Peru - Bayovar Phosphate Engineering and Technical Assistance Project

Document of The World Bank FOR OFFICIAL USE ONLY Rport No. 7722 PROJECT COMPLETION REPORT PERU BAYOVAR PHOSPHATE ENGINEERING AND TECHNICAL ASSISTANCE PROJECT (LOAN 1888-PE) APRIL 7, 1989 Trade, Finance and Industry Division Country Department IV Latin America and Caribbean Region and Africa Technical lepartment 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.  ABBREVIATIONS AND ACRONYMS CENTROMIN - Empresa Minera del Centro del Peru (Central Mining Company of Peru) COFIDE - Corporacion Financiera de Desarrollo DAP - Diamonium Phosphate HIERROPERU - Empresa Hierro del Peru (Iron Company of Peru) IMF - Internatiouial Monetary Fund INI - Instituto Nacional de Industria (National Industrial Institute of Spain) MINEROPERU - Empresa Minera del Peru (Mining Company of Peru) PROBAYOVAR - Empresa Promotora Bayovar (Bayovar Promotional Company) SPCC - Southern Peru Copper Corporation TPY - Metric Tons Per Year TSP - Triple Super Phosphate CURRENCY EQUIVALENTS Currency Unit = Inti (I/.) AVERAGE EXCHANGE RATES 1979 US$1 = I/. 0.224 1980 US$l = I/. 0.288 1981 US$1 = I/. 0.422 1982 US$1 = Il. 0.698 1983 US$l - I/. 1.629 1984 US$1 - I/. 3.467 1985 US$1 = I/. 10.975 1986 US$1 = I/. 13.949 1987 US$1 = I/. 16.839 1988 US$1 - I/. 33.000 (April 1988) FISCAL YSAR January 1 - December 31  FOR OVICA USE OLY THE WORLD SANK Washington. D.C. 20433 U.S.A. April 12, 1989 umaAmDU( TO TEL EXCUTJVE DIECTORRS AID THE PRESIDENT SUBJECTs Project Completion Report on Peru - Bayovar Phosphate Engineering and Technical Assistance Project (Loan 1888-PE) Attached, for information, is a copy of a report entitled gProject Completion Report on Peru - Bayovar Phospnate Engineering and Technical Assistance Project (Loan 1888-PE)l prepared by the Trade, Finance and Industry Division, Country Department IV, Latin American and Caribbean Region and Africa Technical Technical Department. Full evaluation of this project has not been made by the Operations Evaluation Department. Attachment Tfhis document hss a metricted distribution and may be used by recipients only in the pCrrrfoace of their olic:al duties. Its contents may not otherwise be disclosed without Wcrld Bank autborhtion.  FOR OFmFCUIL USE ONLY PROJECT COMPLETION REPORT PERU BAYOVAR PHOSPHATE ENGINEERING AND TECHNICAL ASSISTANCE PROJECT (LOAN 1888-PE) TABLE OF CONTENTS Page No. Preface ..* * * ...** **** *********................... ... .... Basic Data Sheet ..... . . . .... ...... ... , ....... .... ii Htighligphts ................... iv I. Introduction ......................1 Economic Environment and Sectoral Performance ....... 1 Mining Sector ........... 0............................ . . 3 Phosphate Industry. ....... .. ......... 5 II. Project Preparation and Appraisal Objectives ....5 Preparation ... **........... ....5 Empresa Promotora Bayovar S.A. (PROBAYOVAR) .**e**. 6 PROBAYOVAR Shareholders ............................. 7 Major Issues Discussed during Loan Preparation and Negotiations ....................7 (a) Project Scope and Configuration ....... 7 (b) PROBAYOVAR Sharholder's Agreement ............. 8 (c) Market for Phosphate Fertilizers .............. 8 (d) Bank Commitment .................. 8 (e) Foreign Exchange Financing ......8........... 8 (f) Loan Processing Period 8 .... ........... 8 (g) Retroactive Financing .................. 8 Appraisal Objectives ........ ....................... 9 ftrlt.- Phase .....................9 Second Phase ............... 10 Project Cost and Financing ............................ 11 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.  Table of Contents (Cont.d) Page No. III. Project Implementation and Management ................. 11 Achievement of First ?hase Project Objectives ......... 11 Implementation of the Second Phase .................... 12 Achievement of First Phase Project Objectives ......... 13 The Phosphate Market Development ...................... 14 Project Management .... *..... ........ ... ........ ... 16 Performance of Consultants ............................ 16 Role of the Bank ...................................... 16 Reallocation of Loan Proceeds ......................... 17 Total Project Cost ...... .................. 17 Disbursements . .................... ... ........ *. * * * * . 17 IV. Conclusions .........******.***** .**.....*........ '-8 Overall Assessment ... .................... ............. 18 Lessons Learned ......... .. .. . .. . ................................. 19 ANNEXS 1 - PPOBAYOVARs Appraisal Project Cost ..................... 21 2 - PROBAYOVAR: Estimated Cost of Phosphate Investment ..... 22 3 - PROBAYOVAR: World Supply/Demand for Phosphate Fertilizer 23 4 - PROBAYOVAR: Phosphate Prices ........ ............... . 24 5 - PROBAYOVAR: Original, Revised and Actual Allocation of Loan Proceeds ............................ 25 6 - PROBAYOVAR: Total Estimate and Actual Cost ............. 26 / - Glossary of Technical Terms ............................. 27 8 - Conments Received from the Government and PROBAYOVAR .... 28 MAP: IBRD 15062  - i - PROJECT COMPLETION REPORT PERU BAYOVAR PHOSPHATE ENGINEERING AND TECHNICAL ASSISTANCE PROJECT (LOAN 1888-PE) PREFACE This Project Completion Report (PCR) reviews the performance of the BAYOVAR Phosphate Engineering and Technical Assistance Loan to the Republic of Peru channeled to Empresa Promotora Bayovar S.A. (PROBAYOVAR). As part of the Bank's first support in Peru to phosphate exploitation and processing, PROBAYOVAR was created in 1980 to carry out the project. Loan 1888-PE for US$7.5 million was approved on June 26, 1980, and declared effective on December 22, 1980. The original closing date (June 30, 1983) was postponed three times to June 30, 1986. The tota' amount disbursed was US$4.96 million. The undisbursed balance of US$2.54 million was cancelled on July 16, 1986. Prepared by the Trade, Finance and Industry Operations Division of the Country Department IV, Latin American and Caribbean Region and Africa Technical Department, this report reviews the implementation of the loan, based upon data from the project documents and files at the Bank. The last supervision of the project was carried out in May, 1986, and no Bank mission visited Peru for the purpose of preparing the Project Completion Report. The Borrower did not prepare a draft completion report. Comments on this report were received from the Government and PROBAYOVAR. The essential conclusions of these comments are reflected in the report and a translation of the comments has been annexed. In accordance with the revised procedures for project performance audit reporting, this Project Completion Report was read by the Operations Evaluation Department (OED), but the project was not audited by OED staff.  - ii - PROJECT COMPLEMION REPORT PERU BAYOVAR PHOSPHATE ENGINEERING AND TECHNICAL ASSISTANCE PROJECT (LOAN 1888-PE) BASIC DATA SHT (US$ millions) LOAN STATUS ---As of 02/29/88--- Original Disbursed Cancelled Repaid Outstanding Loan No. 1888-PE 7.5 4.96 2.54 3.76 1.20 CUMULATIVE LOAN DISBURSEMENTS FY81 FY82 FY83 FY84 FY85 FY86 DEC. 86 (i) Estimated 1.7 6.2 7.5 7.5 7.5 7.5 7.5 (ii) Actual 0.9 2.5 3.1 3.8 4.4 4.9 4.96 (iii) (ii) as Z of (i) 52.92 40.31 41.3Z 50.6? 58.6? 65.32 66.1? KEY PROJECT DATA Original Plan Actual Project Appraisal 01/11180 01/11180 Board Approval 06/26/80 06/26/80 Loan Signing 08121180 08/21/80 Loan Effectiveness 09/00/80 12/22/80 Loan Closing 06/30/83 06/30/86 Completion of First Phase a/ 12/30/82 06/30/82 Borrower: Government of Peru Executing Agency: Empresa Promotora Bayovar a/ The first phase was completed by mid-1982, but the second phase, after encountering a delay of 3 years, did not fully materialize and therefore the balance of US$2.54 million was cancelled.  - iii - MISSION DATA Mouthl No. of No. of Staff Date of Items Year Weeks Persons Weeks ReDorts Identification 07179 1 2 2 08103179 Appraisal 01/80 1 2 2 02/08/80 Appraisal Follow-up 03/80 1 1 1 03117/80 Appraisal Follow-up (Spain) 04180 112 2 1 n.a. Supervision I 10/80 1 1 1 10120/80 Supervision II 02182 1/2 2 1 n.a. Supervision III 06182 1 2 2 07113/82 Supervision IV 10185 1/2 2 1 10/25/85 Sutpervision V 02/86 1 2 2 03/11/86 Supervision VI 05186 0.3 1 0.3 05130186 STAFF IWUT (Umuweks) FY77 FY78 FY70 FY80 FY81 FY82 FY68 FY84 Fyas FYU FY37 afll TOTAL PrapprTonla - - - 21.9 - - - - - - - - 21.9 Appraisal - - - 1.0 - - - - - - - - 1.0 N"otiation - - - 4.8 - - - - - - - - 4.8 Supervision - - - - 9.6 18.4 2.8 6.6 8.6 10.4 2.0 7.7 54.9 TOTAL - - - 27.7 9.5 18.4 2.6 5.6 8.s 10.4 2.0 7.? 82.0  - lv - PROJECT CONPLETION REPORT PERU BAYOVAR PHOSPHATE ENGINEERING AND TECHNICAL ASSISTANCE PROJECT (LOAN 1888-PE) HIGHLIGHTS 1. The Loan under review in this report was to support the Government of Peru to determine the technical, economic and financial viability of developing the large Sechura desert phosphate deposits, estimated to contain ore resources of as much as ten billion tonnes (approximately 15Z of the world's total). The Loan was for US$7.5 million to finance the foreign costs of the project, with a total estimated cost of US$9.5 million. 2. Although the existence of phosphate deposits in the Bayovar area had been known for a long time, serious interest in their exploitation arose in the mid-1970's when grades of existing phosphate mines started to decline and world demand for and traie in phosphate products offered substantial growth prospects. During that period a preliminary study was carried out which showed the feasibility of a project designed to produce phosphate fertilizers ptincipally for exports. The project was based on mining and beneficiation of phosphate rock, conversion of the concentrate into phosphoric acid, and production of phosphate fertilizers (para 2.01). The total costs were estimated to range between US$700 and 800 million. Based on these findings it was concluded that it was worth pursuing the project idea but that further studies would be needed to determine the optimal size and product mix for the envisaged investment. Against this background the Bank agreed on financing the foreign exchange part of these studies through the Loan. 3. The project was appraised in January 1980, approved by the Board in June 1980, and became effective in December 1980. The project consisted of two phases. The first phase included the followings (i) studies to determine the level of phosphate reserves, optimum mining methods, and the most economic source of sulfuric acid for the production of phosphoric acid; (ii) physical, chemical and acidulation tests to establish the most economic phosphate rock treatment process as a basis for plant design; (iii) studies to determine plant site location, water supply and other infrastructure requirements; (iv) preparation of a market analysis and marketing strategy; (v) a preliminary study of the feasibility of uranium recovery from phosphate processing and exploitation of nearby potash deposits; and (vi) preparation of a feasibility report based on the above studies. The second phase was to finance preparation of basic engineering and contract documents, other pre-contracting activities and a study of project organization if the feasibility report confirmed the technical and economic viability of the Bayovar investment project (paras. 2.09-2.15). The executing agency for the project was PROBAYOVAR.  4. During the initial period the project w&s implemented smoothly and on schedule. By mid-1982 consultants contracted by PROBAYOVAR submitted the main feasibility study and by the end of that year the first phase of the project could be considered virtually completed. The main result of the study was a detailed project proposal in three stages to allow for gradual penetration of the export market. The first stage, based on production of 1.5 million tpy of phosphate rock and conversion of part of it to fertilizers, was in itself economically viable, showing a rate of return of 13.5t, and requiring US$700 million in investments (para. 3.01). The Bank agreed with the conclusions of the feasibility study, considered the first phase of the project completed and approved start of the second phase. The drawback of the study on the first stage investment was its reliance on overly optimistic projections for fertilizer prices, which raised doubts about the viability of the investment in a weakening market. 5. The second phase of the project was initially oriented towards promotional work to attract an experienced and competent technical partner for the proposed investment. In the beginning of the 1980's, however, the market prospects for phosphate fertilizers deteriorated considerably due to accumulating overcapacity and slower than expected demand growth (para. 3.11). Moreover, during the same period Peru's economic situation worsened and with it the investment climate. These two developments made the promotional efforts difficult and slow and prompted PROBAYOVAR to hire an investment banking firm to provide financial advice for conducting discussions with foreign partners and negotiating joint venture agreements. In order to provide additional incentives the Government agreed to assume direct responsibility for the infrastructure required by the proposed investment (para. 3.03). As a result of these measures the promotional activities finally showed success in early 1984 (after delays of about 18 months) when three potential foreign partners demonstrated clear interest in the investment. A priority partner was finally selected and a Memorandum of Understanding signed with PROBAYOVAR in mid-1984 (paras. 3.02-3.04). 6. Given the status of the phosphate market and Peru's ecoaomic situation, the foreign partner went with PROBAYOVAR and in coordination with the Bank through a very detailed review of the investment proposal which required one more year. Finally, by mid-1985 the decision was taken that in view of the market situation the envisaged investments should be considerably curtailed through deletion of phosphoric acid and fertilizer facilities, concentrating only on mining and beneficiation of phosphate rock (para. 3.04). This option brought down investment costs to US$183 million including interest during construction and initial working capital requirements (para. 3.08). It therefore appeared a sensible solution in a period with increasing difficulties of mobilization of financing. It also concentrated on a product (phosphate rock) which was less difficult to market than fertilizers and in which Peru appeared to maintain a comparative advantage for Asian markets (para. 3.13). Finally it was an option which in itself remained economically viable showing a rate of return of 15X at revised price forecasts. 7. With the change of Government in 1985, the official support for the project and the proposed investment decreased and PROBAYOVAR's role and resources were severly reduced (para. 3.07). The interest of the foreign  a - vi - partner nevertheless remained and discussions on the appropriate organization and financing of the proposed investment continued. Meanwhile the Bank had extended the closing date for the Loan three times to June 30, 1986 to demonstrate its continued support of the project. Shortly before the closing date there were encouraging signs indicating the readiness on both sides to negotiate an association agreement. The Bank actively supported this development trying to organize a meeting of all interested parties in July and then again in August 1986 (para. 3.09). On both occasions, however, the Peruvian delegation cancelled its participation on very short notice. Contacts on the proposed investment were subsequently broken off and the remaining funds of the Loan (US$2.5 million designated for completion of the second phase) were cancelled. The reasons for PROBAYOVAR's breaking off the contacts were principally: (i) insufficient financing offered by the foreign partner, (ii) disagreements on an appropriate association arrangement, and (iii) doubts about the Bank Group's possible involvement in financing of the investment. 8. The overall achievement of the project consists in its contribution to the assessment of a major investment possibility (para. 4.01). Technical options were analyzed in detail and the feasibility of the proposed investment evaluated. Through the project it was possible to raise interest from foreign partners in the investment despite deteriorating market and economic conditions (para. 4.02). Discussions with one prospective partner even came close to the conclusion of an association agreement. The project's final results, however, were seriously affected by unforeseen developments (para. 4.03). The feasibility study financed under the project analyzed investments in fertilizer facilities during a period when the market prospects deteriorated rapidly. Had this happened earlier or had the study been implemented later, this particular part could have been deleted or shortened which would have resulted in cost savings. Furthermore, the project lost a good part of its effectiveness when official support diminished after the change in Government in 1985. Since negotiations with the selected foreign partner on an association agreement failed, the project will not generate the expected results in the foreseeable future. 9. In the longer term the efforts made under the pro4c-t may still bear fruit (para. 4.04). Most of the technical studies are likely to remain valid for some time and could be updated, along with the financial and economic evaluation, inexpensively in a short period. In fact, PROBAYOVAR pointed out that it has, at little additional cost, brought the existing studies for the mining investment to feasibility level. If the markets and Peru's economic situation improve, these studies could thus be used to revive interest in the investment. In the near future, however, it seems highly unlikely that the investment project as conceived (production of 1.5 million tpy beneficiated phosphate rock) can be implemented because of the current difficulties in mobilization of financing for projects in Peru. Fad negotiations with the foreign partner succeeded, financing of this investment as enclave project would have appeared feasible. Without prospective partners, the Government would have to come up with the total equity requiring a cash contribution of about US$50 million and mobilize loan financing for an entirely Government owned venture. This, however, cannot be considered a realistic option, given the Government's budget situation and Peru's restricted access to financial markets. While the Government authorized PROBAYOVAR to seek financing through debt/equity  - vii - swaps and counter-trade arrangements, its efforts to reach an understanding with the USSR on possible financing do not appear to have resulted yet in definitive arrangements for implementation of the proposed investment project. 10. Lessons learned from this project are (para. 4.06)s (i) that an engineering and technical assistance project can serve as an effective vehicle to maintain the momentum on a major investment decision even in a deteriorating economic environment, (ii) that in order for the project to remain effective all interested parties, in particular the Government, have to support it fully, and (iii) that appropriate institutional arrangements and resources are required to carry out the promotional work necessary.  PROJECT COMPLETION REPORT PERU BAYOVAR PHOSPHATE ENGINEERING AND TECHNICAL ASSISTANCE PROJECT (LOAN 1888-PE) I. INTRODUCTICN Economic Environment and Sectoral Performance 1.01 Peru is among the seven Latin American and Caribbean countries experiencing actual declines in per capita income over the last decade. Weak overall economic growth translated into sluggish employment growth, coupled with rapid (2.5? per annum) population growth, resulting in sharply declining per capita income during 1970-83. Although GDP grew by 4.8Z in 1984, it remained nearly 7? below the 1982 level and 2.62 below that for 1980. The declines in GDP have had highly adverae effects on average household real incomes, which dropped 242 between 1980 and 1983, bringing them to 192 below even 1971-72 levels. ! 1.02 Real per capita GDP in 1983 was no higher than in 1963; betweer 1970 and 1983, F..r capita GDP fell 102. In 1966, Peruvians had attained a per capita income equal to 92 of the US level and, by the same measure, ranked eleventh among the 20 largest Latin American and Caribbean countries.1 By 1983, Peruvian per capita GNP had fallen to only 72 of the US level, and Peru's ranking had dropped to number 14, superior only to Costa Rica, Nicaragua, El Salvador, Honduras, Bolivia and Haiti. In 1982, Peru stood with Bolivia, Haiti and Nicaragua as one of the four countries with the lowest life expectancy at birth (under 60 years) among the 26 major Latin American and Caribbean countries. 1.03 The Belaunde Government, which took office in mid-1980 was confronted with the 1981-83 world recession, bringing with it declines in metals prices and export volumes. Between 1980 and 1982, Peru's terms of trade declined by 162. Also the new Government confronted a high and rising rate of domestic inflation, with the annual rise in the consumer price index (CPI) climbing from 61Z in 1980 to 73? in 1981. The Government tried to reduce inflation y slowing the pace of the currency depreciation during 1981 and 1982. At the same time, it pursued expansive monetary and fiscal policies, allowing the public sector deficit to rise from 12 of GDP in 1979 to 8.6? in 1982. The current account deficit in the balance of payments reached US$1.6 billion during the same year. Peru's exchange reserves had fallen by over US$500 million, and the Government sought the assistance of the International Monetary Fund (IMF). In mid 1982, the IMP approved an SDR 850 million compensatory-cum EFF financing to support Peru's stabilization and structural adjustment efforts. 1/ Based on World Bank Atlases.  -2- 1.04 In 1983, a number of events produced a massive (llZ) drop in real GDP. The country's still sizeable public sector and current account deficits, combined with the reduced availability of new external loans from international commercial banks, forced the Government to implement deflationary policies by late 1982. The new measures included a large cut in public investment, accelerated price increases for publicly supplied goods and services, and faster reduction of food subsidies. 1.05 While real consumption dropped 102, investment fell even more, with public fixed investment dropping by 202 and private investment by 32Z. The output decline was dominated by a drop in production in the manufacturing, services and agricultural sectors, although output in some smaller sectors, such as fishing and construction, fell even more sharply. Unemployment rose from 7? in 1982 to over 92 in 1983, and real per capita GDP fell by 13.3X. Nonetheless, the financing of the balance of payment deficit required a renegotiation of commercial bank debt (in March 1983) and official bilateral debt (in July 1983). The rescheduling agreement with the commercial banks included the phased release of US$450.0 million in "new money," subject to the Government's receiving continuing IMF support. However, public sector revenues declined substantially during the recession and the public sector deficit substantially exceeded the Government's target under the IMF arrangement. 1.06 In 1984, the economy experienced a modest recovery, with GDP increasing about 4.8Z. Goods and services exports rose slightly, while goods imports fell again due to continuing slack domestic demand. While the current account deficit recorded a further sharp contraction from US$872.0 million in 1983 to US$252.0 million in 1984, the apparent improvement was overstated by virtue of a rise of about US$260.0 million in interest arrears on external debt during the year. 1.07 On July 28, 1985, a newly elected Government, headed by the President Alan Garcia, inherited an extremely difficult economic and social situation; Peru's real per capita income was at the level of the early sixties; two-thirds of the population was either unemployed or underemployed; real wages were about half their 1973 levels; the inefficient public sector spent half the GDP; annualized inflation based on the first seven months of the year was 250Z; external debt was 752 of GDP with interest arrears of about US$750 million; over half the money supply was in dollar-denominated deposits. In addition, external prospects looked bleak with low projected prices for minerals, which account for half of Peru's exports, declining prices and volumes of Peru's largest export, petroleum, and little hope of obtaining access to external capital markets for new money. President Garcia reacted to the difficult economic situation announcing to limit Peru's external payments to 102 of its export income. 1.08 The Government announced its stabilization program devoted mostly to control inflation and stimulate growth. It also emphasized improvements in the income of the poorest, and agricultural development, especially in the poor southern Andean mountain region. The Government, in order to break inflationary trends initiated adjustments in utility tariffs and petroleum prices, froze prices and wages, lowered effective interest rates in several stages as a means to control costs, and fixed the exchange rate.  3 The Government initiated some public expenditure cuts, including reduction in the purchase of military equipment. The initial fiscal measures resulted in a major improvement in the budgetary position, mostly due to nonpayment of foreign public interest obligations. However, with recessionary pressures from the stabilization program setting in, the Government took expansionary measures to stimulate the economy. 1.09 The reaction of economic activity to