ See on this subject the comments from the Government and SIDERMEX (Attachment 1, para. 6; and Attachment 2, page 2). 2/ See the attached comments from CCIS (Attachment 3). 3/ Including a large and under-utilized repair workshop for lack of alterna- tive local facilities. - 15 - spontaneously. The general feeling was indeed that shelter construction and other urban services required to ensure a balanced growth of the city would either be generated without intervention, or could be taken care of by a traditional housing program. 40. To carry out such a housing program, a Trust Fund, Fideicomiso Ciudad Lazaro Cardenas (FIDELAC), was created by the Government at the end of 1972. FIDELAC was made responsible for the planning and construction of housing facilities on a 696 ha lot allocated for that purpose. Infrastruc- ture requirements remained the responsibility of the respective functional agencies, one of FIDELAC's functions being to ensure that each public agency (e.g. water, sewerage, power) appropriated sufficient funds to cover its contribution to urban development. During negotiations, the Bank obtained assurances from the Government that adequate support would be given to the city-s construction program (Section 3.04 of the Guarantee Agreement). 41. Local population growth as a result of the project has been spectac- ular, averaging 15% p.a. between 1970 and 1978. The constructicn of the plant caused the arrival of flocks of migrants: first, during erection which necessitated as many as 7,000 workers on site; and again later, when SICARTSA began to build up its operational staff. Migration eventually exceeded by a large margin (and was in fact almost twice) that directly resulting from SICARTSA's job offerings1/. Total employment in the area was recently estimated at about 14,000, of which direct employment by SICARTSA accounted for about 45%. Substantial contribution to employment came from services and the construction industry1. By 1978, the population of Lazaro Cardenas had reached 67,000, an increase of about 45,000 persons over the 1970 level - more than seven times SICARTSA-s work forcel. 1/ On the basis of a dependency ratio of 3.7 persons (the Mexican national average), more than 12,000 families moved to Lazaro Cardenas between 1970 and 1978, compared to SICARTSA's total work force of 6,200 in the latter year. 2/ Contrary to expectations, forward linkages afforded by the project have so far been very weak, as transport cost differentials tend to favor the production of metal products close to market outlets rather than at the proximity of steel mills. Moreover, SICARTSA-s main product line was for reinforcing bars used in the construction industry and had therefore little role in the development of forward linkages. 3/ Population projections made at appraisal were based on an estimated ratio of population increase to direct employment creation close to the actual figure. They assumed for SICARTSA, however, a labor force two thirds the actual figure and thus underestimated population growth by a comparable margin. Reportedly, SICARTSA-s excessive manpower was built up as a result of high absenteeism, itself a mark of general dissatisfaction with living conditions and lack of proper transport to distant settlement areas. This suggests that a vicious circle ensued from the delayed execution of social infrastructure. - 16 - 42. The implementation of FIDELAC-s housing program did not proceed as expected. Budget constraints, poor management, and the resulting lack of coordination among the agencies involved led to important delays in execution. By June 1975, FIDELAC had completed 20% only of the development work assigned to it, as against 80% anticipated in the original plan. Budget constraints and lack of coordination between the Ministry of Public Works and other functional agencies (sewerage, water supply, electrification, health and education) hindered also the development of urban services outside FIDELAC-s project area. For lack of a centralized local authority, decisions relevant to the development of the city were taken by each agency on the basis of its own particular constraints rather than with an eye on the development of the area as a whole. Lack of functional coordination also reflected the absence of spatial planning at the national level, each ministry or agency producing its own assumptions regarding regional development to determine the geograph- ical distribution of its operations. 43. Besides being substantially delayed, FIDELAC's housing program also suffered from its failure to adapt to the means of most in-coming workers. Housing programs in Mexico have traditionally been characterized by a lack of correspondence between the cost of housing provided and the paying capacity of the intended beneficiaries. As a result, they have been catering mostly to the needs of middle-income households. FIDELAC's program was no exception. In preparing the project, little attention was given to the fact that a majority of immigrants in search of employment would belong to the low-income brackets. The spontaneous creation of large squatter settlements in areas lacking any kind of facilities ensued. 44. The project suffered considerably from the inadequacy of housing conditions in Lazaro Cardenas and the general disorganization of the urban environment. The expanding of slum areas and lack of housing caused wide- spread dissatisfaction among SICARTSA's employees, and were eventually respon- sible for the high staff turnover the company has experienced since the beginning of its operations. Only when the non-acceptability of the social situation and its adverse impact on project performance and SICARTSA-s oper- ating staff build-up became apparent, were pressures exercised to expedite the completion of FIDELAC-s initial housing program. To mitigate the situation, SICARTSA also undertook a housing program of its own to meet the requirements of its technical and administrative cadres; notwithstanding this effort, the absence of schooling and health facilities in the city remained a major source of concern and a primary cause of turnover. 45. To help alleviate the shortcomings of the original development program for Lazaro Cardenas, the Bank financed, in April 1978, an urban project, the Lazaro Cardenas Conurbation Development Project (supported by loan 1554-ME), with FIDELAC as implementing agency. The project was designed to improve the living conditions of low-income groups through the provision of shelter and urban services. It included, as an important element, the upgrad- ing of illegally occupied communal land, which needed first to be expropriated before being offered for sale in the form of serviced plots. Construction material loans were also made available to encourage self-help (and mutual- aid) housing construction. As of mid-1980, less than one third of SICARTSA's - 17 - workforce lived in houses built by FIDELAC, or with its credit assistance. The housing situation is thus far from being resolved and, among other evils, it will severely affect SICARTSA-s staffing position in the years to come. 46. Recent Institutional Developments. Partly as a result of the on-going dialogue with the Bank on economic matters, the Government took, in recent years, a number of innovative measures intended to supplement the country's administrative apparatus. These reflected (i) the Government's concern over the excessive concentration of wealth and population in the Mexico City area, and its consequent objective to encourage and monitor a wider geographical pattern of population (and urban) growth; and (ii) the Government s increased awareness that appropriate planning and executive capabilities needed to be created to conceive and implement a cogent region- alization strategy and coordinate investment among sectors. 47. Foremost among the measures taken by the Government to promote a more orderly urban growth across the country were (i) the adoption, in June 1976, of the Law of Human Settlements, which provided the Government with the legal authority for planning and implementing programs to achieve spatial goals; and shortly thereafter (ii) the broadening of the responsibilities of the Ministry of Public Works to include human settlements and the preparation of a National Urban Development Plan (completed in December 1977) translating the Government's objectives into operational goals. The project under review predated both sets of measures. 48. Mexico-s current administration has also endeavored to promote the development of the country-s planning apparatus, a "global" development plan having been issued in April 1980. A major element in the Government-s efforts to promote planning, coordination and monitoring of resource spending was the creation of a Secretary of Programming and Budgeting (Secretaria de Programacion y Presupuesto) featuring a General Directorate of Regional Planning. Moreover, intersectoral coordination within the framework of particular development projects has been enhanced recently by the creation of the Officina Coordinadora de Proyectos de Desarollo, reporting directly to the President. This office is now involved in the preparation of a number of development projects. One of them, "Industrial Ports," which the Bank is supporting through a project preparation loan, covers future development in the Lazaro Cardenas area. Mexico's current administration has also taken steps to promote a greater decentralization of decision-making and enhance the federal nature of the country-s political system. Efforts are made to build up planning capability at the state level; these efforts materialized recently in the preparation of a development plan by each state. IV. Conclusions 49. Aware that the Government's policy of decentralization had contrib- uted to the decision to build the plant, the Bank promoted, with a large measure of success, a technocratic approach to project preparation. This resulted in a somewhat long lead-time in preparing the project--though by no means a too long one given the complexity of the project--as the Bank - 18 - endeavored to address thoroughly a number of important issues. In partic- ular, the Bank was instrumental in ensuring that the Government took steps to meet the plant-s infrastructure needs, and in convincing SICARTSA to appoint a team of technical advisors for assistance in designing and imple- menting the project. 50. The origin of the prolonged and severe teething problems experienced in building up plant production following its timely start-up can be traced back to the company-s underestimation of difficulties in operating the new facilities. SICARTSA-s decision to terminate its technical assistance con- tract shortly after start-up proved very damageable; other factors--organi- zation problems and staff turnover--compounded its effect. The Bank had identified at appraisal the need for continued technical assistance at the operational stage, and a covenant under the loan agreement specifically provided for assistance during start-up and initial operations of the project. However, when SICARTSA took the decision to terminate its contract with its consultants, the Bank failed formally to insist with SICARTSA and the Govern- ment that the operating advisors be retained during the initial operations phase, although there is no certainty that, had the Bank adopted a stronger stand on this issue, it would have been able to enforce its loan agreement with the company. 51. As regards the development of social facilities, the guarantee agreement between the Government and the Bank provided that the Government would "give full support to the construction program in the city." However, the program initiated at the time of appraisal included mostly FIDELAC-s construction program which was clearly insufficient to meet the additional requirements created by the project. The Bank-s review of the Government's social investment program did not identify these lacunae; later, when the Government-s monetary policies curtailed the availability of public funds, the guarantee agreement provided no safeguard against the Government's inability of planning, coordinating and implementing the necessary social infrastructure. 52. Although the principal impact of the project in fostering the development of a "growth pole" in the region has been so far reflected in the demand of SICARTSA-s employees for consumer goods and services, this impact has been large. The increase in population and construction activities has put a severe strain on social infrastructure. This was expected and should have made it urgent to develop a general plan for providing additional facilities in a timely manner to allow the company to attract and retain a qualified operating labor force. Social infrastructure requirements needed to be carefully identified and coordinated with national policies, necessitating specific Government decisions to ensure timely implementation. Since the project involved the construction of a green-field plant, such developments were project-related, and it would have been appropriate for the Bank to focus on them more sharply in its appraisal, expanding its appraisal team and calling on specific expertise as needed. The lead-time in project preparation caused by the discussion of other issues provided ample time to initiate such discussions which did not need delay implementation of the project. - 19 - 53. Continuous support from the Government was an essential factor in the successful erection of the plant. The Bank took note of the project-s strong political backing but did not fully appreciate the nature and strength of the political decision to construct a steelworks in Lazaro Cardenas and, therefore, the need to place this decision within a cogent regional develop- ment approach. For lack of spatial planning at the time of appraisal, the impact of large-scale investments on migration and the resultant geographical distribution of equipment needs were dealt with on an ad-hoc basis, with no institutional framework available for the planning of fast-growth areas. The project would have gained from being evaluated in the context of a wider and integrated analysis of local development, providing a clear formulation of the inter-relationships of infrastructure requirements with the project as well as other future productive investments in the area. 54. The Bank was apparently not convinced of the realism of the Govern- ment's hope for large-scale regional development derived from the project. There is some justification to the argument that the project by itself lacked the critical mass to spark such development. However, since the project rationale hinged in part on such long-term objectives, some assessment of the viability of regional development in the area would appear to have been indicated. A wider multi-sectoral framework of analysis, if it had been adopted both by the Bank and the Government, might have resulted in the creation of a regional development body (similar in some respect to the Corporation Venezolana de Guayana [CVG] in Venezuela1!) to help coordinate the programs of the respective functional agencies, acting as a focal point for data gathering, program conception and overall monitoring in the light of specific targets set up at appraisal2/. The Bank did try to use the critical size of the project to promote institution building by encouraging the Government to create CCIS but its efforts were relatively unsuccessful. The Bank now follows closely recent institutional developments and underlines their importance as part of its economic dialogue with the Government. 1/ CVG also acts as the Government-s shareholder of local industries (in- cluding steel-producing SIDOR), a role fulfilled on a sectoral basis by SIDERMEX in the case of SICARTSA. 2/ Clearly, the creation of a regional development body would not have been sufficient to ensure interministerial coordination--and indeed CVG also failed to provide the infrastructure in a timely manner for SIDOR-s needs--; it could, however, have helped in bringing about such coordina- tion. - 20 - - 21 - ATTACHMENT 1 COMMENTS RECEIVED FROM THE GOVERNMENT DIRECCION GENERAL DE CREDITO PUBLICO DIRECTnN DE FINANCIAMIENTO EXTERNO Subdir ic- de OrgarA ;tms Fl 2 -cieros InternaL:.o:iaes Of. No. J05. II. 4. 1122 RE: Comments to the Proiect Performance Audit-PPAR- on Las Truchas Steel Project (Loan 934-ME) SECRETARIA DE HACIENDA Y CREDITO PUBLICO M4xico, D. F., March 19, 1981. MR. SHIV S. KAPUR Director Operations Evaluation Department The World Bank In referenceto your letter dated January 23, 1981 addressed to Lic. Jorge Leipen Garay, Diiector-General-SIDERMEX - regarding the first draft of the project performance audit report on the - MEXICO- Las Truchas Steel Project (Loan 934-ME of 1973) we would like to - let you know that in general, the PPAR is of excellent quality and reflects objectively and in a realistic wa-7 the main lessons learned by both the - Mexican Government and the Bank during the implementation of such important Project. We are grateful to the Bank and its - staff, specially Mr. Jean Paul Pinnard, for their help and ;nderstanding on the main issues yet to be resolved at the Las Truchas Steel Project. We - are positive that the conclusiones drawn in the PPAR wil be taken into - account for better planning schemes on the expansion of the Project. The draft was analyzed by different - - agencies and their comments will be sent to you directly. On our side, we found that the report should have analyzed more deeply the thechnical - - problems observed during the implementation and start up periods of the - Project. The focus is more on the socioeconomic and regional planning - - aspects of the Project (indeed, the housing problem amounts to 15 percent - of the PPAR pages), therefore, we think the reports need more balance. Some specific comments are pointed out as follows: 1. The last line of paragraph 3 should read "...steel plant, other indus - tries that have followed are a large diameter pipe line and a casting - and forge plant. A grain terminal by CONASUPO, and a container termi - nal are almost finished. Other industries are in their final negotia - tions for site allocation on the Lazaro Cardenas Industrial Port". 2. In regard to the capacity utilization (%), table in paragraph 24 should be as follows: ...2 - 22 - GAI SoOf. No. 305. II. 4. 1122 ;ECRETARIA DE HACIENDA Y CREDITO PUBLICO CAPACITY UTILIZATION (%) 1977 1978 1979 December 1980 Pellets 44 54 57 67 Pig Iron 47 52 58 68 Raw Steel 23 50 55 68 Billets 19 44 50 63 Finished Products Actual 15 44 50 60 Expected 50 88 100 100 3. The third line of para. 29 should read "... Low profitability was one, but not the main factor in SICARTSA'S . 4. In para. 32 the last sentence should mention that by the end of 1980, SICARTSA obtained profits for $ 245 million pesos. 5. Refering to para. 35 " Siderurgica Mexicana " should be deleted from - the ninth line. In addition, the last sentence should read "... Sales, Finance and Control, Legal, Purchasing, Planning and Technical depart- ments are common to AHMSA, SICARTSA and FUNDIDORA, and are handled by SIDERMEX. Production and Labor relations are areas handled directly - by each plant". 6. With respect to secction III on Sectoral Planning we consider that - para. 37 does not reflect the current status of economic planning in - the steel sector, given that as of today, we have a clear picture of - the expected growth of this sector through the several integrated - plans like the Steel Sector Plan,the Industrial Development Plan and the Global Development Plan. Therefore, we would like this paragraph to be deleted or to be rephrased in such a way as to accurately - - reflect the present situation. ..3 - 23 - .6l0OS Of. No. 305. II. 4. 1122 SECRETARIA DE HACIENDA Y CREDITO PUBLICO 7. On page -21- of the draft, the issues related to Population Growth and Urbanization should be reordered and summarized. For example, para. - 40 mentions the FIDELAC housing program, para. 41 presents the popula- tion growth and para. 42 retakes the FIDELAC program. 8. Para. 48 "Industrial Harbours" should read "... Industrial Ports" and it would be convenient to mention that the World Bank is supporting - this Program through a Project Preparation Loan for Industrial Ports - Development. 9 Regarding Section IV "Conclusiones", para. 49 should end with "..Never theless, because of World Bank special requests, like the ore deposits study in the area, and its insistence on addressing thoroughly a - - number of issues, the SICARTSA works started with a relatively long - lead time". 10. Finally, we consider that the two last conlusiones on paras. 53 and - 54 contain common elements and the main emphasis is on regional - - development approach and the Bank's role in using the critical size of the project to press for the organization of planning bodies. We - - recommend that para. 54 be deleted and that para. 53 be organized to - include the first sentence of para. 54. We certainly would appreciate it if our views and comments are reflected in the performance audit report to be distributed to the Executive Directors. Sincerely, Lic. Jos6 Angel Gurria Trevino Director of External Financing JLGG*mgvs - 24 - - 25 - ATTACHMENT 2 COMMENTS RECEIVED FROM THE BORROWER SIDERURGICA LAZARO CARDENAS-LAS TRUCHAS,S.R. AVENIDA YUCATAN No. 15 CO. LAZARC CAROENAS, MICH. MEXICO 7,O.F. TEL.533-1640 TELS: 3-2823 Y 3-2876 APARTADO POSTAL. 7-844 APARTADO POSTAL No. 46 SICARTSR TELEX: 017 73147 017 74307 TELEXi 017-74242 SILCAME March 12, 1981 MR. So KAPUR DIRECTOR OPERATIONS EVALUATION DEPARTMENT THE WORLD BANK COMMENTS BY SICARTSA TO THE PROJECT PERFORMANCE AUDIT REPORT (LOAN 934 ME) Page 2 - End 3 Industries that have followed are a large dia- meter pipe plant, casting & forge plant & a large fertilizer complex (Fertimex),grain terminal by Conasupo & other. Page 14 - #24 Annex is correct table. Page 15 - #27 Labour turnover in 1980 it was 10.8%. Page 16 - #28 There were other reasons than profitability to terminate the technical assistance contract. Page 18 - #32 Equity debt ratio by end of 1980 was 0.78%o Net profits for the year of 1980 were 245 million pesos in unaudit- ed balance sheet annexed. Page 19 - #35 All sectors of Ahmsa, Fundidora & Sicartsa such as Sales, Finance & Control, Legal, Purchasing, Planning, Tech- nical, etc., are common to the three companies, and thus handl- ed by Sidermex. Production & Labour relations are areas that are handled directly by each steel plant. - 26 - SIDCRURGICA LAZRO CARD6NAS-LAS TRUCHAS,S.A. AVENICA YUCATAN No 15 CO LAZARD CAROENAS, MICH. MEXICO7.DF TEL.533-1640 TELS 3-2823 Y 3-2876 APAPTADO POSTAL 7-844 A-ARTADO POSTAL No 46 SicARTSA TELEX 017 73147 017 74307 TELEX 017-74242 SILCAME 2. Page 20 - # 37 The steel sector plan, Industrial plan & Global plans have been produced. Those attempt to coordinate steel & other sectors. Attachment. 3.02.- Sidermex is the correct name not Siderurgica Mexicana. 3.07.- Anex is a description of organization & operations of Sidermex companies. 3.08.- Ing. Gabril Magall6n was appointed Director of Produc- tion on September 1979. He replaced Ing. Francisco Zabroki who was also Director of Production before, and who is present- ly Director of Production at Fundidora Monterrey. 3.09.- Sidermex. A description of Sidermex group of companies describes present & planned organization. Avios de Acero & - Internacional de Acero are the distributors of all sales three steel mills, 5.02.- Correct table annex. 5.08.- Correct table annex. LIC. ARTUR CIA-TO H. Direct e Finanzas y ontrol c.c.p. Lico Jorge Leipen Garay.- Director General, c.c.p. Lic. Jose Luis Flores- Director de Organismos Interna- cionales S.H.C.P. c.cop. C.P. Armando Herrera.- Sub-Director de Finanzas-SICARTSA. - 27 - ATTACHMENT 3 COMMENTS RECEIVED FROM THE IRON AND STEEL COORDINATING COMMISSION (CCIS) Translation of incoming telex of April 9, 1981 to Mr. Shiv S. Kapur, Director, Operations Evaluation Department, the World Bank, from Alfredo Acle T., Director General of CCIS and Director General of Parastatal Basic Industry, Mexico City. With reference to your letter of January 23, 1981, I take the liberty of offering the following comments, which I feel can usefully be divided into two sections, namely those pertaining to SICARTSA and those dealing directly with the Comisi6n Coordinadora de la Industria Sider5rgica (Steel Industry Coordinating Commission). We agree with your observations as regards the evaluation proper of the so-called first phase of SICARTSA. However, we feel that more details ought perhaps to be given of the negative impact on production of problems in maintenance and repaii, which situation the Management of SICARTSA has already taken steps to remedy. It is important to draw attention to the infrastructure problems, as these not only presented obstacles to implementation of the project, but also since financially some works of this nature were incorporated into the industrial projects, thus distorting to some extent the investment amounts. Furthermore, since the problems of the Lgzaro Cgrdenas area were exceeding the capacity of the enterprise to solve them (covering as they did a very diverse range of issues), an inter-secretarial commission was set up in 1977 to coordinate the participation of the entities involved in the problems of the area. This experience will be invaluable for development of the Industrial Ports program. - 28 - With regard to the Comisi6n Coordinadora de la Industria Sider6rgica (CCIS--Steel Industry Coordinating Commission), allow me to make the following remarks: 1. I regret that I did not have the opportunity to talk directly to Bank staff regarding the current situation of CCIS. Thus before entering into details I feel it would be useful to explain briefly how CCIS fits into the structure of the Federal Public Administration, as reorganized starting in 1977. CCIS is formally composed of the Secretaries o:' Government Properties and Industrial Development; Program and Budget; Treasury and Public Credit; and Commerce, represented by the Director General of Nacional Financiera, S.A. The Commission is provided with technical support through a Director General, who at the same time serves as Director General de la Industria Bgsica Paraestatal (Director General of Parastatal Basic Industry), through which the Secretariat of Government Properties and Industrial Development coordinates, inter alia, the enterprises making up the para- statal steel sector. Thus the technical staff of CCIS corresponds to the staff of the Directorate, and in particular to the Subdirectorate respon- sible for the steel sector. The Director of CCIS participates in his capacity as Director of Basic Industry on the boards of SIDERMEX, AHMSA, Fundidora and SICARTSA, and also on the Management Board of the Instituto Mexicano de Investigaciones Sider5rgicas (IMIS--Mexican Steel Research Institute). 2. It is important to note that the establishment of SIDERMEX reflected a desire to rationalize the operations, marketing and development of the - 29 - three parastatal steel companies. The basic difference between SIDERMEX and CCIS is that while SIDERMEX is responsible for operating and managing the companies in the group, CCIS's main function is to advise the Federal Government in drawing up plans for the steel sector, both public and pri- vate. I thus do not believe that there is any overlapping of functions, nor that SIDERMEX has absorbed functions previously assigned to CCIS. 3. In point of fact, as the report indicates, the Coordinating Commis- sion is far from achieving all the purposes for which it was set up. Despite this, the Mexican Public Administration remains fully aware of the need to have a body to draw up plans for the national steel industry and to measure and evaluate investment decisions by the public and private sectors. 4. It is important to note that, starting in 1976, a series of events occurred both in the Mexican economy and in the steel industry in particular that in some measure held back the growth of certain of the Commission's tasks. In particular, preparation of the Steel Program, the methodology for which had been laid down at the end of 1976, had to be suspended since the Mexican economy was in a state of crisis and planning was impossible in the absence of clearly defined parameters. Subsequently, in 1977, while the rapid economic recovery introduced optimistic and encouraging elements, it necessitated the drawing up of a long-term national industrial develop- ment plan from which a national energy plan would be derived. The first of these plans was published in February 1977 and the second in September 1980. On the basis of these two fundamental documents for sectoral planning, - 30 - CCIS is currently working on what has been termed the Steel Program for the period 1981-90. 5. Since August 1979 we have reinforced the technical side of the Commission by engaging specialized staff, and two advisers have been recruited, one with recognized expertise in the steel sector and the other with experience in project appraisal. 6. We have restructured our statistical bulletin and are currently adapting our informational resources to allow computer processing. 7. With regard to research, CCIS has played an active role in the medium- and long-term development of the Instituto Mexicano de Investigaciones Sider6rgicas to enable it to perform properly its func- tions for the benefit of each and every one of the steel companies, public or private, large or small. 8. In the transportation sector, CCIS is participating with the Secretariat of Communications and Transportation in examining problems in that area affecting the steel sector, which have become critical in the course of the past two years. 9. With regard to human resources, and as part of the aforementioned Steel Program, the Coordinating Commission has charged IMIS to conduct a manpower survey for the steel sector for the ten-year period 1980-90. This study is due to be completed toward the last quarter of this year. 10. Finally, at the last OECD Symposium on Steel, Mexico was officially represented by the Coordinating Commission. As you will have observed, CCIS is still far from accomplishing all the purposes for which it was set up, but it is working on sectoral - 31 - planning, in full awareness of the fact that the expected growth in demand for steel over the coming decade will require a clear reference framework on which to base investment decisions involving appreciable human and financial resources. Yours, etc. Alfredo Acle T. - 32 - - 33 - ATTACHMENT 4 PROJECT COMTLETION REPORT I. PROJECT DESCRIPTION AND IMPLEMENTATION A. Project Background and Description 1.01 In 1948, a Mexican Government commission began to study the pos- sible construction of an integrated steel works at the border of two of the poorest states in the country (Michoacan and Guerrero) that would exploit the iron ore deposits of Las Truchas, adjacent to the Balsas river delta on the Pacific coast. SICARTSA was created in 1969 and charged with formulating a specific plan for a modern steel plant. Overseas consultants were hired and a detailed feasibility study for a non-flat products plant with a raw steel capacity of 1.2 million tpy was formulated in 1971. The plan envisaged ultimate expansion of production capacity to 10 million tpy through four stages, of which the first stage project was proposed to the Bank for assistance 1/. 1.02 Steel consumption in Mexico was projected to expand from 3.1 to 6.7 million tons of finished products between 1972 and 1980. For non-flat pro- ducts, then in great demand to support Mexico's housing and public works program, consumption over the same period was projected to expand from 1.2 to 2.8 million tons, i.e. by 1.6 million tons of which the Las Truchas project was to meet 1 million tons. Before deciding to proceed with the project and utilize the conventional blast furnace technology, two alternatives were studied to meet the expected demand growth: (i) through imports and (ii) the addition to electric smelting facilities. But both were found less suitable; the former because of the then expected unpredictability of supplies and prices of steel products in the world market, and the latter because of high energy cost (Mexico, it will be recalled, had not yet discovered the extent of its vast oil and gas resources). After considerable analysis, it was also concluded that Lazaro Cardenas was the optimal location for this new plant. It is within 20km of iron ore reserves, near an outstanding deep water port (to import coal), relatively close to the major consumption center of the country's capital and, last but not least, the location was also consistent with the government policy to create a development pole away from the congested Mexico City area. 1.03 A second stage (Stage II) of the project, designed to increase annual raw steel capacity by a further 2.1 million tons for conversion into 1.7 million tons of flat products was appraised and approved by the Bank for implementation in 1976; however, its execution has been temporarily stopped due to local currency constraints which arose in part from the need to meet the credit ceiling requirements of the IMF, and, consequently, the Bank loan was cancelled at the request of the Mexican Government. 1.04 The main elements of the Stage I project are: (i) Mining and benefication of iron ore bodies in the Las Truchas region, with transport of concentrate by slurry pipeline to the steel works; 1/ Several Bank technical missions visited Mexico to review project preparation prior to field appraisal missions in November 1972 and April and June 1973. A loan of US$70 million for the Stage I project was approved by the Executive Directors of the Bank in September 1973; the loan became effective in October 1973 and the project was physically completed in November 1976. - 34 - (ii) Agglomeration of the iron ore fines to form self- fluxing pellets; (iii) Conventional coke-making based mainly on imported coals; (iv) Blast furnace iron-making with one blast furiaace; (v) Basic oxygen (B.0.F.) steel-making with two vessels and provision for a third; (vi) Continuous casting of billets with three 6-strand machines; (vii) One wire rod and bar mill of 500,000-tpy and one bar and light section mill of 500,000 tpy capacity. 1.05 A description of the principal production facilities is given in Annex 1. B. Project Construction and Completion 1.06 At the time of appraisal, project completion was envisaged for March 1976 with a rather rapid production build-up to bring the plant to full capacity output in 1979. Even at the time of appraisal it was recognized that this was a tight schedule. The plant was officially inaugurated on November 4, 1976 with most of the major production facilities on stream. The actual implementation schedule compared with the appraisal is given in Annex 2. The average composite delay was less than 9 months, of which detailed engineering accounted for 0.6 months, procurement for 0.9 months, fabrication of equipment for 2.4 months and construction and start-up for 4.8 months. Taking into account that the project started to be implemented just before the 1973/74 oil crisis, this was a remarkable achievement. The major reasons for the delays in the principal project areas are given in the table below. Las Truchas Steel Project Reasons for Delays in Principal Project Areas (in months) Total Detailed Construction Facility or Item Delay Engineering Procurement Fabrication & Start-uD Ore Mining 13 1 1 3 8 Pellet Plant 12 - 1 2 9 Coke Ovens 10 1 1 4 4 Blast Furnace 5 - - 2- 3 Steel Making Plant 7 1 1 2 3 Continuous Casting 9 1 1 2 5 Mill Building 5 1 - 1 3 Light Section Mill 7 - 1 3 3 Rod Mill 10 - 2 4 4 Average Comvosite Delay: 8.7 - 35 - 1.07 Details for delays in other project areas are given in Annex 3. Construction was the major cause of delay due primarily to difficult local working conditions in a remote and underdeveloped region where it was dif- ficult to attract qualified construction workers and accommodate staff. The Mexican construction industry's capabilities were overestimated at the time of appraisal and virtually all construction equipment had to be imported. This led to initial construction delays while foreign suppliers were called upon to take responsibility for the erection of their equipment. Moreover, lack of coordination between local suppliers for structural works and infrastructure contributed to further delays during the erection phase. 1.08 The plant started commercial production in January 1977 with a delay of nine months compared to the original schedule. However, in view of delays in the start of implementation, the overall project execution time was only five months longer than forecast. Taking into account the local constraints, the complexity of the project, the tightness of the implementa- tion schedule, and the adverse effects of the aftermath of the 1973/74 oil price hikes, this achievement can be considered as very satisfactory by any international standard. However, it has also to be recognized that the quality of construction suffered slightly from this constant pressure to expedite implementation and may explain at least in part the initially slow production build-up. As a matter of fact, during the early stage of production build-up, maintenance was overloaded with unusual adjustments or repairs resulting from hasty erection. Responsibility for the implementation of the project was with SICARTSA management. 1.09 However, during the basic engineering studies and subsequent pro- curement, construction and start-up stages of the project, substantial assis- tance was given to SICARTSA mainly by the British Steel Corporation (BSC) including sub-contracted staff from W.S. Atkins & Partners and McLellan & Partners, all of the United Kingdom. Specialized assistance was provided by Societe Francaise d'Etudes Minieres (SOFREMINES) in iron ore exploration and mine planning, by Hoogovens Idmuiden for the pelletizing plant, and by Bechtel Corporation for the iron ore slurry pipeline. The BSC team acted as advisers who did not have line responsibilities until a late stage in the project implementation. However, the positive role played by the BSC team was fully recognized and appreciated and the generally satisfactory project implementa- tion can be attributed to SICARTSA's top management and its BSC technical advisory team. C. Project Scope and Cost 1.10 Total financing required amounted to USS1,008.7 million, compared to US$678.5 million estimated at the time of appraisal. The total coste overrun is therefore US$330.2 million or equal to 48.7% of the appraisal estimate of total financing required. The final capital cost is detailed in Annex 4 and summarized below in comparison with the appraisal estimate: - 36 - Las Truchas Steel Project Capital Costs - Appraised and Actual (US$ million) Appraisal Actual Foreign Local Total Foreign Local Total Plant and Equipment (including Freignt, Spares and Insurance) 204.0 94.3 298.3 238.1 75.7 313.8 Services 5.3 9.8 15.1 - 17.2 17.2 Erection, Commissioning 11.3 62.2 73.5 71.8 178.8 250.6 Civil Works, Design, and Engineering 9.5 112.4 121.9 20.3 182.6 202.9 Structural Works 9.2 19.6 28.8 20.8 40.5 61.3 Total Fixed Assets 239.3 298.3 537 .6 351.0 494.8 845.8 Pre-operating Expenses 19.8 50.2 70.0 1.4.3 71.7 86.0 Initial Working Capital 8.0 20.0 28.0 9.0 22.0 31.0 Total Project Cost 267.1 368.5 635.6 374.3 588.5 962.8 Interest during Construction /a 42.9 - 42.9 36.7 9.2 45.9 Total Financing 310.0 368.5 678.5 41.1.0 597.7 1,008.7 /a Including refinancing of early debt maturities and operating interest. 1.11 The final capital cost was calculated in cooperation with SICARTSA on the basis of data provided by SICARTSA. Some adjustments were made between cost categories. Occasionally it was difficult for SICARTSA to provide data for the final capital cost because virtually all staff involved in the monitor- ing of the capital cost had left the Company after completion of the project and because the data base was not always consistent and complete. Improved project cost control was only gradually achieved, particularly upon the strong recommendation of a May 1975 Bank follow-up mission. 1.12 The capital cost overrun by cost category showing the overrun. attributable to various factors is given below: - 37 - Las Truchas Steel Project Capital Cost Overrun Summary (US$ million) Overrun due to Under-estimates, Actual Price Higher Changes Category Overrun Increase Quantities in Scope Other (%) Plant and Equipment (including Freight, Spares and Insurance) 15.5 4.7 5.4 - 10.1 - Services 2.1 0.7 1.1 1.0 - - Erection and Commissioning 177.1 53.6 65.7 54.8 34.6 22.0 Civil Works, Design and Engineering 81.0 24.5 37.8 40.1 3.1 - Structural Works 32.5 9.8 11.5 10.5 10.5 - Total Fixed Assets 308.2 93.3 121.5 106.4 58.3 22.0 Pre-operating Expenses 16.0 4.9 15.0 - 1.0 - Initial Working Capital 3.0 0.9 3.0 - - - Total Project Cost 327.2 99.1 139.5 106.4 59.3 22.0 Interest during Construction 3.0 0.9 3.0 - - - Total Cost Overrun 330.2 100.0 142.5 106.4 59.3 22.0 1.13 About 54% of the total cost overrun is accounted for by increased costs for erection and commissioning. Originally, the responsibility of all major equipment suppliers included only the supply of equipment and supervi- sion of erection and start-up. However, due to problems encountered with local erection contractors, the responsibilities of the equipment suppliers were increased to also cover erection of equipment, using Mexican sub-contractors, and thus ensure timely completion and suitable performance guarantees.' Where the main suppliers were unwilling to take responsibility for erection, another foreign company was contracted to do the work. The work involved in erection and commissioning appears to have been underestimated at appraisal particularly in view of the lack of experienced Mexican labor. Man-hours actually used under chis category exceeded appraisal estimates by about 50% and accounted - 38 - for about US$55 million of the overrun. The cost of this category also increased as a result of the rapid local inflation that equally affected the Mexican construction industry. Price increases totalled 52% in US dollar terms in 1973 and 1974 and thus by far exceeded the provisions for price contingencies included during appraisal. These price increases accounted for about US$65 million in overruns under this category. Changes in scope further increased the cost of erection by about US$35 million. Finally, around US$22 million of the overrun in this category can be attributed to the fact that some excess materials and equipment were bought for later use in Stage II. 1.14 The second largest cost overrun occurred in the category of design and engineering exceeding appraisal estimates by US$45.2 million or 141%. In this category again, a major cause for the overrun was the price inflation in the Mexican construction industry in 1973 and 1974 (US$14.1 million), while the remainder was accounted for by higher than estimated participation by the Company in the administration of the project (US$28 million), and by scope changes and redesigning to take into account revised seismic codes (US$3.1 million). 1.15 Other significant overruns occurred in the categories of civil works (US$35.8 million) and structural works (US$32.5 million). In both cases the single largest factor was the higher than expected increase in construction and steel prices during implementation. Quantities of material and labor were also higher than appraised, and contributed to the overrun. Finally, alterations in the seismic code for the area referred to above led to an increased scope with regard to structural works. 1/ The cost increase for pre-operating expenses was mainly caused by excessive staffing of the adminis- trative personnel, partly directed towards Stage II. Equipment cost increases were relatively small, as most orders were placed -- many on a fixed price basis -- before the oil crisis and its subsequent impact on prices. D. Financial Plan and Cost Overrun Financing 1.16 The table below shows the financing plan at appraisal and the actual financing pattern: 1/ it should be noted that, subsequently, the project has withstood two earthquakes and a hurricane with no damages. - 39 - Las Truchas Steel Project Financing Patterns - Appraised and Actual (US$ million) Appraisal Actual Difference US$ million % US$ million % US$ million % IBRD Loan 70.0 10.3 70.0 6.9 - - IDB Loan 54.0 8.0 54.0 5.3 - - Foreign Bilateral Credits 178.6 26.3 161.4 16.0 -17.2 -5.2 Other Loans 75.4 11.1 301.0 29.9 225.6 68.3 Total Long-Term Debt 378.0 55.7 586.4 58.1 208.4 63.1 U.K. Grant (0.D.A.) 0.5 0.1 0.5 - - - Equity 300.0 44.2 421.8 41.8 121.8 36.9 Total Financing 678.5 100.0 100.0 330.2 100.0 1.17 The cost overrun of US$330.2 million was financed from additional loans of US$225.6 million from NAFINSA and increases in equity of US$121.8 million. While the Bank and the IDB loans were fully disbursed and utilized, there was a reduction of US$17.2 million in bilateral credits as compared to the level envisaged at appraisal. This reduction occurred as some of the bilateral lenders set limits to their credits, based on amounts requested by SICARTSA before their respective closing dates. SICARTSA therefore had to find local financing from NAFINSA to cover this gap as well. E. Procurement, Allocation of Bank Loan and Disbursement 1.18 The equipment packages financed by the Bank were procured in accor- dance with the Bank's procurement guidelines. The selection of items for Bank financing and the procedure for applying preferences in bid comparisons were based on the intention to (i) broaden SICARTSA's supply base beyond the nations offering bilateral financing in order to increase competition, and (ii) enable Mexican manufacturers to participate in equipment supply on an internationally competitive basis beyond the relatively low limits of local financing available through bilateral lenders. To meet these objectives, a bidding and preference system was adopted which recognized that much of procurement for the project must necessarily comprise large packages with single contractor responsibility -- i.e. the blast furnace, pellet plant, etc. Since no Mexican supplier could meet prequalification criteria for such overall responsibility, an incentive to use Mexican resources was given to non-Mexican bidders by way of a 15% margin of preference on the clearly identified Mexican components of non-Mexican bids. For this purpose, a component was defined as being of Mexican origin (i) when supplied by a company incorporated in Mexico and (ii) when the costs of local materials, - 40 - labor and services used in its manufacture were not less than 50% of the total value of the component. In those cases where Mexican companies could pre- qualify to bid directly, and not simply as subsuppliers, their bids were considered entirely Mexican when Mexican value added reached 50%. 1.19 Procurement under the IDB loan followed similar principles. Annex 5 compares the equipment actually financed by the Bank's loan with the expecta- tions at the time of appraisal. Other equipment packages totalling US$49.0 million were financed by IDB (Interamerican Development Bank). Bilateral and other agencies financed packages totalling equivalent of US$200.1 million. Unlike normal practice, packages were not earmarked for specific bilateral agencies, but were put up for international bidding, with financing subse- quently being provided by the bilateral agency associated with the winning supplier. This allowed SICARTSA to benefit from a larger competition and to purchase equipment at more favorable prices. While the Bank considerably assisted SICARTSA during all stages of procurement, SICARTSA benefited in particular from employing the 'bid evaluation procedures recommended by the Bank. Civil works were competitively bid in Mexico and financed locally while erection and installation contracts were competitively bid in some cases locally and in others internationally. As a result, 75% of the erection and installation contracts for the major production facilities were awarded to the equipment suppliers and to a German contractor. At the time of appraisal, it was anticipated that Mexican manufacturers would win up to about 30% of total equipment. This, however, proved to be an overestimate of the Mexican firms' supply capabilities and, actually, Mexican manufacturers won only 16.5%. 1.20 The following table highlights the breakdown of supply countries for all the equipment packages financed out of IBRD, IDB and bilateral loans: Las Truchas Steel Project Sources of Supply and Financing of Equipmen: Packages Country IBRD IDB Bilateral Total and Local US $ US $ US $ US $ million % million % million % million % Australia 7.7 11.9 -- -- -- -- 7.7 2.4 Austria -- - - -- 31.5 15.7 31.5 10.0 Canada -- -- -- - 10.9 5.5 10.9 3.5 France -- - -- -- 31.5 15.7 31.5 10.1 Germany 16.2 25.0 6.1 12.4 17.5 8.8 39.8 12.7 Italy 17.8 27.5 0.7 1.4 13.7 6.8 32.2 10.3 ipan -- - -- - 46.0 23.0 46.0 14.7 exico 16.0 24.7 17.5 35.7 18.0 9.0 51.5 16.4 Switzerland -- - 4.7 9.6 -- -- 4.7 1.5 United Kingdom -- - 13.0 26.5 31.0 15.5 44.0 14.0 USA 7.0 10.9 7.0 14.4 -- -- 14.0 4.4 Total 64.7 100.0 49.0 100.0 200.1 100.0 313.8 100.0 - 41 - 1.21 Equipment supply was widely spread over Mexico and ten foreign countries with major shares going to Mexico, Japan, United Kingdom, Germany, Italy, France and Austria. Surprisingly, US suppliers won only 4.4% of the value of total equipment. 1.22 The actual pattern of disbursement is shown in Annex 6. After early lags due to delays in the start-up of implementation, disbursement picked up in 1975 and was generally in line with appraisal estimates. F. Infrastructure 1. General Facilities 1.23 Plans for the construction of the city of Lazaro Cardenas which were to be executed by a Government Trust Fund were reviewed by the appraisal mission and found satisfactory. Government gave assurances during negotia- tions that adequate support would be given to the city's construction program. However, the efforts to develop a social infrastructure in Lazaro Cardenas lagged far behind the implementation of the steel plant. Among shortcomings of the original development program for Lazaro Cardenas was the notion that the development of the new growth pole would only require the establishment of a strong economic base. Characteristic of such an approach was the belief that shelter and other urban services required to ensure the organic and balanced pattern of growth of the new center could either be generated without intervention, or could be taken care of by a traditional housing program. Scores of new immigrants flocked to the area in search of employment and better living conditions increasing the population of Lazaro Cardenas from about 6,000 in 1971 to over 29,000 in 1977 and the magnitudes of their needs were not anticipated. The situation in Lazaro Cardenas was further aggravated by the lack of coordination among the 14 agencies that were entrusted to carry out shelter and other urban development programs in the area. Given this fragmentation of efforts, even the few programs that were established have been inefficient. The problems are expected to be alleviated by the Bank- prepared Lazaro Cardenas Conurbation Development Project 1/ which is expected to provide housing at affordable cost to about 47,000 low income people. 1.24 Medical, educational and recreational facilities in Lazaro Cardenas have also been a serious problem which contributed to the rather unattractive image of Lazaro Cardenas. Government and state agencies have recognized the problem and are undertaking several programs to improve facilities and the area's infrastructure in general. Independently, SICARTSA has developed its own social and other programs. As a result of the various efforts by state agencies and by SICARTSA, Lazaro Cardenas has come a long way from a frontier settlement to a mid-size town with corresponding support facilities and a modest but expanding social life. 1/ Lazaro Cardenas Conurbation Development Project, Appraisal Report 1904-ME of April 5, 1978. - 42 - 2. Transport Links 1.25 Over 75% of SICARTSA's domestic shipments of finished products are destined for Mexico City. Transport is currently by road, as the rail alternative envisaged in the Bank's appraisal report would not be available for commercial operations until late 1979 after completion of the 200 km rail link between Las Truchas and Nueva Italia. At appraisal the rail link was expected to be completed by 1978 following assurances by the Mexican government during negotiations. The physical completion date is now set at July-August 1979. The main reason for the delay is understood to be celays in allocation of the necessary funds by the Mexican government in view of monetary con- straints. The completion of the rail link is expected to considerably reduce SICARTSA's transport costs of finished products. The road transport cost for steel products for the 800 km haul between Las Truchas and1 Mexico City is around US$20 per ton against rail costs of between US$10 to 12 per ton depend- ing upon the weight of shipments. Officials of the national railways indicated that the railways would be in a position to handle SICARTSA's potential raw materials, intermediate and finished products traffic. 1.26 One of the main advantages foreseen for the present location of the steel plant was -- and still is -- its proximity to a new port at Lazaro Cardenas and the consequent inexpensive sea transportation of imports, mainly coal, and of exports of finished products. The port was constructed by the Ministry of the Navy (Marina) during 1973 to 1975 following a review by the Bank of its technical and economic aspects. The timely completion of the port benefited SICARTSA by enabling convenient delivery of imported equipment and materials required during construction and subsequent periods. At present, over 90% of the cargo handled by the port is on SICARTSA's account but this is expected to decline to less than 50% by 1982. The volume of cargo traffic is expected to increase from around 900,000 tons in 1978 to 4 million tons in 1982. II. POLITICAL AND ECONOMIC ENVIRONIENT 2.01 Project implementation and production build-up were affected by a number of factors outside SICARTSA's control that could not be foreseen at appraisal. In the late 1960s and early 1970s, the Mexican economy had been growing at an average annual rate of 6.3%. In contrast, this growth declined to 3.0% in the period 1973-1976 and remained at about 3% in 1977, SICARTSA's first year of operations. The deficit in the balance of payments for goods and services more than doubled between 1973 and 1974 from USS1,490 million to USS3,000 million and reached US$4,180 million in 1975 and USS3,600 million in 1976. The annual rate of inflation which had been around 6%*in 1972 increased to 23% per year between 1973 and 1977 and is estimated to have been around 15% for 1978. The combined impact of these circmstances led the Mexican government to revise the exchange rate from 12.5 Mexican pesos to the US dollar to 22.6 Mexican pesos, implying a devaluation of around 80,. As a consequence, SICARTSA's domestic currency costs of imported raw materials - 43 - and equipment and of debt servicing for loans in foreign exchange increased substantially. To overcome the economic disequilibria, the Mexican government initiated an austerity program severely restricting fiscal expenditure, and this particularly affected infrastructure development in Lazaro Cardenas and early operations at SICARTSA. The delays in government support for the establishment of the required infrastructure affected SICARTSA through, among other things, high turnover, absenteeism, and low labor productivity and diversion of much management attention from production build-up and marketing. 2.02 The new administration which followed the Presidential elections in 1976 resulted in some changes in appointments, including the replacement of key personnel in the steel industry and in SICARTSA. This in turn led to changes in management personnel at different levels of SICARTSA and the initial uncertainties caused by management turnover affected SICARTSA's operations. The slow-down in Mexican economic growth caused by the austerity program together with the uncertainties about the future course of economic growth resulting from the financial crisis and devaluation constrained the growth of the construction industry, SICARTSA's main market. While the construction sector had grown at an average annual rate of 9.7% during 1965-70 and 8.3% during 1970-75, its growth became negative in 1976 (-2%) and in 1977 (-3%). There has been an improvement in 1978 when the volume of construction activity increased by about 10% (between January and June) over the corresponding period of 1977. The combined effect of the above circumstances was to directly or indirectly affect key aspects of SICARTSA's operations in a manner that could not have been foreseen earlier at the time of the project's formulation. III. THE COMPANY A. Ownership and Control 3.01 As of December 31, 1978, nearly 70% of the subscribed share capital of SICARTSA was held by the Federal Government of Mexico as compared to 51% envisaged at appraisal. The evolution of the structure of share capital from appraisal to the present is shown in Annex 7. In order to comply with the maximum debt-equity ratio (60:40) laid down in the loan agreement, SICARTSA's share capital had to be increased. As the other subscribers were unable to raise their participations to the extent required, the Federal Government had to correspondingly increase its share to close the gap. As of December 31, 1978, the total share capital of USS594.7 million includes a Federal Government grant/subsidy of USS48.5 million to SICARTSA to cover its operating and other deficits in 1973. 3.02 On January 28, 1978, the Mexican Government announced the appoint- ment of Mr. J. Leipen Garay as Director General of the three government con- trolled steel companies, AHMSA, SICARTSA and FUNDIDORA. At the same time, the Government prepared the creation of a holding company for the govern- ment controlled steel industry under the name of - 44 - SIDERMTEX. It is expected that the Federal Government holdings in SICARTSA will eventually be transferred to SIDERMEX when the latter is formally estab- lished as a corporation. At present, the three companies Eunction autono- mously, though under a single management to enable coordination. The union of steel companies was regarded as part of an administrative reform which provides for the fusion, reinforcement, and in some cases, liquidation of state-affiliated enterprises "according to their efficiency and the require- ment of each sector". The purpose of the reorganization was "to coordinate the operations of the three companies so as to rationalize and maximize their output, ... and to make it possible to handle their problems of production, commercialization and transport with timeliness, rapidity and efficacy, in both domestic and foreign markets". Additionally, SIDERMEK assists the Steel Commission to define and plan the expansion of the Mexican steel industry and participates in the review of domestic steel prices. B. Organization and Management 3.03 The organization and management of the company, especially during 1977 and the early part of 1978, was affected by (a) the destabilizing effects of excessive management turnover at all levels with the consequent adverse effects on decision-making and operations, and (b) the difficulties in trans- forming the organizational and management structure from its early orientation towards construction-type activities to meeting the vastly different needs and challenges of operations. Since then, under the leadership of Mr. J. Leipen Garay, President of SIDERIEX, the situation has considerably improved in both the above areas. 3.04 As noted, turnover has been high among management. This was prim- arily a result of political changes that followed the new administration taking office in 1977 and that led to a fundamental reorganization of the Government controlled economic activities. These changes were accompanied by replacements of key personnel in the steel industry. In late 1977 and early 1978, SICARTSA's General Director and the three General Managers of production, finance and administration and development were replaced, followed by wide- spread personnel changes at the middle management levels. The frequent per- sonnel changes and the need for the newcomers to familiarize themselves with their area of responsibility led to uncertainties and delays in decision- making, thereby affecting all areas of operations including production. The personnel situation among management has now begun to stabilize due to the efforts of the new management team. 3.05 The development of adequate cost control and management information systems was not pursued with sufficient vigor in the initial stages. Early lack of coordination among the concerned departments resulted in management -ften being insufficiently aware of the cost implications of various activi- es. Largely at the suggestion of the Bank and with its assistance, SICARTSA officials visited steel companies in Brazil and Venezuela to familiarize themselves with the cost control systems used by them. These visits were beneficial in the eventual development of a cost control system by SICARTSA. - 45 - 3.06 The organizational transition from the construction to the opera- tional stages proved more difficult than foreseen. The very success of the construction phase in setting up a greenfield steel plant in a short period of time served in a way to reinforce the prevailing organizational set-up and prevented a smooth and timely adaptation to the changed needs of oper- ations. Though changes did occur in the formal organizational charts, these remained nominal for a long time, and in effect, there was a lack of delega- tion of responsibility with even day-to-day decision-making being largely centralized in a few key officials. Besides, there were considerable delays in setting up adequate systems of financial control and reporting, particu- larly for purposes of budget control and internal auditing. Organizational and management problems also resulted in inadequate coordination between production and maintenance and in the delays in developing an effective marketing network. 3.07 During the past year, SICARTSA has taken a number of steps towards rationalizing its organizational structure and improving its information 1/ and reporting systems. The current organization chart is given in Annex 8- . Recent changes have involved a strengthening of the financial control func- tion through a redistribution of functions between the finance and the other departments. The management information system has been improved, particularly in the cost-control area where a 56-member group now produces detailed monthly cost information reports by individual cost and supply centers. Other changes have been aimed at ensuring a better coordination between the production and maintenance activities by placing control over both functions under the same head at the level of the four principal production areas, namely, Mines and Concentration Plant, Raw Material Processes, Iron and Steel-Making, and Finished Products. Improvements in marketing are expected to occur following the changes in marketing organization described in paragraph 3.09 below. 3.08 A decision which emains to be taken is the appointment of a Director of Operations at the plant. There is no director of operations at present and coordination is currently achieved through a committee of the concerned plant superintendents under the general guidance of the Sub-Director-General. It is understood that a decision in this matter will be taken in the context of the forthcoming transfer of certain headquarters functions from Mexico City to the plant. 3.09 The creation of SIDERMEX should result in an improved coordination of the current and future activities of the state steel companies including the allocation of financial, technical, material and human resources and the rationalization of production and marketing. It is envisaged that, to the extent possible, common agencies would be created to service these companies as in the case of marketing where SICARTSA's domestic and export sales are currently effected through two channels, (i) the marketing department of AHMSA, and (ii) Avios de Acero, a subsidiary of AHMSA. AILVISA is responsible for marketing against orders of 500 tons or more and 3or exports, while Avios de Acero deals with smaller domestic customers3". 1/ Annex 8 shows SIDERNEX's organization chart in 1979. 2/ The position of Director of Production was filled in September 1979. 3/ Avios de Acero and Internacional de Acero are now sole distributors for SIDERMEX products. - 46 - IV. THE STEEL MARKET 4.01 SICARTSA produces non-flat products, namely deformed reinforcing bars, bars, light sections and wire-rod. SICARTSA has been competing in the domestic market with its two sister companies, AHMSA and FUNDIDORA, a private integrated steel producer, Hojalata y Lamina, S.A. (HYLSA), and privately owned non-integrated rerollers. With the creation of SIDE.UMEX, a holding company for the state owned steel mills, production programs have been rationalized and therefore FUNDIDORA will no longer compete with SICARTSA. 4.02 The projections of steel consumption in Mexico made during appraisal took into account the several earlier studies of projected steel demand made by various official agencies. In addition, the Bank was instrumental in urging the Mexican Government to undertake the first comprehensive study of the existing status and future prospects of the Mexican steel industry which was carried out by the Battelle Institute of the U.S. in 1973-74. However, several extraordinary circumstances which could not be foreseen at appraisal coincided during project implementation (paras. 2.01-2.02) and thereby reduced actual Mexican steel consumption below appraisal projections as shown below: MEXICO - Steel Consumption a/ ('000 tons of finished products) 1977 1978 Product Appraisal Actual Appraisal Actual Total Steel Products 4,775 4,249 5,292 4,479 Flat Products 2,542 2,220 2,807 2,349 Non-flat Products 2,233 2,029 2,485 2,130 of which: - Rebars 972 860 1,C86 887 - Wire Rod 525 450 580 470 - Bars, Light Sections 524 480 585 505 - Heavy Sections, Rails 212 239 234 268 a/ Excluding seamless pipes. Source: CCIS (Steel Coordinating Commission). Until 1975, the growth of steel consumption in Mexico proceeded even -aster than foreseen at appraisal, largely as a result of the near-boom conditions prevailing in the years 1973 and 1974. Thus, between 1972 and 1975, actual consumption of non-flat steel products increased at 13.8% p.a. as compared to a rate of 11.2% p.a. foreseen at appraisal, The slowdown in growth of steel consumption was experienced in the second half of 1976 and subsequent years, mainly as a result of the devaluation ir that year and of the various deflationary measures like reductions in public expenditure taken by the Government in order to check rising inflation. As described earlier, these factors significantly affected the construction sector, SICARTSA's main market, even leading to negative growth in this sector in 1976 and 1977. The divergence between appraised and actual steel consumption, therefore, appears to be the result of factors that could not have been foreseen at appraisal. - 47 - 4.03 According to CCIS domestic steel consumption is expected to grow at an average of 8.3% p.a. with consumption of non-flat products projected to grow at a somewhat lower rate of 7.8% p.a. The table below shows actual and projected steel consumption in Mexico: MEXICO - Steel Consumption a/ ('000 tons of finished products) Actual Forecast Year 1977 1978 1979 1980 1981 1982 1984 1985 Steel Products 4,249 4,479 4,984 5,569 6,018 6,541 7,932 8,133 Flat Products 2,220 2,349 2,637 2,994 3,246 3,542 4,102 4,443 Non-Flat Products 2,029 2,130 2,347 2,575 2,772 2,999 3,430 3,690 of which: - Rebars 860 887 970 1,061 1,135 1,229 1,386 1,489 - Wire Rod 450 470 510 551 595 642 739 790 - Bars, Light Sections 480 505 548 592 640 695 801 865 - Other non- flats 239 268 319 371 402 433 504 546 a/ Excluding seamless pipes. Source: CCIS. Consumption of SICARTSA's main products - rebars and wire-rod - is expected to grow at 7.3% and 7.5% respectively, and thus somewhat more slowly than the total of non-flat products (8.2%). These projections appear to be in line with the expected rates of growth of the Mexican economy of between 7.5% to 8% a year during 1979-1985. It should be recalled that the construction industry, SICARTSA's main market, has in the past (1965-75) grown at a somewhat faster rate than GNP and is expected to resume this trend after the recessionary years of 1976 and 1977. 4.04 SICARTSA's main competitors are the independent rerollers, but its products also compete with those of HYLSA and other SIDERMEX plants, as shown below: MEXICO - 1978 Steel Production Capacities at 100% a/ ('000 tons of finished products) Other Others Product SICARTSA SIDERMEX HYLSA (rerollers) Total Flat - 2,500 694 - 3,194 Non-flat 1,000 523 475 1,277 3,275 of which rebars, wire rod, bars, and light sections 1,000 400 475 1,145 3,020 Total Steel Products 1,000 3,023 1,169 1,277 6,569 a/ Excluding seamless pipes. Source: CCIS. - 48 - Total production capacities exceeded domestic consumption of non-flat steel in 1978 by 54% and consumption of rebars, bars, light sections and wire-rod by 62%. 4.05 This situation is expected to be reversed in the early 1980's and by 1982 the projected demand for non-flat products would exceed domestic capaci- ties (at 90% capacity utilization). In order to cover the domestic supply deficits expected for the 1980's, but, more importantly, the current deficits in the supply of flat steel products, Mexico envisages an expansion program as outlined below: MEXICO - Steel Expansion Program (1978 - 1985) a! (in '000 tons of additional capacity of finished products) Other Product SICARTSA SIDERMEX HYLSA Others Total Flat - 639 459 - 1 ,098 Non-flat 120 307 32 93 552 - of which: rebars, wire rod, bars, light sections (120) (186) (32) (93) (431) Total Steel Products 120 946 491 93 1,650 a/ Excluding seamless pipes. Source: CCIS. 4.06 With the planned expansions, the following demand-supply balance is projected for 1985: MEXICO - Demand-Supply Balance for Steel in 1985 a/ ('000 tons of finished products) Supply Surplus/ Product Supply Demand Deficit Other SICARTSA SIDERMEX HYLSA Others Total Flat - 3,139 1,153 - L.,292 4,443 (151) Non-flat 1,120 830 507 1,370 3,827 3,690 137 - of which: Rebars , wire-rod, bars, light sections 12120 586 507 1,238 3,451 3.144 - 307 Total Steel Products 1,120 3 969 1 660 1,370 8L 8.133 (iE) a/ Excluding seamless pipes. Source: CCiS. - 49 - While overall demand and supply for steel in Mexico in 1985 are projected to be roughly in balance, the situation is much different if the market is looked at by type of products. A deficit is expected for several flat products and for heavy profiles and rails. A balanced situation is expected for light and heavy plate. The only relevant production surplus is expected for SICARTSA's products group - i.e. wire-rod, rebars, bars and light sections. The expected surplus would be equal to about 9% of the corresponding domestic production or about 27% of SICARTSA's output. This indicates that under present assump- tions, the Mexican steel industry, including probably SICARTSA, would continue to export a gradually declining part of its production through 1985. 4.07 The regional distribution of SICARTSA's sales has been concentrated upon Mexico City, as shown below: Las Truchas Steel Project Regional Distribution of Domestic Sales in 1977 (in %) States Rebars Wire-Rod Sections Mexico City 78.3 37.9 85.5 Mexico State 7.1 17.1 0.2 Nuevo Leon 0.3 21.3 1.7 Others 14.3 23.7 12.6 Total 100.0 100.0 100.0 Source: SICARTSA. The concentration of sales upon customers in and around Mexico City, where SICARTSA bears the transport cost in order to compete with local re-rollers, has affected the Company's financial performance (para. 5.18). V. PROJECT OPERATION A. Production Build-Up 5.01 The project came into operation at a very difficult period in the Mexican economy and consequently this has affected the production build-up of the project to a great extent. As a consequence, SICARTSA's production build-up has lagged behind the appraisal expectations. Some of the reasons for this slower than expected production build-up were outside the Company's control (paras. 2.01-2.02). Other reasons have included the high turnover in company management, and some problems arising from the design of some of the plant sections (such as the lack of flexibility between blast furnace, BOF and continuous casting). In the general context of these problems affecting the production build-up, SICARTSA's decision to terminate the technical assistance contract with BSC proved somewhat premature as it denied SICARTSA the advisory resources of BSC during this critical period. - 50 - 5.02 1977 was the first year of commercial operation. SICARTSA's pro- duction performance is given below and compared with appraisal estimates: Las Truchas Steel Project Production Performance ('000 tons of finished products) 1976 1977 1978 1979 1980 1981 Actual/Estimate2/ - 148 360 600 875 1,000 Appraisal Case A 150 500 800 1,000 1,000 1,000 Appraisal Case B 135 350 700 800 900 1,000 Source: SICARTSA, IBRD. The Appraisal Report contained two base cases regarding production build-up (A and B). Case A reflected a situation in which SICARTSA would fully use technical assistance, while Case B was to show production build-up with less technical assistance. The financial projections were based on Case A which is referred to as the yardstick below. SICARTSA's production in 1977 was 148,000 tons of finished products or about 30% of the appraisal estimate, and in 1978, about 360,000 tons or about 45%.1/ This was the result of (i) a 9 month delay in project implementation, and (ii) a slower than projected production build-up (para. 5.03). If adjusted for the 9 month project imple- mentation delay, production in the first year of commercial operation was 58% of appraisal estimate (Case A) and 61% in the second year, as shown below: Las Truchas Steel Project Production Performance and Project Delay ('000 tons of finished products) 1976 1977 1978 1979 1980 1981 Actual/Current Forecast - 148 360 600 875 1,000 Appraisal Case A Adjusted for Project Delay - 255 595 890 1,000 1,000 Appraisal Case B Adjusted for Project Delay - 223 380 740 875 975 Source: SICARTSA, IBRD. 1/ Actual figures for 1977 to 1981 are 148, 363, 469, 598 and 800 thousand tons. 2/ However, besides "finished products", additional criteria ought to be taken into account to assess SICARTSA's production performance (para. 5.08). - 51 - As shown above, the delay of project implementation explains a large part of the production shortfall, and if Case B is used as measurement, most of it. 5.03 From an operational point of view, the slower than projected pro- duction build-up was a result of a variety of factors some of which were mentioned previously: (i) very high turnover at virtually all levels of management and labor, (ii) lack of spare parts, (iii) a serious cash shortage in 1977, (iv) technical problems associated with the synchronizing of opera- tion among the three major production facilities, blast furnace, BOF shop and continuous casting machines and the difficulties encountered in starting, maintaining and operating the casting machines properly, which were particularly felt after the termination of the technical assistance contract with BSC, and (v) a 10 day strike in August 1977. 5.04 The high turnover and absenteeism in labor seemed to be mainly caused by unsatisfactory social conditions in Lazaro Cardenas (paras. 1.23 - 1.24). High turnover among management was primarily a result of political changes that followed the new administration taking office in 1977 and that led to fundamental reorganization of the Government controlled economic activities (para 3.04). 5.05 The lack of spare parts was a consequence partly of inadequate administration of such parts, but mainly of the very serious cash shortage in 1977. Cash shortages and budget cuts were a general feature in Mexico at that time reflecting the credit squeeze and ceiling on government expendi- tures to slow down inflation. In the period immediately after start-up, the main cash inflows were projected to be the Government's equity contributions, which virtually came to a halt. As a result, SICARTSA faced very substantial difficulties in meeting payments for salaries, wages, contractors, raw mate- rial supplies and spare parts, and at the end of 1977, had about US$24.5 million in overdue liabilities. Contractors and suppliers became reluctant in 1977 to deal with SICARTSA, and the most serious impact was felt in the purchasing of spare parts. After the change in SICARTSA's management, Bank intervention with NAFINSA and Government, and with growing Government support in 1978, this problem has substantially been overcome and there were no overdue liabilities at the end of 1978. 5.06 The main technical problems slowing production build-up were encountered in the operation of the continuous casters and in the coordina- tion of the these casters with the two other major units of the iron and steel making plant, i.e. the blast furnace and the BOF shop. The technical problems were compounded by the lack of spare parts (para 5.05). As a consequence, one of the three casters had to be shut down to serve as a reservoir of spare parts for the remaining units. The continuous casting shop became a bottleneck to the product flow in the plant and due to its inability to handle the.flow of liquid steel, considerable quantities of pig iron had to be dumped, 266,662 tons alone in 1977. In 1978, due to improvements in operating and coordinating the key units of the plant, this figure was down to 45 ,020 tons. While dumped pig iron can be sold (para. 5.10), it is difficult to handle and to market. 7o add flexibility to the plant, SICARTSA is erecting a pig iron casting machine. - 52 - 5.07 A ten day strike hit SICARTSA in August 1977. As a consequence the Company's output declined to about half the production level achieved in July and September of 1977. The strike according to SICARTSA was caused by wage related claims, bad living conditions and the intention o:: a union to assert itself as the dominant force in collective bargaining vis--a-vis management. No labor conflicts have occured since. 5.08 The output of finished products may not necessarily be the best criterion to measure capacity utilization. Because of the bottlenecks mainly in the continuous casting shop, SICARTSA has sold considerable quantities of pellets, pig iron and coke. In these areas capacity utilization has been much higher than in terms of finished products, as shown below: Las Truchas Steel Project Production Performance ('000 tons) 1977 1978 1979 (est.) Capacity Capacity Capacity '000 tons Utilization '000 tons Utilization '000 tons Utilization Pellet Plant 806 44% 951 51% 1,283 69% Coke Plant 375 67% 394 70% 490 88% Blast Furance 522 47% 563 51% 700 64% BOF 215 18% 570 49% 763 65% Continuous Casting 206 19% 463 42% 687 62% Rolling Mills 148 15% 355 36% 600 60% 5.09 The above table demonstrates that continuous casting has been the bottleneck; other units did operate at higher rates of capacity utilization and could have run even higher. For example, the pellet plant reached 78% of capacity utilization in March of 1977 but was forced to slow down because of production bottlenecks elsewhere. The problems in continuous casting appear now resolved and the casters produced at above 60% of capacity in December of 1978. To achieve this rate for the whole of 1979 seems even conservative. The reason that SICARTSA has not set a higher production target for 1979 reportedly was (i) increased focus on improvement of maintenance and control of costs and (ii) the shift to higher quality products which will be more difficult to produce, such as high carbon rod. It appears that SICARTSA can now move towards attaining full production, though some technical problems such as in the slurry pipes from the mining area to the plant and in electronic -nd computer equipment in blast furnace and BOF shop persist. These con- straints are, however, being tackled and are not expected to limit production build-up. 3. Sales 5.10 SICARTSA's*sales performance in 1977 and 1978 is summarized below and comoared to aporaisal estimates: - 53 - Las Truchas Steel Project Sales Performance of Finished Products ('000 tons) 1976 1977 1978 Appraisal Actual Appraisal Actual Appraisal Actual Finished Products 150 - 500 83 800 360 - Reinforcing bars 76 - 253 50 404 177 - Bars 21 - 70 5 112 54 - Wire rod 26 - 87 24 140 86 - Light sections 20 - 65 4 104 43 - Spring flats 7 - 25 - 40 - However, since a major part of SICARTSA's revenues has come from sales of intermediate products, the sales of pellets, pig iron and billets are given below in terms of tons and in terms of equivalent of finished products: Las Truchas Steel Project Total Sales in Equivalent of Finished Products a/ ('000 tons) 1977 1978 Tons Tons Finished Tons Tons Finished Prod. Equiv. Prod. Equiv. Finished Products 83 83 360 360 Pellets 136 74 Pig Iron 44 41 261 245 Billets and Second Quality Products 13 12 65 61 Total -- 136 -- 742 a/ Intermediate products are converted into finished products equivalent using the following yield factors: billets - 1.053; pig iron - 1.067; pellets - 1.815. SICARTSA's sales of finished products in 1977 and 1978 lagged behind appraisal estimates because of (i) the slower production build-up (para 5.03), (ii) the market constraints (paras. 4.01-4.07) and (iii) deficiencies in the marketing organization. Though production bottlenecks prevented SICARTSA from convert- ing all its intermediate products into finished products, SICARTSA was able to sell considerable amounts of intermediate products, which was not foreseen in the appraisal report because of the assumption that all intermediate products would go into finished products. If intermediate products sold could have been processed into finished products, total sales performance in 1978 would have amounted to 74% of productive capacity for final products. SICARTSA also sold by-products such as tar and benzol, which also was not taken into con- sideration at appraisal. - 54 - 5.11 An institutional constraint to SICARTSA's sales in 1977 was defi- ciencies in the marketing organization. Marketing had been neglected somewhat by SICARTSA and while the regrouping under SIDERMEX began in early 1978, there was still a lot of uncertainty regarding the envisaged crganizational set-up and the sharing of responsibilities. After this was worked out, the sales performance began to improve considerably and all finished products produced in 1978 were sold. Also, large amounts of intermediate and by-products produced in 1977 were sold (in 1978). 5.12 Exports have been a major outlet for SICARTSA's products. In 1977, SICARTSA exported 22,000 tons of finished products totalling US$3.9 million and in 1978 154,000 tons, which accounted for about 27% of net sales revenues. SICARTSA's main customer is Venezuela; other buyer countries include Central America, Kuwait, Iraq, South Korea and China (People's Republic). SICARTSA is currently negotiating also with Japan. Intermediate products have been sold to European countries. No exports have gone to the U.S. so far because the U.S. trigger prices (i.e. prices below which imported steel products are not allowed to enter the U.S.) for SICARTSA's products have been above current domestic U.S. prices, so that SICARTSA has not been competitive in this market. Product Mix and Prices 5.13 Total output at full capacity is estimated at 1,000,000 tpy of finished products in line with the appraisal. The composition of SICARTSA's output with associated prices is estimated as follows (in 1982): Las Truchas Steel Project Product Mix and Prices at Full Capacity (1982) (in 1979 terms) Actual Appraisal '000 Tons USS/Ton a/ '000 Tons USS/Ton b/ Before After Price Price Revision Revision Rebars 554 265 331 645 308 Wire-rod 389 285 356 175 313 Bars and Profiles 57 257 321 130 294 Spring Flats - 4I3 n.a. 50 424 Total _1000 272 340 1,000 313 a/ The Mexican Government approved increases in steel prices by about 25% in early 1979. b/ Adjusted for inflation, in USS of 1979, using local inflation index and exchange rate variation. - 55 - As seen from the table above, before the price revisions in early 1979, the average price for SICARTSA's products was about 12% below appraisal estimates, adjusted for inflation. Thus, for the first two years of its operations, 1977 and 1978, SICARTSA was permitted only lower prices than envisaged at appraisal. However, with the price revisions of 1979 amounting to about 25% on the average, the price level for SICARTSA's products is slightly over the level expected at appraisal. In comparison, production costs have increased substantially faster as compared to appraisal expectations as seen in paras. 5.15 to 5.17 below. Production Costs 5.15 It is now estimated that direct production costs at full capacity in a normal year of operation (1982) will be 55% higher than those expected at the time of appraisal in real terms, as shown in the following table: Las Truchas Steel Project Operating Cost at Full Production (1979 US$/ton of finished products) Percentage Increase Appraisal adjusted Appraisal updated Current over for inflation with current unit costs Estimate Appraisal (%) Wages and Salaries 20.7 27.1 32.9 57 Raw Materials: - Coal 25.5 46.5 52.0 104 - Other 8.9 8.7 8.7 (2) Fuel and Energy 6.2 6.7 13.5 117 Maintenance Materials 19.6 21.9 26.0 33 Consumables/Sundries 13.8 15.1 21.3 54 Plant Insurance 1.7 1.7 2.4 41 Total Operating Costs 96.4 127.7 156.8 63 Administrative Expenses 4.1 5.7 8.6 110 Transport of Finished Products 13.4 10.6 11.0 (18) Total 113.9 144.0 176.4 55 5.16 it should be noted that this projection assumes several improvements in plant operations and management which would result in lower costs and expenses, namely: (i) manpower has been assumed to be reduced from its present level which includes provision for the still high turnover to a more standard manpower, with corresponding adjustments in wages and salaries; with the likely implementation of Stage II of the project in the near future, it is - 56 - assumed that a substantial portion of the excess labor currently employed would be transferred to Stage II of the project; (ii) the cost of transpor- tation and distribution is expected to be US$11/ton (and thus lower than the US$13/ton estimated for 1979 on the basis of appraisal expectations) after the completion of the rail link through Nueva Italia to Mexico City, SICARTSA's main market; (iii) a substantial reduction in administrative costs through improvements effected by the new management team; (iv) coal consumption per ton of finished products is projected to be US$52/ton of finished products compared to US$75/ton achieved in 1978 on a limited production of 360,000 tpy - the corresponding appraisal estimate was USS46.5/tcn of finished product at full production; 1/ and (v) a 15% reduction in fuel and energy costs due to reduction in energy consumption, is.assumed. However, even with these improvements, SICARTSA's operating costs (excluding depreciation and financial charges) at full production are expected to be about 55% higher than expected at appraisal, as shown in the above table. Of this difference, 26% is a result of the fact that prices for SICARTSA's inputs rose on the average faster than inflation. Compared to general inflation progressing between 1973 and 1978 at about 9.5% p.a. in US dollar terms, average prices for SICARTSA's inputs increased by about 14.9% p.a. during the same period. As can be seen from the above table, the unit cost increases of inputs explains only part of SICARTSA's high cost of production. The remaining 29% result from ineffi- ciencies such as higher consumption of inputs, lower yields and low labor productivity. The following table gives a breakdown of the operating cost overrun by factor: Las Truchas Steel Project Analysis of Operating Cost Overrun (%) 1. Input prices increased faster than inflation 26% 2. Lower yields and productivity 29% of which - excessive payroll 5 - coke rate and coal consumption 5 - administrative expenses 3 - consumables consumption 5 - energy consumption 6 - other 5 Total Operating Cost Overrun 55% Price and-Cost RelationshiD 5.17 The margin between average selling price and average direct cost per ton is substantially below the level anticipated at appraisal and has deterio- rated from about 62% to about: 48% of selling prices (at full production in a normal year of operation) as can be seen from the table below. 1f/ The 7performance foreseen at appraisal does not seem likely to be achieved. It should be noted, however, that the appraisal estimates of both coke production and consumpt .on -were rather optimistic. - 57 - Las Truchas Steel Project Price and Cost Relationship (current US Dollars) a/ Average Price Per Ton Average Cost Per Ton b/ Gross Profit Margin d/ Appraisal Actual Appraisal Actual Appraisal Actual 1973 186 - 70 - 62% n.a. 1978 313 272 156 302 f/ 50% (11%) 1982 c/ 313 340 e/ 144 136 54% 48% a/ Appraisal estimate adjusted for actual inflation. b/ Excluding depreciation and financial charges. c/ Estimate, in 1979 US Dollars. d/ Gross profit in % of sales revenue. e/ Based on an increase of about 25% in nominal terms in early 1979 and constant prices in real terms thereafter. f/ Reflecting the low degree of capacity utilization. This development is primarily attributable to the steep increases in the cost of imported raw materials, fuel, energy and labor following the 1973 oil crisis and the major devaluation of the Mexican Peso in 1976 on the one hand, and to lower productivity than envisaged at appraisal. C. Financial Performance 5.18 For the reasons discussed earlier (paras. 5.01-5.17) SICARTSA's financial performance has not met the expectations formulated during appraisal, as shown below: Las Truchas Steel Project Financial Performance (US$ million) a/ c/ Financial Year Ending December 31 1977 1978- Appr. Act. Appr. Est. Net Sales 158 23 258 112 Cash Operating Costs b/ 81 92 109 148 Financial Charges 48 69 48 78 Depreciation 63 7 63 13 Net Profit Before Taxes (34) (145) 38 (127) a/ Appraisal figures have been adjusted to 1979 US dollar values. b/ Excluding depreciation and financial charges. c/ Estimates for 1978 are based on actual performance for 11 months, January to November as shown in Annex 10. - 58 - 5.19 The reasons for the difference between SICARTSA's actual financial performance and the appraisal projections are (i) a shortfall in the company's production and sales performance (paras. 5.01-5.12); (ii) the capital cost overrun financed by medium-term loans; (iii) the aftershocks of the devaluation of the Mexican Peso which led to an 80% increase in the debt service for foreign loans and higher than expected costs of imported raw materials and spare parts (para 2.01); (iv) an increase of production costs at a much faster rate than general inflation (paras. 5.15-5.16); (v) a much higher production cost level (paras. 5.15-5.16) in physical terms as evident from yields lower than estimated at appraisal and a payroll exceeding appraisal projections by nearly 60%; and (vi) attempts by the Government to control inflation by controlling price increases for basic inputs such as steel, thereby decreasing steel prices in real terms. The historical financial statements for SICARTSA are given in Annexes 10 and 11. 5.20 When SICARTSA's financial troubles became evident, the Bank strongly urged SICARTSA to prepare a plan of action to be presented to the Mexican Government that would (i) make SICARTSA a financially viable Company and therefore, (ii) free the state budget from continuing heavy budget contribu- tions. The Bank suggested that this plan should include: (i) take-over of all debt by the Government; (ii) increase of steel prices in real terms; (iii) achievement of full production; (iv) reduction of general expenses; and (v) reduction of operating costs. While the first two measures were to be taken by the Government, the remaining three needed to be handled by SICARTSA. 5.21 The substantially increased debt service has been a major drain upon SICARTSA's financial resources. The capital cost overrun had forced SICARTSA to increase its debt to cover the overrun through additional loans from NAFINSA. To the extent that a substantial part of the additional debt was medium-term and at rates above those prevailing in the market, it further added to the increases in debt service caused by the devaluation of the peso in late 1976 and the decline of the dollar against other hard currencies subsequently. In late 1978, the Government agreed to take over three NAFINSA loans totalling USS298 million (49.8% of SICARTSA's long-term debt) and to cover SICARTSA's cash deficit in those years when it cannot meet its obligations due to the debt service. 5.22 As approved by the Government, an average increase in steel prices of 25% took place in early 1979. As noted above, this measure has brought SICARTSA's prices slightly over the levels projected at appraisal and makes them comparable with domestic steel prices prevailing in the industrialized countries. The average price for SICARTSA's product mix is now around USS340 per ton (after the price increase of 25%) as compared to prevailing prices of around S330 to 5350 per ton in the EEC countries and in Japan. After that, the Government and the Steel Commission intend to maintain steel orices in - 59 - real terms. It appears that with the implementation of the two decisions regarding debt service and prices, the Government has essentially created the necessary preconditions to strengthen SICARTSA's financial viability. 5.23 The Bank has urged SICARTSA to take adequate measures to expedite achievement of full production and to reduce operating costs and general expenses from the excessive levels of 1977 and 1978. While SICARTSA is now confident of achieving full production by 1981, and recognizes the possibili- ties of improving yields and technical performance, reductions in personnel are considered more difficult because of strong political and social pressures. However, it should be possible to absorb a substantial part of the current excess labor for the Stage II project which is presently being considered. Financial projections indicate that the above comprehensive action program will significantly strengthen SICARTSA's financial position and make the Company profitable after exceeding 77% of capacity utilization in 1980. The projected income statement as a consequence of the action plan is slomarized below. The associated projected balance sheets up to 1985 are given in Annex 12. Las Truchas Steel Project Effect of Action Program on Financial Performance a/ (US$ million of 1979) 1979 1980 1981 1982 1984 1986 1988 Production (000 ton) 600 850 1,000 1,000 1,000 1,000 1,000 Net Sales 218.7 288.6 309.0 315.0 324.0 310.0 330.0 Transport Cost 16.5 10.6 11.5 11.0 11.0 10.5 11.0 Operating Cost 186.1 180.7 175.5 170.4 165.4 157.1 165.4 Financial Charges 27.8 22.4 17.7 13.9 7.8 3.7 - Sub-Total (11.7) 74.9 104.3 119.7 139.8 138.7 153.6 Depreciation 22.0 22.5 22.5 22.5 22.5 22.5 22.5 Other Charges 7.5 7.5 12.7 9.5 7.2 1.0 1.4 Net Profit Before Taxes (41.2) 44.9 69.1 87.7 110.1 115.2 129.7 a/ See para. 5.16 for assumptions. Compliance with Covenants 5.24 SICARTSA has largely complied with the covenanted maximum debt-equity ratio of 60:40 as seen from SICARTSA's debt-equity ratios of 60:60 in 1976, 63:37 in 1977 and 62:38 in 1978. With the take-over by the Government of SICARTSA's debt to NAFINSA, to which the Government has already agreed, SICARTSA should be in a position to maintain the debt-equity ratio as agreed in subsequent years. However, SICARTSA was unable to comply with (a) the ratio of current assets to current liabilities as covenanted in the Guarantee Agreement, and (b) submission of audited financial statements within the agreed period of 6 months after the close of the fiscal years 1976 and 1977. In the Guarantee Agreement between the Government of Mexico and the - 60 - Bank, it was agreed that till such time as SICARTSA's production and sales reached a level of 450,000 tons during a period of six continuous months, the Government would make arrangements to provide SICARTSA with funds adequate to maintain its current assets at a level at least equal to or exceeding one and a half times its current liabilities at the end of the fiscal year concerned. In this context, SICARTSA's current ratios have been 0.29 in 1976, 0.63 in 1977 and 1.26 in 1978. As in the case of the debt-equity ratio, SICARTSA's current ratio is expected to improve following the implementation of the action plan to improve operational and financial performance. The Bank has also urged SICARTSA that, in future, audited financial statements should be ready more promptly after the end of the fiscal year than has been the case so far. D. Financial Rate of Return on Investment 5.25 The appraisal report estimated the financial rate of return (FRR) at about 10% and pointed out that the rate of return was most sensitive to possible increases in production costs, or to a start-up delay and capital cost overrun. The FRR is now expected to be about 5.5 to 6%. Annex 13 shows the financial cost and revenues streams used in the rate of return calculations. The decrease in the FRR is attributable to the adverse developments in all the relevant areas discussed above, e.g. a capital cost overrun of about 49%, operating costs which are expected to be about 55% over appraisal estimates even at full capacity, a delay of 9 months in start-up and a slower learning curve. E. Economic Benefits of the Project 5.26 The Mexican Government's main objectives in un6ertaking the SICARTSA Steel Project, import substitution and regional development (para 1.02), have largely been achieved. 5.27 At appraisal, the net direct foreign exchange savings due to import substitution from the project over its assumed operating period (1976-91) were estimated at US$1,714 million in 1973 prices (or about US$2,690 million in 1978 prices). In comparison, it is expected that the project will now lead to foreign exchange savings of about US$2,470 million (Annex 14). The shortfall of about USS220 million is largely on account of an increase in the cost of imported materials and in foreign debt service charges (both amortization and interest) as compared to appraisal, and to a slower-than-expected production build-up till 1979. This has been offset to some extent by higher inter- national steel prices than foreseen at appraisal. 5.28 SICARTSA has contributed substantially to regional development of the Lazaro Cardenas region. In 1978, SICARTSA employed about 6,200 persons, accounting for about 25% of the economically active population of the Lazaro Cardenas municipal region, and, probably, for a higher share of total employ- ment in the region in view of prevailing unemployment and underemployment. SICARTSA has also directly and indirectly contributed to the development of supporting infrastructure in the region. The port, which is one of the principal assets of the region, was originally constructed to meet SICARTSA's - 61 - needs though other potential users have now appeared. Similarly, the railway link between Las Truchas and Nueva Italia will also initially be mainly on SICARTSA's account, but other uses can now clearly be foreseen as commercial traffic through the Lazaro Cardenas port is expected to increase. Apart from these, SICARTSA has directly stepped in to meet specific infrastructure requirements as evidenced by its expenditures on construction and maintenance of housing, schools and other social facilities, as well as in the construc- tion and improvement of connecting and access roads, airport improvement etc. SICARTSA also maintains a training center for personnel, the benefits from which are shared with the rest of the economy as trainees leave to accept employment in other regions. 5.29 SICARTSA's potential for generating additional employment through "linkage" and other indirect effects was estimated in the Bank's appraisal report for Stage II, as the creation of 20,000 new jobs in the city of Lazaro Cardenas and about 30,000 in the project area. While this potential has not yet been realized due to the postponement of Stage II, the indirect employment impact has been substantial, though it has been manifested largely outside the Lazaro Cardenas area, principally due to the hesitation of entrepreneurs so far to invest in Lazaro Cardenas. 5.30 The project's economic rate of return (ERR) is currently estimated to be approximately 9 to 9.5% as compared to 12-13% expected at appraisal. The basis for the calculation is given in Annex 15. The reasons for the decrease have been detailed earlier in this part under Sections A to D. F. Labor and Social Aspects 5.31 The social environment of Lazaro Cardenas has in the past been a major cause of discontent, and resultant absenteeism and turnover proved to be a serious constraint to the build-up of SICARTSA's production (para. 5.03). Efforts are underway to improve this situation, such as the Bank project for the regional development including improvement of living conditions in Lazaro Cardenas 1/, and various Government programs and independent efforts by SICARTSA. The labor-related problems affected management's efforts to in- crease productivity and forced SICARTSA to maintain a bigger payroll than it would have under more stable conditions. 5.32 The results of improvements in conditions are reflected in the decreased turnover. Turnover was about 42% in 1977, but as a consequence of the various efforts by authorities and SICARTSA declined to an average of about 15% for 1978 and to about 14% (on an annual basis) at the end of 1978. Particular progress has been achieved with regard to workers for whom turnover decreased to an average of 13% in 1978. Considerable improvements also have been achieved in reducing absenteeism. While absenteeism in 1977 was extremely high, in 1978, it seems to be under control and at a reasonable level,-and it shows a further declining trend from about 2.4% in January to 1.5% in November. 1/ Lazaro Cardenas Conurbation Development Project, Report 1904-ME of April 4, 1978. - 62 - G. Environmental Aspects 5.33 Although pollution control laws and regulations have been in existence in Mexico for only a few years, SICARTSA from the outset has re- cognized the need to exercise control over all aspects of environmental pollution, and towards this end, has installed pollution control equipment in all major areas - mines, pellet plant, blast furnace, steel plant, rolling mills, power plant and oxygen plant - as expected at appraisal. A list of the principal equipment involved is given in Annex 17. Overall, the equipment has been functioning satisfactorily; there have been some cases, however, where a lack of imported spares has caused equipment to malfunction e.g. in the lime and pellet plants and BOF shop; future ready availability of spares is expected to curtail such occurrences. Currently there is no systematic monitoring of pollution control within SICARTSA. However, the Mexican Government has instituted new reporting requirements in June 1978 and to meet these, SICARTSA is considering setting up a special group under the General Technical Services Department, whose function will be to coordinate matters relating to pollution control. VI. THE BANK'S ROLE A. Project Formulation and Supervision 6.01 The Bank's role in the formulation of the project was multi-fold. It was instrumental in convincing the Mexican Government authorities and the Company of the need for technical assistance. SICARTSA then selected an operat- ing partner (BSC) to review the prefeasibility study completed by John Miles & Partners. BSC further assisted SICARTSA in the design, procurement, construc- tion, commissioning, and early operation of the project, and in training of personnel. Because of a lack of coordination in the growth of the steel sector and because of the largely unplanned and unbalanced nature of steel sector development, the Bank advised the Mexican Government to form an Iron and Steel Coordinating Commission (CCIS) to plan for the long-term development of the steel industry. CCIS has become an efficient institution of planning and coordination in the steel sector. The Bank was also instrumental in urging the Mexican Government to commission the first comprehensive study of the existing status and future prospects of the Mexican steel industry. This was carried out by the Batelle Institute of the U.S. in 1973-74. By approving the project, the 3ank encouraged bilateral agencies to participate in financing and SICARTSA gathered relatively easily the required funds at very favorable terms and conditions. The introduction at the Bank's request of international competitive bidding even for bilaterally financed packages (para 1.19) made it possible to acquire foreign equipment at very favorable p:ices. The Bank also supervised the bid evaluation of the bilaterally financed packages and persuaded SICARTSA to use the same procedures as for international competitive bidding. During construction, the Bank played a role in helping keep project implementa- tion on time. For example, the Bank helped expedite decision maKing by con- vincing SICARTSA to create a Decision Committee which could take procurement decisions instead of the SICARTSA Board. The Bank also u:ged SICARTSA to proceed further with the exploration of iron ore deposits to dentifv proven reserves Eor at least 20 years. During appraisal, the Bank recognized - 63 - the importance of the regional aspects and the development of social infra- structure. Substantial delays, however, took place in this regard. During supervision, the Bank continued to stress the importance of the development of infrastructure, and now through the Lazaro Cardenas Conurbation Development Project is playing a key role in the development of the physical infrastructure of the region and in the advancement of planning and management capabilities through a technical assistance component of the same project. The Bank recommended that SICARTSA follow environmental standards in force in indus- trialized countries, specially in terms of air and water pollution. Recently, the Bank played an active role in urging SICARTSA to prepare a plan of action that would make SICARTSA financially viable. 6.02 Since the appraisal of the project, Bank staff has devoted at least 38 man-weeks to the supervision of the project 1/. Discussions with SICARTSA management during these missions were considered to be most positive by the Bank, the Company and the Mexican authorities. During implementation and after start-up, financial covenants were helpful in urging the Government to make money available to the Company and to increase prices to a realistic level. I/ For the reasons explained earlier in the Basic Data Sheet, the acttal time spent on supervision of the project may be substantially more. - 64 - ANNEX 1 MEXICO LAS TRUCHAS STEEL PROJECT PRODUCTION FACILITIES The principal production facilities are the following: -- Iron-ore mines; -- Primary, secondary, tertiary crushing and homogenization yard; -- One concentration plant with a production capacity of about 1.6 million tons per year; -- Lime-stone quarry, calcining and hydrating plants; -- Raw material handling and storage equipment for coal, -ellets and fluxes; -- A pelletization plant with a production capacity of about 1.85 million tons per year; -- Two batteries of 30 coke ovens with a production capacity of about 560,000 tons per year; -- One blast furnace with a daily production capacity of 3,300 tons; -- A B.O.F. steel plant with 2 vessels of 120 tons with a production capacity of about 1.15 million tons per year; -- An oxygen plant with 2 units of 230 tons/day; -- 3 continuous-casting units with 6 strands each, with a yearly casting capacity of 1.1 million tons; -- A rod and bar mill with a yearly capacity of 500,000 tons of finished products; -- A bar and light sections mill with a yearly capacity cf 500,000 tons of finished products; -- A power plant including three high pressure steam generators, two blast furnance turbo blowers and two 13.5 MVA/10.7 MW pass out/condensing turbo alternators; -- Utilities including water treatment facilities, compressed air, BF and CO gas distribution systems, workshops, laboratories and administrative buildings. Industrial Projects Deoartment June 1979 MEXICO LAS TRUCHAS STEEL PROJECT IMPLEMENTATION SCHEDULE PERIOD YEARS No. Ce AREA 1972 1973 1974 1975 ' 1976 Center 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 11 MINES u m -m- 12 2 13 CONCENTRATION PLANT - 1 m l oj_ 14 t 3 15 LIMESTONE MINES e ma ~M= 0 a m= i r M 21 DOCK -- - 5 31 PELLET PLANT - - - 6 33 COKE PLANT kwmp moso 7 35 LIME PLANT - - m m 8 41 BLASTFURNACE R 'In- 9 51 BOF r rmZ [mZ -- 10 52 CONT. CASTING . .....:. . . 11 61 ROLLING MILL BUILDING L 12 62 BAR MILL 13 63 ROD MILL - T mmm 14 71 OXYGENPLANT I um i a ma 15 72 POWER PLANT e efld u§i - 16 73 DISTRIBUTION OF ENERGY - 17 74 WATERTREATMENT - 18 15/16 GENERALSERVICES 1 77/79 t 19 a1 MAINTENANCE 88 .AND AUXILLARY BUILDINGS, ga N APPRAISAL ESTIMATE u~m R E A L World Bank - 19862 - 66 - ANNEX 3 MEXICO LAS TRUCHAS STEEL PROJECT REASONS FOR DELAYS IN PROJECT COMPLETION (months) Detailed Construction & Total Engineering Procurement Fabrication Start-up Facility or Item Delay Delay Delay Delay Delay Ore mining 13 1 1. 3 8 Ore processing & slurry pipeline 11 1 1 2 7 Limestone quarry 13 2 2 2 7 Raw matrials handling 11 1 4 6 Pellet Plant 12 1 2 9 Coke ovens 10 1 1 4 4 Lime burning plant 10 1 2 2 5 Blast furnace 5 2 3 Steel making plant 7 1 1 2 3 Continuous casting 9 1 1 2 5 Mill building 5 1 1 3 Light section mill 7 1 3 3 Rod mill 10 2 4 4 Oxygen plant 10 1 4 4 Power plant 11 1 1 3 6 Electrical dis- tribution System 14 1 1 5 7 Water services system 5 2 1 2 General services 14 1 4 4 5 Control engineeing workshops 14 2 3 5 4 Industrial Projects Depatment June 1979 MEXICO LAS TRUCHAS STEEL PROJECT PROJECT COST BY PRINCIPAL FACILITIES - APPRAISED AND ACTUAL (US$ million) ------ - --------------------------------Appraised--------------------------- -------------------------------Actual----------------------------- Plant, Spares, Plant, Spares, Services, Insurance & Erection & Structural Services, Insurance Erection & Stru:tural Facility Freight Commissioning Civil Works Works Total & Freight Comissioning Civil Works Wor! s Total Mine & Quarry 8.2 0.3 1.0 0.1 9.6 5.4 3.7 2.1 0.2 11.4 Crushing & Concentration 14.4 3.0 7.1 1.1 25.6 28.9 20.3 11.5 1.7 62.4 Slurry Pipeline 1.1 0.8 1.0 0.0 2.9 2.2 1.5 0.8 0.2 4.7 Pellet Plant 15.5 4.5 3.7 1.8 25.5 17.9 17.4 4.3 3.0 42.6 Blast Furnace 20.7 2.9 5.2 3.7 32.5 25.6 19.8 10.5 6.0 61.9 Basic Oxygen Furnace 27.9 8.5 6.7 4.9 48.0 35.1 18.7 8.0 8.0 69.8 Continuous Casting 15.3 2.4 5.2 2.2 25.1 19.1 10.2 4.4 4.2 37.9 Bar Mill 39.2 11.5 8.0 10.3 69.0 35.0 21.6 9.2 11.5 77.3 Rod Mill 40.9 11.6 13.0 - 65.5 39.0 24.0 10.4 13.0 86.4 Oxygen Plant 5.6 1.4 0.5 - 7.5 4.9 5.0 0.7 0.5 11.1 Lime Kiln 4.3 1.2 0.5 0.3 6.3 5.2 5.0 1.2 0.3 11.7 Docks and Raw Material Handling 19.6 4.4 4.1 0.1 28.2 13.2 13.6 5.5 0.7 33.0 Coke Ovens 25.7 6.0 5.2 - 36.9 34.1 32.9 8.1 2.0 77.1 Fluid, Electrical Services & Power Plant 51.5 13.3 6.5 1.9 73.2 48.5 49.9 7.8 4.5 110.7 Workshops, Labs & Offices 18.7 1.7 12.6 2.4 35.4 15.3 6.0 19.6 5.5 46.4 Site & Temporary Services 1.4 10.8 12.2 1.6 1.0 22.8 25.4 Insurance 3.4 3.4 Sub-Total 313.4 73.5 91.1 28.8 506.8 331.0 250.6 126.9 61.3 769.8 Design and Engineering 30.8 76.0 TOTAL FIXED ASSETS 537.6 845.8 Preoperating Expenses 70.0 86.0 Working Capital 28.0 31.0 Interest during Construction 42.9 45.9 TOTAL FINANCING REQUIRED 678.5 1008.7 Industrial Projects Department June 1979 X4 - 68 - ANNEX 5 MEXICO LAS TRUCHAS STEEL PROJECT EQUIPMENT FINANCED BY IBRD LOAN Appraisal Actual US$ Million % US$ Million % I. Plant and Equipment 62.0 88.6 64.7 92.4 of which: (a) Iron making equipment 19.0 27.1 including blast furnace, auxiliary equipment and spare parts (b) Iron ore pelletizing 21.7 31.0 equipment and spare parts (c) Building structure and 2.5 3.6 rolling mills (d) Other equipment and spare 21.5 30.7 parts II. Interest and charges on the loan accrued on or before March 31, 1976. 8.0 11.4 5.3 7.6 Total 70.0 100.0 70.0 100.0 Industrial Projects Department June 1979 - 69 - ANNEX 6 MEXICO LAS TRUCHAS STEEL PROJECT SCHEDULE OF DISBURSEMENTS OF WORLD BANK LOAN (US $ million) Year Quarter Appraisal Estimate Actual By Quarter Cumulative By Quarter Cumulative 1973 IV 3.4 3.4 0 0 1974 I 4.2 7.6 2.3 2.3 II 8.6 16.2 4.2 6.5 III 15.5 31.7 2.0 8.5 IV 16.1 47.8 6.4 14.9 1975 I 8.2 56.0 10.8 25.7 II 3.1 59.1 15.0 40.7 III 1.7 60.8 10.4 51.1 IV 1.3 62.1 6.5 57.6 1976 I 1.3 63.4 2.8 60.4 II 1.3 64.7 4.2 64.6 III 1.0 65.7 0.5 65.1 IV 1.0 66.7 0,8 65.9 1977 I 1.3 68.0 0.7 66.6 II 1.0 69.0 2.2 68.8 III 0.5 69.5 0.7 69.5 IV 0.5 70.0 0.5 70.0 Total 70.0 70.0 70.0 70.0 Industrial Projects Department June 1979 - 70 - ANNEX 7 MEXICO LAS TRUCHAS STEEL PROJECT SICARTSA'S SUBSCRIBED SHARE CAPITAL 1/ June 1973 June 1976 December 1978 (Appraisal - Stage I) (Appraisal - Stage II) (Current) US$ US$ US$ million % million % million % Federal Government 20.4 51.0 269.3 51.0 381.3 69.8 of Mexico National Financiera 10.0 25.0 132.0 25.0 84.1 15.4 S.A. (NAFINSA) Altos Hornos de 4.8 12.0 63.4 12.0 40.9 7.5 Mexico S.A. (AHMSA) Federal Government 4.3 10.8 62.8 11.9 39.6 7.2 Trust Fund Mr. Bernardo Quintana 0.5 1.2 0.5 0.1 0.3 0.1 (Private Industrialist) Sub-Total 40.0 100.0 528.0 100.0 546.2 100.0 Federal Government -- -- -- -- 48.5 - Subsidy Total 40.0 -- 528.0 -- 594.7 - 1/ All figures are expressed in current US dollars. Exchange rates used for converting pesos into US dollars are US$1 12.5 pesos up to August 1976 and US$1 = 22.7 pesos in 1978. Industrial Projects Department June 1979 一71一 ANNEXS ……：甘… 工ndustria工P了oj已c七sD已par七二en七 June 1979 72 - ANNEX 9 Mexico LAS TRUCHAS STEEL PROJECT PRODUCTION PERFORMANCE ('000 tons) 1976 1977 1978 Appraisal Actual Appraisal Actual. Appraisal Actual Pellets 272 - 908 806 1,452 952 Pig Iron 160 - 534 522 854 562 Steel 175 - 583 215 933 570 Billets 158 - 527 206 842 463 Finished Products 150 - 500 148 800 360 - Reinforcing bars 76 - 253 98 404 182 - Bars 21 - 70 11 112 62 - Wire rod 26 - 87 25 140 70 - Light sections. 20 - 65 14 104 46 - Spring flats 7 - 25 - 40 - Capacity Utilization 15% - 50% 15% 80% 36% (in terms of finished products) Industrial Projects Department June 1979 - 73 - ANNEX 10 MEXICO LAS TRUCHAS STEEL PROJECT HISTORICAL PROFIT AND LOSS STATEMENTS (Million US$) 1977 1978 (Jan. - Nov.) 1978(Jan.-Deca/ (audited) (unaudited) (estimated) Net Sales 23.0 102.5 111.8 Cost of goods sold 55.6 112.7 122.9 Gross profit ( 32.6) ( 10.2) ( 11.1) Administrative expenses ) ( 27.7) ( 30.2) ( 23.7) Sales expenses ) ( 1.1) ( 1.2) Write-off on inventories ( 13.1) - - Financial charges ( 69.0) ( 71.2) ( 77.7) Other income - 6.1 6.6 Sub-Total (138.4) (104.1) (113.6) Depreciation, amortization ( 6.6) ( 11.9) ( 13.0) Total net income (145.0) (116.0) (126.6) a/ Estimates for January to December 1978 are based on actual performance for January to November as shown. Industrial Projects Department June 1979 MEXICO LAS TRUCHAS STEEL PROJECT HISTORICAL BALANCE SHEETS (MILLION US $) Asaets 1976 1977A/ 1978-b/ Liabilities and Equity 1976/ 1977a/ b/81 Cash and Banks 12.7 15.2 11.6 Short-term debt to NAFINSA 16.0 91.2 9.3 Receivables -- 14.6 16.9 Short-term debt to other banks 22.3 26.2 34.0 other loans 1.8 6.2 3.5 Sul-pliers and Contractors 99.1 51.4 45.3 Finished products 0.6 11.2 11.1 Inventories Taxes and Financial Other Inventories 33.6 81.3 77.1 Charges Outstanding 27.9 35.4 4.8 Current Assets 48.7 128.5 120.2 Current Liabilities 165.3 204.2 95.4 -41 Plant and Equipment 830.8 777.1 770.2 Long-term debt to suppliers 0.3 Subuidiaries 25.9 23.8 25.5 NAVINSA 214.0 208.7 229.1 Preoperation expenses 32.5 29.6 28.8 Long-term debt to toehr banks 249.9 264.2 301.3 Paid-in capital 308.4 281.9 318.9 Tot"! Actetz 937_9 959-0 944.7 Total Liabilities and Equity 937.9 959.0 944.7 Debt/Equity 60:40 63;37 62:38 Current Ratio 0.29 0.63 1.26 a/ As of December 31 and audited b/ As of November 31 and unaudited Source SICARTSA Industrial Projects Department June 1979 - 75 - All,x 12 MEXICO LAS TRUCHAS STEEL PROJECT PROJECTED BALANCE SHEIETS, 1979 TO 1985 (US$ million of 1979) 1979 1980 1981 1982 1983 1984, 1985 A. Assets Accounts Receivable 39.1 48.6 53.0 53.5 53.7 54.0 55.0 Net Inventories 71.0 76.0 80.1 82.7 82.7 83.4 84.4 Cash & Other Current Assets 11.0 30.2 70.5 125.5 184.9 257.3 337.3 Total Current Assets 121.1 154.8 203.6 1. z 394.7 476.7 Net Fixed Assets 499.0 487.9 465.4 442.9 420.4 397.9 375.4 Investment in Subsidiaries 4.6 2.4 2.4 2.4 2.4 2.4 2.4 Preoverating & Start-uo Exoenses for Amortization 21.8 18.2 15.2 11.3 8.2 5.0 1.9 Total Assets 646.5 663.3 686.6 718.3 752.3 800.0 856.4 B. Liabilities Accounts Payable 35.5 41.0 43.3 43.5 43.5 43.5 43.3 P1zat fortion of Long-Term Debt 33.0 33.2 33.4 33.4 32.6 33.2 33.8 Income Tax - -.7 Profit Sharing - 2.7 4.6 5.5 6.0 6.9 7.9 Dividend Distribution - 10.5 17.8 21.2 22.9 26.7 30.2 Total Current Liabilities 68.5 83.4 99.1 103.6 105.0 110.3 115.4 Long-Term Debt 238.2 205.0 171.6 138.2 105.6 72.4 38.6 Reserve for Blast Furnace 1.7 4.0 - 2.3 4.6 6.9 9.2 Total Long-Term Liabilities 239.9 209.0 171.6 140.5 110.2 79.3 47.8 Paid-in Capital 556.5 593.1 593.1 593.1 593.1 593.1 593.1 Subsidies for Operations 90.7 54.1 54.1 54.1 54.1 54.1 54.1 Retained Earningz for Period (39.5) 28.8 49.0 58.3 62.9 73.3 82.8 Accumulated Retained Earnings (269.6) (309.1) (280.3) (231.3) (173.0) (110.1) (36.8) Total Liabilities 646.5 663.3 686.6 718.3 752.3 RIM00 856.4 Debt: Equity Ratio 42:58 36:64 29:71 23:77 17:33 12:88 7:93 Current Ratio 1.8 1.9 2.1 2.5 3.0 3.5 4.0 Indusrial ~Projects Department Juni 1979 - 76 - ANNEX 13 MEXICO LAS TRUCRAS STEEL PROJECT FINANCIAL STREAMS FOR RATE OF RETURN CALCULAT"ONS (In current US dollars till 1978 and constant US dollars thereafter) (US$ million) Capital Operating Net Net Year Costs Costs Revenue Benefits (1) (2) (3) (4W -(-(2) 1973 42.0 - - - 42.0 1974 164.6 - - -164.6 1975 394.4 - - -394.4 1976 293.0 - - -293.0 1977 82.2 75.6 22.1 -135.7 1978 32.5 146.4 112.7 - 66.2 1979 201.6 218.7 - 17.1 1980 191.0 288.6 + 97.3 1981 187.0 309.0 +122.0 1982 181.4 315.0 +133.6 1983 178.4 318.0 +139.6 1984 176.4 324.0 +147.6 1985 176.4 330.0 +153.6 1986 167.6 310.0 +142.4 1987 176.4 330.0 +153.6 1988 176.4 330.0 +153.6 1989 176.4 330.0 +153.6 1990 176.4 330.0 +153.6 1991 167.6 310.0 +142.4 1992 176.4 330.0 +153.6 Industrial Projects Department December 1978 MEXICO LAS TRUCHAS STEEL PROJECT DIRECT FOREIGN EXCHANGE SAVINGS DURING OPERATING PERIOD (IN MILLION US DOLLARS--CURRENT VALUES TILL 1978 AND CONSTANT THEREATER) 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1. Gross Foreign Exchange Savings 21.5 98.5 184.5 282.6 312.6 332.5 339.0 352.0 365.0 343.0 365.0 365.0 365.0 365.0 343.0 2. Operating Expenses Coal 23.4 24.7 42.3 52.6 41.6 51.9 51.8 51.8 51.8 41.4 48.4 51.7 51.6 51.6 41.3 Maintenance Materials 7.6 9.9 9.7 9.8 9.8 9.9 9.9 9.9 9.9 9.9 9.8 9.9 9.9 9.9 9.8 Others 0.5 0.6 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 Sub-Total 31.5 35.2 52.7 63.1 52.1 62.5 62.4 62.4 62.3 52.0 58.9 62.3 62.2 62.2 51.8 3. Debt Service Amortization 12.2 21.1 105.3 46.5 58.6 63.9 54.5 53.6 54.2 54.8 52.1 28.4 20.9 20.9 5.2 Interest 57.4 55.4 56.4 67.7 51.8 47.5 38.6 32.7 26.8 20.9 16.0 9.5 5.9 2.8 0.2 Sub-Total 69.6 76.5 161.7 114.2 110.4 111.4 93.1 86.3 81.0 75.7 68.1 37.9 26.8 23.7 5.4 4. Net Foreign Exchange Savings (1-2-3) -79.6 -13.2 -29.9 105.3 150.1 158.6 183.5 203.7 221.7 215.3 238.0 264.8 276.0 279.1 285.8 Industrial Projects Department June 1979 - 78 - ANNEX 15 Page 1 MEXICO LAS TRUCHAS STEEL PROJECT CALCULATION OF THE ECONOMIC RATE OF RETURN The project's economic rate of return has been calculated by making the following adjustments to the cost and benefit streams used for calculating the financial rate of return: 1. Prices: Over 75% of SICARTSA's domestic sales of finished prod- ucts are in Mexico City. Domestic prices have therefore been replaced by the prices of equivalent imports delivered to Mexico City. These have been determined on the basis of current EEC f.o.b. export prices which average US$310 per ton for SICARTSA's product mix, further adjusted for costs of sea transport, insurance and handling up to the Mexican port estimated at US$55 per ton. These prices are in line with the US trigger prices based on the costs of production of Japanese producers which range between US$290 to US$330 per ton f.o.b. Japan, with a. similar average of about USS310. Export prices have been estimated on the basis of prevailing domestic prices in industrial countries ranging between US$330 to $350 per ton. Allow:.ng for transport and handling costs, a realisable export price of US$300 per t-on has been adopted. The assumption is further made that both sets of prices would continue to be maintained at the present levels in real terms till 1992, i.e. the remaining period of the project's assumed life of 18 years. 2. Capital Costs: The US dollar equivalent of the local currency component of capital costs has been calculated on the basis of estimated real exchange rates for the peso against the US dollar during the relevant period of 1973 to 1977. These estimates have been used as an approximation for shadow exchange rates for the period. The exchange rate of the peso against the US dollar was revised in August 1976 from 12.,5 to 22.5 and the average rate during 1977 was 22.6. Using this as the base, the corresponding average real exchange rates against the US dollar for the period 1973 to 1976 were estimated on the basis of trade-weighted adjustments of relative infla- tion in Mexico and in its principal trading partners to be 19.5 pesos for the period 1973 to 1975 and 20.6 p,2sos for 1976. 3. Taxes and Subsidies: Adjustments to operating costs include reduc- tions to reflect average income taxes of 14% (SICARTSA's estimate) of total wages and salaries and turnover taxes of 2% on purchases of local raw materials and intermediate products. Revenues from exports have been adjusted downwards by 5% on account of a 1.8% sales tax on exports absorbed by SICARTSA and 7% subsidies on exports. 4. Transport Costs: Following the completion of che Las Truchas-Nueva Ttalia rail link in late 1979, SICARTSA would have the alternative of cheaper transport for its Zinished :roducts. The differential between road and rail costs is currently estimated to be approximately USS8-10 per ton, and it has been assumed that SICARTSA could benefit to this extent .from 1980 onwards. - 79 - ANNEX 15 Page 2 5. Port Costs: In the appraisal report, the capital costs of the port were assigned on an annualized basis to SICARTSA as the latter was the only potential user of the port at that time. By 1982, however, SICARTSA's share in total port traffic is expected to decline to less than 50%. Further declines can be expected till 1992 unless Stage II of the project is imple- mented. In view of this, no adjustment is made to the cost stream on this account. Industrial Projects Department June 1979 - 80 - ANNEX 16 MEXICO LAS TRUCHAS STEEL PROJECT EXCHANGE RATES (X) AND WHOLESALE PRICES (P) IN :XICO AND IN PRINCIPAL TRADING PARTNERS MEXICO USA JAPAN GERMANY BRAZIL VENEZUELA X P X P X P X P X P X P 1970 12.5 59.8 1.0 63.1 358.15 63.8 3.646 73.8 4.494 36.54 4.499 66.0 1971 12.5 62.1 1.0 65.2 348.03 63.3 3.481 77.0 5.304 44.01 4.501 67.3 1972 12.5 63.8 1.0 68.1 303.11 63.8 3.189 79.0 5.960 52.10 4.400 70.0 1973 12.5 73.9 1.0 77.0 271.22 73.9 2.673 84.2 6.128 60.70 4.305 75.1 1974 12.5 90.5 1.0 91.5 291.51 97.1 2.592 95.5 6.843 78.52 4.285 87.5 1975 12.5 100.0 1.0 100.0 296.80 100.0 2.461 100.0 8.204 100.0 4.285 100.0 1976 15.43 122.3 1.0 104.6 296.55 105.1 2.518 103.9 10.770 143.16 4.290 107.2 1977 22.57 172.6 1.0 111.0 268.51 107.0 2.322 106.6 14.114 204.00 4.293 115.0 1978-122.75 198.5 1.0 121.0 217.01 105.0 2.039 107.5 18.075 256.50 4.293 126.0 1/ Estimates. Note: Exchange rates are expressed in terms of units of domestic currency per US dollar. Wholesale prices are expressed as index nmbers with 1975 = 100. Industrial Projects Dept. June 1979 - 81 - ANNEX 17 MEXICO LAS TRUCHAS STEEL PROJECT ECOLOGY Air and Water Pollution Control Facilities Installed Plant Equipment 1. Iron-ore crushing Pulverization system with water recircula- tion to recover dust generated by crushing operations. 2. Pellet plant Dust collection system. 3. Raw material handling Shelters for conveyor belt system. 4. Coke plant Scrubbers for coal pulverizer. Quenching stations for dust removal. Coal charging car, smokeless type. Biological treatment plant. 5. Calcining plant Dust collection system. 6. Blast furnace Gas cleaning system with gas recovery. Water cooling and circulation system. 7. BOF shop Primary gas cleaning system. Water cooling and recirculation system. 8. Rolling mills Recovery of scale. 9. Continuous annealing Water cooling and recirculation system. 10. Oxygen plant Water cooling and recirculation system. Industrial Projects Department June 1979 { 뺑 IBRD-12021 ,JANUARY 1976 -30- Cý BA. E X l C 0' MAJOR STEEL:PRODUCTIOUCENTERS 0 190 2CO 300 400 SCIT KI LOMETERS GUZ F OF A4EAl C 0 TI 14-lid -E 111,47AN jiCA2-AN T." R.,OS PEIVINSLIL A d. WHER MAIN R.A.S o Al- Al CAN ROAD PLANNED QR UNDER CONSTRUCTIDN LWAIS ",,m FULLY INTEGRATED STEEL PRODUCTIONI CENTERS GLIERRER0 -OR NON-INTEGRATED STEEL PRODUCTION CENTERS IS-I-I, A-Ifi.g, m..) T. DEVELØPMENT REGIONS (STATES OF MICHOACAN GUERRERW STATE SOUNDARIES A." INTERNATIONAL BOUNDARIES L %, 11A1 1.1 A HONDURAS T.- l. 14  103°40 1 To Nva//// 103j45' 10 CL Los Amates - 002ý -~ ',of MEXICO Mexico 6RER Qi Mexi A PREA/ GUERRERO -International Boundaries The uunattsk~~n on thisý map d, not -- 1°05 mpt enarsem nt r aceptace by the San Juan ana ris a 0,re> LAS TRUCHAS R EL VOLCANQ LMANGO \IIRON ORE DEPOSITS SANTA CLARA 5 OF (J MESTONE MNE La Mira JOSE Ma MORELQS DAM --STEEL PLANT SITE (LA VILLRTAS 4 MI/CH0A CAN IVV PROJECTED CITY EXPANSION E RROTE PVE ROADS iJ(SAN SIDRO) Acalpican Lo Villita UNPAVED ROADS 7- SATE BOUNDARY ~RIVERS Las Guacamayas -18°0o \ Zeccatul 1800- 1 ~La Orilla 7> / Playa Azul 70' Lazaro Cådnas MEXICO SIDERURGICA LAZARO CARDENAS-LAS TRUCHAS 17°55' GENERAL LOCATION MAP a 0 Crdtýrci C a,~1 2 3 4 5 _ -cc 1434KILOMIERS 103'4 0' 1030451 1031,50, 103>55 <'