Ecuador - Power sector memorandum

FILE COPY Document of UN-54 The World Bank FOR OFFICIAL USE ONLY ECUADOR POWER SECTOR EME1ANDUM may 12, 1981 Projects Department Latin America and the Caribbean Regional Office This doeument has a restricted distribution and may be used by recipients only In the performance of their official duties. its cantents may not olberwise be disclosed without World Bank 2uthorizaden.  CURRENCY EOUIVALF.NTS Currency unit m Sucre (S/.) SI. 1.nn = 100 centavos - US$0.04 SI. 1,000,000 US$40,000 !SS51.00 - S/. 25.00 i/ uSSI,000,000 S/. 25,000),000 1/ USS mill 1= S/. 0.0250 ACPRONYMS CENAFE = Centro Nacional Franco-Ecuatoriano CEPE Corporacion F.statal Petrolera Ecuatoriana CONZADF. = Consejo 'acional de Desarrollo EEO Empresa Flectrica de Ouito S.A. E-4ELEC - Empresa Flectrica del Ecuador Inc. FONAPRE = Fondo Facional de Preinversion IDB = Inter-American Development Bank IFCO International E.ngineering Co. - U.S.A. INE - Instituto N-acional de Energia INECEL = Instituto Ecuatoriano de Electrificacion PNE = Ministerio de Pecursos Naturales y Energeticos OLADE = Latin-American Energy Organization SFNI National interconnected System ABBREVIATIONS, UNITS JAZ-D IEASIUFS kcal = kilocalorie (1,000 calories = 1.163 kIh) kW - kilowatt ilhr = megawatt (1,000 kW) k0h = kilowatt hour G*1h = gigawatt hour (1,000,000 kl.t) kV kilovolt (1,000 volts) ILA megavolt-ampere (1,000 kPA) km = kilometer (0.6214 mile) km2 - square kilor.eter (0.386 so. mi) ha = hectare (0.01 km2 = 2.471 acres) TOE = ton of oil equivalent (107 kcal) FISCAL YE-A? INECEL's fiscal year ends December 31 1/ Exchange rate as of 'March 31, 1981, which wsas used to compute currencv equivalents in this report.  ECUADOR POWER SECTOR EMERANDUw Table of Contents Page No. SUHMARY, ISSUES AND RECOMMENDATIONS ..................... i-Lv PART I THE ENERGY SECTOR 1. Energy Resources I.................* ..................... 1 Hydrocarbons ............................................ 1 Hydroelectric Resources .... ..... .......... ............. 2 Alternative Energy Resources ............................ 2 Geothermal Resources 2.................................. 2 Fuelwood ............................................... 2 Uranium Fuel ....... .................................... 2 Other Non-Conventional Energy Sources ................... 3 2. Energy Balance - Consumption ............................ 4 The Present Energy Market ........... ... S* *0*6O**SSO... 4 Future Demand ........................*.*........... 6 Rural Energy Survey 6.................. 6 3. Domestic Oil Prices 7............................*...... 7 Current Level and Structure 7 ............. ....* 7 Price Subsidies ......09.0 ........ ....... S Criteria for Future Pricing Policy ...................... 8 4. Organization of the Energy Sector ....................... 10 Consejo Nacional de Desarrollo .......................... 10 Ministerio de Recursos Naturales y Energeticos .......... 10 Corporacion Estatal Petrolera Ecuatoriana .........*... 11 Instituto Ecuatoriano de Electrificacion ................ 12 Instituto Nacional de Energia ........................... 12 This report is based on the findings of a sector mission which visited Ecuador in July 1980. The mission comprised Ms. Ursula Weimper and Messrs. Jorge Larrieu and Ricardo Halperin. The report was updated to incorporate the findings of the TIECEL transmission project appraisal mission, which took place in Fovember 1980.  Table of Contents (Continued) Page No. PART II THE POWR SECTOR 5. Sector Organizatiin, Institutions and Human Resources .... 15 Legal Framework ........................... e*e**s*........ 15 A. Instituto Ecuatoriano de Electrificacion 15 Role in Sector . ................................. 15 Organization and Management ........15 Supervision of Electric Power Companies 16 Sector Planning 17 Accounting 18 Auditing ......................................... 18 Procurement 19 Management Problems ...................... . 19 B. Empresa Electrica de Quito 21 C. Eapresa Electrica del Ecuador 22 D. Other Electric Power Companies 22 Human eeso u r c e 6 23 Present Human Resources Awailability ......23 Future Human Resources Requirements 23 Training Activities ...........24 6. Sector Facilities 25 Generation 25 Transmission .......... ,................... 26 Subtransmission 25 Distribution *.................................-...e 26 7. The Power Market and the Sector Development Program 27 The Present Power Market 27 The Puture Power Market 28 r Construction Program and Investment Requirements ......... 29 Sector Finances 30 Current Financial Situation ...... 30 Investment and Financing Plan ............................ 30 Future Finances 32 Tariffs 33 Tariff Structure .......... ....00....35 Tariff Issues .. ...35  LIST OF ANNE%ES Annex 1 Page No. Attachment 1.1 - Energy Balance 1978 .............................. 37 Annex 2 - The Oil Industry ........ ................. .............. 42 Table 2.1 - Oil Reserves *e*e....e*..*....***.*................. .. 57 Table 2.2 - National Production of Crude Oil ...................... 58 Table 2.3 - National Production of Oil Derivatives ................ 59 Table 2.4 - Sales of Petroleum Derivatives, 1972-1979 ........ .. .... 60 Table 2.5 - Imports of Petroleum Derivatives and of Blends 1972-1979 ........ .. .................... .................. 64 Table 2.6 - Estimation of Subsidy to Domestic Market ............... 66 Table 2.7 - Retail Prices of Petroleum Derivatives, 1980 .......... 68 Table 2.8 - Crude Oil Export Revenue Distribution, 1979 ........... 69 Annex 4 Chart 4.1 - Ministry of Natural Resources and Energy Organization Chart .... .. .......... ; ............ 70 Annex 5 Table 5.1 - INECEL's Participation in the Capital of the Electric Power CompWanies . ............................ 71 Chart 5.1 - INECEL Organization Chart .... ...................... 72 Table 5.2 - 1978 Operation and Maintenance Costs Breakdown ........ 73 Table 5.3 - 1978 Gross Generation/Purchases, Sales, Local Use and Losses .................................... 74 Table 5.4 - Manpower Resources ..... ....... .................... . 75 Annex 6 Table 6.1 - Ecuador's Installed Capacity ..... ..................... 76 Attacbment 6.1 - Oagoing and Future Development Projects .......... 77 Attachment 6.2 - Main Characteristics of Future Power Plants . ...... 78 Attachment 6.3 - National Interconnected System ...... 81 Annex 7 Table 7.1 - National and SNT Energy Forecast ...................... 82 Table 7.2 - National and SNI Demand Forec.ast ...................... 83 Table 7.3 - 1980-1985 Iavestment Program .................... .... 84 Annex 8 Table 8.1 - Power Sector Estimated Balance Sheets 1978-1979 ....... 85 Table 8.2 - Power Sector Estimated Income Statements 1978-1979 .... 86 Table 8.3 - Power Companies' Financial Rates of Return .. .......... 87 Map - National Iuterconnected Systm .... ....... .. .................. 88  FUEL PRICES: AN UPDATE 1. On February 18, 1981 the Government of Ecuador approved across-the- board increases in the domestic-prices of petroleum derivatives 1/. The following table summarizes the old a-d new prices: Proportion of total Percentage Product Consumptior (Z) Old Price New Price Increase (US$ cents per gallon) S. 92 octane gasoline 4 72.8 80.0 9.9 80 octane gasoline 34 18.6 60.0 222.6 63 octane gasoline 2 16.4 40.0 143.9 diesel 24 14.4 44.0 205.6 kerosene 11 13.4 24.0 79.1 jet fuel 4 44.8 88.0 96.4 bunker 21 10.4 28.0 169.2 2. These increases represent a major breakthrough and show that the Government is willing to implement the policy changes required to address the issues facing the sector. It is estimated that, ceteris paribus, the increases vill reduce the Implicit subsidy to consumers (as given by the difference between the domestic price and the international price), from about 8% of GDP in 1980 to 4S in 1981. 3. Despite the above measures, domestic prices still average less than 50% of world market levels. Thus the need for further price adjustments in the future remains. 4. Another important issue still outstanding is the inconsistency of the structure of petroleum price derivatives with either cost of production or raorld market values. For example, the new price of kerosene, widely used by lower-income groups, is about half that of diesel. This, and other similar differences in the cases of other products, are likely to induce undesirable substitutions, with the resulting distortions in the allocation of resources. Thus, the Bank should continue to convey its concern that the Government address the need for a more rational price structure. 1/ The price revision did not include specialty products and LPG, which approximately represent 7% of consumption.  SUMM4ARY, ISSUES AND RECONMENDATIONS 1/ 1. Ecuador has abundant renewable and non-renewable energy resources. The hydroelectric generation potential is very significant and yet largely untapped. Since 1972, the country has become a major oil producer and there are good prospects to increase reserves, both of conventional and of heavy crude oils. The use of associated gas is being developed, and in the Guayaquil Gulf important natural gas deposits have been detected. In z2eition, a preliminar- inventory of geothermal resources is now being completed by the Organizacion Latinoamericana de Energia (OLADE). Wood and bagasse prc.ide a substantial portion of non-commercial energy and the Instituto Nacional de Energia (INE)*is currently evaluating the efficiency of its use, together with solar and biogas possibilities. 2. The oil price increase that has taken place in world markets since 1973 caused an economic bonanza with, however, some negative side effects which are now becoming increasingly evident and which the Gevernment is trying to correct. Due to failure to adjust internal fuel prices, consumption has been high, and, also, fuel destined for the internal market has been smuggled to neighboring countries. Inadequate pricing policy has createa an inconsistency between the structure of primary energy consumption and that of available resources, in particular favoring thermal electricity generation over the development of the large hydropower potential; similarly, the oil consumption pattern and refinery yields have become increasingly unbalanced. Furthermore, exploration activities have been low, and proven reserves have been declining. Under pessimistic assumptions of production and growing demand, this could imply that, as early as 1988, Ecuador would cease to be an oil exporting country. 3. Ecuador's major objectives for the energy sector are the following: Ca) increase petroleum exploration and optimize petroleum production; ob) cause changes in the structure of petroleum consumption, to ration- alize its use and to prevent smuggling and waste; Cc) cause changes in the domestic prices for petroleum derivates, to enhance the sector's financial capability; (d) develop the hydroelectric potential, improve the use of wood charcoal in the rural sectors and develop other energy sources (geothermal, solar and biogas); (e) integrate isolated electric generating systems, develop rural electrification, and assure the supply of electricity both in urban and in rural areas. The power sector also has important social objectives to be implemented by connecting lower income consumers to the grid and by reducing, in relative terms, the tariffs paid by the less affluent. 1/ For a fuller discussion of economic issues, see "Ecuador, Development Problems and Prospects". IBRD, July 1979.  - ii - 4. The power sector goals for the short and medium term are ambitious. Commissioning of the first stage of the Paute hydroelectric project is scheduled for 1982 (200 MW) and 1983 (300 MW); it will triple existing hydro capacity. By 1984 other Important hydro projects, Agoyan (150 MW), Paute "C' (500 MW) and Daule-Peripa (130 MRW), will be under construction, and by 1986 two other large hydroprojects will be starting: Paute-Mazar (140 MW) and Toacni (300 MW). Investment in transmission will be substantial; while currently there is only one major transmission line in operation (between Quito and Guayaquil), by 1985 most of the regional systems will have been interconnected to the national grid. Finally, in distribution the goal for 1985 is to increase the electrification rate 1/ from about 40Z to 50Z and to reduce overall distribu- tion losses from 15Z to 12% by upgrading the various networks. 5. The achievement of these goals will require a major mobilization of financial and human resources. Sector investments between 1980 and 1985 are expected to amount to over USS1,600 million (at 1980 price levels), while at present, the sector's revalued gross fixed assets in operation amount to little over US$800 million equivalent. Employment within tie electric utili- ties is forecasted to grow from about 7,300 people in 1980 to nearly 11,000 in 1984. 6. Thus, the Government authorities face a formidable challenge, which will put to a severe test their ability to implement the actions required. The Bank's review of the sector has identified several issues which will have to be adequately addressed if the sector objectives are to be satisfactorily met. The main issues and recoamendations on how they may be handled are presented uelow. Issue No. 1 7. Fuel Prices. The prices of petroleum products in Ecuador are among the lowest in the world. In 1978 these prices constituted an implicit subsidy 2/ amounting to about 6% of GDP. Due to subsequent world oil price increases, in 1980 the subsidy is likely to have been as high as 8%. The problems and the distortions ca-used by the low internal prices are significant and, unless substantially reduced, will act as a brake to the country's economic growth. 8. Fuel price subsidies are specially important in the transport sector and also within the power sector, where they encourage auto-l'roduction and thermal generation, and distort electricity costs inducing excessive consump- tion and uwste. 9. Recommendations. Implementation of a policy of price increases to bring the internal levels in line with international values should be a prerequisite of further Bank financing to Ecuador's productive sectors. It Population with electricity service/total population ratio. 21 'he subsidy has been calculated as the difference between domestic prices and the price of petroleum derivatives posted in Caribbean refineries.  - iii - 10. The secror financial projections developed by the Bank mission assume that the prices of fuels used for electricity generation (Bunker C, diesel and kerosene) will be progressively increased to the following proportion of international levels: 25% in-1981, 37.5% in 1982 and 50% in 1983. Such policy, if accompanied by regulatory measures to induce optimal generation schemes, would allow Bank support for the Instituto Ecuatoriano de Electrificacion transmission project now under consideration and for future projects in the power sector. Issue No. 2 11. Electricity Tariffs. At present the provisions of the electricity tariff regime (which requires that tariffs be set so as to yield a rate of return on revalued assets of 8.5% per year) are not being complied with. As a result, electricity tariffs are low and the power sector's consolidated rate of return is negligi1ble, while net internal cash generation is negative. 12. Recommendations. Retail tariffs should be progressively increased so as to allow reaching an 8.5% rate of return in 1984. The Bank mission has forecast that rates of return of 2% in 1981, 4% in 1982, and 8% in 1q83 would be achieved. This would result in a self-financing ratio for 1982-85 of about 20%, which is a modest target, especially in view of the very large sector investment program. By 1985 retail tariffs would have tripled; however, after adjusting for domestic inflation, the increase would only be about 50%, which should be a feasible target. Issue No. 3 13. Management and Organization. Both the management of INECEL and of its subsidiaries leave room for considerable improvement. Areas deserving specific attention are: (a) INECEL's coordination and control over the operations of its subsidiaries; (b) overstaffing, both within certain areas in INECEL and in its subsidiaries; and (c) information systems, especially accounting, budgetary, financial and statistical information) l/. 14. Recommendations. Qualified consultants should be engaged soon to assist INECEL in the above matters 2/. Until such consultants' recommendations become available, INECEL should take such immediate measures as may be feasible to improve its performance. 11 The mission found that the quality of technical and financial information developed by INECEL or gathered from its subsidiaries is extremely poor. Lack of consistency is frequent. Financial statements do not follow accepted accounting practices. 2/ These consulting services would be part of the proposed INECEL Transmission Project.  - iv - 15. Independent external auditors, both for INECEL and for its subsidiaries should be engaged at the earliest to assist in the upgrading of the accounting system, revision of accounting criteria and adjustments to the historic financial statements, asset revaluation, and preparation of consolidated financial state- ments. Issue No. 4: 16. Financing* The Implementation of the proposed 1980-84 investment program will require a massive financial effort. 17. Recommendations. The tariff actions discussed in paragraph 12 will have to be complemented by Government financing and by substantial borrowings in international financial markets. With regard to the Government contribu- tions, an early definition would be required so that, based on it, alternative financing strategies may be devised. 18. In view of the magnitude of the financial issues, the Bank should include a major projects clause in the Guarantee Agreement for the proposed INECEL Transmission Project, which clause would be designed to ensure that any major projects undertaken within the sector are economically justified and are adequately financed. Issue No. 5 19. Training. The planned sector expansion will result in a significant increase in workforce requirements. The successful implementation of the expansion program and the achievement of more satisfactory efficiency levels, will, to a large degree, be contingent upon the adequacy of the sector's training program. IVECEL is conscious of this need and - in consultation with the Bank - has already taken steps to engage consultants to assist in the identification of training requirements and formulation and implementation of programs. 20. Recommendations. The proposed INECEL Transmission Project would include a substantial training component, which would address this issue. Issue No. 6: 21. System Losses. The statistical information available shows that some of INECEL's subsidiaries have unacceptably high levels of losses. While in some cases this may be partly attributed to deficiencies in the information itself, it is quite clear that many distribution systems exhibit flaws which require remedial action. 22. Recommendations. To address this issue, INECEL should develop a program for the study of losses within its subsidiaries and for system upgrading and administrative improvements to reduce losses to acceptable levels. Such a program is to be implemerted as early as feasible.  U PART I THE ENERGY SECTOR  - 1 - 1. ENERGY RESOURCES 1.01 Ecuador has a large and diversified energy base which has not yet been fully assessed. In the following paragraphs, known reserves and potential resources of fossil fuels, as well as renewable sources of energy, are discussed. Hydrocarbons 1.02 Total sedimentary basins extend over an area of 17 million ha. of which less than 20% has been explored. The most important oil reserves were discovered in 1969 by the Texaco-Gulf consortium in the Eastern region. During the 1970s exploration activities were limited, and proven reserves decreased from 1.6 billion barrels in 1972 to 1.2 billion barrels in 1979. Actual proven reserves might be higher and are to be assessed by a reserve audit study. Currently, the reserves-to-production ratio averages 15 years. The prospects for increasing the resource base are favorable; both for con- ventional and for heavy crude oils and the Government objectives for the next five years are to add 730 million barrels of crude oil to proven reserves through enhanced recovery, development of known fields and new exploration, and to maintain an average production volume of 225,000 barrels per day. 1.03 The economic future of Ecuador depends to a significant degree on the success of achieving the above objectives. Major responsibility for this is assigned to the national oil corporation: Corporacion Estatal Petrolera Ecuatoriana (CePE) 1/. As a means of overcoming CEPE's technical and financial limitations, the Government has also announced its interest in attracting fo1.eign contractors to join in the exploratory effort. The terms of the hydrocarbon operations contracts under which new companies are to operate have not yet been adequately defined. Also, agreement with already established companies over future operating conditions must be reached if foreign participation is to increase. 1.04 Natural gas is expected to become an important energy source in the future. At present, only the LPG (propane and butane) fraction of associated gas produced at the Santa Elena oil fields is being recovered, but in 1981 a new LPG plant and a pipeline will enable the economic recovery of part of the associated gas produced in the Eastern region. In addition, preliminary exploratory work shows important free gas resources in the Gulf of Guayaquil. These are to be developed during the next five years and will be used to promote industrial development in the area. 1/ CEPE and its currently associated operators are to evaluate 902 of sedimentary basins and drill 350 wells, which will require an invest- ment of some USS470 million. CEPE's share in this program is USS370 millions, which represents one-third of its total investment budget for the five-year period 1980-84.  -2- Hydroelectric Resources 1.05 The Andean mountain range separates the eastern from the western watersheds, which have drops of more than 3,000 meters. Twenty-two hydro- graphic basins have beei identified, covering 85% of the country's surface. The usable hydroelectric potential is currently estimated at 22,000 MW, mainly contained in the Pastaza, Santiago and Napo basins. Fully developed, these basins could generate 90,000 GWh/year of firm energy (which if thermally generated would require about 150 million barrels of oil per year). It is presently estimated that about 12,000 MW could be economically developed, but at present only about 2% of this potential has been tapped. In 1983, however, this ratio will increase to about 6% with the commissioning of the 500 MW paute hydroelective development. The 1980-84 development plan has set as an objective the rapid development of hydroelectric capacity and by 1985 it is estimated that 72Z of electricity requirements will be provided by this source. This is a significant change in the generation structure if compared with the present hydro generation ratio of about 25%. Alternative Energy Resources 1.06 One of the major problems for effective energy planning is the lack oF reliable data on alternative energy resources. The 1980-84 Development Plan includes both studies and in-the-field measurements of these resources; a brief sumary of the present state of knowledge is given in the following paragraphs. Geothermal Resources 1.07 Ecuador's localization offers favorable prospects for geothermal development. Superficial showings have been detected in Tungurahua, Pichincha and Azuay (see Map). The Instituto Ecuatoriano de Electrificacion (IECEL) has the responsib4 ity for evaluating the geothermal potential and in the first stage has received assistance from OLADE. Fuelwood 1.08 Fuelwood is an important source of energy in the rural areas. The country has important forestry resources, mainly in the Amazonas region and in the province of Esmeraldas. -owever, the lack of a reforestation policy and the indiscriminate use of wood for industrial and energy purposes, has reduced considerably the forest area and the rural regions are facing shortages of fuelwood. The Instituto Nacional de Energia (INE) is attempting to address the problem by developing improved stoves for cooking with fuelwood. Uranium Fuel 1.09 The Ministerio de Recursos Faturales y Energeticos (MRME) and the Atomic Energy Authority have undertaken to explore for uranium. Although no proven deposits have been determined, it is thought that the mineral exists in the Oriente region.  - 3- Other Non-conventional Energy Sources 1.10 Currently, the possible use of solar energy, minihydropower, and other sources is being itudied by INE. In addition, OLADE is promoting the construction of biodigestors, in which animal and vegetables waste is converted into methane. A demonstration plant has been built in cooperation with the Provincial Council of Pichincha and OLADE is also providing technical assistance to other provinces.  -4- 2. ENERGY BALANCE - CONSUMPTION 1/ The Present Energy Market- 2.01 Despite the fact that petroleum represents less than half of Ecuador's known energy resources, the national economy has become increasingly dependent on this source. Oil exports amount to approximately 65% of total primary energy production, which can be estimated at 10.8 million tons of oil equivalent (mtoe) in 1978, and over 95% of domestic commercial energy needs are supplied by oil. The basic objective of long-term energy policy is to make energy consumption more consistent with available resources. The thrust of the present Development Plan is on the supply side, mainly accelerated development of the hydropower potential and expansion of the productive capacity of the oil industry. The Plan is less specific with respect to energy consumption, although the consequences of postponing meas- ures to rationalize domestic petroleum demand are discussed. 2.02 Between 1973 and 1978, final consumption of commercial energy increased on the average by 14% per year.. which is high when compared with its prior evolution and with the more recent performance of the economy. 2/ The breakdown by fuel type (Annex 1, Attachment 1.1) shows that gasoline is by far the most important product in the market. Although the price of LPG is considerably higher than that of competing fuels, its market penetration has been limited only by available supplies. Electricity still has a rather small participation; furnishing only about 14% of industrial energy requirements and servicing mainly urban areas. The structure of final energy consumption by type of fuel is shown below. 1/ INE has initiated work on energy balances and up to now has produced balances for 1969-78, based on commercial energy demand at the final consumer level (which means that conversion losses are not accounted for). In Annex 1, Attachment 1.1, an attempt is made to construct the global energy balance for 1978, which reveals the degree of under- estimation Implicit in the first approach. Information on the structure and trend of consumption over time is taken from INE's work. 2/ During the period 1969-73, final energy consumption rose by 7.2Z per year. Between 1973 and 1978, GDP at constant prices, excluding the energy sector, increased by 6.8% per year.  -5- 1978 Relative Average Annual Growth Market Share (Z) Rate during 1973-1978 (%) LPG 3.2 35.1 Gasolines 1/ 39.4 (43.2) 11.3 (15.4) Jet Fuel 5.0 28.5 Kerosene 10.7 12.2 Diesel Oil 16.8 12.6 Residual Fuel Oil 16.5 18.2 Electricity 8.4 16.7 Total 100.0 14.1 2.03 The high proportion of light and middle distillates in total petroleum consumption is not in balance with the yields obtained from domestic refineries. As a result, refinery operations are not optimal, deficit products have to be imported and refining capacity has to be expanded at an accelerated pace. 2/ 2.04 Fuel consumption for public electric generation purposes repre- sents 17% of petroleum sales. It is important to note that presently about 75% of the electric generating capacity is thermal, distributed as follows: internal combustion generating units, about 60%, and steam-driven turbine generating units, about 15%. The reduced share of steam generators is due to the existence of numerous small isolated systems which consume important volumes of diesel oil and, if available, kerosene. Information on fuel input to auto-generators is not available. 1/ The figures between brackets reflect actual sales of the product, whereas those lined up in the columns, refer to estimated effective domestic con- sumption. The difference is attributable to smuggling and indicates the results that can be expected from drastic measures to control this traffic. 2/ In 1979, the refineries had to process 26% more crude oil than warranted by straight volumetric requirements and produced a 52% surplus of re- sidual fuel oil which had to be exported. In addition, 2.7 million barrels of gasoline and other clean products had to be imported to supply domestic requirements, at a cost equivalent to the export of 4.9 million barrels of crude oil. Annex 2 discusses at length the oil industry's difficulties in supplying the domestic market.  - 6 - 2.05 The table below presents the demand structure by economic sectors. 1/ 1978 Relative Average Annual _ Market Share t%) Crowth Rate 1973-78 (%) Agriculture and Fishing 7.1 8.2 Mining and Industry 17.8 10.5 Transport 52.8 17.4 of wbich: Private Car Fleet 22.6 18. 5 Air and Maritime Shipping 11.4 36.1 Residential and Commercial 20.7 12.9 Others 1.6 8.7 Total 100.0 14.1 The figures shown confirm that transport takes over one-half of final energy consumption and provides further evidence that substitution of traditional fuels has taken place, mainly in the residential sector, and that efficiency in energy use has been declining. Future Demand 2.06 Future demand for liquid fuels and for electricity is expected to increase at rates of 12% and 11.5% per year respectively. These seem reason- able, aud perhaps on the high side for petroleum products, since the market for these fuels is already showing a certain level of saturation, as evidenced by the slower growth in 1980 (9% over 1979); in addition the expansion of hydroelectric generation and the interconnection of the power system will reduce fuel requirements for thermal generation. Rural Energy Survey 2.07 INE is currently carrying out a survey of non-commercial energy use by rural households and cottage industries. Preliminary information gathered indicates that the use of wood and charcoal are much less important than previously thought, and that their weight in total primary energy consumption probably is in the range of 17 to 23Z. The use of bagasse in sugar refineries has not yet been studied. 1/ Aggregated from tables in "Balance Energetico, la parte: Analisis del Consumo Final", INE, May 1980.  - 7 - 3. DOMESTIC OIL PRICES Current Level and Structure 3.01 The Government recognizes the need to adjust energy prices, but the necessary decisions to correct the absolute and relative price levels have not yet been taken. Laws have been passed to adjust electric tariffs but they have not been enforced (para. 8.10) and changes in petroleum product prices have not affected major fuels. As a result, direct and cross-sector subsidization practices pervade. These practices not only reduce the self- financing capability of CEPE and of INECEL, but also lead to inter-institutional conflicts that reduce efficiency and induce poor allocation of productive resources. Thus, to achieve Ecuador's long-run economic objectives, a coherent pricing policy should be implemented. 3.02 Prices for liquid fuels have not changed substantially since 1973. Compared with the domestic inflationurate, the consumer Is actually paying 120X less in 1980 than he did in 1973. Moreover, the current average retail price of USS7.033 per barrel is less than 20% of world market prices (compared with mid-1980 levels). 3.03 Price changes of individual products distort the relative prics structure and lead to undesirable substitutions. As shown in the following table, LPG and asphalt are priced close to international levels. In 1980, prices for international bunkers were increased by about 652 for volumes above a basic quota, and a new grade gasoline (92 octanes) was introduced in the domestic market at a price equivalent to US$30.58 per barrel (US$0.73/gal.) 'The Government expects to gradually substitute the lower priced product by this new fuel in the more affluent areas and to achieve within one year a 10% market penetration, representing a 36% increase in CEPE's revenues from total gasoline sales. USS/Gallon US$/bbl LPG 0.522 21.91 Gasoline 92 octanes 0.728 30.58 Gasoline 83 octanes 0.186 7.81 Gasoline low grade 0.164 6.89 Kerosene 0.134 5.62 Diesel 0.144 6.05 Residual Fuel 0.104 4.37 Asphalt 0.578 24.27 1/ Mid-1980 price for the Guayaquil area. Due to transportation costs prices in other parts of the country are generally slightly higher.  Price Subsidies. 3.04 - The subsidy to the domestic consumer should be measured by comparing prices to marginal long-run supply costs or to world market prices (opportunity cost). 'Powever, even if measured in terms of current technical production costs, the subsidy is still substantial. 3.05 The bulk price for crude oil delivered by the oil companies for the domestic market is negotiated by the Government on the basis of pre- sumptive production costs. All producing companies share market requirements in proportion to their relative production. The current average price is USSI.55/bbl, but the range is from US$1.40/bbl. for the older production ventures to over US$6.0/bbl. for the more recent ones. The latter is indica- tive of the long-run marginal cost for crude. It is estimated that by 1985 about one-third of crude production will have to come from higher cost sources. If, in addition, consideration is given to the new investments that have to be made in refining, transport and marketing facilities, it is evident that the average cost of supplying the Ecuadorean market will increase sig- nificantly in the coming years. - 3.06 Based on average technical supply costs, the net subsidy to the domestic consumer of petroleum products can be estimated at USS1.56/bbl. for 1980 1/. However, the subsidy paid by CEPE is considerably larger (US$3.641bbl), as the company's revenue from sales (US$4.96/bbl) is the average retail price (US$7.03/bbl), less consumption taxes (US$2.08). The current supply cost is estimated at US$8.59/bbl including the cost of importing deficit products, while the technical production cost of products derived from domestic crude oil is about US$5 per barrel (this figure, however, assumes a zero value for the crude oil itself). Thus, the real amount of the subsidy is far larger than indicated, given the opportunity cost value of oil in interna- tional markets and its replacement cost, as measured by the long-unm marginal production cost. 3.07 Cross-sector subsidization transfers resources from the petroleum to the power sector. To finance the expansIon of the power sector, 472 of the state royalties are directly allocated to INECEL and additional funds are made available through an Electrification Fund and transfers to Provincial Councils. In 1980, limits were set to these automatic allocations 2/. Criteria for Future Pricing Policy 3.08 In adjusting the price structure, the Government should avoid the danger of a fragmented policy and of further distortions of the demand struc- ture. The following factors should be taken into account in the determination of relative prices for petroleum products: 1/ See Annex 2, Table 2.6. 2/ Pegulation No. 57 of February 11, 1980 establishes the follov&tg ceilings for automatic participation: (a) price of crude oil exported at USS23.50! bbl; (b) price of heavy fuel oil exported at USS17.50/bbl; and (c) income from the domestic market is frozen both in volume and prices.  - 9 - (a) LPG is priced close to world market levels. This product is going to be in ample supply after mid-1981 when the pipeline from Shushufindi enters into operation. In order to create an incentive to use this new supply, the prices for keroserne and for low grade gasoline would have to be increased above that of LPG; (b) the fact that kerosene is priced below diesel oil creates an industrial demand for this fuel. This has been controlled in the past by limiting the supply of kerosene to the market, thus reducing its availability to low income consumers, which runs contrary to the social objectives of the Government's policies; (c) the current price differential between diesel and fuel oil is insufficient to induce the use of heavy fuel oil in industry and in power generation. As a consequence, Government has had to Impose quantitative restrictions which distort resource allocation; and (d) current fuel oil prices do not provide an adequate incentive for hydroelectric development, end have also discouraged the development of the country's naturi- gas resources. 3.09 A realistic pricing policy should take Into account the political feasibility of implementing the changes required. This is an extremely sensitive matter, and any evaluation is tainted with sutjectivity. However, in view of the problems presently caused by subsidized prices, and the likeli- hood that they have not had any positive distributional effects, the argument is strong for implementing the required changes at a reasonably fast pace. The Bank should therefore insist on significant initial steps prior to making any new loans to Ecuador's productive sectors and should discuss the pace of programmed future increases to ensure that expected targets will be achieved in a reasonable time.  - 10 - 4. ORGANiZATION OF THE ENERGY SECTOR 4.01 The Constitution of Ecuador and specific sector legislation estab- lish that the Executive is to exploit the nation's fossil energy resources directly or in association with private enterprise and that the Government holds X monopoly on electricity generation, transmission and distribution, but that it can to authorize private operations. Decisions are taken at the following levels: general energy policy is decided by the President of the Republic; MRNE defines and coordinates sectorial policies; and CEPE and INECEL are in cbarge of the administration and implementation of the policies. A brief description of the main institutions of the sector follows. Consejo Nacional de Desarrollo (CONADE) 4.02 CONADE, chaired by the Vice-President of the Republic, is responsible for overall economic planning, and in March 1980 it completed the preparation of a development plan for 1980-84, which is mandatory for public sector institutions and which sets investment targets for both the oil and the power sectors. In order to insure that the objectives of the plan are achieved, annual programs are to be drawn up and performance is to be measured against milestone goals. Ministerio de Recursos Naturales y Energeticos (MMNE) 4.03 MNEM is the central authority for energy matters, responsible for policy formulation and for overall organization and administration of the sector. Three undersecretaries, respectively responsible for Natural and Energy Resources, for Administration and for Fisheries, are under the direct authority of the Minister (Annex 4, chart 4.1). 4.04 The Undersecretary for Natural and Energy Resources supervises the departments of Byirocarbons (Direccion General de Hidrocarburos - DGH) and of Geology and Mines. DGH is the policymaking and supervisory body for oil and gas, foreign investors' participation in the oil sector, approval of investment plans, revision of petroleum laws and pricing of petroleum products. 4.05 The scope of the activities of DG& calls for higbly experienced personnel but because of the public salary structure and political changes personnel turnover has been very high. Since ]976 about 150 professional staff have left and most of the present staff are relatively new. 4.06 There are two energy-related advisory bodies to the Minister. The first is the National Energy Council, composed of the heads of the Ministries of F_nance and Industry, CONADE, and the Joint Command of the Armed Forces, and chaired by the Minister of Natural and Energy Resources. The second is the Committee on Petroleum Policy, which brings together CEPE's General Manager and experts on the petroleum industry. 4.07 Also under the jurisdiction of MRME are three autonomous institu- tions: CEPE, INECEL and InE, all of which are discussed below.  - 11 - Corporacion Estatal Petrolera Ecuatoriana (CEPE) 4.08 CEPE, a public sector corporation established by Decree No. 522 of June 23, 1972, was set up as an instrument for government participation in all phases of the petroleum industry. CEPE is involved in the following activities: (a) Exploration and Production. In addition to direct operations, CEPE has a 67.5% share in the CEPE-Texaco consortium, which produces 98Z of Ecuador's oil and owns 507 of the trans-Andean pipeline and the associated export terminal facilities. CEPE supervises the activities of foreign contractors: Texaco, Cities Service and Yacimientos Petroliferos Fiscales (Argentinii). (b) Refining. CEPE owns and operates Ecuador's largest refinery at Esmeraldas and holds, respectively, a 24.2% and 12.3% partic'pation in the Anglo and Gulf refineries. It plans substantial expansion of throughput and conversion capacity and proposes full reversion of privately held shares. (c) Natural Gas. It manages the Shushufindi LPG plant and pipeline project and plans the development and -utilization of gas resources in the &uayaquil Gulf. (d) 1'arketing. It sells in international markets, not only its own sbare in crude oil production and its surplus of refined products, but also the Government's royalty crude. It imports deficit products and has a monopoly for local distribution and marketing. 4.09 CEPE's organization is composed of (a) a Board of Directors, whose functions include the appointment of management staff, approval of the budget and of major investment decisions, and policy formulation regarding private contractors; (b) a General Manager, who is the chief executive; and (c) oper- ating and administrative units, which are being reorganized into major area divisions. 4.10 In the past, CEE's efficiency has been hamperwd by a weak internal structure and by poor relations with MRNE and with other Government agencies. To deal with the first of the above, a foreign consultant 1/ was engaged to carry out an organizational study. This study has now been completed and its recommendations are being implemented. Regarding the second aspect, CEPE has has argued that it lacks autonomy in decision making-, being subject to the Ministry's approval in matters related to personnel, procurement and management. To solve these problems, CEPE has proposed increasing the decision-making power of its Board, which would be fully responsible for policy implenentation 1/ SNC (a Canadian consulting firm) proposed the reorganization of CEPE in order to improve coordination of activities, delegation of authority, and project supervision. As a result, an Assistant teneral I'anager was appointed and operational divisions were established. Also, a new system of accounting and management information and new procedures are being implemented .  - 12 - within guidelines given by the Energy Council 1/. It is evident that the Ministry's supervisory role is compatible with managairial autonomy, if adequate long-term efficiency criteria are clearly established. Thus, the Bank should support CEPE's position.. It is open to question, however, whether CEPE will be able to overcome its present organizational, financial and technical limitations and accomplish within the five-year period the proposed objectives. The Government has recently appointed a new Minister of Natural and Energy Pesources and a new General Manager of CEPE, and, as a result, it is expected that project priorities will be redefined and coordinated in the context of a realistic policy. 4.11 The 1980-84 Development Plan includes an investment program for hydrocarbons in an amount equivalent to US$1,300 million in 1979 constant dollars, of which 862 would be financed by CEPE. However, revised estimates are being prepared, and it is expected that investments will be increased above the company's present financing ability. If this is considered in conjunction with CEPE technical limitations, it becomes evident that priorities will have to be redefined or human and financial resources wiil be spread too thin to be productive. 4.12 A final, but not less important factor for the success of the proposed oil development plan is the Government's policy towards foreign companies, whose expertise is especially important in exploration activities. This policy has to define the incentives for potential newcomers, as well as solve the problems with present operations, and in particular with Texaco. The Government is currently proposing to establish a jointly operated company, Petroamazonas, staffed by personnel from both CEPE and of Texaco in proportion to their respective capital shares and which would become totally integrated to CEPE after a five-year transition period. As a result, Texaco is reluctant to invest in new projects (of which supplementary recovery is of high priority), unless adequate incentives are provided by the Covernment. Bank participation in the sector should be contingent upon a clarification of the Government's policy in these matters. Instituto Ecuatoriano de Electrificacion (INECEL) 4.13 Decree No. 1042 of September 1973 established INECEL as the public utility in charge of electric generation, transmission, distribution and marketing. Its organizational structure as well as the issues related to the power subsector are discussed in the second part of this memorandum. Instituto Nacional de Energia (INE) 4.14 IINE was created in 1978 as a technical-scientific body for the purpose of analyzing alternative energy strategies in the context of the changing international energy situation. It is a small institute with limited financial resources and staff and under the 1980-84 Development Plan, it has been assigned two main objectives: 1/ CEPE's Board of Directors and the Energy Council are composed of the same Government authorities (para. 4.06).  - 13 - (a) to develop national energy balances and to inventory Ecuador's energy resources; (b) to analyze existing technologies on production and use of renewable sources of energy and promote the implementation of those best suited to Ecuador's resource endowments 1/. 4.15 I1ME has prepared historic commercial energy balances at the final consumer level for 1969-78 and is carrying out a survey on the use of renewable energy sources in Ecuador's rural areas. This has been done with the technical and financ'al assistance of the European Economic Community, which provided an energy planner and is making a second one available for 1981. flTE is also introducing a more efficient stove for cooking with wood and charcoal and is trying to promote the installation of solar water heaters in new constructions. 1/ This comprises solar, eolic, geothermal energy, biodigestors, micro- and minihydraulic generation and forestry, as well as more efficient use of fueluood, through the introduction of better designed cooking stoves.  - 14 - PAPRT II THE POWER SECTOR  - 15 - 5. SECTnR ORG.ANIZATION, INSTITUTIONS AND HUMAN RREOURCES Legal Framework 5.01 The most Important legal provisions governing Ecuador's power sector are contained in the Electricity Law, passed in 1973 and subsequently amended on several occasions. The law, as it currently stands, establishes that the Government (through INECEL) has the monopoly on electricity generation, transmission and distribution; it is empowered, however, to authorize private operations. The Executive power defines sector policies through the Ministry of Natural Resources and Energy, the Ministry of Defense (when national security matters are at issue), and INECEL. 5.02 The provisions of the Electricity Law are generally sound, basically, tending toward the unification of power systems in INECEL. INECEL is provided with a sufficient degree of autonomy to enable it to carry out its operations efficiently. A. Instituto Ecuatoriano de Electrificacion Role in Sector 5.03 INECEL was created in 1961 as an autonomous entity. It operates the National Interconnected System and is the majority stockholder in 15 of the 16 utilities which operate in the sector. 1/ INECEL's participation in the capital stock of these companies ranges from 54Z to nearly 99X, thus giving it full legal control (see Annex 5, Table 5.1). The 16th company, Empresa Electrica del Ecuador (EKELEC), is 100% privately owned and operates in the city of Guayaquil under a concession contract (para. 5.28). 5.04 INECEL's functions are defined in the Electricity law; the main ones are: (a) to program, coordinate, execute and supe-rvise the de7elopment of electrification in all its phases; (b) to take an inventory of national electricity generation resources; (c) to plan, finance, purchase and operate generation, transmission and distribution facilities; (d) to obtain the internal and external financing required to fund its investment prograts; and (e) to promote the develo"ment of regional electric companies through the merger of existing utilities. 1/ There are also small electric power installations which operate in isolated systems and are owned by local municipalities, as well as a significant number of private autoproducers.  - 16 - Organization and Management 5.05 INECEL's Organization Chart is shown in Annex 5, Chart 5.1. Policy decisions are taken by_the Board of Directors and day-to-day administration is entrusted to a General Manager. 5.06 INECEL's Board is composed of the Minister of Natural Resources and Energy, who presides over it; the Minister of Finance, the Minister of Industry and Commerce; the President of the Planning Board 1,, the Chief of Staff of the Armed Forces; and one representative from each of the following: the electric power companies, the National Association of Power Engineers and the electric sector workers 2/. Reporting to the General Manager are six operating units: Industrial Relations, Engineering and Construction, System Operations, Marketing and Distribution, Finance, and Rural Distribution. The latter is now being set up, as a condition of IDB's lending for rural distribution. Several staff groups also report directly to the General Manager: Planning, Systems Analysis, Legal Department, Procurement Committee, and Public Relations. The functions of these units are the stanidard ones associated with the respective names, except for marketing and distribution, discussed below. Supervision of Electric Power Companies 5.07 The Marketing and Distribution unit encompasses two main functions: (a) standards and supervision, which involves setting up standards for works and supervising operations and maintenance in INECEL s subsidiaries; and (b) supervision of managerial performance, which involves looking into the operations of the subsidiaries, seeing that norms instituted by INECEL. are properly applied, and coordinating the work of INECEL's representatives at the Boards of Directors of its subsidiaries. 5.08 Until now, INECEL has seldom made its presence felt in the manage- ment of its subsidiaries. Though in all IDECEL holds the voting power majority (para. 5.03), the other Board members represent the municipality in which the subsidiary operates and carry heavy political weight. Also, in some cases INECEL has appointed to Boards staff who lacked the adequate skills or personalities for the tasks, which may be one reason why INECEL's success in Improving the quality of management within its subsidiaries has been limited. Currently, INECEL's management is trying to shape up its supervisory role. New staff have been appointed and further changes are being considered. It is too soon to evaluate these efforts, but they represent steps in the right direction and deserve the support of the Bank. 1/ This provision is likely to be amended as the Planning Board has now been replaced by CONADE, which is presided over by the Vice-President of the Republic. 2/ The Government Directors may be represented by alternates.  - 17 - 5.09 INECEL also faces the additional problem that the subsidiaries are frequently unable to provide adequate information in a timely fashion. This is particularly true with regard to financial information. Even though INECEL appoints "comisarios," with-on paper--some of the functions of an external auditor, in general these people, performing such roles on a part-time basis and without supportirg staff assistance, tend to rubber-stamp whatever infor- mation the subsidiaries provide. This results in a very noticeable lack of external control over tbe subsidiaries' operations. For the proposed INECEL transmission project, the Bank has requested that independent external auditors be appointed to all th- sabsidiaries 1/. This should result in an improvement of the subsidiaries' financial statements (which now generally are of poor quality) and provide some measure of external control. INECEL is also con- sidering, albeit with some internal resistance from other areas, bolstering up its internal auditing group, presently understaffed, so as to exercise additional controls over the subsidiaries. Recent Bank missions have encour- aged this approach. Sector Planning 5.10 INECEL is responsible for sector planning, which has to be consistent with the macroeconomic guidelines developed by CONADE. With the assistance of consultants (Lahmayer-Germany and Ridroservice-Brazil), INECF.L is currently preparing the National Electrification Baster plan (with Bank financing through Loan S-006-EC). The main objectives of the Plan are to: (a) study Ecuador's future power market; (b) select the least-cost program for power generation considering hydroelectric, geothermal and conventional thermal alternatives; and (c) define optimum transmission and distribution investment programs. 5.11 The Master Plan studies are being developed in three stages: short term (1978-85), medium term (1985-92) and long term (1992-2000). The following studies are also included under the Master Plan: (a) inventory of hydroelectric 2/ and geothermal 3/ resources, which will recollect existing information and create new information banks containing cartographic, hydro- logical and geological data, as well as information regarding the developmeur stages of hydroelectric sites (identification, evaluation, pre-feasibility, feasibility and detail design studies); and (b) development of an Integrated Planning System (SIP) which will optimize the hydro/geothermal power plants (identified in the inventory of hydro/geothermal resources) and their installa- tion sequence. 1/ Only one of these subsidiaries, Empresa Electrica de nuito, currently engages external auditors. un EEO's case, this stems from a covenant under IDA Credit 286-EC, approved in 1972. 2/ The inventory is expected to cover about 225,000 km2 or about 70% of Fcuador's area and about 802 of Ecuador's estimated hydroelectric potential. 3/ The inventory of geothermal resources, originally to be financed by the Bank, 's now being financed through a grant from the Organizacion Latinoamericana de Energia (OLADE).  - 18 - 5.12 The short-term Master Plan (1978-85) studies have already been completed and the draft reports were found to be satisfactory by the Bank. The Faster Plan medium/long-term studies are currently progressing satisfac- torily and draft reports are expected to be available in February 1982. Accounting 5.13 The quality of INECEL's financial statements is extremely poor, possibly because of the lack of importance hitherto attached to such informa- tion, department head changes, old fashioned recording systems, and absence of competent staff in the area. Contributing factors, too, have been the insuffi- cient staff engaged in internal auditing tasks and the delays in the Contraloria General's external auditing interventions, which have limited their usefulness. 5.14 The main problems detected by the Bank missions are the following: (a) despite the fact that INECEL's share in the capital stock of its subsidiaries ranges between-54% and 99%, INECEL shiws this partici- pation as an investment (at historic cost; profits, or losses, earned by the subsidiaries, but not distributed, are not shown) and does not prepare financial statements which consolidate the data of its subsidiaries 1/; and (b) fixed assets are shown at cost, despite legal provisions which require their annual revaluation. 5.15 Other problems stem from the poor quality of some of the figures and from the excessive time taken to produce reports. For example, accounts receivable include items which are highly unlikely to be collected and an offsetting reserve for bad debts has not been set up; inventory figures are not supported by physical checks (not even on a sample basis); and studies undertaken in the past for projects which were discarded are shown within deferred charges, amortized over five year periods, instead of being written- off. As to the time taken to prepare reports, the Accounting Department emphasizes the delays it-experiences in receiving information and the poor quality of data sent by warehouse managers 2/. Auditing 5.16 By law, INECEL's financial statements are audited by the Contraloria General de la Nacion and this has resulted in major delays in the issuance of 1/ The power companies follow a uniform system of accounts (originally prepared in 1966 with the assistance of Middle West Service and updated in 1977), which is reasonable. 2/ Yanagers have to provide data in a manner which allows allocating costs to each project under construction or to maintenance, and what they send is frequently incomplete, or inaccurately coded.  - 19 - the audited statements due to the Contraloria's lack of staff. The Contraloria issues "long" reports which include a professional opinion as per the standard format; and, when necessary, has appropriately qualified its opinion or has explicitly stated that in its opinion the financial statements did not fairly present the financial position of the company. 5.17 In connection with the proposed transmission project currently under consideration, INECEL has agreed to request the authorization of the Contraloria to engage a private firm of external auditors. It is expected that this should reduce the delays in the completion of audits and, too, that the auditors would provide advice in solving the deficiencies in the accounting system noted in paragraphs 5.13 to 5.15. Procurement 5.18 Government agencies' procurement procedures are governed by a national procurement law. In 1977, a Bank mission visited the country to study the law and to examine whether it could cause conflicts with the Bank's procurement procedures. The main conclusions then reached were that the provisions of the law itself are basically reasonable and do not generally collide with Bank guidelines. 5.19 The problems identified by the 1977 mission may be summarized as follows: (a) bidding committees tend to adopt restrictive interpretations of the law, thus drawing complaints from bidders; (b) the most serious deficiency in the legislation is that which limits the use of price adjustment clauses. Price adjustment is subject to various decrees (that lie outside the procurement law) Which are broadly worded and confusing; gc) the Ecuadorean practice has been to require bank guarantees, since they do not have experience with performance bonds. Thus, in Bank financed projects, it becomes necessary to ensure that the option of furnishing a performance bond is provided and, too, to rev,Lew the relevant provisions of the bidding documents; (d) the law appears to exclude the use of international commercial arbitration, which may work to the detriment of the executing agency; and (e) the law requires that contracts be awarded within 60 days of the receipt of the technical committee report. Often, this does not allow a reasonable time for the Bank to study the report. Management Problems 5.20 INECEL currently faces important organizational and managerial difficulties, which, if no remedial action is taken, are likely to increase in the coming years due to the strains imposed by corporate growth and a very ambitious investment program. IPECEL's top management is conscious of this,  - 20 - and, in the proposed transmission project which the Bank is currently consider- ing, it has included consulting services for institutional development. This project component is of substantial importance as, through it, the Bank would be able to provide an important input to INECEL's institutional development. 5.21 INECEL's current difficulties, discussed above, are mainly in the following areas: (a) accounting and financial information systems, due to the poor quality of the information and the excessive time taken to produce reports; (b) information systems in general, because of lack of coordination, absence of checks and duplication of efforts; (c) long-term financial planning, which (partly due to the factors mentioned above and, also, to lack of competent staff) is inadequate. Presently, efforts are being undertaken to improve this situation; (d) lack of adequate coordination between various departments which tend to operate as autonomous entities. Tackling t.is problem will require an in-depth analysis of the organizational structure and division of responsibilites and it is likely to be one of the major difficulties faced by the consultants; Ce) unclear or, in some cases, non-existent policies with regard to the management of its subsidiaries (para. 5.08) and inadequate staff to supervise them; and (f) a weak internal auditing department, which is performing only a fraction of the functions it should undertake. 5.22 A sensitive issue has been the frequency of changes in the position of General Manager, as well as in other high management posts. Though the law establishes that the General Manager is appointed for a four year term, and may be reappointed, changes have been more frequent because the position has been considered to be of a political nature. This is bound to have affected policy continuity and, consequently, company efficiency. Furthermore, the expectation of short tenures would lead to emphasizing short-term goals over long-term objectives. Since the problem stems from political practices in Ecuador, it is doubtful that it could be solved through legal provisions. 5.23 It has been preliminarily agreed with INECEL that the first phase of the consultants' study will be a diagnosis of the present situation, which would provide a more comprehensive analysis than outlined above.  - 21 - B. Empresa Electrica de Ouito 5.24 EEQ is organized as a private corporation. Its main shareholders are INECEL and the Munfcipality of Owito (other private sector shareholders account for about 2% of EEQ's capital). The organizational structure calls for a Board of Directors, a General Manager, and five operating units: engineering and construction, operations, commercial, administration, and finance. The organization is reasonable, though in the past the company has had management problems. 5.25 EEQ provides electric service to a substantial part of the province of Pichincha, including the city of Ouito. At present, EEO has over 160,000 customers and a customer/employee ratio of 131/1, above the national average as may be expected in view of the characteristics of the area it serves. EEO now has a generating capacity of about 136 14 and an additional 34.2 MW are to be commissioned in early 1981. 5.26 EEQ has been the main recipient of Bank Group funds within Ecuador's power sector 1/. The first two Bank operations (in 1956 and 1957) helped to finance the 40 MW Cumbaya hydroelectric project, several diesel plants and extension of the distribution systems (these works were completed by the end of 1961 and have been operating satisfactorily). 5.27 IDA Credit 286-EC for USS6.8 million was approved in 1972 and covered part of the foreign exchange costs of the Nayon hydropower plant, a diesel engine generating unit, transmission lines and a rural electrifi- cation component. A PPAR on this operation was issued on May 30, 1980 (PPAR No. 3003). Its main conclusions were that: (a) the physical objectives of the project were met, albeit with delays and cost overruns; (b) progress toward the institutional objectives of the project was disappointing; (c) most of the covenants related to the financial aspects at the institution were not met; and (d) lack of cooperation affected the efficiency of IDA supervision efforts, which, however, also required more frequent field supervision than actually took place; These lessons should be kept in mind for the proposed transmission project currently being considered with IPECEL. 1/ The only other financing provided by the Bank to the sector has been through Loan S-006-EC to FONAPRE for the Master Plan studies and feasibility of Paute-Mazar hydro-development, currently under way (para. 5.10).  - 22 - C. Empresa Electrica del Ecuador 5.28 Like EEQ, EHELEC is organized as a corporation. It is, however, privately owned. EMELEC's concession was granted by the municipality of Guayaquil in 1925 and was ratified by the National Government by a decree- law passed in 1966. The concession expires in 1995 after which time (but subject to a three-year advance notificatinv), .he Municipality may acquire all the company facilities at a "fair price." 5.29 The Government has, through the 1980-84 National Development Plan, expressed its concern at the negative effects associated with the private ownership of EYELEC and has indicated that eventually EMELEC should be nationalized. No date has, however, been set and, in some quarters, there seems to be some uncertainty at the position taken. It would be desirable if action is taken soon, as nationalization would reflect itself on the sector's financing requirements. Uncertainty over the Government's position on this matter could hypothetically result in a slower pace of investment by EMELEC's present ownership, eventually affecting the quality of the service it provides. 5.30 EMELEC serves the city of Guayaquil and some neighboring areas, totaling about 172,000 customers. EMELEC's generating plants are all thermal; with an installed capacity of about 183 MU. The company employs about 850 persons. D. Other Electric Power Companies 5.31 Besides EEO and EMELEC, there are 14 other electric power companies of fairly small size operating in Ecuador. Additionally, 42 municipalities operate small local power facilities. The Goverment has set as one of its objectives in the sector the consolidation-through merger-of these companies. The medium-term target (for which no date has been set) is to reduce the total number of power companies from 16 to 9, a sensible effort that the Bank should support. 5.32 The income statements of the power companies (shown in Annex 8, Table 8.2) do not present a breakdown of O&M expenses, since the corresponding information is not available. The cost data which is available is simmarized in Annex 5, Table 5.2. Particularly striking is the difference in absolute costs and in cost structure between EEO and EMELEC, on the one hand, and the smaller power companies on the other. One of the factors causing higher O&M costs in these smaller companies is the high incidence of system losses (para. 7.04, and Annex 5, Table 5.3). Another reason is system size, since the small companies face diseconomies of scale, which are reflected in higher labor costs. However, it would seem that EMELEC manages to operate with a relatively much lower labor force than EEQ or the other INECEL subsidiaries. *The available data roughly indicates that kFWh sold per employee for EEQ come to about half that for EMELEC, while for the other INECEL subsidiaries they were again about half as much as in EEQ (in some cases they were as low as one-fourth or one-third). These factors, the management weaknesses, and shortage of professional staff detected in some of the smaller IFECEL subsidiaries, lack of policy directives from TIECEL, and casual style of control exercised over the subsidiaries together are reflected in performance inefficiencies and constitute an issue which ought to be addressed promptly.  - 23 - E. Human Resources Present Human Resources Availability 5.33 The following table illustrates the current human resources situa- tion within the power supply industry: Customer/ GWh Sold/ Employees Z Employees Employees INECEL 1,657 25 - a/ - a/ EKELEC 860 13 182 1.0 EEO 1,342 20 131 0.44 INECEL subsidiaries and municipalities 2,714 42 106 0.21 Total Power Sector 6,573 100 90 b/ 0.31 b/ a/ INECFL is a bulk supplier. hi Includes INECEL's employees. The above figures and rptios were considered within acceptable limits when compared with other Latin American countries which had similar sector infra- structure and level of development. 1I However, once again notice should be taken of the disparities within the various public supplier organizations, which are shown above and discussed in paragraph 5.32. About 5,532 persons were also engaged by consultant and contractor firms working in activities directly related to the power sector. Annex 5, Table 5.4 provides additional statistical data on human resources. Future Manpower Requirements 5.34 By the year 1985, INECEL expects that the power supply industry will require about 11,200 employees, nearly 2,800 of whom are to be engaged by I1ECEL and 8,400 by INECEL's subsidiaries, municipalities and EMELEC. The sector GWh sold/employee ratio is expected to improve from 0.31 in 1979 to 0.44 in 1985, while the connected customer/employee ratio is expected to increase from 90 in 1979 to 92.6 in 1985. It is also expected that in 1985 nearly 10,000 people will be working with consultant and contractor firms. 5.35 The different Bank missions that visited Fcuador recently reviewed the sector's humen resources requirement projections and found them reasonable. Nevertheless, it appears that some areas of the sector (especially within 1/ Customer/employees and CWh sold/employees ratios were respectively 68 and 0.4 for Panama, 77 and 0.24 for Uruguay, 94 and 0.67 for Costa Rica, 233 and 1.08 for Peru.  - 24 - INECEL and its subsidiaries) may be overstnffed. This issue is to be properly addressed and assessed in the proposed consulting studies for institutiQnal development. Furthermore, INECEL is expected to agree with the Bank during the forthcoming negotiations for the proposed transmission project on targets for improving efficiency in this respect. Training Activities 5.36 INECEL has established an important and active Training Department which has, over the past seven years, developed a good, if somewhat centralized, training system. Training services are available to, and are widely used by, the staff of INECEL and its subsidiaries. The training system is based upon sound training principles and benefits from executive management commitment and support. The following features of the existing training scheme are indicative of the systematic manner in which training services have been developed and are now being routinely provided: (a) an annual policy statement on human resources and training is updated and circulated each year; (b) regular human resources planning and forecasting for the complete sector is undertaken as a corporate management exercise; tc) an annual training program is issued to all regional utilities, detailing the training programs to be offered at INECEL's training center and a variety of approved programs of education and training available in Ecuador and externally for which training grants are available; and (d) INECEL operates a well established residential training center (Centro Nacional Franco-Ecuatoriano-CENAFE-present capacity 100 trainees) with a highly trained staff and a good mix of well equipped practical training and classroom facilities. Since the successful implemer.tation of the 1980-85 development program will require a major mobilization of human resources, as well as improvements in management practices, the INECEL transmission project, currently under Bank consideration, would include a substantial training component.  - 2.5 - 6. SECTOR FACILITIES Generation 6.01 As of December 1979 installed power generating capacity was about 924 NW, of which 700 MW, or 75Z of the total, was thermal and the balance hydroelectric. A summary description of these Installations is given in the table below (see also Annex 6, Table 6.1). Internal Oil-fired Combustion Steam Plant Hydro Total Public Service 423.2 136.0 212.5 771.7 Self-Producers 140.6 12.1 152.7 Total 563.8- 136.0 -224.6 924.4 About 520 NW, or 56% of the total installed capacity, are currently intercon- nected through the 230 kV Quito-Guayaquil transmission line and the 69/34.5/22 kV Ouito-Latacunga-Riobamba-Ambato subtransmission network. 6.02 Present electricity public supply (through INECEL, its subsidiaries, EKELEC and municipalities) accounts for about 84% of total power supply. Private generation (self-producers - mostly industrial and agricultural undertakings), accounts for the remaining 16% (about 153 MW capacity, of which 141 MW are dieael generators and 12 MW are hydroelectric plants). It is expected that the share of self-producers' in electric generation (mainly thermal generation) will be reduced in the future when: (a) the National Interconnected System becomes operational (the 230 kV Ouito-Guayaquil transmission line was commissioned in August 1980 and different interconnecting transmission lines will be commissioned during 1981-84); (b) the Paute hydroelectric development is commissioned (500 MW during 1983 and 500 MW during 1987); and (c) petroleum price subsidies for electricity generation are reduced. 6.03 The table below shows the power plant additions already committed to be installed and commissioned during the period 1980-82. Internal Oil-fired Combustion Steam Plant Hydro Toral MW 180.0 198.0 33.2 411.2 INECEL is also installing 5 x 100 MW h7droelectric units at Paute, to be commissioned in 1982/83.  - 26 - 6.04 To meet 1986-90 forecasted energy requirements, INECEL, based on the results of the short-term Master Plan studies, developed a least-cost expansion program which involves the installation and commissioning of the following hydroelectric power plants (see also Annex 6, Attachments 6.1, 6.2 and 6.3): Power Plant Capacity (MW) Tentative Commissioning Date Agoyan 150 1986 Paute C 500 1987 Daule-Peripa 130 1988 Paute-Mazar 140 1989 Transmission 6.05 The existing transmission system is reduced to short transmission links between major consumption centers and the nearby power generating stations. The first SNI major interconnecting link was commissioned during August 1980 and ties the two biggest consumption centers, Guayaquil and Quito, through a 327 km - 230 kV, double circuit transmission line. The following transmission lines are currently under construction and are expected to be commissioned before the end of 1982 (See Annex 6, Attachment 6.3): (a) 183 km - 230 kV, double circuit Guayaquil-Paute; (b) 80 km - 138 kV single circuit, Ouito-Ibarra; (c) 154 km - 138 kV, double circuit, Santo Domingo-Esmeraldas; and (d) 107 km - 138 kV, single circuit, Ouevedo-Puertoviejo. 6.06 During the period 1982-85, IINECEL intends to install and commission about 538 km of 230 kV transmission lines, 427 km of 138 kV transmission lines and about 280 MVA step-up/down transformation capacity at different substations. This will allow INECEL to: (a) incorporate the different isolated systems to the SNI network; and (b) deliver the hydro-electricity to be produced by the existing and proposed hydro-power plants (see Annex 6, Attachment 6.3). Subtransmission 6.07 Some of the isolated systems (all of them INECEL subsidiaries) will be integrated into the main SNI network through subtransmission lines (69 kV and 34.5 kV). Therefore, about 1,300 km of 69 kV and 34.5 kV sub- transmission lines and about 450 MVA step-up/down transformation capacity at different substations are to be installed and commissioned during the period 1982-85. Distribution 6.n9 From 1982 to 1985, INECEL aims to provide electricity to about 1,500,000 additional inhabitants in different areas (which represents about 250,000 new electricity consumer services). This would increase Ecuador's electrification rate from 38Z in 1978 to 50% in 1985. For this purpose, InECEL and its subsidiaries plan to: (a) construct new low voltage distribu- tion circuits; (b) extend and Improve existing distribution systems; and (c) implement a two-stage rural electrification program, part of which is being financed by IDB.  - 27 - 7. THE POWER MARKET AND ThE SECTOR DEVELOPMENT PROGkAM The Present Power Market 7.01 Ecuador's per capita installed capacity, energy consumption and population access to electricity are among the lowest in South America. 1/ Nevertheless, from 1970 to 1978, Ecuador substantially improved its electrifi- cation level as shown by the indicators in the following table: Capacity Ilstalled/ Consumption/ Electrification Year Inhabitant Inhabitant Rate (X) 1970 51 watts 155 kWh/year 28 1975 74 watts 266 kWh/year 32 1978 122 watts 333 kWh/year 38 About 63Z of the total electricity produced in the country (estimated at 2,600 GWh in 1978) is consumed in the Guayaquil (970 GWh or 37Z) and Ouito (680 MWh or 26Z) areas. 7.02 Ecuador's electric public utilities (INECEL, its subsidiaries, EMELEC and municipalities) currently supply energy to about 622,000 customers, of whom about 162,000 (26% of the total) are customers of EEQ and about 172,000 are customers (28% of the total) of EMELEC. About 73Z of the popula- tion in Quito and about 71% of the population in Guayaquil are currently connected to the public supply distribution system. 7.03 In 1978, total electricity generation amounted to 2,573.5 GWh (of which 2,181.8 GWh were sales and 391.7 GWh were losses and power station use). Industrial customers consumed about 863.3 GWh, while residential and commercial customers used 792.4 GWh and 299.9 GWh, respectively. Public lighting and municipal use amounted to 226.2 GWh. Total electricity sales in Ecuador have steadily increased at an average annual rate of about 13%, from 791.0 GWh in 1970 to 2,181.8 GWh in 1978 (see Annex 7, Table 7.1). Simultaneously, maximum demand has increased from 224.0 MW in 1970 to 564.5 MW in 1978 (see Annex 7, Table 7.2) at an average rate of about 12%. 7.04 In 1978, INECEL's subsidiaries' and EMEIEC's system losses (see Annex 5, Table 5.3), including transformation and distribution losses, power station use, thefts and unaccounted, amounted to 293.6 GWh, or 13% of the utilities' gross generatioul purchases (estimated at 2,277.6 GWh). Some of INECEL's subsidiaries have reached an unacceptable level of losses and/or unaccounted for consumption (up to 35% of gross generation/purchases), mainly due to inadequacies of the distribution systems (overloaded distribution 1/ Consumption per capita and electrification rates of some other South- American countries are, respectively: Argentina 1,236 kWh and 80Z; Brazil 912 kWh and 62%, Chile 927 kWh and 87%; Colombia, 691 kWh and 62%; and Peru 532 kPh and 35%.  - 28 - transformers and lines, lack of compensating/regulating equipment - capacitors and voltage regulutors, lack of adequate metering devices and registration methods). A program designed to address this issue is, therefore, urgently required. The Future Power Market 7.05 The Master Plan load forecast was developed after considering the results obtained from alternative projection methodologies: extrapolation of historical and actual electricity consumption trends, correlation with macro- economic indicators, and regional and national forecasts by sectors. Total electricity requirements are expected to increase from 2,912 GWh in 1979 to 6163 GWh in 1986 at an average annual rate of about 11.52 1/ Yzximum demand i8 expected to increase from 658.3 MW in 1979 to 1,355.6 MW in 1986 at an average annual growth rate of about 11%. The generation plant load factor is expected to improve from 50.5% in 1979 to 51.8% in 1986. Details of the energy and demand forecasts are given in Annex 7, Tables 7.1 and 7.2. 7.0O Between 1978 and .1986 the industripl consumption is expected to increase from 34% to 38% of total electricity consumption, while losses and power station use are expected to decrease from 15% to 122. 2/ Otherwise, the structure of electricity consumption is expected to remain basically unchanged, as shown below: x of Total Generation Category 1978 1986 Residential 30.8 31.0 Commercial 11.7 12.2 Industrial 33.5 37.7 Public Lighting and Others 8.8 7.1 Losses and Power Station Use 15.2 12.0 Total 100.0 100.0 1/ This growth is in line with Ecuador's economic projections as outlined in a Bank country study of July 1979 (Ecuador: Development Problems and Prospects) and with the macroeconomic forecasts contained in the 1980-84 development plan. 2/ It is reasonable to expect such reduction in energy losses and power station use because: (a) the bulk of the energy will be transferred through high voltage lines (230 kV and 138 kV); (b) existing subtrans- mission and distribution systems are expected to be improved; (c) INECEL and its subsidiaries are expected to improve the existing methods of energy monitoring and theft control; (d) power station use at thermal plants (which accounts for the bulk of this item) is expected to be reduced substantially, as the SNI thermal generation requirements will decrease when the Paute hydroelectric development becomes operational in 1983.  - 29 - Construction Program and Investment Requirements 7.07 In order to meet energy and power capacity requirements during the period 1980-90, IPECEL and its subsidiaries have prepared generation, transmission, and distribution construction programs based on: (a) detailed analysis of the capability of existing gener:ition and transmission facilities and of facilities being added to the existing system; and (b) the results of the short-tern Master Plan optimization studies. The construction program includes the following major works: (a) about 945 MW and 1,220 MR of new generating capacity to be installed during 1980-85 and 1986-90, respectively; (b) about 860 and 980 circuit-kilometers of 230 kV and 138 kV transmission lines to be commissioned during 1980-82 and 1983-86, respectively; and (c) expansion of subtransmission and distribution systems. lDetails of capacity and commissioning dates for the different construction program works are given in Annex 6, Attachments 6.1 and 6.2. 7.08 The investment requirements for 1980-85 (see Annex 7, Table 7.3) are estimated at USS1,640 million (at 1980 price levels).. About US$1,372 million are to be invented-by INECEL in: (a) SNI generation plants (US$829 million); (b) 138 kV and 230 kV SNI transmission lines (US$308 million); (c) 69 kV and 34.5 SNI subtran6mission lines and rural electrification (USS169 million); and (d) studies and general investments (US$66 million). In addition, EMEIEC and INECEL's subsidiaries are expected to invest about US$264 million in their distribution systems. 7.09 INECEL also has estimated the 1986-90 generation program investments at about US$1,200 million. Tlhe 1986-90 transmission, subtransmission and distribution investment requirements would be only defined by February 1982, when the results of the medium-term master plan studies become available. A summary of the sector 1980-90 investment program (not including the 1986-90 transmission, subtransmission and distribution programs) is given below: Sector Investment Program (a) 1980 - 1985 US$ million C1980 ice level) SKI generation program 8Z9 SKI transmission program 308 SNI subtransmission and Rural electrification programs 169 INECEL studies and general investments 66 INECEL's subsidiaries and EMELEC distribution programs 264 Total 1,636 (b) 1986-90 SNI generation program 19200 1980-90 total investment 2,836  - 30 - 8. SECTOR FINANCES Current Financial Situation 8.01 In 1979 total sector investments in power facilities amounted to nearly US$250 million equivalent, of which a substantial part corresponds to the Paute hydro project, currently under construction. By historic standards, this figure is very high, as the sector's revalued gross fixed assets in operation now amount to little over US$800 million equivalent. Current plans call for an even greater investment effort in the coming years. 8.02 Presently, the sector's net internal cash generation is negative. Equity funds are derived mainly from INECEL's participation in oil royalties (over US$160 million in 1979). INECEL, EEO and EMELEC are fairly active borrowers in international financial markets. *1owever, IMECEL has lacked long-term financial planning and borrowing strategies and, as a consequence, it has relied too much on suppliers' credits with fairly short amortization periods, which is resulting in heavy debt service burdens. IDB has made several loans to the sector, and so has the Bank Group (to EEO, see paras. 5.26-5.27). INECEL's subsidiaries tend to rely on INECEL for equity funds and for loans, complementing this mainly with supplier credits. Their borrowing in international markets is very low, and, to a large extent, this is due to the limited ability of local financial managers, to the red tape involved in obtaining approval from the Government, and to the high cost associated with obtaining the required guarantees. 8.03 Annex 8, Tables 8.1 and 8.2, respectively show the consolidated power sector balance sheets and income statements for 1978 and 1979 as estimated by the Bank mission. As of December 31, 1979, the sector had a low debt-equity ratio (38:62 with fully revalued assets 1/ and 46:54 without asset revaluation) which would indicate that, provided revenues are increased so as to yield an adequate debt coverage ratio 2/, the sector ought to be able to finance a substantial proportion nf Fts investment program through borrowings. Investment and Financing Plan 8.04 The consolidated investment and financing plan for INECEL and its subsidiaries is summarized below: 3/ 1/ The highest debt equity ratio corresponds to INECEL (40:60). EEQ and EMEIC have figuLas of 35:65 and 33:67 respectively, while the average for INECEL's subsidiaries (excluding EEQ) is only 8:92. 2/ The Bank mission forecasts are that in 1980 the debt service coverage ratio will be about 0.5. The tariff issue is discussed in paragraphs 8.10 to 8.23. 3/ EHELEC's forecast investments in the same period amount to less than US$50 million (and no financing problems are foreseen), thus the table is representative of the evolution projected for the sector as a whole.  - 31 - CONSOLIDATED INVESTMENT AND FINANCING PLAN*. 1982-1985 (In millions of current dollars) Amount % Requirements for Funds Investments in: Hydro generation 693.1 38.2 Transmission 209.3 11.5 Other, operational 241.8 13.3 Other, non operational 119.6 6.6 Studies 73.6 4.1 Subtotal 1,337.4 73.7 Interest during construction 354.1 19.5 Subtotal 1,691.5 93.2 Net working capital 123.2 6.8 Total requirements -1814.7 100.0 Sources of Funds Net operating income 541.5 29.8 Other income (net) (99.9) (5.5) Depreciation 272.6 15.0 Total gross cash generation 714.2 39.3 Less: Debt service (357.4) (19.7) Net internal cash generation 356.8 19.7 Equity contributions: Oil royalties 517.6 28.5 Miscellaneous taxes 10.5 0.6 Other Government contributions 230.8 12.7 Subtotal 1,115.7 61.5 Borrowing (gross) 699.0 38.5 Total sources 1,814.7 100.0 *Figures may not add up because they have beeT rounded off.  - 32 - 8.05 The Bank has worked closely with INECEL and with the Government in developing a suitable program financing scheme. The Government is expected to assign over US$1 bii