Mexico - Third CFE Power Project (Vol. 1 of 2) : Report

RESTRICTE D FILE COPY Report No. P-158 This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS of the PRESIDENT to the EXECUTIVE DIRECTORS on a PROPOSED LOAN to the COMISION FEDERAL DE ELECTRICIDAD and NACIONAL FINANCIERA, S.A. for ELECTRIC POWER DEVELOPMENT in the UNITED MEXICAN STATES April 22, 1958  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT ADT RECCO-NMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE COMISION FEDERAL DE ELECTRICIDAD AMD NACIONAL FINANCIERA, S.A. FOR THE EXPANSION OF PGWER GENER- ATING ASD TRANSMISSION FACILITIES IN MEXICO 1. I submit herewith the following Report and Recommendations on a proposed loan in an amount in various currencies equivalent to $34 million to Comision Federal de Electricidad (Comision) and Nacional Finaniciera, S.A. to finance the foreign exchange costs of expanding Comision1s generating and transmission facilities. PART I - HISTORICAL 27 The Bank has made two loans to Comision, the first for $24.1 million in 19L'9 (12 ME) and the second for $29,7 million in 1952 (56 ME). The hydro, steam and diesel plants and related facilities partly financed by these loans have added some 600,000 kw capacity to Comision's installations. 3. To meet the growing power demand, Comision is now engaged in an expan- sion program whose total cost has been estimated at about $250 million. Last fall Comision applied to the Bank for a loan to finance the foreign exchange costs of the major plants within the program which consist of fifteen instal- lations with a total capacity of 748,O0o kw and their related transmission facilities. 4. In October and November 1957, a Bank mission appraised Comision's program and reviewzed Comision's organization and procedures. Of the major plants included in the program there are four which are most urgently needed and on wjhich work is already under way. The other plants are less urgent or need further planning and engineering. It was agreed with Comision, therefore, that the Bank would at this time consider a loan for the first four plants and their related transmission facilities. 5. Formal negotiations began in Washington on March 17, 1958. The Mexican Government was represented by Mr. Raul Martinez Ostos, Assistant Director- General of Nacional Financiera, and Comision was represented by Mr. Carlos Ramirez Ulloa, the Director-General of Comision. Negotiations were concluded on April 11, 1958.  - 2 - 6. If the proposed loan is made, it would increase the total amount of Bank loans in Mexico to $186.3 million net of cancellations and refundings. The Bank has already made the following loans to Mexico: No. Borrower Purpose Amountl/ 12 ME Nacional Financiera and Fed- eral Power Comrmission Power $ 24,1 million 24 ME Mexican Light and Power Company, Limited Pow.er 26.0 million 33 1ME Consortium and Nacional Fin- anciera Private Industry 0.5 million-/ 56 ME Nacional Financiera and Ped- eral Pow,er Conmiissi II Power 29.7 million 103 PIE Ferrocarril del Pacifico Railroad Rehabilitation 61eO million 186 ME IMexic2n Light and Power Co:upany, Limited Power ll,0 million Total (Net of Cancellations and Refundings) .......... $152.3 million Amount Sold ....................................... . . . 14G 1 million 4$138, 2 million Amount Repaid ........... $11.3 million Less Repa-ments to Th-ird Parties .... . 5.7 million 5.6 million Net Amount Held by Bank (includes $808 not yet disbursed) .................. $132c6 million 7. Other projects which may come up for active consideration in the Bank in the near future, aside from the further expansion of Comisionts facilities, are those for the construction and rehabilitation of the Chihuahua-Pacifico railroad and for additional expansion of the facilities of the Mexican Light and Power Company, Limited. 1/ As of March 31, 1958. 7/ Loan 33 ME was originally for $10 million of which $9.5 million were cancelled.  - 3 - PART II - DESCRIPTION OF THE PROPOSED LOAN 8. The proposed loan would finance most of the foreign exchange cost of the construction of three hydroelectric plants and the expansion of an existing steam plant together with related transmission facilities. Comision's gener- ating capacity would thereby be increased by 413,600 kw. The loan would have the following characteristics: Borrowers: Comision Federal de Electricidad, a goverrment agency charged wfith the development of electric power in Mexico, and Nacional Financiera, S.A., which has been designated by the Mexi- can Congress the sole agency for the nesc tiation an- administra' :.cn of ex- te: 2al loans on behalf of Hexican Gov ernment, Guarantor: The United Mexican States. Amolnt: The equivalen-t in var-ious currencies of $34.0 mill -l Amortization: 43 semi-annual installments, August 1962 to August 1983. Interest Rate: 512e Commitment Charge: 3/4% per annum. Payment Dates: February 1 and August 1. PART III - LEGAL INSTRUMENTS AND LEGAL AUTHORITY 9. Drafts of the following legal instruments are attached (Nos. 1 and 2): (1) Loan Agreement (2) Guarantee Agreement 1o. The following provisions are of special interest: Loan Agreement (a) Section 5e0h provides that Comision shall not, without the prior approval of the Bank, incur any debt if as a result the aggregate amount req2ired in any fiscal year for service on all of its outstanding long-term debt would exceed  66-2/3% of the aggregate amount of revenues during a period of any twelve consecutive months out of the fifteen months last pre- ceding the date on which Comision proposes to incur such debt. (b) Section 5.11 provides that Comision shall take all necessary steps to obtain such rate adjustments as may be required to en- sure the continued operation and expansion of its business in accordance with sound financial and public utility practices. Guarantee Agreement (a) Section 3,07 provides that the Mexican Government shall take ell necessary action so that Comrision earns a reasonable return on its investment. ill Nacional F4nanciera and Comision are authorized to enter into the Loan Agreement by resolutions of their Boards of Directors and the guarantee of th.c United HexicaA States would be given pursuant to authorization by Congrcsse 127 The report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank is attached (No. 4). PART IV - APPRAISAL OF THE PROPOSED LOAN 13. A detailed appraisal of the projects (T.O. 166a) is attached (No, 5). The Projects 14. The projects consist of: (1) a 156,000 kw hydroelectric plant and auxiliary works on the Apulco River in the State of Puebla (Mazatepec); (2) a 1514,000 kw hydroelectric plant and auxiliary works using the existing Miguel Aleman flood control dam on the Tonto River in the State of Oaxaca (Temaxcal);  -5- (3) a 73,600 kw hydroelectric plant and auxiliary works on the Cupatitzio River in the State of Michoacan (Cupatitzio); and (4) a 30,000 kw turbo generator at the Guaymas steam plant with auxiliary works (Guaymas). 15. The power market for the four projects is well established. The projects will serve the regions of Mexico City, Puebla-Veracruz, Guadalajara and Sonora, which have all shown rapid economic growth during the last four years based on industrialization and a prosperous agriculture. AIl indications are that this growth will continue and an adequate supply of electric power will be one of the most important conditions of such further growth. As in- dicated in the Technical Report., the systems to be served now have restrictions of service and operate without anv reserve. The demand for electricity is likely to alsorb the additional capacity to be provided in one to three years. The four plants are all technically sound and represent efficient methods of providing power to their respective regions. The Financial Position of Co.ision 16. Comision's net operating revenues have so far been very low. From 1953 to 1956 they ranged from 151o to 3.3% of the investment ("investment" meaning here the fixed assets at historic cost, less provision for retirements and replacements, plus an allowance for working capital). The Technical Report shows that if the basic tariffs remained unchanged, the return on Comisioits total investment during the next ten years would range between 5.9% and 4.6%. Comision,would, therefore, require continued Government appropriations to carry on its program, if investment is to grow at the rate of 9% per year which has been assumed to be the growth in investment needed to meet the demand over the next few years. 17. Comision will agree to take all necessary steps to obtain a rate of return of at least 9% on the rate base of each of its major systems and to ask for additional adjustments, if necessary, to ensure the continued operation and expansion of its business in accordance with sound financial and public utility practice (No. 3a). The Government has informed the Bank that it con- siders a 9% rate of return on Comision's major systems reasonable in the present circumstances and that it will, in the future, take all necessary action in accordance with its laws so that Comision will continue to earn a reasonable return (No. 3b). j.60 One of the principal reasons why Comision has not been able to obtain fully satisfactory returns is the administrative delay in effecting rate adjust- ments. This could be remedied if Comision were permitted to effect those adjustments automatically subject, of course, to ex post facto review by the  - 6 - Tariff Commission. The administrative procedure could also be expedited if Comision were allowed to consolidate its smaller systems for the purposes of rate determination. Comision has informed the Bank that it will make studies and submit proposals along those lines to the Tariff Commission (No. 3c). The Bank wJill inform the Government that when the time comes for the Bank to con- sider further financing of Comision's program, it will, in the light of the record, consider what measures, if any, are necessary to ensure the prompt adjustment of rates (No. 3d). 19. The steps mentioned in the foregoing paragraphs, tSking into account for some time to come less satisfactory fina.rcial rc-sults in the smaller systems, are likely to raise the return on the investment of Comision as a whole over a period of about four years to about 7-8%. This rate would permit Comision to continue to expand its investments after 1962 by 9% per year with Federal Govern- ment appropriations substantially smaller than the recent average. 20. In the past, Comision's investments have not bien effectively coordin- ated with those of the interconnected companies. Some m-;lications have resulted and uneconomical irvestments have been made. Comision has agreed to initiate and maintain periodic consultations with the interconnected companies with a view to reach ng agreement on future investments. The Bank would not want to consider further financing of Comision!s ini;_etmenth program until substantial progre2s has been made in those consultations (No. 3e). Methods of Procurement 21. The orders for equipment required for the projects have been and will be placed on the basis of international competitive bidding. In the opinion of the Bank's engineers the selection of equipment by Comision is carried out satisfactorily and in line with sound utility practice. Comision would be re- imbursed from the loan account for the foreign exchange expenditures for the projects incurred after August 31, 1957. 22. Comision would be authorized to use funds from the loan account to cover the foreign exchange cost of component parts imported into Mexico for goods manufactured in Mexico when the cost of such components exceeds 10% of the total cost of the goods. Economic Situation 23. The economic position and prospects of Mexico were reviewed in the report on Mexico's Public Investment Program (1957-58) (WH-59a), which was transmitted to the Executive Directors on September 19, 1957 (Secretary's Memo- randum No. 57.136). This report indicated that the outlook for economic growth in Mexico is favorable. The Government has been increasing its investments to a level adequate to maintain economic growth. Private investment has shown a  - 7 - strong upward trend as a result of favorable economic conditions. Despite its reactions to any instability in domestic finances, the balance of payments position is basically strong because of the variety of exports, the high earn- ings from tourism, and the ability to produce locally a large percentage of essential consumer goods and an increasing amount of capital goods. The report concluded, however, that maintenance of an adequate rate of economic growth under conditions of stability would require that Mexico increase its savings, particularly the public sector by appropriate tax reforms and increases in prices of goods and services produced by Government enterprises. 24. Last year Mexico's rate of economic growth was reduced primarily because weather conditions adversely affected agricultural output. Investment increased at a faster pace than output in general, as a result of an 8% increase in public investment. Public investment did not increase by as much as had orig- inally been intended since the Government attempted to keep capital outlays within the limit of available financial resources. Even so, the public sector exerted inflationary pressures caused by a small deficit in the Federal Govern- ment budget, and by the financing of food subsidies and Governnent ent-errises outside the Federal budget. On the other hand, the restrictive policy toward private credit was continued. Money supply increased by 7% and domestic wnole- sale prices by 6% during 1957. 25. Due to the decline in export earnings and the continued high level of importz, there was a sizeable deterioration in the currei-. account balance of payments in 1957. However, there was only a moderate decline in gold and foreign exchange reserves (from $469 million in December 1956 to $441 million in December 1957) due largely to an inflow of capital. While there is likely to be a decline in earnings from metals and coffee exports in the next year or so, it is expected to be largely offset by increased earnings from other exports and tourism. The upward trend in imports levelled off. The maintenance of the present relatively strong international financial position depends essentially on the ability of the Government to maintain the Federal Government budget in a balanced position and to keep Central Bank financing of Government banks rnd public enterprises to a minimum. The Government is well aware of the need for these policies. 26. Mexico's external debt service has increased considerably in recent years because of the rise in medium-term credits from suppliers and private banks. However, Mexico's external public debt is being controlled by the Special Commission for External Financing which is pursuing a policy of keeping debt service within reasonable limits. In 1957, total debt service amounted to $131 million (or 11% of foreign exchange earnings), of which $83 million repre- sented service on suppliers' and private bank credits. Service on existing long-term debt is relatively stable during 1958-63, ranging between $48 and $57 million per annum (or between 3.7 and 4.5% of foreign exchange earnings). Service on the proposed loan of $34 million to Comision would amount to $2.7 million per annum, when full amortization begins in August 1962. Mexico should experience no difficulty in meeting this additional debt servicing obligation. Provided the Government continues to follow cautious economic policies and exercises restraint in medium-term borrowing, there should be margin for addi- tional long-term debt for productive purposes.  - 8 - Prospects of Fulfillment of Obligations 27. Comision's organization is on the whole sound and its management is well qualified. Comision has undertaken to review some of its financial and budgetary systems and the procedures followed in the operation of its plants and is retaining experts to assist in this review. Comision has also taken appropriate steps to ensure the adequate execution and operation of the projects including the retention of a consulting firm to assist in the design and to supervise the construction of the Mazatepec hydro project which involves some technical problems which are new to Comision. 28. The local costs of the projects will be financed mostly from re- investment of operating surplus, the 10% electricity tax and Government appro- priations. The Guarantee Agreement would provide that if the amount of local currency available to Coni;ion for carrying out the projects is inadeqlate, the Government wTould provide Ccirdsicn with the amounts of local currency needed to meet the deficiencv, 29. Conision should have no difficulty in earning the pesos reqTired to service the p2oposed loan. On the basis of the existing basic tariffs and of rate adjustner.Os to compenvate for sorme increased costs ji-.ch as labor and fuel, net operating ravenu-s betfre depreciation yuid, o. r tihe next ten yars., cover teLIl detit service flGm 1.7 to 3.5 tinr,s. I4li:ico .hould be able to pro- vide the necessary foreign exchange to service the proposed loan in addition to its existing debt. PART V - COMYPLIA1CE WITH APRTICLES OF AGRZEENT 30. I am satisfied that the proposed loan would comply wfith the Articles of Agreement of the Bank. PART VI - RECOIMENDATIONS 31. I recommend that the Bank make a loan to Comision Federal de Electri- cidad and Nacional Financiera, S.A. with the guarantee of the United Mexican States, in an amount in various currencies equivalent to $34 million for a total term of 25 years with interest (including coInirdssion) at 51!% per annum and on such other terms as are specified in the attached draft Loan and Guarantee Agree- ments and that the Executive Directors adopt a resolution to that effect in the form at-tached (No. 6). Eugene R. Black President Attachments. Washington, D. C. April 22, 1958