Mexico - Second Power Sector Project

FILE-copy, RESTRICTED Report No. TO-661 This report was prepared for use within: the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF THE INVESTMENT PROGRAM OF THE ELECTRIC POWER SECTOR MEXICO June 11, 1968 Projects Department  CURRENCY EQUIVALENTS Currency Unit = Peso (Mex$) 1 US$ = 12.50 (Mex$) 1 Mex$ = 100 centavos (0) = 0.08 US$ ]. million Mex$ = 80,000 US$ WEIGHTS & MEASURES kw = Kilowatt Mw - Megawatt kwh - Kilowatt hour Gwh = Gigawatt hour kv - Kilo volt kva = Kilovolt-ampere Mva = Megavolt-ampere One kilometer (km) = 0.6214 mile One square kilometer (km2) - 0.3861 square mile One meter (m) = 3,281 feet One cubic meter (m3) = 35.31 cubic feet CFE1s Financial Year - Calendar Year  TABLE OF CONTENTS Pape No. SUMM9ARY i 1. INTRODUCTION 1 A. Present Situation of the Power Sector 1 B. Previous Bank Lending for Power in Nexico 2 2. THE BORROWER 3 A. Administration and Coordination 4 B. Capital Structure and Financial Position 5 C. Past Earnings Record 12 D. Auditors 12 E. Tariffs 12 3. THE SECTOR PROGRAM 14 A. Design and Supervision 16 B. Capital Requirements 17 4. JUSTIFICATION OF THE PROGRAM 19 A. Power Market 19 B. Expansion Planning 20 5. THE LOAN 21 A. Procurement and Disbursement 23 6. FINANCING PLAN AND FUTURE POSITION 24 A. Proposed Financing Plan 24 B. Future Earnings 27 C. Future Financial Position 27 7. CONCLUSIONS 29 This report is based on the findings of a Bank mission consisting of Messrs. R. H. Sheehan, C. de Beaufort and S. Gishman which visited Mexico in Mlarch 1968.  LIST OF .4i'.ES 1. Installed Capacity and Generation 2. Power Sector Balance Sheets 1967-1972 3. Power Sector Long and Medium-Term Debt Outstanding December 31, 1967 4. CFE Balance Sheets 1963-1967 5. Centro Balance Sheets 1963-1967 6. CFE Financial Ratios 1963-1967 7. Centro Financial Ratios 1963-1967 8. CFE Income Statements 1965-1967 9. Centro Income Statements 1963-1967 10. Expansion Program - List of Facilities 11. Estimated Cost of Construction and Forecast of Expenditures 12. Demand and Capacity Charts 1 to 8 13. Sales to Ultimate Consumers 14. Power Sector Forecast Sources and Applications of Funds 1968-1972 15. Power Sector Debt Service Projections 1968-1972 16. Power Sector Forecast Income Statements 1968-1972 17. Power Sector Financial Ratios 1967-1972 MAPS  APPRAISAL OF THE IYVPSTMENT PROGRAM OF THE ELECTRIC POWER SECTOR M E X I C 0 SUMM4ARY i. The Government of M4exico has requested the Bank to make a second loan to the Power Sector to assist in the financing of its continuing invest- ment program. Loan 436-ME made in 1965 for US$llO million was the first loan to finance this program, and has been completely drawn down. A new Bank loan for US$90 million is now proposed. ii. This report covers the appraisal of the investment plans and finan- cial positions of the Comision Federal de Electricidad (CFE) and Compania de Luz y Fuerza del Centro (Centro), the Sector's two major entities. The Borrower would be CFE which is responsible for the fiscal control of the Sector. Funds required for expenditures of Centro would be made available from the Bank loan by CFE under the terms of a subsidiary loan agreement. By thus controlling all the loan funds CFE is able to coordinate the Sector's planning and operations. It is the intention that ultimately the whole Sector, which is almost completely owned by the Government, will be merged into one entity. As was the case with previous Bank loans to CFE, Nacional Financiera S.A. (NAFINSA) would be the co-borrower and the Government would guarantee the loan. iii. The program proposed for financing includes the construction of generating plants, transmission lines, substations, and extensions to distribution works which were under construction on April 1, 1968 or are expected to be started before April 1, 1969. Initial work on the change of frequency of the Central System from 50 to 60 cycles per second is included in the program. The Sector expansion plan is justified and the estimated cost is reasonable. The staffs of the Sector entities are capable, with the assistance of consultants, of carrying out the program. iv. s The Sector's capital structure and financial position is generally sound, but its debt position should be further improved. Since the Power Consumption Tax was increased in 1966, the Sector has been able to earn a return in excess of the minimum rate of 8 percent agreed with the Bank in 1965. The financing plan for 1968 and 1969 is satisfactory; net internal cash generation would make an adequate contribution towards the financing of the Sector's requirements. v. Joint loans are expected to be made available by a number of countries which have agreed with the Bank on a formula under which they would provide one-third of the financing of eligible orders for imported equipment, procured under international competitive bidding. vi. The proposed Bank loan of US$,90 million would be appropriate to cover: (a) estimated financial requirements of the Sector for the one year period April 1, 1968 through March 31, 1969, to the extent of US$71 million; and (b) specific contracts for major generating equipment requiring more than one year for manufacture and erection, to the extent of US$19 million. A term of 20 years, including a grace period of 4 years, is recommended.  APPRAISAL OF THE INVESTMENT PROGRAMl OF ThE ELECTRIC POW{ER SECTOR M E X I C 0 1. INTRODUCTION 1.01 The Government of Mexico has asked the Bank to make a second loan to the Power Sector which would help to finance construction expenditures on the continuing investment program. The loan would be made to the Comision Federal de Electricidad (CFE) which would make available a portion to Com- pania de Luz y Fuerza del Centro (Centro) through a subsidiary loan agree- ment. Nacional Financiera S.A. (NAFINSA), the Mexican Government's develop- ment bank, would be the co-borrower as with previous loans to CFE. 1.02 This report was prepared by Messrs. R.H. Sheehan, C. de Beaufort and S. Gishman following an appraisal of the programs and financial positions of the Power Sector's two major entities, CFE and Centro, made in Mexico during March 1968. Additional information was submitted to the Bank in April and during the negotiations which were held in Washington in May. 1.03 The first Mexican Power Sector Loan, 436-ME,, in the amount of USt110 million was fully drawn down on April 24, 1968. A loan of US090 million is now proposed which would be applied mainly to the estimated ex- penditures on the Sector's generation, transmission, and distribution facilities through March 1969. A part of the loan would also cover certain generating equipment which requires more than one year for manufacture and erection. The size of the proposed Bank loan is based on the prospects that appreciable amounts of joint loans will be made available by Belgium, Canada, France, Germany, Italy, Japan, Spain, Sweden, Switzerland, United Kingdom and the United States on reasonable terms, similar to the arrangements nego- tiated in conjunction with 436-ME. At the Second Meeting on Joint Financing held in October 1967 in Paris, it was decided that external financing for the Second M4exican Power Sector Program would be provided for - two-thirds by the Bank and one-third by the supplying country. This financing formula would cnLy apply to individual orders for imported goods of at least US^200,000 aggre- gating at least US$1 million in any one supplying country. Chapter 5 con- tains a further discussion of the loan amount. A. Present Situation of the Power Sector 1.04 The total installed generating capacity in Mexico at the end of 1967 was 5,665 Mw of which 922 Mw was "captive plant" owned and operated by industry for its own needs. (See Annex 1.) The 4,743 Mw of capacity available to supply the public sector consisted of 4,031 MIw owned by CFE, 667 Mw owned by Centro, and 45 Mw owned by small utility companies. The private companies which have not yet been acquired by the Government operate only 14 Mw of the above 45 Mw. For all practical purposes the nationalization of the Mexican public electricity supply is now completed. A summary of the history of the Power Sector is contained in pages 1 - 3 of Report TO-497b dated November 26, 1965.  - 2 - 1.05 Since the signing of Loan 436- in 1965, further progress has been made toward consolidation of the Sector bv merging 19 of CFE's affiliates with the parent organization. These affiliates were various public utilities scattered throughout the country. In July 1966 CFE reached an agreement with the two unions representing its employees and those of its affiliates which provided a basis for the integration. This agreement simplifies the staff organization, eliminates some of the dunlication of jobs, standardizes work rules, and provides for the gradual achievement of identical contract con- ditions, including wages, by 1971. Following this settlement, the Government in August 1967 issued a Decree consolidating the affiliates into CFE. The complete process of integration wfill require some time but the action taken so far represents a significant step forward. In the meanwhile Centro, whose labor contract is with a third union, remains an independent, Government con- trolled corporation. So far the dissolution of ,lexlight 1/ has not been practicable because the funds needed to pay off its minority interests and the part of its secured debt owed to the public (some US15 million) could be better employed in the development of the Sector. B. Previous Bank Lending for Power in Mexico 1.06 The Bank has made eight loans for power in Mexico for a total amount of US$364.8 million 85.7 percent of this total or USM312.8 million went to CFE and 14.3 percent or US$52 million went to Centro/Mexlight. The amounts of the loans and the years when they were made are given in the following table: 1/ Centro is the main operating subsidiary of The Mexican Light and Power Company, Limited (Mexlight) which is now only a holding company (see Paragraph 2.04).  - 3 - Year Loan No. Beneficiarv Loan Amount (in thousands of USi,) 1949 12-ME CFE 2)4,100 1949 13-ME CFE - 1/ 1950 24-ME Mexlight 26,000 1952 56-ME CFE 29,700 1958 186-ME Mexlight 11,000 1958 l94-ME CFE 34,000 1962 316-ME CFE 130,000 1965 436-mE CFE 95,000 Centro 15,000 110,000 364,800 1/ Loan 13-i'IE for US,110 million was made to CFE and relent to Mexlight pending its reorganization; the reorganization was concluded in 1950 and the Loan was repaid from part of the proceeds of Loan 24-ME. 1.07 All of the above loans are fully disbursed and the projects which were financed with the help of the loans up to and including 316-ME are in operation. These Bank loans helped to finance the installation of 2,630 Mw of new capacity in every important region of the country, in addition to large amounts of transmission and distribution. When Loan 436-ME was completely drawn down in April 1968 there was approximately 1,560 Mw of generating capacity under construction which had been partially financed by the Bank. 2. THE BORROWER 2.01. CFE is a public agency created in 1937 for the main purpose of constructing and operating power facilities and. of participating in the ownership of separate nower undertakings. Its oronerties are unencumbered by any liens or mortgages. CFE is headed by a Board of Directors presently composed of the Secretary of Industry and Commerce, who is the Chairman; the Secretary of Hydraulic Resources- the Undersecretary of Finance-, the Director General of Petroleos Mexicanos; and the Director General of NAFINSA. The Board of Directors appoints CFE's Director General and the Assistant Director General. The present Director General and his assistant form a competent team which is effectively improving CFE's administration and organization. 2.02 CFE has divided the national territory into ten geographical regions each of which is served by a division. At present, CFE has about 19,250 employees and supplies apnproximately 2,500,000 consumers. CFE is exempt from most taxes, and any customs duties it pays are refunded. 2.03 As in the previous loan to the Sector, funds required for the capital expenditures of Centro would be made available through CFE. By thus  - 4 - controlling the expansion funds of Centro, CFE is better able to coordinate the Sector's planning and operations. This procedure is expected to help in bringing about a complete consolidation of the Sector. 2.04 Centro is owned by the Mexican Light and Power Company Limited (M-lexliaht) which was founded in 1902 as a Canadian corporation. The Mlexican Government obtained control of Mexlight in 1960 and it now owns more than 98 percent of the outstanding common shares and about 80 percent of the preferred shares. Up to 1963 Mexlight was a combination of a holding and operating company with very substantial assets and with several wholly owned operating subsidiaries. In November 1963 it sold its Mexican assets to one of its operating subsidiaries talking additional shares and bonds of the subsidiary. This subsidiary was subsequently renamed Compania de Luz y Fuerza del Centro, S.A. (Centro). Mexlight thus ceased to be an operating company and has assumed the role of a holding company. Centro outweighs the other Mexlight subsidiaries by far in importance and size because it serves the high density Mexico City market, whereas the other subsidiaries supply the outlying areas. For purposes of simplification, whenever in this report the term Centro is used it should be understood to comprise the other operating subsidiaries as well. The group can actually be considered as a single organization because the top officials of Centro also have the corresponding positions in the other Mexlight subsidiaries. Three members of CFE's Board namely, the Secretary of Industry and Commerce as Chairman, the Undersecretary of Finance, and the Director General of NAFINSA, are also on the Board of Centro. The other two Centro Board members are Centro's President and the Director General of CFE. 2.05 Centro supplies consumers in and around Mexico City, selling at retail only. In addition to what it generates in its own plants, Centro purchases large blocks of power from CFE. Last year the bulk purchases of energy amounted to 4,650 Gwh or 74.5 percent of Centro's sales of energy. Centro has about 13,500 employees and serves about 1,300,000 consumers. A. Administration and Coordination 2.06 At the tine of the signing of the last loan, the Mexican Govern- ment informed the Bank that a basic objective was the full coordination and progressive integration of the Power Sector. Since then progress has been achieved along several lines. These include giving CFE full budgetary control of the Sector operations and the responsibility for approving the investment plans of Centro. A significant achievement was the setting up of a load dispatch office for the Central System with complete responsibilitr for scheduling the operations and overhaul of all the generating plants in the system. This arrangement has resulted in minimizing thermal generation with resulting savings in fuel cost. 2.07 Another important advance was the reorganization of Centro during 1967. The company and its labor union were able to agree on several changes which will bring about economies, including the combining of some offices, a new data processing center to do the work formerly done by several depart- ments, the paying of customer bills at commercial banks, and the removal of  -5- extreme limitations on the duties of ermn'ovees. This latter change, for example, permits the reduction in size of work crews. eliminates a separate chauffeur for distribution crews, and requires personnel to work on "hot lines" using new techniques and procedures. The reorganization will permit the present staff to meet a substantial increase in load growth without a corresponding increase in the work force. 2.08 On the negative side, however, cooperation between the two Sector entities has been disappointing with regard to the frequency unification (see paragranh 3.02). Although the present organization of CFE's Board and Centro's Board imnlies a unity of direction through common members, little has been done to start on the actual frequency unification. In April of 1967, the Board of Centro unanimously directed Centro's President to start the unification using his own personnel under the direction of CFE, but it is only in the last few months that Centro's engineers have beaun to discuss the planning with CIT. During negotiations the Bank obtained satisfactory assurances that Centro will active]v cooperate on this vital issue. B. Capital Structure and Financial Position 2.09 The Sector's canital structure and financial position is generally sound. However, as explained below, the debt structure should be further improved. The following table contains a summary of the consolidated balance sheet for the Sector as of December 31, 1