Peru - CENTROMIN Expansion Project

Document of The World Bank FL O' FILE COQ94 F0R OFFICIAL USE ONLY Report No. 997-PE PERU CENTROMIN EXPANSION-PROJECT STAFF PROJECT REPORT May 12, 1976 Industrial Projects Department This document has a restricted distibution and may be wsed by recipients only In the perfor mnce of their olmclu duties. Its cootents may not otherwise be disclosed withot World Bank autborIation.  INTERNATIONAL BANK FOR RECCNSTRUCTION AND DEVELOPMIT INTERNATICNAL DEVELOPMNET ASSOCIATICK PERU CENTROMIN EXPANSION PROJECT STAFF HIJJECT REPORT CURRENCY EQUIVALENTS Except where otherwise indicated, all figures are quoted in Soles (S/.) and U.S. Dollars (US$) Up to September 26, 1975 After September 26, 1975 S/. 1.00 US$0.026 S/. 1.00 US$0.022 S/. 38.70 = US$1.00 S/. 45.00 = US$1.00 S/. 1,000,000 = US$25,840 S/. 1,000,000 = US$22,222 ABBREVIATIONS AND ACRONYMS ASARCO Formerly American Smelting and Refining Company, a U.S. mining company. GAF Corporacion Andina de Fomento CENTROMIN, Company Empresa Minera del Centro del Peru CIDEC Conseil International pour le Developpement du Cuivre, an association of copper producers CIPEC Conseil Intergouvernmental des Pays Exportateurs du Cuivre, an association of major copper exporting countries COCI Mining Compensation Fund COFIDE Corporacion Financiera de Desarrollo, a Government-owned development corporation CPE Centrally Planned Economy EDC Export Development Corporation of Canada ELECTROPERU Government-owned electrical utility Government Republic of Peru HIEEROPERU Empresa Hierro del Peru, a Government-ouned iron-mining company, formerly known as Marcona Mining Company IDB Inter-American Development Bank INCITEKI Institute for Scientific and Technological Research INP National Institute of Planning JETRO Japanese External Trade Organization IME London Metal Exchange MINEROPERU Eknpresa Minera del Peru, a Government-owned mining cmpany MINPECO Mineroperu Commercial, a Government-owned minerals marketing agency MTPY Metric Tons Per Year Kw Megawatt, one million watts SPCC Southern Peru Copper Corporation, a U.S. Controlled copper mining company STPY Short Tons Per Year USBM U.S. Bureau of Mines WBMS World Bureau of Metal Statistics WEIGHTS AND MEASURES 1 Short Ton 2,000 pounds 1 Metric Ton = 2,205 pounds 1 Kilometer (km) - 0.62 miles CENTROMIN FISCAL YEAR January 1 - December 31 Industrial ProJects Department May 1976  FOR OFFICIAL USE ONLY PERU CENTROMIN EXPANSION PROJECT STAFF PROJECT REPORT TABLE OF CONTENTS Page No. S LIKRY ................................... i I. INTRODUCTION .............................................. ...... t II. THE PERUVIAN MINING SECTOR ............................. 2 A. Recent Trends and Developments ..................... 2 B. Structure of the Sector ............................ 4 C. Legislation Governing the Mining Sector ............ 6 D. Sector Investment Program and Financing Needs ...... 7 E. Contribution to the Economy .........4- .. .......... 9 III. THE COMPANY ............................................. 10 A. Background and Ownership ..................g or ........s 10 B. Organization and Management ......... ............... 11 C. Operations ....... 0 ........ ........................ ............. 13 D. Past Performance and Recent Financial Position 17 E. The Stage I Expansion Program ..................... 23 1. Description of the Program .................... 23 2. Utilities and Transport . ..................... 25 3. Employment and Training ....................... 25 IV. THE METAL MARKETS ........ ................................. 25 A. The Copper Market .... ....................... ...... 26 1. International Supply and Demand ............ ... 26 2. Price Structure and Projections ...........O.. .. 29 B. The Zinc Market .................................... 30 1. International Supply and Demand ............ . .. 30 2. Price Structure and Projections ............ ..... 32, C. The Lead Market ... ................................. 33 1. International Supply and Demand ............... 33 2. Price Structure and Projections ................ 35 This report has been prepared by Messrs. R. Rodger and H.E. Wackman of the Industrial Projects Department. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS (Cont'd) Page No. D. The Silver Market ......................... ........ 36 1. International Supply and Demand . ........... 36 2. Price Structure and Projections ............ 37 E. Marketing Arrangements ............. ............. 37 V. THE PROJECT .......................................... 38 A. The Cobriza Mine Expansion ............... ........ 38 1. Technical Description ..... ................. 38 2. Environmental Aspects ..... ................. 41 B. The Cerro De Pasco Mine Water Treatment Plant ... 42 1. Technical Description ..................*. 42 2. Environmental Aspects ..................... 44 C. Capital Costs and Financing Plan .... ............ 44 1. Capital Costs ...... ........................ 44 2. Financing Plan ............. . ................ 47 VI. PROJECT IMPLEMENTATION .48 A. Project Organization and Management. ...... 48 B. Implementation .................. ............ 49 C. Procurement and Disbursement and Allocation of Bank Loan....... 50 1. Procurement ..... . ...... .. 50 2. Allocation of Bank Loan and Disbursement ... 50 VII. FINANCIAL ANALYSIS...... 54 A. Financial Rate of Return of the Project .. . 55 B. Future Sales and Profitability of CENTROMIN ..... 62 C. Break-even Point of CENTROMIN after Stage I *.a.. 6 . .a...aa..a.....a 62 D. Financial Rate of Return of Stage I ... 62 E. Company Financing During Stage I and Financial Position .......... ..... 63 F. Debt Service Coverage . . .65 G. Further Expansion . . .65 H. Major Risks ...65 I. Auditing Requirements . . 66 VIII. ECONOMIC ANALYSIS ...66 A. General Economic Effects and Government Benefits. 66 B. Foreign Exchange Effects ..66 C. Employment Effects. 67 D. Economic Rate of Return . 67  TABLE OF CONTENTS (Cont'd) Page No. IX. AGREEMENTS ......................................... 67 A. Commitments from the Government .... *so ........ 67 B. Commitments from CENTROMIN ..... ................ 68 ANNEX Additional Reports and Data Related to the Project Available in the Bank MAPS IBRD 11755 - Peru IBRD 11756 - CENTROMIN Expansion Project - Detail Area   PERU CENTROMIN EXPANSION PROJECT STAFF PROJECT REPORT SUMMARY THE MINING SECTOR A. Background 1. Peru is a mineral-rich country with large proven deposits of copper, zinc, silver, iron ore and lead. Exploitation of Peru's mineral resources goes back to the mining of gold, silver and copper by the Incas prior to the Spanish conquest in order to fashion them into adornments, weapons and utensils. The growth of the mining sector was particularly impressive dur- ing the 1950s, when the enactment of a simplified mining code with a clear and favorable tax regime greatly improved the investment climate and foreign capital flowed into the sector. Copper production increased from 30,000 MT to 180,000 MT during the decade, the output of lead, zinc and silver more than doubled, and exploitation of Peru's iron ore potential began. In to- tal, the value of mineral production rose from US$41 million in 1950 to almost US$200 million by 1960. 2. In contrast to the previous decade the 1960's were years of relative stagnation in the sector, characterized by decreasing investor confidence and little investment. After the 1968 coup the Government began to assume a more active role within the sector. In 1970 a state-owned mining company, Empresa Minera del Peru (MINEROPERU), was established with the purpose of bringing into operation a series of high-priority mining and metallurgical projects. The Cerro de Pasco Corporation, now CENTROMIN, was nationalized in early 1974 and the Marcona Mining Company, now HIERROPERU, in mid-1975. Compensation has been paid for Cerro de Pasco and a compensation package for Marcona is being negotiated. The Government has also taken over all overseas marketing of metals and centralized this function in a new state enterprise, MINEROPERU COMERCIAL (MINPECO). B. Current Institutional Situation 3. Four companies --CENTROMIN, HIERROPERU, Southern Peru Copper Corporation (SPCC) and MINEROPERU-- now constitute the large-scale mining group, which accounts for 65% of the country's mining output and almost 45% of the sector's work force. CENTROMIN has the most diversified out- put, producing copper, silver, zinc, lead and other metals at seven mines in Peru's Central Sierra and accounts for around one-third of the sector's output and employment. HIERROPERU operates Peru's major iron ore mining complex. SPCC, the only remaining private company in large-scale mining, is the country's single largest producer and exporter of copper. MINERO- PERU's only plant in operation thus far is a large copper refinery at Ilo.  - ii - 4. Peru's medium-scale mining operations consist of a heterogeneous coLlection of some 60 companies producing partially-treated copper, lead, zinlc and silver ores. These operations, which account for 30% of Peru's mining output and employ 40% of the sector's work force, are almost all pr:Lvately owned. The small mining operations comprise more than 1,000 pr:Lvately-owned small mines, most of them poorly mechanized, labor-inten- sivie operations. A large portion of the concentrates produced by the small and medium miners is sold to CENTROMIN for smelting and refining. Expansion of medium and small-sized mines is expected to be much slower than for the large companies during the seventies, and their present share of output will probably decline. 5. Peruvian experience in the planning of major mining development projects is limited both in the companies themselves and in the various Gov- ernument institutions, since this function has traditionally been performed in the headquarters of the foreign parent companies. All mining operations including sector planning now come under the jurisdiction of the Ministry of Energy and Mines, which is responsible also for the petroleum and power subsectors. The Ministry's Planning Department establishes investment prJiorities but leaves to Corporacion Financiera de Desarrollo (COFIDE) the primary responsibility for financing the investment projects of the state- ownied enterprises. COFIDE is relatively inexperienced in the mining industry and has been slow to help the public sector companies with planning their investment programs, partly because of the uncertainty of government funding to COFIDE for such programs. The Planning Department of the Ministry of Energy and Mines has not proven to be effective enough in establishing reaLlistic priorities and programs for the industry's expansion. 6. The operational problems in the sector include labor unrest. Government policy has raised the wages of workers and miners, resulting in substantial increases in operating costs, but despite the improvement in worker benefits, labor unrest has continued. Besides disputes over wages and working conditions, there has been controversy and uncertainty over the management participation of the mining communities, i.e. the associations representing the mine workers. As has been the case in the private indus- trial sector since 1970, this participation in the private mining sector now, takes the form of profit-sharing and a mechanism for increasing share ownership up to a maximum of 50%. The effects and future structure of this experiment in worker participation are still uncertain. In the case of CENTROMIN, the mining communities receive bonds rather than shares, and the Government has resisted any excessive influence over decision-making by the mining community or other agencies. Although CENTROMIN is nominally a subsidiary of MINEROPERU, it is effectively controlled by the Ministry of Energy and Mines. C. Mineral Exports, Prices and Strategy 7. The volume of Peru's mineral exports has increased in recent years only marginally and changes in their value have occurred mainly because of fluctuations in world prices. Exports rose from US$465 million in 1970 to  - iii - US$875 million in 1974 but fell back to an estimated US$567 million in 1975. Peru accounts for 19% of world mine output of silver and about 12% of wforld exports of zinc and lead and 5% of world copper exports. Since copper constitutes roughly 40% of the value of Peru's mineral exports, variations of its price have a substantial impact on the country's exports. Despite large fluctuations, copper prices followed a long-term upward trend in real terms from 1929 through early 1974, reaching an all-time high of US$1.52/lb. on the London Metal Exchange in early 1974. Since then, cop- per prices fell sharply to below US$0.55/lb., mainly because of the slow- down in world economic growth, but have recently firmed up to about US$0.70/ lb. In November 1974 the Conseil Intergouvernmental des Pays Exportateurs du Cuivre (CIPEC) --a grouping of copper exporting nations of which Peru is an important member-- agreed to reduce exports temporarily by 10% in an attempt to halt the decline in copper prices. A further cutback of 5% was agreed to in April 1975. In November 1975 the cutbacks were extended through June 1976. Because of the reduced demand for copper some of the major U.S. and Canadian copper companies have also cut production. Peru's export earnings from metals are expected to increase substantially with the economic recovery now under way in major metal consuming countries. Mletal prices have recently begun to recover from their depressed levels. An upward trend in real terms is expected over the next few years and the long-term upward trend in world metal demand will call for continuing ex- pansion in the world capacity to produce various minerals. 8. Peru's development strategy, given the relative paucity of her agricultural resources (outside of fishing), and the still small industrial base, is to rely heavily on her richly endowed mining sector to provide the bulk of the foreign exchange earnings needed to maintain her economic growth. In line with this strategy, Peru's four large-scale mining companies have been projecting expansion which, in combination with the prospective invest- ments of other entities in the sector, would have called for total invest- ments in excess of US$3.5 billion during the 1975-80 period. Taking into account the limited project preparation and executing experience of the companies and probable financial constraints, investment in the sector is not likely to exceed US$2 billion during 1976-80, 60% of which would be public. Even this, however, depends on the country's ability to raise the necessary financing. Given this investment rate, the value of Peru's min- eral exports could reach some US$2.5 billion in current prices by 1980 or about 70% above the 1974 value, with about half of the increase resulting from increased production. The largest single project to date is SPCC's development of the Cuajone mine, which is scheduled for completion in early 1977. Cuajone will effectively double Peru's copper producing capacity. After 1980 sector growth is expected to be fuelled primarily by investment in copper and to a lesser extent in zinc, phosphates, lead, and silver.  - iv - THE PROJECT A. Project Concept 9. Bank staff have worked closely with CENTROMIN on the formulation of a Stage I expansion program consisting of six projects designed to im- prove the Company's operating performance through replacement of obsolete facilities, to expand production and the degree of processing, and to re- duce environmental pollution. The six projects include the expansion of the Cobriza and Casapalca mines, the modernization and expansion of the copper smelter/refinery, the zinc refinery and the lead sinter plant at La Oroya, and the replacement of a copper cementation plant with a solvent extraction and electro-winning plant at Cerro de Pasco. The following two components of the Stage I expansion program comprise the proposed project and have been selected for Bank financing because of their high priority to the country, their advanced state of preparation, and their self-con- tained nature: (a) The Cobriza Mine Expansion - This project would expand under- ground mine production from 0.7 million STPY of ore grading 2.2% copper to 3.5 milLion STPY grading 1.8% copper. This ore will be treated in a new ,concentrator, increasing concentrate output from 50,000 STPY to 223,000 STPY ,containing 25% copper and 5.5 oz of silver/ton. Related administrative, in- dustrial, and social infrastructure are also included in the project. Proj- ect cost is estimated at US$134.1 million. (b) The Cerro de Pasco Mine Water Treatment Plant - This proj- ect would improve the economics of copper recovery by replacing an exist- :ing cementation plant with a more efficient solvent extraction and electro- winning plant producing refined copper in place of cement copper, and eliminating the existing plant's pollution of the San Juan and Mantaro rivers. Project cost is estimated at US$12.4 million. B. Costs and Financing 10. The total cost of the two projects (excluding interest during construction) is estimated at US$146.5 million equivalent with an estimated foreign exchange component of US$76.3. The estimated direct foreign exchange costs of the project (US$61.3 million), consisting of equipment, supplies, erection, engineering, project management and technical assistance services would be financed by the IBRD and the IDB on a 55:45 basis. The IBRD/IDB loans would also finance interest during the construction period. Total financing requirements are estimated to be US$176.2 million equivalent, of which the Bank would provide US$40 million and the IDB US$33.4 million. The IDB loan has been negotiated and is expected to be submitted to the IDB Executive Directors during the month of June. 11. The remainder of the financing (US$102.8 million) would be covered almost entirely by US$99.8 million in loans from COFIDE having a term of about 10 years, including four years of grace and an interest  - v - rate of 8% per annum. The IBRD loan would have a term of 15 years, includ- ing 4-1/2 years of grace, at the prevailing interest rate of 8..50% per annum, in addition to which the Company would pay the Government a guarantee fee of 1.5