Mexico - Third Power Sector Project

Report No. 859 CIRCULATING COPY Confidential TO BE RETURNED TO REPORTS DESK INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROJECT PERFORMANCE AUDIT REPORT on MEXICO: THIRD POWER SECTOR PROGRAM (Loan 659-ME) September 9, 1975 Operations Evaluation Department PREFACE This paper reports on a Performance Audit of the project partially financed by Loan 659-ME of February 27, 1970 to the Comision Federal de Electri- cidad (CFE) of Mexico and the Nacional Financiera. The loan was closed in August 1972. This report is based on study of Loan documents and relevant Bank archives, a visit to Mexico and discussions with Bank staff involved with the project. The assistance and cooperation afforded by the Mexican Government and CFE is gratefully acknowledged. Currency Equivalent: Mexican Peso (Mex$) Throughout the period - Mex$ 12.50 = US$ 1.00 PROJECT PERFORMANCE AUDIT REPORT MEXICO: THIRD POWER SECTOR PROGRAM (Loan 659-ME) TABLE OF CONTENTS Page No. Summary i-iv Introduction 1 General Provisions of the Bank Loan 2 Expansion of Physical Plant 3 Frequency Unification 6 Overall Program Costs 7 The Original Financing Plan: 1970-71 8 The Contribution of Loan 659-ME 10 The Contribution of Joint Financing 11 Three-Year 1970-72 Financing Pattern 11 Financial Covenants under Loan 659-ME 14 (a) Rate-of-Return Requirement 14 (b) Acquisition Debt Service 15 (c) Debt Limitation 16 Conclusions 18 ANNEXES I - MEXICO: Bank Loans to the Mexican Power Sector: 1949-1970 II - Integration of the Mexican Electric Power Sector III - Mexico - Power Sector: 1970/1971 Construction Program - List of Major Facilities IV - Mexico - Power Sector: Growth of Installed Capacity and Gross Production, 1968-1972 V - Mexico - Third Power Sector Program: Progress Under Frequency Unifica- tion Covenant VI - Mexico - Power Sector: Actual Compared with Forecast Consolidated Sec- tor Balance Sheets as of December 31,1968-1972 (In Mex$ millions) VII - Mexico - Power Sector: Actual Compared with Forecast Consolidated Sector Income Statements by Calendar Years, 1968-1972 (in Mex$ millions) VIII - Mexico - Power Sector: Actual Compared with Forecast Sources and Uses of Funds (In Mex$ millions) IX - Mexico - Power Sector: Medium - and Long-Term Debt Outstanding, End-of- Year (In Mex$ millions) SUMMARY In February 1970 the World Bank loaned US$ 125 million to Mexico for the Third Power Sector Program: 1970-1971 (Loan 659-ME). This was the second largest loan ever made by the Bank up to that time. One larger loan, for US$ 130 million, had been made in 1962 to Mexico, also for the development of elec- tric power. Loan 659-ME was the tenth power loan for Mexico from the Bank and marked the third in a series of "power sector loans" initiated in 1965 to finance foreign exchange costs of equipment, civil works and consultants that comprised part of a large investment program for the entire public sector power. The co- borrowers were Comision Federal de Electricidad (CFE) and Nacional Financiera S.A. (NAFINSA) -- the Government's development bank -- with the Government of the United Mexican States as guarantor. The loan was fully disbursed by the end of August 1972, thirty months after the date of signing. The co-borrower Comision Federal de Electricidad (CFE) is an autono- mous public entity in control of all public power in Mexico, which at the end of 1969 comprised 10 major generating and distribution systems plus a number of isolated facilities with a total installed generating capacity of 5,658 MW. Given that overall responsibility for development of the power sector resided with CFE, the World Bank would review CFE's investment program to assure the consistency and optimality of plans for the expansion mix of hydro, steam and gas generating capacity, as well as interconnection of various separate power systems, as representing a least-cost alternative for meeting the projected future demand for electric power throughout Mexico. Under the "power sector loan", the Bank would then in effect underwrite the investment program by agree- ing to provide foreign exchange financing to cover a large share of the estimated total cost of the program rather than attaching the loan to specific installations or projects. This lending arrangement put the Bank in a posi- tion to mobilize substantial joint financing with bilateral lending agencies in capital-supplying countries in support of CFE's investment program. The execution of the Third Power Sector Program did not proceed accor- ding to plans. Procurement of equipment as well as construction work on the expansion of facilities suffered delays. As a result, initial operation of most major new generating plants and transmission lines was postponed by one or more years. Instead of about 1,300 MW of new generating capacity becoming operational during 1970-1971 as anticipated in the plans, only 840 MW (or 65% of the planned amount) of additional capacity was functioning by the end of 1971. In some instances, the delays necessitated changes in the original plans, as when emer- gency generating equipment would be temporarily installed to meet peak load demand pending the completion of a major new facility. A case in point was in the Mexico City area served by the 50-cycl.e Centro System. As plans for con- verting Centro's 50-cycle power supply to 60-cycles, beginning with industrial users, were not implemented, new 50-cycle generating equipment was required to be installed to meet growing industrial demand. In other cases, such as the northern power systems, departures from the original plans were undertaken when it appeared that demand for power was growing faster than originally projected. In particular, "turn-key" contracts and other arrangements were made in order to accelerate the installation of new equipment. Taking into account the size and scope of the Power Sector's invest- ment plans for 1970-1971 as originally envisaged, the extent of the changes made durii,g implementation, aside from stretching out installation schedules, was - ii not extraordinary. However, if the Mexican economy had not suffered a recession during 1971, when the demand for elactricity grew only by about B percent as compared with the projected growth of 12 percent, many more remedial changes in the plans might well have been required in the face of implementation delays. As it was, no serious power shortages occurred in any of CFE's systems. The most significant problem was encountered in the Centro System because of the postponement of work on frequency unification. Although Loan 659-ME had included a specific sche- dule for work on frequency unification which was agreed to be carried out by the Mexican Government, the Bank chose not to invoke sanctions for failure to abide by that agreement because no constructive purpose would have been served. The total financial reqLircment in 1970-1971 for the Third Power Sector Program was estimated beforehand to amount to the sizeable sum of about Mex$6,500 million (or US$520 million equivalent). Notwithstanding delays in executing the program, investment outlays by the Power Sector for those two years were 35 percent higher than planned. These outlays resulted in more borrowing than had been assumed in the financing plan, which in turn added to the debt service burden of the Power Sector. Consequently, net internal cash generation of the Power Sector was adversely affected, becoming negative by 1972. The additional financing needed in 1970-1971 above the planned requirements amounted to Mex$2,850 million (or US$228 million equivalent). Because of the delays in implementation of planned investment, the three years 1970-1972 -- during which Loan 659-ME was completely disbursed -- may be considered as the period of execution of the Third Power Sector Program. The financial requirements for the program, which was plagued with higher than expected outlays during that period, totalled Mex$14,700 million (or US$1,176 million equivalent). Net internal cash generation supplied only Mex$955 million, or 6.5 percent of the financial requirements. The original financial plan had envisaged that the Power Sector's net internal cash generation would cover more than 25 percent of the investment program. Furthermore, the original financial plan had explicitly provided for some refinancing of outstanding obligations of the Power Sector to Nacional Financiera, S. A. (NAFINSA) in order to reduce debt service during the period 1970-1974, but no net additional input of financial resources from NAFINSA to the Power Sector was contemplated. This latter provi- sion of the financial plan was considered to be an important objective designed to reduce the Power Sector's habitual dependence on governmental financial support. This objective was not met. As the investment outlays for the program escalated, the Government allowed the Power Sector to use debt financing exclusively to meet expenditures rather than raising tariffs. The Power Sector obtained new loans from NAFINSA on the order of Mex$1,235 million (or about US$ 99 million) annually in 1971 and in 1972, thereby absorbing resources from the government's development bank at the expense of alternative development priorities. The poor performance in the execution of the Third Power Sector Program was largely a reflection of a management problem stemming from diffuse organiza- tional structure in conjunction with inadequate information feedback systems and lack of cost control procedures. Centralized administrative supervision of the investment program being carried out by eight separate departments was not pos- sible without uniform reporting and monitoring. Worse yet, no systematic recor- ding of actual investment outlays in comparison with budget estimates were pro- duced. Without such detailed information about the costs of completed investment projects the reasons for the escalation of investment outlays cannot be deter- mined. The Bank has since tak!n sLep6 co try to remeay this situation. - iii - The deterioration of the Power Sector's financial position during the period of disbursement of Loan 659-ME was a source of concern to the Bank. Financial performance covenants in the loan agreement had been designed to promote a financially independent Power Sector that was neither supported by government revenues nor dependent on government borrowing. Although the performance tests of these financial covenants under Loan 659-ME were cumbersome to monitor, it became apparent by mid-1971 that the Power Sector would not be able to satisfy all the tests. Therefore, the Power Sector was obliged to consult with the Bank about undertaking additional borrowing from whatever source over-and-above the amounts provided for in the financial plan. The Bank was not in a position to enforce sound financial practices on the Power Sector, if the Government and the management of CFE was not inclined to follow them. However, the Bank effect- ively exercised its influence by requiring that all borrowing by the Power Sector should have minimum terms of five years. In this way the Bank sought to soften the debt service burden of the additional borrowing incurred by the Power Sector. The conclusion of this audit of Loan 659-ME is that the Third Power Sector program marked a regressive stage in the extended period of the Bank's in- volvement with financing power in Mexico. The progress over the longer term in integrating the power systems and consolidating the planning and financial manage- ment for the Sector in CFE have been notable; in particular, in recent years, since the conclusion of Loan 659-ME disbursements, the frequency unification pro- gram has finally achieved great momentum. Nevertheless, the Bank's financial support to the Power Sector has been extraordinary, averaging US$ 40 million annually since 1962. The question then arises about whether the achievements over the longer-term and the prospects for future accomplishments justify the absorption of Bank resources on this scale, but an answer to this question calls for an assessment of alternatives beyond the scope of this report. If it is argued that despite poor performance by the Power Sector under Loan 659-ME, the relatively rapid disbursement of the loan was important for Mexico's balance of payments, the facts do not strongly substantiate this argument. Disbursements on Bank loans to the Power Sector in Mexico during 1970, 1971 and 1972 supplied only about 6% of the gross foreign capital inflow to the public sec- tor in those years. Although the importance at the margin for Mexico's balance of payments of more than US$ 45 million annually of IBRD disbursements for power is incontestable, it is nevertheless not overwhelmingly significant in the context of gross capital inflows. As much as US$ 70 million was eventually committed by bilateral lenders under the joint financing arrangements of Loan 659-ME, but it is not possible to say that these funds would have been unavailable to the Mexican Power Sector in the absence of the IBRD loan, even though they might htave been provided on different terms. The fact that IBRD disbursements financed only 12% of the 1970-72 Sector Program underscores the very large size of the Mexican Power Sector. The sector lending approach adopted by the Bank had the -inherent advantage of provid- ing flexibility in the use of the resources. But one lesson of the experience reviewed is that when undertaking a very big job such as rationalizing the Mexican Power Sector,the Bank should not underestimate the amount of time, effort and resources that will in all likelihood be required to achieve the sector lending objectives. The hopes held out in the Bank's appraisal report for the Third Mexican Power Sector Program proved too optimistic. Yet, in the context of measures adopted for an investment control system and improved budgetary control as well as the progress achieved on frequency unification, after Loan 659-ME was - iv - fully disbursed, it may be said that the loan contributed to the process of promoting the ongoing rationalization of the Power Sector and helped create a somewhat better [ramework for the Bank's subsequent further sector loan. PROJECT PERFORMANCE AUDIT REPORT MEXICO: THIRD POWER SECTOR PROGRAM (Loan 659-ME) Introduction Between 1949 and 1970 the World Bank made ten loans for power in Mexico for a total of US$ 580 million, net of cancellations (Annex I). These loans supported the development of Mexico's power sector by helping finance projects and investment programs accounting for about 80 percent of the expan- sion of electric generating capacity over the twenty-year period as well as large amounts of additional transmission and distribution equipment. The Comi- sion Federal de Electricidad (CFE) was the recipient of US$ 500 millicn (86 percent) of this Bank lending, including a loan for US$ 130 million in 1962 which was the largest single IBRD loan or IDA credit approved prior to FY74. The Mexican Government had created CFE in 1937 as a wholly owned government organization to construct and to operate on a non-profit basis electricity supply facilities. In 1949 CFE was reorganized as an autonomous public entity. In the twenty years that followed, CFE obtained control over the entire power sector --except for "captive plant" owned and operated by industry for its own needs -- through the acquisition of pripte electric companies and integration of separate public utility companies.- By the end of 1969 the installed capacity of the power sector serving the general public under the control of CFE amounted to 5,658 MW2/ and the fixed assets in service (generation, transmission and distritution faci- lities) were valued at a cost of more than US$ 2,250 million, or, after allowing for depreciation, a net value of about US$ 1,775 million. The power sector under CFE consisted of 10 major systems plus a number of isolated facilities. Since 1960, CFE had been responsible for the installa- tion of all new generating plants and also had the responsibility to coordinate investment planning for the sector. All the major systems operated at a 60- cycle frequency except for the Central System (Centro) serving consumers in and around Mexico City, which ran at 50 cycles. One of the objectives of sector- wide investment planning was to establish a program for the interconnection of the major systems, including the conversion of the Central System to 60-cycles, as part of a least-cost solution for meeting the long-run growth of demand for electricity in Mexico. In view of the control and overall planning of power sector investment that resided with CFE, the World Bank adopted a lending posture for power in Mexico whereby the Bank would review CFE's investment program for the sector and would underwrite the program by agreeing to finance a large portion of the foreign exchange cost for equipment and civil works and consultants. Under this proce- dure of financing a share of the entire sector investment program rather than selecting isolated installations or projects within the program, the Bank was in 1/ A more complete description is presented in Annex II. 2/ In addition, "captive plant" for industry amounted to somewhat more than 1,000 MW of generating capacity in Mexico. - 2 - a position to organize substantial joint financing with bilateral lending agen- cies in capital-supplying countries in support of CFE's investments. In addi- tion, the Bank financed items procured under its guidelines which were not attractive vehicles for supplier credits (e.g. small contracts and civil works). As a result, Mexico benefitted by obtaining a greater volume of foreign capital on better terms for the power sector than would have been the case if Bank financing were to have been restricted to individual projects. In 1965 the Bank adopted this posture with a loan of US$ 110 million in support of the First Power Sector Program (Loan 436-ME) followed by another US$ 90 atillion (Loan 544-ME) in 1968 for the Second Power Sector Program. In 1970 the Bank approved the second largest loan in its history to'that time -- Loan 659-ME for US$ 125 million in support of the Third Mexican Power Sector Program: 1970-71. As with the two pre- vious loans, the co-borrowers were Comision Federal de Electricidad (CFE); and Nacional Financiera S.A (NAFINSA) -- the Government's development bank -- with the Government of the United Mexican States as guarantor.!/ General Provisions of the Bank Loan Loan 659-ME was to help finance the foreign exchange costs of generation, transmission and distribution facilities to be installed during 1970 and 1971 as part of the power sector's ongoing development program. Items financed by the loan were to be procured on the basis of international competitive bidding with a 15 percent margin of preference for Mexican manufacturers. The major part of the Bank loan -- in part jointly with loans from supplying countries -- was to finance 100 percent of contracts won by foreign firms and the foreign exchange component of contracts won by local manufacturers, estimated to average 50% of the contract amounts. The loan was also to be used to finance 35 percent of civil works contracts, which was the estimated average foreign exchange component. All civil works con- tracts above Mex$ 20 million (US$1.6 million equivalent) were subject to interna- tional competitive bidding. The appraisal estimate as compared with the actual allocation of Loan 659-ME is shown below. Appraisal Actual Forecast Allocation (Millions of US$) (a) Foreign exchange cost of equipment 96.0 99.8 (b) Foreign exchange component of civil works 27.0 23.2 (c) Consultant fees & training expenses payable in foreign exchange 2.0 2.0 Total 125.0 125.0 Closing date: June 30, 1972 August 31, 1972 1/ Loan 659-ME was approved by the Executive Directors on February 24, 1970, signed on February 27, 1970 and became effective on May 22, 1970. - 3 - The term of the loan was 20 years, including a four-year grace period followed by amortization in semi-annual installments beginning March 15, 1974, adjustable in light of the terms of bilateral loans actually obtained under joint financing arrangements, so as to make the combined amortization as close as possible to what it would have been had all the funds been provided on IBRD twenty-year terms. The interest rate on Loan 659-ME was 7 percent per annum and there was a commitment charge of 3/4 of 1 percent. Retroactive disbursements of up to US$ 15 million were provided under the Bank loan. These reimbursements were to cover payments made by the power sector after December 1, 1969 for which funds from the previous Bank loan (544- ME) had been exhausted. Expansion of Physical Plant The expansion of physical plant for the power sector during the period 1970-71 was estimated at the time of appraisal of the Bank loan to cost US$ 491.4 million equivalent, including purchase of equipment and installation costs. CFE's investment program comprised expansion of generation capacity on the order of 3,000 MW, as follows: 1,545 MW of steam plant; 1,173 MW of hydro plant; 168 MW of gas turbines; 75 MW of geothermal plant; and 23 MW of diesel generators. Less than half (about 1,300 MW) of this additional generating capacity was ex- pected to become operational during 1970-1971, bi,t orders and delivery of gener- ating equipment to come into operation in later years were to be financed under the program. Although some overinvestment, in excess generating capacity, may have occurred in the power sector during the early 1960s, the more rapid growth of demand for electricity than had been forecast for the latter part of the d cade had effectively eliminated excessive margins of generating capacity by 1970.1' As for transmission and distribution facilities, CFE's program for 1970-1971 in- cluded 866 km of 400 kV tranmission lines, 4,150 km of 220 kV transmission lines, 3.,830 km of 69-161 kV transmission lines, and 10,200 MVA of mai.n transrormer stations, US$ 136 million of distribution and rural electrification, and US$ 12 million for the first stage of frequency unification. Virtually all of these facilities were to be operational before the end of 1971. Procurement and construction work on the expansion program proceeded more slowly in 1970 and 1971 than had been forecast. CFE's construction schedules in the program had been predicated on continued rapid growth of the Mexican economy, which in turn was projected to lead to a growth in demand for electricity averaging 12.6% annually during the period 1969-1972. In the event, construction schedules on most major facilities increased by a year or more as compared with plans. As a result, the year of initial operation of major new generating plants and transmission lines slipped by one-to-two years for a majority of the facilities (See Annex III). Instead of about 1,300 MW of additional generating capacity becoming operational during 1970-1971 as anticipated,in the program, only 840 MW (65 per cent of the planned amount) of additional capacity was put into operation. Simi- larly, only about halfcf the transmission facilities that had been planned for completion by the end of 1971 were actually operational by that date. 1/ A detailed analysis of reserve generating capacity in Mexico during the 1960s is contained in Chapter IV of OPerations Evaluation Report: Electric Power Case Study: CFE, Mexico (mimeograph, IBRD Report No. Z-17/6, April 1972) Delays on procurement as well as in construction were not without con- sequences which required changes in the expansion program. In the northern power systems (Falcon-Monterrey, Torreon-Chihuahua, and Sonora-Sinaloa) demand for electricity in 1970 grew faster than had been forecast in 1969. Furthermore, there was a potential shortfall in the reliable supply of hydro power as a result of an increasing and higher priority need for available water for irrigation to expand production for export. Under these circumstances, CFE found it necessary to negotiate the procurement of two 87.5 MW units for the Guaymas II steam plant as a "package" on a bilateral basis rather than with international competitive bidding in order to have them in service by mid-1972 in the Sonora-Sinaloa system. Also, in the Sonora-Sinaloa system a new 150 MW steam unit at Mazatlan was added to the expansion program in place of a 41 MW steam unit at Topolobampo. To ease the expected power supply shortfall in the Falcon-Monterrey system, procurement of the sixth 84 MW steam unit for Monterrey I was advanced by negotiating a con- tract directly with a firm which was concurrently working on the fourth and fifth steam units of 84 MW each for Monterrey I. Accelerated development of new industry in 1970 foreshadowed sharply increased industrial demand in 1971 and 1972 for the southern power systems, especially in the area of Mexico City served by the 50-cycle Central System. Since plans for converting Centro's power supply to 60-cycles, beginning with in- dustrial users, had been delayed (see page 6 below), some 220 MW of gas turbine generators (5 of 40 MW and one of 20 MW) were added to the 1970-1971 program to provide additional capacity to Centro. Furthermore, CFE added a fourth 150 MW steam unit for Salamanca in the Michoacan-Chapala-Guanajuato system for procure- ment concurrently with the third Salamanca unit, which was originally in the program. A third 24.5 MW unit was added to the program for Nachi-Cocom in the Yucatan system. These additions and changes in the Third Power Program meant that the Bank had to notify the various joint lenders and obtain their consent. Although no formal objection was raised, three of the joint lenders expressed concern over the bilateral credit arrangements being arranged for some equipment that was originally in the list for international competitive bidding. In retrospect, the rapid increases in demand for electricity in the northern systens that were projected as of 1970 never materialized. Consequently, the procedures adopted by CFE to speed up the installation of new generating capacity for those systems by negotiating "turn-key" contracts or bilateral commercial contracts without international competitive bidding turned out to have been unnecessary. The demand projections for the northern systems made in 1970 were about 10% above actual demand in each of the years 1970-1972 for the Falcon-Monterrey system and were on average 9% above actual demand during 1970-1972 (as much as 15% in the last year) for the Sonora-Sinaloa system. In the first case the projected dewand did not materialize primarily because several new industrial plants (Hylsa, Fun- didora de Monterrey and Altos Hornos de Monclova) did not start operations as soon as had been expected. In the second case, rainfall was sufficient during the period so that demand for irrigation pumping was less than projected and availability of water for hydro-generation presented no problem. According to supervision missions from the Bank, the root of the, problem concerning delays as well as changes in the original expansion program could be found in the organization and management of the power sector. Construc- tion and procurement were carried out by seven different departments in CFE plus one in Centro. Coherent management of the expansion pro:ram was virtually - 5 - impossible because of unsystematic reporting and lack of uniform procedures among departments. This situation was further compounded by a substantial lag in the availability of budget control data. Furthermore, with a Board of Directors appointed by the national President, resulting in top management positions of CFE being quasi-political appointments, a determined effort to correct these problems was apparently lacking. The position of Director General of CFE changed hands twice during the period 1970-1972. The slower-than-expected progress during 1970-1971 on procurement and installation of generating equipment was reflected in the growth pattern of in- stalled capacity in operation from 1969 through 1972. During this period, no additional hydro plant capacity became operational, although an additional 705 MW had been forecast in the Third Power Program to be in operation by 1972. The installed capacity of steam plant increased by 660 MW as compared with the fore- cast increase of 1620 MW. By contrast, installed capacity of gas and diesel gen- erating equipment increased by almost 600 MW as compared with the original planned expansion of less than 200 MW. This sharp growth, in large part the result of delays in converting Centro to 60-cycles and inter-connecting it with other sys- tems, raised the amount of installed gas and diesel capacity in the power sector from 390 MW in 1969 to 990 MW in 1972. In 1969 gas turbine and diesel capacity represented about 7% of total installed capacity in the public power sector, and the original Third Power Sector Program envisaged no increase in that share. Nevertheless, by 1972 gas and diesel generators comprised 14% of total installed capacity (see Annex IV). This outcome was not necessarily less than optimal in response to the immediate circumstances, but it indicated that the investment planning techniques for the power sector needed strengthening. Loan 659-ME pro- vided for consultants to refine the investment planning capability of the power sector and to train CFE personnel in this area. The fact that the Third Power Sector Program was beset by delays in pro- curement and installation of equipment was not entirely unexpected. Experience with the two sector programs previously supported by the Bank indicated that the projections of demand growth tended to be high in the programs but that con- struction and installation schedules were invariably stretched out as compared with the program so that installed capacity ended up meeting requirements. One insurance factor that had1xisted during the previous programs was a margin of excess installed capacity- in some of the power systems, but this was no longer true by 1970. Thus, when the demand for power began briefly, in 1969, to meet and even exceed the projections made for the Third Power Sector Program, not only was it surprising but also it called for some quick remedial measures. Given the size and scope of this expansion program for 1970-1971 as originally envisaged, the extent of the changes made during its execution, aside from the stretching out of installation schedules, was not overwhelming. Nevertheless, if there had not been a recession in the Mexican economy during 1971, when the demand for electricity grew only about 8 percent as compared with the projected average annual growth of more than 12 percent in the program, then in all likelihood either many more remedial changes would have been required or a significant deterioration in service by CFE would have occurred in 1971 and 1972. In any event, overall demand growth in 1969-1972 averaged 11 percent, and no systems suffered serious shortages 1/"Excess" in the sense of unutilized capacity of a system over-and-above the capacity of the largest generating unit in the system. See Operations Eva- luatiun Report op cit. -b- Frequency Unification The two previous power sector loans, 436-ME and 544-ME, had included a covenant in the Guarantee Agreements providing for the timely initiation and completion of the fir3t stage of the frequency changeover in the Central System from 50 to 60 cycles. The Central System operated with more than 2,000 MW of connected load at 50 Hz. The complete frequency changeover was to involve the modification of the 50-cycle hydro and thermal generating units to operate at 60 cycles and the conversion or replacement of consumer-owned frequency s:ensitive equipment that could only operate at 50 cycles. Compared to the development of independent 50 Hz and 60 Hz systems, frequency unification and the subsequent development of a single 60 Hz system in southern Mexico was the least-cost alter- native for the concinuing expansion of the power sector. Nevertheless, no actual conversion of any of the 50 Hz connected load had been accomplished under the previous Bank power sector loans. One of the major factors inhibiting the ini- tiation of the changeover was the reluctance within Centro to be integrated en- tirely into CFE, especially on the pait of the union representing Centro's emplo- yees. CFE's employees were represented by two other unions. However, the basis for the eventual changeover had been established by two decrees issued by the Mexican Government in January and February 1968 which required that frequency sensitive equipment, either imported or manufactured in Mexico, must be capable of operating at 60 cycles or at both 50 and 60 cycles. The Guarantee Agreement cf Loan 659-ME likewise included a covenant to the effect that the Mexican Government should take, or cause to be taken by the Power Sector, all action necessary to carry out the initial stages of fre- quency unification as set forth in a schedule annexed to the Agreement. The agreed program comprised: (1) construction of 60 cycle transmission lines and substations, which were specified along with completion dates; (2) modification of the runners at Infiernillo hydro plant with orders to be placed in February 1970; (3) preparation and actual conversion of consumers' facilities with a total cumulative load of 300 MW to be carried out according to a time-table covering 1971 and 1972. The construction of all the transmission lines and substations specified in the Agreement was undertaken, but the work was not completed according to the agreed time-table (Annex V). All of the specified construction work was to be completed during 1970 except for seven substations that were to be readied for service during 1971/1972 in line with the scheduled changeover for consumers. In the event, theconstructionwork stretched out over 1971 and 1972 and in some cases into 1973. This reflected the lack of progress made toward implementing the changeover for consumers. On the one hand, faced with a presidential campaign in 1970 the Federal Government -as not eager to push a progra of frequency con- version that might alienate consumers. On the other hand, the new administration that assumed control of the Federal Government in November 1970 wanted time to evaluate the priority of the frequency conversion. By July 1971 the new adminis- tration had lined up behind the frequency unification program and a decree was issued to that effect, stipulating that the changeover should be completed by 1977 at the latest. Ten months later, in May 1972, another decree established the - 7 - Frequency Unification Committee as a decentralized public agency to promote, im-- plement and coordinate all activities related to conversion. The Committee was em- powered to carryout free of charge to the customer the modification or replacement of frequency-sensitive equipment to be determined by the Ministry of Commerce and Industry. The provisional list of equipment subject to free modification or replacement included water pumps in houses, washing machines, ballasts for fluores- cent lamps, refrige ators, automatic voltage regulators for TV sets, and record players (Annex V)T Overall Program Costs Although on the one hand physical progress on the expansion program proceeded more slowly than forecast, on the other hand the cost of the program escalated sharply. Actual annual outlays for the slower-than-projected program exceeded planned annual outlays by 29% in 1970 and by 41% in 1971. The total ex- penditure realized for investment during 1970-1971 amounted to Mex$ 8,280 (or US$ 662.4 million equivalent). This represented a margin of 35% above the invest- ment outlays estimated at the time of appraisal to anount to Mex$ 6,143 million (or US$ 491.4 million equivalent). This substantial escalation of investment outlays was all the more remarkable in light of the delays in carryin,- out the program. CFE has not furnished a satisfactory accounting of the increased invest- ment outlays. In fact, t:or the First and Second Power Sector Program as well as for the Third the Bank has accepted a singular lack of information regarding the actual allocation of investment expenditures by the Power Sector. Inasmuch as CFE prepared annual investment budgets with detailed item-by-item estimates of expenditures for projects and programs, and these budgets were then submitted to the National Planning Council in the Office of the President of Mexico for review and final approval, it strains credibility to imagine that systematic records of actual outlays in line with the budget estimates were not required to be produced."/ Yet, this entire area of CFE's operations has been surrounded by a cloud of ignorance, as was acknowledged by the independent external auditors for CFE, for example, when they reported that verification of the value of the Power Sector's inventories of equipment was impossible. The unavailability of detailed cost information on completed in-est- ment projects had ramifications for the planning of future investments. The Bank has been instrumental in helping CFE to improve its planning procedures. Part of Loan 659-ME was used i.o pay consultants' fees to review CFE's investment plans and to design a comprehensive planning model for the power sector which would evaluate alternatives with respect to type of generating equipment and 1/ The Frequency Unification Committee has proven to be a very effective entity. By the end of 1974 about 75 percent of the frequency unification program had been carried out and final completion is expected by the end of 1976. Invest- ments for frequency unification during the period 1972-1974 amounted to Mex$ 167.8 million (or US$ 13.4 million equivalent). 2/ Under Loan 834-ME, CFE agreed to carry out a series of measures to improve its planning and control procedures, including an investment control system and computerized budgetary control -- the latter became oppratioril at the end of 1973. - 8 - timing of installation as well as interconnection of separate power systems. The usefulness of the output from such a planning model depends very much on the assumptions that are made about patterns of demand growth and costs of investment. Although a considerable amount of analysis has been undertaken on the historical growth of demand, there has been no evidence of similar attention being given to the accuracy of cost estimates and reasons for cost overruns. The Original Financing Plan: 1970-1971 In any event, the unexplained investment expenditure increases during 1970 and 1971 resulted in very much larger financing requirements than had been foreseen. Additional financing on the order of Mex$ 2,850 million (or US$ 228 million equivalent) was required for the two years combined. A summary of the financing plan forecast at the time of appraisal of the Third Power Sector Program compared with the actual outcome for 1970-1971 is shown in the following table. - 9 - THIRD POWER SECTOR PROGRAM: FINANCING PLAN: 1970-1971 Appraisal Forecast Actual Outcome 7nlio7- -7ilionT- FINANCIAL REQUIREMENTS: 1970-1971 Investment program (including interest capitalized) 6,143 491.4 93.9 8,280 662.4 88.1 Other applications (including cash) 401 32.1 6.1 1,115 89.2 11.9 Total requirements 523.5 100.0 9,395 751.6 100.0 SOURCES OF FUNDS: 1970-1971 Gross internal cash generation 5,981 478.5 91.4 5,625 450.0 59.9 Less: Debt servicel -4 164 -333.1 -63.6 -4 274 -341.9 -45.5 Subtotal T4T7 -277 , 105.1 ThT. Contributions and transfers from: Federal Government 436 34.9 6.6 436 34.9 4.6 State & Municipal Government 170 13.6 2.6 184 14.7 2.0 Customers 175 14.0 2.7 332 26.6 3.5 Subtotal 781 6. 11.9 952 76.2 10.1 Domestic borrowing NAFINI! - - - 1,269 101.5 13.5 Other Mexican sources 716 57.3 10.9 704 56.3 7.5 Subtotal 716 57. 10.9 1,973 17 21.0 Foreign borrowing IBRD 1,837 147.0 28.1 1,168 93.5 12.4 (Loan 544-ME) (275) (22.0) (4.2) (188) (15-1) (2.0) (Loan 659-ME) (1,562) (125.0) (23.9) (980) (78.4) (10.4) Joint Loans 709 56.7 10.8 310 24.8 3.3 (with 544-ME) (172) (13.7) (2.6) (217) (17.4) (2.3) (with 659-ME) (537) (43.0) (8.2) (93) (7.4) (1.0) Other foreign sources 684 54.7 10.5 3 641 291.3 Subtotal 2 79.7 409-7 Total sources 6,544 523.5 100.0 9,395 751.6 100.0 1/ Excluding domestic refinancing op-ations foreseen (-ex451 million or US$36 Milli6n) and actually carried out (I-IeX$344 milIlion or US$27.5 million) between CFE and NAFIN. - 10 - Among the sources of financing, gross internal cash generation (before debt service) plus contributions from governmental authorities and customers worked out very much as forecast. Actual gross internal cash generation was 6 percent below the forecast for 1970-1971, but this shortfall was partially offset by larger contributions from customers than expected. However, debt service during the two-year period turned out to be Mex$ 110 million (or US$ 9 million) higher than forecast, in part because interest rates on refinancing and roll-oVer of existing debt were higher than anticipated and in part because total borrowing requirements for 1970-1971 were increased due to the escalated cost of the invest- ment program. As a result, net internal cash generation (after debt service) plus transfers 2)s -ix$ 2)3 millioq (or u:.$ 24 mi!l.i ; than had been projected, a shortfall of about 11% in comparison with the financing plan. Thus, whereas net internal cash generation plus transfers had been envisaged at the time of appraisal as supplying 40 percent of the planned financing requirements, these sources actually met only 25 percent of the larger-than-expected financial requirements. There- fore, to cover the financial gap the borrowing undertaken by the power sector during 1970-1971 amounted to about Mex$ 7,100 million (or US$ 567.4 million equivalent) as compared with the forecast borrowing plan of about Mex$ 4,000 million (or US$ 320 million equivalent). The additional borrowing to fill the financial gap came from domestic sources -- only NAFIN -- for an amount of Mex$ 1,270 million (or US$ 102 million equivalent) and from foreign sources -- suppliers' and financial credits -- for an amount of Mex$ 1,890 million (or US$ 151 million equivalent). The Contribution of Loan 659-NE A paradox in this actual requirement for more borrowing than had been anticipated in the program was that disbursement of the Bank's Loan 659-ME and associated joint loans proceeded less rapidly than predicted. In part the slow disbursement rate reflected the delays in procurement and installation of equipment as well as CFE's recourse to bilateral rnmmercial agreements without international competitive bidding, as occurred with the contracts for equipment felt to be urgently needed in the northern systems. But more significantly, many contracts awarded to Mexican firms for equipment or civil works -- for which financing for 50 per- cent or 35 percent, respectively, of the contract was available from Loan 659-ME -- were either placed directly with Mexican firms by CFE or on the basis of local bidding only, thereby rendering them ineligible for Bank financing. The original closing date for Loan 659-ME had been set for June 30, 1972, but because of the slow disbursement rate the closing date was extended by six months. The loan was fully disbursed as of August 28, 1972, just a little more than 27 months from the late of effectiveness. The appraisal financing plan had assumed that the loan would be fully disbursed in the two-year period: 1970-1971. In the event, Loan 659-ME provided financing for CFE's investment expenditures during three calendar (and financial) years in the following amounts: 1970 = US$ 37.0 million 1971 = US$ 41.4 million 1972 = US$ 46.6 million TOTAL- US$125.0 million hence, the loan financed the equivalent of 12 percent of the power sector's actual investment outlays during the period 1970-1972 rather than a 25 percent - 11 - share of the planned investment expenditures for 1970-1971 envisaged in the Third Power Sector Program. The Contribution of Joint Financing Prior to the negotiations with the Mexicans for Loan 659-ME, the Bank organized a meeting of likely major equipment supplying countries in order to arrange joint financing as had been done under the two previous power sector loans (436-ME and 544-ME). One major supplying country strongly advocated parallel financing under the Third Power Sector Program instead of joint financing so that the interest and amortization terms of the supplying country could be assessed in evaluating contract bids. A majority of the countries, however, in- sisted on joint financing../ The final agreement provided that joint financing would be 50 percent by the Bank and 50 percent by the supplying country on indi- vidual orders for imported goods of at least US$ 200,000 -- aggregating at least US$ 1 million in any one supplying country. The term to maturity of joint loans was to be not less than ten years from delivery of the goods, adding an appro- priate grace period in cases where maturity was calculated from date of signature. The interest rate and other charges were to be no higher than themost favorable rate and charges which the country otherwise provided with respect to long-term export credit. Procurement was to be on the basis of international competitive bidding, but without reference to credit terms including interest rates and amortization schedule. The Bank also included a cross-default provision in its Loan Agreement. The 50-50 sharing formula adopted with Loan 659-ME reflected the Bank's effort to increase the financial support for Mexico's power sector from major supplying countries. Joint financing under the previous power sector loan (544-ME) had been shared on the basis of two-thirds by the Bank,and one-third by the supply- ing countries. The revised formula was expected to produce an increased volume of financing from the supplying countriet. estimated at US$,43.,million. In fact. more than US$70 million was mobilized th1ough contracts awarded before December 31, 1971, in eight supplying countries, under the joint financing arrangements of Loan 659-ME. This represented more than double the US$ 31 million of joint financing mobilized with contracts under Loan 544-ME. However disbursements of the joint loans arranged with Loan 659-ME were limited to US$ 31.2 million during the period 1970- 1972 before funds from the Bank loan were exhausted. The remaining joint loan dis- bursements for about US$ 40 million were to take place in conjunction with funds available from the Bank's Fourth Power Sector Loan (836-NE) made in June 1972. Three-Year 1970-1972 Financing Pattern To compare the ex post financing of the Power Sector investment program with the ex ante plan is difficult because of the time lags between commitments made for the purchase of investment goods and cash disbursements made on delivery of the goods. In order to make purchase commitments for the Third Power Sector Program, the Power Sector needed assured means of financing. The ex ante plan was concerned with arranging financing for purchase commitments on equipment that was not all intended to be delivered or in operation before December 31, 1971. 1/ Parallel financing replaced joint financing in connection with the Fourth Power Sector Program supported by IBRD Loan C3'-ME for US$ 125 million appLuved and signed in June 1972. - 12 - Some disbursements in payments of such equipment would logically occur after 1971. Nevertheless, the earlier discussion of the physical investment achieve- ments indicated that the execution of the Third Power Sector Program encountered substantial delays. But investment expenditures of the Power Sector were sub- stantially higher than planned, and increased borrowing was undertaken. Thus, whether the analysis of ex post financing is confined to the two years 1970-1971 or is considered for the three years 1970-1972, on the evidence that the Third Power Sector Program was stretched out over that period, the conclusions are not altered. Quite simply, the financial situation of the Power Sector was seriously strained by the investment expenditures incurred during 1970-1972. POWER SECTOR FINANCING: 1970-1972 1970-1972 Cumulative Mex$ US$ % (millions) FINANCIAL REQUIREMENTS Investment expenditures (including interest capitalized) 13,195 1,056 89.8 Other applications (including cash) 1205 120 10.2 Total requirements 1j,700 1,176 100.0 SOURCES OF FUNDS Gross internal cash generation 8,610 689 58.6 Less: Debt Servicel/ -,65 - 613 - 52.1 Net internal cash generation 955 76 6.5 Contributions and transfers 1,480 119 10.1 Subtotal 2,435 195 16.6 Domesti /borrowing NAFIN- 2,470 198 16.8 Other 2,450 196 16.7 Subtotal 4,920 394 33.5 Foreign borrowing IBRD 1,760 141 12.0 Joint loans 640 51 4.3 Other 4,945 395 33.6 Subtotal 7,345 587 49.9 Total sources 14,700 1,176 100.0 1/ Excluding domestic refinancing operations arranged between CFE and NAFIN totalling Mex$ 862 million (or US$ 69 million equivalent). The Power Sector's investments during 1970-1972 amounted to more than lb$ I billion. The Bank disbursed a total of US$ 140.7 million during the period - 13 - (US$ 15.7 million of Loan 544-ME plus US$ 125.0 million of Loan 659-ME), thereby financing only one-eighth of the.Sector's investment outlays. Disbursements of joint loans during the three years totalled US$ 51.3 million, covering less than one-twentieth of the investment expenditures. The Power Sector contracted large amounts of suppliers' and financial credits totalling US$ 196 million from domes- tic sources and as much as US$ 396 million from foreign sources. Although the Power Sector's net operating income before interest payments remained stable dur- ing the period, the additional borrowing undertaken to finance the increasingly expensive investment program imposed a heavy interest cost on the sector. Hence, the Sector's net income position worsened. The added burden of debt amortization from the increased borrowing -- much of which consisted of financial credits without grace periods -- combined with interest payments resulted in a debt ser- vice burden by 1972 that exceeded gross internal cash generation, as shown in the following table. MEXICO - POWER SECTOR FINANCE: 1970-1972 (In Mex$ millions) 1970 1971 1972 Total operating revenues 6,160 6,675 7,424 Less: Total operating expenses -4,120 -4,600 -5,284 Operating income before interest 2,040 2,075 2,140 Other income (net) 110 (25) 12 Net income before interest 2,150 2,050 2,128 Less: Interest charged to operations -980 -1 052 -1 124 Net income 1,170 998 1,004 Depreciation 668 757 856 Subtotal 1,838 1,755 1,860 Less: Debt amortization-Y - 905 -1,335 -2,255 Net internal cash generation 933 420 -395 Contributions and transfers 472 480 530 Subtotal 1,405 900 135 Less: Investment expenditures -4,110 -3,713 --4,610 Interest Capitalized -220 -237 -305 Financial resource deficiency -2,925 -3,050 -4,780 FINANCING Domestic borrowing NAFIN!1 - 1,270 1,200 Other 202 500 1,745 Subtotal 202 1,770 2,945 Foreign borrowing IBRD 575 595 590 Joint loans 135 175 330 Other 2,195 1,445 1,3)5 Subtotal 2,905 2,215 2,225 Change in working capital and cash (increase -) -182 -935 -390 1/ xkcluding domestic refinancing operations arranged between CFE and NAFIN for Mex$ 101 million in 1970, Mex$ 243 million in 1971,and Mex$ 518 million in 1972. - 14 - Under these conditions all investment outlays were being financed with borrowed funds in 1972. The Power Sector's long-term debt (maturity greater than one year) rose by more than 50 percent in three years from Mex$ 15.6 billion (US$ 1.25 billion) at the end of 1969 to Mex$ 23.8 billion (US$ 1.90 billion) by the end of 1972. (See Annex IX). The long-term debt-to-equity ratio of the Sector, which had remained stable at 54/46 in the later 1960s, deteriorated to 59/41 by 1972 (Annex VI). This worsening financial position was very distressing as far as the Bank was concerned because covenants in the Loan and Guarantee Agreements for 659-ME had been designed to prevent such a situation. Financial Covenants under Loan 659-ME One of the Bank's objectives in making the power sector loan, besides providing a transfer of resources to alleviate the balance-of-payments constraints on Mexico's development, was to encourage sound financial performance in the operations of the power sector. The rationale for such an objective was that the power sector should be as financially independent as possible in order not to constitute an excessive drain on government revenues or borrowing capacity. To this end of sound financial performance, the Loan and Guarantee Agreements in- cluded covenants establishing minimum performance criteria to be attained by the power sector during the period of disbursement of the loan - in this case, 1970-1972. (a) Rate-of-Return Requirement The consolidated power sector was required to earn a return of at least 8 per- cent on the rate base.The rate base was defined as the sector's net fixed assets iii service at the beginning of the year, increased by a notional 4 percent to allow for completion of plant during the year. Should actual earnings (including proceeds of the Power Consumption Tax) fail to produce a rate of return of at least 8 percent on this rate base in any given yziar, the shortfall would have to be compensated in the following year. When actual earnings exceeded the required minimum of 8 percent, the Power Sector could utilize such excess funds either to compensate for shortfalls in later years or to make payments on certain acquisition debts. According to the financial accounts provided to the Bank by CFE the performance of the sector in meeting this 8 percent rate-of-return requirement was as follows: PERFORMANCE UNDER RATE-OF-RETURN COVENANT 1968 1969 1970 197 1972 (In MexVTmillions) Net fixed assets in service at beginning of year 17,622 18,264 22,180 24,685 27,345 Notional 4% additional completi.on of plant 705 731 887 987 1,94 Rate base 18,327 18,995 23,067 25,672 28,439 xO.08 xO.08 xO.08 xO.08 x0.08 8% return on rate base 1,466 1,520 1,845 2,054 2,275 Actual operating income attained by Power Sector 1,792 1,857 2,039 2,075 2,140 Actual return on rate base 9.8% 9.8% 8.8% 8.1% 7.5% Excess (or Jeficiency) with respect to 8% rate-of-return requirement 326 337 194 21 (135) Retroactive charges against surplus - - - (421) (504) - 15 - The Power Sector apparently earned a return greater than 8 percent in 1970 and in 1971, although with a shrinking margin compared to the actual rate of return of 9.8 percent attained in 1968 and 1969. However, retroactive charges were made to surplus amounting to Mex$ 421 million in 1971. By 1972 the actual rate of return had fallen to 7.5 percent, a shortfall in actual earnings of Mex$ 135 million below the level needed to meet the 8 percent minimum reqtirement in that year. Furthermore, retroactive charges to surplus in 1972 amounted to Mex$ 504 million. Thus, although the actual earnings in excess of the minimum requirement during the years 1968, 1969 and 1970 accumulated to Mex$ 857 million, because of the large retroactive charges to surplus in 1971 and 1972 amounting to more than Mex$ 900 million the Bank has asked the Power Sector and its auditors to review the balance of the excess funds set asi7de Ln years in which reported earnings exceeded the rate-ot-return requirement. Until this review is complete, it will not be possible to determine whether the Power Sector had accumulated sufficient excess funds above the minimum requirement during the period 1966-1970 to have covered the retroactive charges to surplus in 1971-1972 and still have met the requirement ot the rate-of-return covenant.!/ RETROACTIVE CHARGES TO SURPLUS 1971 1972 --Mex$ million-- Adjustment of prior years' income 218 - Increases of bad debt reserves 100 113 Increases in reserves against inventory losses 103 100 Amortization of intangibles - 172 Frequency conversion expenditures - 93 Other direct charges to surplus - 26 421 504 (b) Acquisition Debt Service The acquisition debt service covenant stipulated that any debt held by the Power Sector that had been contracted in connection with acquisition of private power companies could only be serviced from funds accumulated as a result of opera- ting income which exceeded the minimum rate-of-return requirement of 8 percent. Inasmuch as the acquisition debt service covenant was defined in relation to the rate-of-return covenant, the determination of whether the former covenant was met cannot be made until the verification of the rate-of-return performance has been completed. Prior to 1971 when the power sector was exceeding the 8 percent rate-of-return requirement with a margin of Mex$ 200 million or more annually, there was no question that the acquisition debt service covenant was being met. But, as explained above, during 1971-1972 when the rate-of-return covenant may not have been met, the servicing of acquisition debt amounted to Mex$ 64 million. This debt service would be charged against the accumulated funds of earlier years in excess of the 8 percent rate-of-return requirement. 1/ The verification difficulties with the rate-of-return covenant are twofold. First, audited financial accounts prior to 1968 exist for CFE and Centro separately but not on a consolidated basis (which would differ from a simple summation of the separate accounts). Second, the exact origin and nature of the retroactive charges to surplus in 1971 and 1972 requires further clarification by CFE and the auditors. - 16 - (c) Debt Limitation A debt limitation covenant in Loan 659-ME, consisting of an interest coverage test and two debt/asset tests, provided that the Power Sector would not incur debt without the agreement of the Bank if: i) net income before interest was less than 1.6 times maximum interest on consolidated debt (debt with original maturity of one year or more) in any succeed- ing year; or ii) the sum of net fixed plant in operation plus work in progress was less than 1.5 times the consolidated debt; or iii) the part of the consolidated debt with an original term of five years or less was more than one-tenth of the sum of net fixed plant in operation plus work in progress. The sector consistently complied with the two debt/assets tests, (ii) and (iii) above, as shown in the following table: DEBT/ASSET TESTS FOR POWER SECTOR (In Mex$ millions) 1970 1971 1972 (a) Next fixed plant in operation plus work in progress 30,043 33,188 36,934 Total consolidated debt 17,578 20,416 23,815 Less: NAFINSA - Acquisition debt -_1,760 - 1,772 -1,56 *(b) Consolidated debt for purposes of test (ii) 15,818 18,644 22,059 Ratio: (a)/(b) 1.90 1.78 1.67 Minimum acceptable for test (ii) 1.50 1.50 1.50 (c) Consolidated debt with an original term of five years or less 2,847 2,853 1,546 Ratio: (c)/(a) 0.095 0.086 0.042 Maximum acceptable for test (iii) 0.100 0.100 0.100 The interest coverage test turned out to be a stumbling block after 1970. Although the dependence of the test on projections of future interest payable made supervision difficult, by June 1971 it was recognized in the Bank that the levelling off of operating income of the power sector during that year would result in failure to cover projected interest payments for 1972 by 1.6 times. Actual annual interest coverage, instead of gradually strengthening over the 1968-1973 period fromZ.0 to 2.5, as projected in the appraisal report, steadily deteriorated from 2.d to only 1.0 in 1973, as shown in the following table: - 17 - NET INCOME COVERAGE OF INTEREST PAYMENTS 1968 1969 1970- 1971 1972 1973 Projected 2,0 2.2 2.0 2.1 2.2 2.5 Actual 2.0 2.0 1.8 1.6 1.5 1.0 The failure to meet the interest coverage test obliged the Borrowers to obtain Bank agreement to incur additional debt. In response the Bank insisted that any new debt incurred must have a minimum term of at least five years. CFE adhered to this condition in arranging the substantial amounts oE suppliers' and financial credits utilized in the latter part of 1971 and in 1972. As a result, the ongoing growth of consolidated debt with original terms of 5 years or less was checked in 1971 at a level of Mex$ 2,853 million and declined in 1972 to Mex$ 1,546 million. As a percentage of total consolidated debt, the portion with original terms of 5 years or less declined from 16.2 percent at the end of 1970 to 14.0 percent in 1971 and to 6.4 percent in 1972. Furthermore, the Bank urged the Mexicans to consider raising power tariffs so that the net internal cash generation of the sector would be improved and less reliance on debt financing of the inves;:ment program would be needed. This issue of increasing power tariffs was central to the Fourth Power Sector Loan (834-ME) made in 1972. The tariffs were eventually raised in October 1973, but not before the financial situation of the Power Sec- tor had suffered a major deterioration during the period of execution of the Third Power Sector Program. One conclusion that emerges from this review of the financial covenants contained in the Loan and Guarantee Agreements for 659-ME is that their complexity made them difficult to monitor. Moreover, even as the covenants were apparently being met insofar as one could determine at the time, nevertheless the financial plan for the investment program was going seriously awry. The plan had been pre- pared with the objectives of minimizing the Power Sector's recourse to government credit from NAFINSA and of maintaining a healthy debt/equity position that would enable the sector to be creditworthy on its own merits for some commercial debt financing on reasonable terms for its investment program. To this end, as a pre- condition to the Bank's loan, an agreement was reached in principle between CFE and NAFINSA that all debt amortization due to NAFINSA from the Power Sector result- ing from borrowing prior to 1970 would be refinanced during the period 1970-1974. No net additional new borrowing by CFE from NAFINSA was contemplated in the ori- ginal financing plan. Yet, in 1971 the Power Sector tapped NAFINSA for new credit in the amount of Mex$ 1,270 million (or US$ 102 million equivalent) followed in 1972 by an additional Mex$ 1,200 million (or US$ 96 million equivalent). Also, the Power Sector made extensive use of market credits (domestic and foreign) to meet more than half of total financial requirements during the period 1970-1972, whereas IBRD financing represented one eighth of the total. The original financ- ing plan for the Third Power Sector Program had envisaged an improvement in the debt-equity ratio of the Power Sector from 54/46 in 1969 to 50/50 by 1972. Instead, as was previously noted, the ratio deteriorated to 59/41. Realistically, however, the Bank was in no position to enforce sound financial practices on the Power Sector, if the Government and the management of CFE was inclined for whatever reason not to follow them. With access tc government financial assistance either in the form of direct credit or debt gua- rantees or transfers, the Power Sector was not dependent on financing from the Bank. The Bank was fully aware of the deteriorating financial situation and - 18 - recommended that remedial .,easures be taken as early as mid-1971. The limited influence of the Bank was effectively exercised by insisting on minimum terms of five years on all borrowing by the Power Sector. Conclusions Loan 659-ME could well be considered an unsuccessful loan inasmuch as most of the Bank's objectives in supporting the Third Power Sector Program were not achieved. The frequency conversion of the Central System was not started as had been planned. This in turn necessitated the addition of extra emergency generat- ing equipment to the .nvestment program. The revision in 1970 of projected growth of demand for electricity in the'northern systems, in the face of delays in pro- curement and installation of equipment, led to changes in the program and compro- mises being made with regard to procurement practices. In retrospect these changes and compromises turned rut to have been unnecessary because the projected growth of demand never materialized. The Third Power Sector Program was certainly not carried out according to the original time-table, but the extended phasing of the Program coincided with a recession in the Mexican economy so that service to consumers suffered no apparent deterioration due to a lack of installed generating capacity. However, the financial situation of the Power Sector did deteriorate seriously. As the investment outlays of the Power Sector increased sharply above the levels envisaged in the financing plan, the Government allowed the Sector to use debt financing exclusively to meet the expenditures rather than raising tariffs. CFE obtained new credit on the order of US$ 99 million a year in 1971 and in 1972 from NAFINSA, which had not been contemplated in the financing plan. CFE's new borrowing from NAFINSA thereby diverted those resources of that development insti- tution from other uses. Furthermore, the extensive recourse to suppliers' and financial credits imposed a heavy debt service burden on the Power Sector and worsened its creditworthiness for future additional borrowing. A vast amount of investment needed for increased future output was of course carried out, but the disparity between the plan and actual performance points to ;the need for an ana- lysis of past inveEtment expenditures to determine the reasons for cost overruns. This would improve the basis for cost estimates in future plans. The poor performance in the execution of the Third Power Sector Program was principally a reflection of a management problem. The problem stemmed from the diffuse organizational structure within CFE whereby no specific unit was given responsibility for supervising the implementation of the investment program. But centralized administrative supervision at that time was not possible because of the inadequate information feedback systems and the lack of cost control proce- dures. For this reason, the Bank was not in a position to alter significantly the performance through more intensive supervision missions. Nor would the out- come have been improved if the Bank had interrupted disbursements on Loan 659-ME on the grounds that the frequency conversion covenant was not being adhered to. CFE's prominence in the public sector and its close ties with the Federal Government through presidential appointment of the Governing Board and the Director General result in management momentum or inertia, as the case may be -- for example, fre- quency unification or the merger of Centro with CFE -- which may be determined by considerations outside the scope of interest of the Power Sector. Therefore, the influence of the Bank on the performance of the Power Sector is dependent on government support, and exhortation by the Bank in connection with a loan cannot necessarily be expected to produce dramatic changes in performance in the absence of such support. - 19 - The argument has been made ttat the tinancial performance criteria established for the Power Sector under Bank loans can provide a useful restraint on the use of governmental resources (borrowing from NAFINSA) by the Sector. The financial performance conditions were designed to strengthen the financial inde- pendence of the Sector and wean it away from dependence on governmental resources that could be better used for social priorities that do not have independent - financial means. But this argument cuts both ways, because Bank loans might also be alternatively utilized on projects or sectors where the pay-off in terms of achieving appraisal objectives is higher than in the Power Sector. The per- . formance under the Third Power Sector Program proved that the Bank's financial performance conditions were not an effective restraint against CFE's borrowing from NAFINSA. The failure to achieve that objective was not a reflection of the inadequacy of the performance tests. In fact, the complexity of some of the tests resulted from a compromise reached during the loan negotiations whereby the Bank agreed not to insist on a minimum rate-of-return requirement higher than 8 percent because of the adverse political repercussions that might have ensued in Mexico concerning the appropriateness of the rate-of-return to be earned by a public entity. The complexity of the tests made no difference in the final outcome, for the Power Sector did not meet all the tests in any case. Different tests would not have altered the financial performance of the Power Sector; they likewise would not have been met. In these circumstances, the options available to the Bank were limited either to making a bad situation worse or to making the best of a bad situation. The option of interrupting disbursement on the Bank loan or the option of strictly limiting additional borrowing from other sources for the program would have largely paralyzed the Power Sector's investments. Hence, the Bank chose to let the investment program be carried out with additional borrowing at minimum terms of five years in the absence of governmental willing- ness to increase power tariffs. How much of the financial problem with the Third Power Sector Program could have been avoided if better investment planning and budgetary control had been exercised is a matter for speculation. The devaluation of the dollar and the eruption of world-wide inflation that occurred during the period of implementation of the program was not foreseen at the time of appraisal. Nevertheless, the es- calation of i:he program from the planned two-year effort with financial require- ments of Mex$ 6,544 million to an actual three-year effort requiring Mex$ 14,700 million cannot be entirely accounted for by unforeseen exogenous factors such as world-wide inflation. Certainly improved tools for planning and managing the investment program of the Power Sector must be utilized if the Bank's power sector lending is to achieve the least-cost investment objective. From the broader perspective of the Bank's long involvement with the Power Sector, it may be concluded that the Third Power Sector Program marked an aberration or regressive stage in the longer-term development of management and planning capability (institution-building) and of financial strength. The Bank has promoted the integration and consolidation of the power sector since the nationalization in 1960. By 1970 all the planning and financial management were consolidated in CFE. Furthermore, the interconnection of separate power systems was planned and being carried out with Bank support. The particularly touchy problems of frequency conversions of Centro were finally being tackled with some determination by the Mexicans after nearly a decade of urging and cajoling from the Bank. The Bank's association with the Sector has been import- ant for the terms and conditions of joint loans that have accompanied Bank lending. - 20 - Finally to prevent further deterioration in the finances of the Sector, power tariffs were increased in 1973. This measure was central to the Fourth Power Sector Loan (834-ME). The progress and achievements in the power sector over the longer term have been notable, but at the same time the Bank's financial support to the sec- tor has been unprecedented for any single client insttution in the world. Beginning with the first Bank loan made after the nationalization of the sector -- Loan 316-ME for US$ 130 million -- followed by four sector loans totalling US$ 450 million, the Bank has been committing on average more than US$ 40 million annually for power in Mexico. From the macroeconomic standpoint, sometimes introduced to support this lending as a means of providing large, quick support to Mexico's balance of pay- ments1l/, it is noteworthy that Bank lending to the Power Sector has in fact been a relatively small part of Mexico's total capital inflow, even to the public sector alone. A comparison of disbursements on the Bank's power sector loans during 1970, 1971 and 1972 with disbursements on total medium- and long-term foreign borrowing by the entire public sector in Mexico during those years shows that the Bank's power sector loans furnished only about 6% of the gross foreign capital inflow to the public sector. MEXICO - Gross Inflows of Medium- and Long-Term Foreign Capital to the Public Sector (millions of US$ at current prices) 1970 1971 1972 (a) Disbursements on total public sector medium- and long-term foreign borrowing 783 793 1,044 (b) of which: disbursements directly to Power Sector. 232 177 178 (b) as percentage of (a) (30%) (22%) (17%) (c) of which: disbursements of IBRD Loans 544-ME and 659-ME 46 48 47 (c) as percentage of (a) (6%) (6%) (5%) (d) of which: disbursements of joint loans 11 14 26 (d) as percentage of (a) (1%) (2%) (3%) 1/ The Mexico Country Program Paper of March 1970 (para. 39) referred to this point as follows: "The principal contribution which the Bank has made to Mexico's economic development has consisted of the transfer of resources involved in lending a total of $ 957 million over twenty years. Increasingly, the Bank's operations in Mexico have taken on the characteristics of sector lending, and the financing of power and agricultural credit is readily adapt- able to this approach now that competent institutions have been created, ensuring quick disbursement of Bank loans and requiring little detailed supervision." - 21 - If disbursements on joint loans with IBRD loans to the Power Sector were to be added, the contribution would be raised to 8 percent. But, there is no evidence that Loan 659-ME attracted more bilateral foreign financing in the form of joint loans than would have been available otherwise to the Power Sector. The competition among the joint lenders for Mexican power equipment orders was keen, as suggested by the controversy about whether joint financing should be replaced with parallel financing under Loan 659-ME. The importance at the margin for Mexico's balance of payments of an average $47 million annually of Bank disbursements to finance the Third Power Sector In- vestment Program is incontestable. Nevertheless, since these disbursements re- presented about 5% of total gross IBRD disbursements to borrowing member countries during that period, it is disappointing to record that the accomplishments of financial support of this magnitude were not greater. This raises the question of whether or not the Bank's financial and technical assistance might produce more significant results if it were channelled to sectors other than power. But an answer to this question calls for an assessment of alternatives beyond the scope of this report. The fact that IBRD disbursements to the Power Sector during the period 1970- 1972 financed only 12 percent of the Sector Program underscores the very large size of the Mexican Power Sector. Under normal project lending the Bank would generally finance 40-50 percent of the total project costs. Thus, when dealing with the entire Mexican Power Sector the Bank was tackling a supersize "project". The sector lending approach adopted by the Bank had the inherent advantage of providing flexibility in the use of the resources. But, one lesson to be derived from the experience with Loan 659-ME is that when undertaking a very big job such as rationalizing the Mexican Power Sector, the Bank should not underestimate the amount of time, effort and resources that will in all likelihood be required to achieve the objectives. The hopes held out in the Bank's appraisal report for the Third Mexican Power Sector Program proved too optimistic. Yet, in the context of measures adopted for an investment control system and improved budgetary con- trol as well as the progress achieved on frequency unification after Loan 659-ME was fully disbursed, it may be said that the loan indeed contributed to the process of promoting the ongoing rationalization of the Power Sector. ANNEX I MEXICO Bank Loans to the Mexican Pbwer Sector: 1949-1970 Loan Amount Year Loan No. Beneficiary (In millions of US$) 1949 12-ME CFE 24.1 1949 13-ME CFE - 1/ 1950 2k-ME Mexlight 26.0 1952 56-ME CFE 29.7 1958 186-ME Mexlight 11.0 1958 19k-ME CFE 34.0 1962 316-ME CFE 130.0 1965 436-ME OFE 95.o Centro 15.0 110.0 1968 Sk-ME CFE 78.0 Centro 12.0 90.0 Subtotal k5.8 1970 659-ME CFE 109.0 Centro 16.0 125.0 Total 579.8 1/ loan 13-ME for US$10 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 2k-ME. ANNEX II page 1 of 2 INTEGRATION OF THE NE,'ICAN ELECTRIC POWER SECTOR The electric power sector was nationalized in December 1960 by a constitutional amendment after the Mexican Government had obtained control of the sector by acquiring: (i) the assets of Impulsora de Empresas Electricas S.A. (Impllsora), a subsidary of 1merican and Foreign Power Company; (ii) the majority of the shares of the Mexican Light and Power Company Ltd. (Mexlight), which controlled the operating company -- subsequently renamed Compania de Luz y Fuerza del Centro S.A. (Centro) -- providing power to the Mexico City market at a 50-cycle frequency; (iii) a subsidary of the International Power Company of Canada, Ltd.; and (iv) several distributing companies. After the nationalization the companies were managed in three main groups, cor- responding to the collective labor contracts held by three different labor unions. In 1963 Mexlight was reorganized solely as a holding company for Centro, and Impulsora was t:,ken over by Industrial Electrica Mexicana S.A. (IEMSA) which was affiliated with CFE. Eighteen other entreprises had also become subbidaries of CFE but because of the exis- tence of different labor unions they continued to have their own manage- ment and organization, which was costly. An agreement concluded in 1966 between CFE and two of the unions made possible the integration of IE4SA and the 18 subsidaries with CFE. The actual merger to)k place during 1967. Thereafter the Power Sector consisted virtuall- of two entities: CFE and Centro. ANNEX II page 2 of 2 -2- In January 1969 Centro's union joined the 1966 agreement between CFE and the other unions, and pledged to support the Power Sector's in- tegration in general and the frequency change to 60-cycles in Centro's system in particular. During 1968, the integration process continued when CFE's share purchases gave it a majority of Mexlight shares. Another step was taken in the middle of 1969 when, under the pressure of financing problems, the debt and funds management of the sector was effectively centralized under CFE. Although CFE had acquired a majority of Mexlight's shares in 1968,little progress was made towards coordination of planning and operations between CFE and Oentro. This problem was resolved in January 1970 when the Director General of CFE was also appointed as President of Centro. Nevertheless, Centro has continued as a separate legal and operational entity with its own financial accounts, although management of its finances and operations is controlled through CFE. Therefore, in this report the term Power Sector is used to connote the consolidated accounts of CFE and Centro. MEXICO - POWER SECTOR 1970/1971-CONSTRUCTION PROGRAM - LIST OF MAJOR FACILITIES I, GENERATING PLANTS Appraisal Forecast Status in 1973 Year of Year of No. & Size Initial No. & Size Initial System Plant & (Unit No.) Type of Units (MW). Operation of Units (MW) Operation Under construction on October 1. 1969: Central Valle de Mexico (2,& 3) steam 2 x 150 1970 gas 2 x 30 1972 Valle de Mexico (4) steam 1 x 300 1972 1 x 300 1973 Infiernillo (5 & 6) hydro 2 x 180 1972 2 x 170 1975 Puebla-Veracruz La Angostura hydro 3 x 156 1975 3 x 180 1975 Michoacan-Chapala- Sa3amanca (1 & 2) steam 2 x 150 1970 2 x 150 1971 Guanajuato La Villita hydro 4 x 75 1971 4 x 75 1973 Falcon-Monterrey Monterrey (4 & 5) steam 2 x 84 1971 2 x 84 1973 Sonora-Sinaloa Guaymas (4) steam 1 x 41 1969 1 x 41 1970 Tijuana Cerro Prieto geotherm. 2 x 37.5 1970 2 x 37.5 1973 Yucatan Nachi-Cocom II (1 & 2) steam 2 x 24.5 1970 2 x 24.5 1971 Construction to be started before December 31, 1971: Central Tula (1 & 2) steam 2 x 300 1974 2 x 300 1974 Michoacan-Chapala-Guanajuato Salamanca (3) steam 1 x 150 1972 1 x 300 1976 Colotlipa-Acapulco Acapulco (2) gas 1 x 14 1970 1 x 14 1972 Torreon-Chihuahua Durango gas I x 14 1971 1 x 14 1971 Torreon gas 2 x 14 1970 2 x 14 1973 Falcon-Monterrey Monterrey I (6) steam 1 x 84 1972 1 x 84 1974 Monterrey II (1 & 2) steam 2 x 150 1973 2 x 158 1976 Monterrey gas 4 x 14 1970 4 x 14 1971 Las Esperanzas gas 1 x 14 1970 1 x 14 1972 Sonora-Sinaloa Plutarco Elias Calles hydro 1 x 45 1972 1 x 45 1974 Topolobampo (2) steam 1 x 41 1972 not started Guymas II (1) steam 1 x 75 1973 1 x 87.5 1973 Guymas II (2) steam I x 75 1974 1 x 87.5 1974 Humaya hydro added later 2 x 45 1975 Yucatan Campeche steam 1 x 37.5 1972 2 x 37.5 1975 Ciudad Juarez Ciudad Juarez gas 1 x 14 1970 1 x 14 1970 >n GQ 0 - MEXICO - POWER_SECTOR 1970/1971 CONSTRUCTION PROGRAM - LIST OF MAJOR FACILITIES II. TRANSMISSION LINES Appraisal Forecast Status in 1973 Year of Year of Voltage No. of Length Initial Length Initial Location (kV) Circuits _km) Operation (km) Operation Under construction on October 1. 1969: Central Ring (northern & eastern branches) 220 2 87 1970 87 1970 Nopala-Remedios 220 2 3 1970 3 1972 El Vidrio-Zumpango 220 1 30 1971 30 1971 Puebla-Veracruz Mazatepec-Poza Rica - Tampico 220 1 285 1970 285 1970 Malpaso-Minatitlan II (2nd circuit) 400 1 686 1970 145 1970 Michoacan - Carapan-Guadalajara I 220 1 189 1970 189 1970 Chapala - Guanajuato Guadalajara II - Guadalajara 1 220 1 20 1970 20 1971 Queretaro - San Luis - Potosi 220 1 186 1969 186 1969 Aguascalientes - Calera 220 1 130 1970 130 1971 Carapan - Salamanca 220 1 155 1970 155 1971 Salamanca - Leon II 220 1 80 1970 80 1971 Torrcon - Gomez Palacio-Durango 220 1 240 1971 240 1972 Chihuahua Francisco Villa - Avalos - Camargo 220 1 137 1970 137 1974 Falcon - Monterrey San Nicholas - Saltillo - Gomez Palacio 220 1 365 1970 365 1972 Sonora-Sinaloa Obregon II - Navoja 220 1 70 1970 70 1970 To be started before December 31, 1971: Central Valle de Mexico - Cerro Gordo-Nonoalco 220 1 30 1971 30 1972 Puebla - Termixco-Toluca-Remedios 220 1 263 1971 263 1972 Michoacan- La Villita - Infiernillo 220 2 50 1971 46 1973 Chapala Infiernillo - Carapan 400 1 180 1971 changed Guanajuato Infiernillo - Acatlan 400 1 added later 318 1974 Carapan - Guadalajara II 400 1 400 1972 changed Texcoco - Queretaro 200 1 220 1970 220 1970 Guadalajara II - Guadalajara III 200 1 20 1972 changed Acatlan - Guadalajara III 200 1 added later 43 1974 Colotlipa-Acapulco Temixco - El Quemado 220 1 300 1972 240 1974 Torreon-Chihuahua Gomez Palacio - Camargo 220 1 296 1971 296 1971 Falcon-Monterrey Monterrey-Reynosa 220 1 200 1972 200 1976 Sonora-Sinaloa Mochis II - Culiacan II - Mazatlan 220 1 424 1971 424 1974 Guaymas II - Hermosillo III 220 1 140 1973 140 1973 0m ANNEX IV MEXICO: POWER SECTOR GROWTH OF INSTALLED CAPACITY AND GROSS PRODUCTION, 1968-1972 I. INSTALLED CAPACITY 1967 1968 1969 1970 1971 1972 MW MW % inc. MW % inc. MW % inc. MW % inc. MW % inc. Hydro plant 2,511 2,509 - 3,229 28.7 3,228 - 3,227 - 3,228 - Steam plant 1,863 1,933 3.8 2,038 5.4 2,353 15.5 2,677 13.8 2,698 0.8 Other 268 354 32.1 391 10.5 487 24.6 594 22.0 987 66.2 Total 4,642 4,796 3.3 5,658 18.0 6,068 7.2 6,498 7.1 6,913 6.4 II. GENERATION (GROSS) GWh GWh Inc. GWh Inc. GWh Inc. GWh Inc. GWh Inc. Hydro plant 10,855 12,408 14.3 13,303 7.2 14,805 11.3 14,269 -3.6 15,246 6.8 Steam plant 6,601 7,078 7.2 8,974 26.8 10,360 15.4 13,321 28.6 14,780 11.0 Other 479 533 11.3 788 47.8 865 9.8 893 3.2 1,507 68.8 Total 17,935 20,019 11.6 23,065 15.2 26,030 12.8 28,483 9.4 31,533 10.7 ANNEX V page 1 of 3 MEXICO THIRD POWER SECTOR PROGRAM PROGRESS UNDER FREQUENCI UNIFICATION COVENANT 1. Completion dates of the 60 cycle transmission lines and sub- stations as compared to those in the timetable of Schedule 2 of the Guarantee Agreement were as follows: Ca2pletion Date Guarantee Agreement Actual Puebla-Temixco Transmission Line October 1970 1971 Temixco-Toluca Transmission Line October 1970 1972 Toluca-El Vidrio Transmission Line December 1970 1972 Substation Toluca 100 MVA, 230/85 kV October 1970 1971 Substation Temixco 100 MVA, 230/85 kV October 1970 1973 Substation El Vidrio (Apasco) 100 MVA, 23o/85 kV December 1970 1973 Three Substations 30 MPA, 85/23 kV December 1970 1972 Seven Substations During 1971/1972 1973 2. The Bank approved the award of the contract for the 60 cycle runners for El Infiernillo on June 16, 1970. This order was to have been placed in February 1970. 3. By the end of 1972 no actual conversion of consumers' facilities had been carried out although inventories of frequency sensitive equipment had been largely completed as a preparatory step. In addition, the Mexican Government had issued two decrees as follows: ANNEX V page 2 of 3 Decree of July 23, 1971 ordering that frequency unification be carried out The decree stated: - Frequency unification is in the public interest ("Utilidad Publica"). - CFE shall formulate the frequency unification program (and eventual modifications thereof), and shall submit it (and eventual proposals for modifications) to the Ministry of Commerce and Industry for ap- proval. The changeover shall be completed by 1977 at the latest. - The Ministry of Commerce and Industry shall supervise the implementa- tion of frequency unification and dictate such additional regulations as shall become necessary. Decree of May 1i, 1972 creating the "Comite Para la Unificacion de Frecuencia" (The Committee) The decree stated: - The Committee shall be a decentralized public agency with a legal personality and assets of its own. - The Committee shall promote, implement and coordinate all activities related to frequency unification; it shall give free advice on questions concerning the changeover to all power consumers. - The Committee shall carry out free of charge to the customer the modification or replacement of frequency-sensitive equipment on the list approved by the Ministry of Commerce and Industry (a provisional list is given below) and that utilized in rural communities. The power sector shall modify its plant at its own expense. - The Committee shall have a Board comprising the Minister of Commerce and Industry as President, the Ministers of Finance, of the National Patrimony, of the Presidency, and the Director General of CFE. The President of the Republic shall designate the Director General of the Committee who qould be the chief executive of the ANNEX V page 3 of 3 Committee. The Board shall consult with a group including representatives of the governments of the Federal District, the states of Hidalgo, Mexico, and Morelos, and of organiza- tions representing commerce and industry. - Tie Committee shall be financed by Government appropriations. - The Committee shall exist as long as required to complete the frequency unification. Provisional list of appliances to be modified or replaced free of charge to the consumers - Water pumps in houses - Washing machines - Ballasts for fluorescent lamps - Refrigerators - Automatic voltage regulators for TV sets - Record players MEXICO: POWER SECTOR Actual Compared with Forecast Consolidated Sector Balance Sheets as of December 31, 1968-1972 (In Mex$ millions) Actual Forecast Actual Forecast Actual Forecast Actual Forecast Actua ASSETS 1968 1969 1969 1970 1970 1971 1971 1972 1972 Fixed assets in service 23,484 27,440 28,230 30,895 31,361 33,794 34,730 36,726 38,302 Less: accumulated depreciation 55220 _,802 6,050 6,476 6,676 7,223 38 8,03 8,356 Net fixed assets in service 18,264 21,638 22,180 24,419 24,685 26,571 27,345 28,689 29,946 Work in progress 5,392 41 00 5,358 5,000 5,843 _6,988 Total net fixed assets 23,656 26,638 26,595 29,419 30,043 31,571 33,188 33,689 36,934 Current assets Cash 981 806 690 861 535 990 687 1,012 868 Accounts receivable 998 1,000 962 1,150 1,468 1,260 1,499 1,380 1,714 Materials and supplies 1,656 1,075 1,615 1,125 2,280 1,175 2,279 1,225 2,335 Other 316 110 583 120 62 130 43 140 51 Total current assets 3,951 2,991 3,850 3,256 4,345 3,555 4,508 3,757 4,968 Other assets 920 1,224 1 1 1,551 1,481 1,914 1,091 1,940 Total assets 2_82 3 __03 M _5__39 36 60 38___ 43__42 LIABILITIES & EQUITY Equity 11,480 12,409 13,068 13,860 14,512 15,483 15,495 17,306 16,319 Long-term debt Long-term debt for fixed investment 11,282 13,520 15,497 ... 18,644 ... 21,798 Long-term debt for acquisition _208 2081 2,081 1,772 2,17 Total long-term debt 13,366 14,558 15,601 16,222 17,578 16,938 20,416 17,323 23,315 Less: current portion 856 568 983 953 1,138 1,283 _1,545 1299 2,381 Long-term debt (net) 12,510 13,990 14,618 15,269 16,440 15,655 18,871 16,024 21,434 Current Liabilities Current portion-of long-term debt 856 568 983 953 1,138 1,283 1,545 1,299 2,381 Other current liabilities 1,928 2,086 1,002 2,186 1647 2,286 _1,50 2, 1,597 Total current liabilities 2,784 2,654 1,985 3,139 2,785 3,569 3,053 3,685 3,978 Other liabilities 1,753 1,800 2,32 1, 0 1 1900 2,191 _1,95 2,11.1 Total liabilities and equity 28,527 30,853 31,703 34,118 35,939 36,7 3 1 9 38 965 43 842 Long-term Debt/Equity Ratio 54/46 54/46 54/46 54/46 55/45 52/48 57/43 50/50 59/41 Current Assets/Current Liabilities Ratio 1.42 1.13 1.94 1.04 1.56 1.00 1.48 1.02 1.25 MEXICO: POWER SECTOR Actual Compared with Forecast Consolidated Sector Income Statements by Calendar Years, 1968-1972 (In Mex$ millions) Actual Forecast Actual Forecast Actual Forecast Actual Forecast Actual 1968 1969 1969 1970 1970 1971 1971 1972 1972 Percentage le increase 11.4 14.1 15.0 16.7 12.9 10.5 8.3 9.2 11.8 Sales (GWh) 2/ 16,705 19,061 19,212 22,239 21,683 24,578 23,490 26,837 26,250 Average revenue (centavos/kwh) 28.7 28.6 28.2 27.1 28.2 27.1 28.1 27.1 28.0 OPERATING REVENUES Power sales 4,330 4,942 4,909 5,466 5,458 6,021 5,960 6,585 6,664 Power consumption tax 468 510 508 570 649 625 640 683 681 Subtotal - power revenues 4,798 5,452 5,417 6,036 6,107 6,646 6,600 7,268 7,345 Other 42 52 49 54 52 56 75 58 79 Total operating revenues 4,840 5,504 5,466 6,090 6,159 6,702 6,675 7,326 7,424 OPERATING EXPENSES Labor 1,595 2,000 1,791 2,100 2,107 2,275 2,372 2,460 2,746 Fuel 507 498 509 636 585 692 680 728 816 Purchased power 15 14 48 20 18 22 24 25 34 Depreciation 498 581 610 674 669 747 757 814 856 Other 433 554 651 580 741 620 767 671 832 Total operating expenses 3,048 3,647 3,609 4,010 4,120 4,356 4,600 4,698 5,284 Operating income 1,792 1,857 1,857 2,080 2,039 2,346 2,075 2,628 2,140 Other income (net) (25) 80 74 67 110 67 (25) 67 (12) Net income before interest 1,767 1,937 1,931 2,147 2,149 2,413 2,050 2,695 2,128 interest payable 871 861 977 1,071 1,199 1,152 1,289 1,219 1,430 Less: interest capitalized (192) (263) (175) (218) (219) (219) (237) (218) (306) Interest charged to operations 679 598 802 853 980 933 1,052 1,001 1,124 Net income 1,088 1_339 1 249 998 1.694 Return on Rate Base (%) 9.8 10.0 9.8 9.2 8.8 9.2 8.1 9.5 7.5 interest Coverage Ratiol/ 2.02 2.25 1.98 2.00 1.79 2.10 1.59 2.21 1.49 / Net of intrasector power sales between CFE and Centro. / Including power consumption tax. 3/ Defined as: Net Income Before Interest/Interest Payable. MEXICO: POWER SECTOR Actual Compared with Forecast Sources and Uses of Funds (In Mex$ millions) Actual Forecast Actual Forecast Actual Forecast Actual Forecast Actual 1968 1969 1969 1970 1970 1971 1971 1972 1972 SOURCES OF FUNDS Internal cash generation Net income before interest 1,767 1,937 1,931 2,147 2,149 2,413 2,050 2,695 2,128 Depreciation 498 581 610 674 669 747 757 814 856 Subtotal 2,265 2,518 2,541 2,821 2,818 3,160 2,807 3,509 2,984 Contributions & Transfers Federal Government 218 218 218 218 218 218 218 218 218 State & Municipal Governments 86 85 89 85 81 85 103 85 136 Private customers 108 80 94 85 173 90 159 95 175 Subtotal 412 383 401 388 472 393 480 398 529 Borrowing (Domestic) NAFIN - Refinancing - - - 198 101 253 243 468 518 NAFIN - Other 775 289 239 - - - 1,269 - 1,200 Other domestic sources 80 9 593 596 358 202 358 502 358 1,746 Subtotal - domestic 1,584 882 835 556 303 611 2,014 826 3,463 Borrowing (Foreign) IBRD: 544-ME 249 601 680 275 111 - 77 - 8 Joint loans to 544-ME 10 126 132 172 136 - 81 - 34 IBRD: 659-ME - - - 842 463 720 517 - 583 Joint loans to 659-ME - - - 186 - 351 93 - 297 Other foreign sources 835 1,000 1,090 424 2,195 260 1,446 1,350 1,304 Subtotal - foreign 1,094 1,727 1,902 1,899 2,905 1,331 2,214 1,350 2,226 Total borrowing 2678 2455 3208 19 228 2,176 689 Total sources 55 5510 5,679 5,664 9 1 6083 9,202 USES OF FUNDS Investment (incl. interest capitalized) 2,861 3,181 3,382 3,350 4,331 2,793 3,949 2,827 4,915 Debt service 1,710 1,901 2,030 2,237 1,986 2,378 2,632 3,010 3,897 Other uses 273 603 483 22 502 195 782 224 209 Change in cash position 511 (175) (216) 55 (321) 129 152 22 181 Total uses 5,355 5510 5,679 5,66 6 9 6,083 Annex IX MEXICO: POWER SECTOR page 1 of 2 MEDIUM - AND LONG-TERM DEBT OUTSTANDING, END-OF-YEAR (In Mex. $ million) Dec. 31, 1968 Dec. 31, 1970 Dec. 31, 1972 DEBTOR CREDITOR OUTSTANDING SUBTOTALS OUTSTANDING SUBTOTALS OUTSTANDING SUBTOTALS I. MEDIUM-TERM DEBT A. Suppliers 37.4 143.8 126.0 CFE Allen, S.A. 0.2 - Banco de Vizcaya 14.9 7.5 - Banco Exterior de Espana - 93.6 56.2 Cie. Elec.-Mecan. ( 3 credits) 1.7 0.9 - Conductores Monterrey* - - 4.0 Condumex* - - 3.7 Ind. Elec. de Mex., S.A. ( 2 credits) 1.8 Industrial Navarra - 10.0 5.5 Industrias Unidas* - - 1.4 Manufacturers Hanover Trust - 31.6 Mitsubishi - 11.3 6.8 Mitsui - 6.3 3.5 Nacional de Cobre, S.A. 16.1 12.7 9.4 Phelps Dodge Pyesa* - - 3.9 United Aircraft - 1.1 - Westinghouse Intl. (3 credits) 2.7 0.4 B. Banks 1,093.2 2,393.2 1,420.2 CFE Banco Nat. Hip. (Pemex)* 77.9 Bank of America 25.0 - Chase Manhattan (4 credits) 56.3 218.8 218.8 Chemical Bank (4 credits) 162.5 143.7 50.0 Continental Illinois (2 credits) 43.8 16.7 5.6 First Nat. City Bank (3 credits) 98.7 121.8 61.4 Loeb Rhoades Intl. (2 credits) - 280.3 172.5 Kredietbank (2 credits) - 137.7 274.0 Manufacturers Hanover Trust - 62.5 41.7 Merban Corp. - 25.5 9.7 Morgan Guaranty Trust (2 credits) 55.6 90.3 37.5 Swiss Bank Corp. 26.1 11.2 - Union Bank of Los Angeles 11.3 6.2 1.2 CENTRO Chase Manhattan Bank 13.0 187.5 - Continental Illinois (3 credits) 88.0 25.0 Fidelity Philadelphia Trust Co. 25.0 - - Loeb Rhoades Intl. - 187.5 140.6 Merban Corp. - 187.5 - Reynolds & Co. 13.0 - Singer & Friedlander Ltd. 127.0 251.5 - Wells Fargo Bank 2.0 1.0 0.1 Western American Bank 189.0 - Zilkha Bank-.Ltd (5 credits) 79.0 - - Mexican Financigras (6.5 credits)* - 438.5 407.1 CENTRO C, NAFISA 60.0 60.0 60.0 60.0 - CENTRO D 250.0 250.0 250.0 250.0 - II. LONG-TERM DEBT 9 12,6492 5 3,880.7 4,859.2 5,901.2 CFE 12-ME 92.7 57.6 19.8 56-ME 189.7 151.3 109.3 194-ME 342.8 316.6 302.6 316-ME 1,418.6 1,313.9 1,207.2 436-ME 1,375.0 1,313.2 1,243.7 544-ME 248.9 1,081.8 1,272.1 659-ME - 464.6 1,643.7 CENTRO 24-ME (B. Bonds) 131.0 94.5 54.8 186-ME (B. Bonds) 82.0 65.7 48.0 B. Joint Loans 108.7 340.7 829.7 CFE Canada (436-ME) 10.5 9.2 7.6 France (436-ME) 11.6 7.9 5.9 Japan (436-HE) 76.8 70.7 68.6 Belgium (544-ME) - - 9.8 France (544-ME) - 4.1 3.2 Germany (544-ME) - 22.8 36.5 Italy (544-ME) 9.0 8.6 7.5 Japan (544-ME) - 119.7 145.4 Spain (544-ME) - - 7.6 Switzerland (544-ME) 0.8 47.8 50.6 U.K. (544-ME) - 11.8 30.8 U.S.A. (544-ME) - 38.1 27.6 Belgium (659-ME) - - 12.9 Canada (659-ME) - - 6.2 France (659-ME) - - 13.4 Germany (659-ME) - - 11.9 Italy (659-ME) - - 18.5 Japan (659-ME) - - 94.3 Switzerland (659-ME) - - 55.2 U.S.A. (659-ME) - - 216.2 Annex IX page 2 of 2 Dec. 31, 1968 Dec. 31, 1970 Dec. 31, 1972 DEBTOR CREDITOR OUTSTANDING SUBTOTALS OUTSTANDING SUBTOTALS OUTSTANDING SUBTOtALS II " LONG-TERM DEBT (continued) C. I1SA 4,238.7 4,326. 7,469.8 CF1 1970 Refiasncing* - 415.8 1969 Refinancing* - 84.9 370.0 Previous Refinancing* 2,774.6 2,631.6 2,016.7 Account No. 3* 46.7 46.7 235.0 Account No. 4 - - 5.3 Dollar Credit 278.5 241.2 - Direct Credit* 1.8 - 2,200.8 Bonds - Federal Gov't (9 issues) 881.0 1,096.3 2,020.7 Bonds - 1951/52* 3.0 1.1 - General Electric (4 credits) 12.1 7.0 1.4 CENTRO 1969 Refinancing* - 13.3 41.9 Serial Loan - 1953* 121.0 103.1 82.4 Serial Loan - 1957* 78.0 70.3 61.6 Mortgage Bonds - Series D* 42.0 30.7 18.2 D, Suppliers 413.5 560.1 559.4 CFE Brown Boveri (7 credits) 11.6 52.5 48.3 Cie. Elec.-Mecan. (3 credits) 8.5 3.6 - Ex-Im Bank, Wash., D.C. (5 credits) 57.6 115.7 129.8 Export Dev. Corp., Canada - 100.0 81.4 Glyn Mills 21.1 19.0 11.1 Kreditanstalt f.W., Germany 108.4 72.7 47.2 Mashinenfabrik, A.G. 4.9 - - Mitsubishi (2 credits) - 19.6 29.6 Sulzar Bros. (2 credits) 8.1 5.4 3.0 Sybetra (2 credits) 63.7 41.0 24.3 White Superior (2 credits) 16.4 10.3 4.2 White Weld & Co. 12.5 6.2 - Mexican Suppliers (17 credits)* 100.7 114.1 180.5 Banks 624.0 1,940.7 4,692.7 CFE Bank of America (4 credits) - - 500.0 BNSOP - Rothschild - - 312.5 Consortium European Banks - 187.5 375.0 Continental Illinois - - 187.5 First Nat. Bank of Chicago (2 credits) - 275.0 First Nat. City Bank, N.Y. - * 187.5 Loeb Rhoades Intl. (4 credits) - 448.5 490.6 Marban Corp. (9 credits) * 888.3 880.9 Mexican Financieras* - - 864.7 CERrRO CIF Inc. 43.0 24.0 4.8 Financiera Bancorner* 1000 - - First Nat. Bank of Chicago - - 187.5 Merban Corp. ( 3 credits) 126.0 250.5 197.3 Singer & Friedlander (6 credits) 355.0 141.9 22&.4 F..Bond4s 576.3 622.8 798.9 CFE Issues of 1966, 1968, 1969, 1972 439.3 505.6 708.5 CENTRO Mortgage Bonds - Series A 53.0 38.9 22.7 Mortgage Bonds - Series F 45.0 41.4 36.9 Cumulative Income Debentures 39.0 36.9 30.8 III, ACQUISITION DEBT 2208362 A. NAFINS 1,782.4 1,760.3 1,756.2 CFE Chapala Co.* 85.9 81.8 68.7 Monterrey Co. 62.7 49.9 39.2 Territorial Mexicana Co.* 4.6 3.6 2.8 American & Foreign Power Co.* 1,291.6 1,291.6 1,291.6 Mexlight shares* 337.6 333.4 327.3 Refinancing 1970 - - 26.6 BL.2Othr301.2 321.1 261.2 CFE Cia. Carb. Del Rio Escondido* 0.4 - Cia. Elec. De Matamaros* 8.5 4.2 Chapala Co.* (2 credits) 172.0 157.3 137.5 Mexlight shares* 120.3 159.6 123.7 Grand Total 13.366 1 17 2LA 23.B15.3 * Debt denominated in Mexican currency. 1/ Interest paid by Federal Government.