Peru - Issues and options in the energy sector

Report No 46,.-PE Peru: Issues and Optiols in the Energy Sector Januarv 1984 Report of the joint UNDPMbrld Bank Energy Sector Assessment Program Ths document has a restricted distribution. Its contents may not be disclosed without authorization from the Government, the UNOP or the World Bank  JOINT UNDP/WORLD BANK ENERGY SECTOR ASSESSMENT PROGRAM REPORTS ALREADY ISSUED Courntry Date No. Indonesia November 1981 3543-IND Mauritius December 1981 3510-MAS Kenya May 1982 3800-KE Sri Lanka May 1982 3792-CE Zimbabwe June 1982 3765-ZIM Haiti June 1982 3672-HA Papua New Guinea June 1982 3882-PNG Burundi June 1982 3778-BU Rwanda June 1982 3779-RW Mialawi August 1982 3903-MAL Bangladesh October 1982 3873-BD Zambia January 1983 4110-ZA Turkey February 1983 3877-TU Bolivia April 1983 4213-BO FiUi June 1983 4462-FIJ Solomon Islands June 1983 4404-SOL Senegal July 1983 4182-SE Sudan July 1983 4511-SU Uganda July 1983 4453-UG Nigeria August 1983 4440-UNI Neoal August 1983 4474-NEP Gambia November 1983 4743-GM  FOR OFFICIAL USE ONLY Report No. 4677-PE PERU ISSUES AND OPTIONS IN THE ENERGY SECTOR January 1984 This is one of a series of reports of the Joint UNDP/World Bank Energy Sector Assessment Program. Finance for this work has been provided, in part, by the UNDP Energy Account, and the work has been carried out by the World Bank. This report has a restricted distribution. Its contents may not be disclosed without authorization from the Government, the UNDP or the World Bank.   ABSTRACT The economic crisis that has overtaken Peru since early 1982 has forced, or at least coincided with, a reevaluation of investment pro- grams, pricing policies, and institutional arrangements in the energy sector with a view to increasing the efficiency with which investment, manpower, and energy resources are used. The shortage of financial re- sources is especially important in the electric power sector, where an unrealistic and to some extent unnecessarily ambitious investment program must be, and is being, cut back and rationalized. Increased foreign participation in oil exploration has been needed, actively sought, and obtained. Hyper-inflationary conditions have made it difficult to in- crease real energy prices, but significant progress has been made, especially with respect to petroleum products. A new organizational structure for the electricity sector has been enacted into law and the national oil company is undergoing a substantial internal reorganization. Stronger efforts are still required to improve the energy situation in Peru. The traditional fuels (fuelwood and agricultural residues) on which most Peruvians rely for their daily cooking require- nents are becoming increasingly scarce; adequate exploration efforts in the petroleum sector are still not assured, and the financial and or- ganizational problems still facing the power sector are formidable. Priority areas for action on these and other problems are identified and discussed in the report in the areas of demand management, fuelwood and forestry, oil and gas, electricity and coal.   Preface An earlier draft of this report was discussed in November, 1983, with Mr. Fernando Montero, the Minister of Energy and Mines (MEM), Mr. Felipe Thorndike, the President of the National Energy Council (CONERG), and other officials of MEM and some of the principal operating entities in the sector. The main conclusions and recommendations of the report were agreed in principle, although at the same time it was understood that continuation of the progress made in the last several years on some of the most important issues, notably energy pricing and the policy frame- work for contract negotiations with foreign oil companies, is likely to be highly conditioned by political consideration over the next several years. Several important changes that have taken place since the energy assessment mission (November 1982) are reflected in the revisions agreed in the course of these discussions, but no systematic effort has been made to update figures or reflect minor changes that do not affect the report's basic conclusions.   ACRONYMS AND ABBREVIATIONS Acronyms Cenfors Centros Forestales Centromin Compania Minera del Centro del Peru Cofide Corporacion Financiera de Desarrollo Coserelec Compania de Servicios Electricos S.A. DGE Direccion General de Electricidad DGFF Direccion General Forestal y de Fauna EECH Sociedad de Energia de Chimbote S.A. EEPSA Empresa de Energia de Piura S.A. Electroperu Electricidad del Peru GOP Government of Peru IHidrandina Compania Hidroelectrica Andina Hierro Peru Empresa Minera del Hierro IBRD International Bank for Reconstruction and Development (World Bank) IDB Interamerican Development Bank INFOR Instituto Nacional Forestal y de Fauna INGEMMET Instituto Geologico, Minero y Metalurgico ITINTEC Instituto de Investigacion Tecnologica Industrial y de Normas Tecnicas MEM Ministerio de Energia y Minas Minero Peru Empresa Minera del Peru Olade Latin American Energy Organization Petroperu Petroleos del Peru Procarbon Erapresa Promotora del Carbon S.A. Seal Sociedad Electrica de Arequipa S.A. SECH Sociedad de Energia de Chimbote S.A. Sedapal Servicio de Agua Potable y Acueductos Siderperu Empresa Siderurgica del Peru SIH Sociedad Industrial de Huancayo Abbreviations B Billion = 109 bbl Barrel bd Barrel per day Btu British Thermal Unit ft3 Cubic Feet m3 Cubic Meter GW Gigawatt GWh Gigawatthour K Thousand km Kilometer KTOE Thousand Tons of Oil Equivalent kV Kilovolts kW Kilowatt KWh Kilowatthour LPG Liquified Petroleum Gas  MMCFD Million Cubic Feet per day MW Megawatt MWh Megawatthour T Tonnes TCF Trillion Cubic Feet TOE Tons of Oil 'Equivalent This report is based on the findings of an energy assessment mission which visited Peru in November 1982. The members were David Hughart (Mission Leader - Energy Economist), Gabriel Sanchez-Sierra (Energy Plan- ner), Patrice Vabre (Financial Analyst), Fernando Manibog (Renewable Energies Specialist), Arturo Montemayor (Gas Specialist, Consultant), Glenn W. Mortimer (Gas Specialist, Consultant), D.G. Fallen-Bailey (Petroleum and Coal Specialist, Consultant), Carlos Robertson (Power Engineer, Consultant) and Oscar Garces (Energy Conservation Specialist, Consultant). The principal authors of the report were Messrs. Sanchez- Sierra and Hughart.  CURRENCY EQUIVALENTS January 1982 US$1 = 518.63 soles March 1982 US$1 = 562.69 soles June 1982 US$1 = 660.09 soles September 1982 US$1 = 775.57 soles December 1982 US$1 = 949.18 soles April 1983 US$1 = 1298.72 soles July 1983 US$1 = 1652.76 soles October 1983 US$1 = 2113.50 soles ENERGY CONVERSION FACTORS PETROLEUM Crude Oil 138 TOE/bblx103 LPG 95 TOE/bblxlO3 Gasoline 122 TOE/bblx1O3 Kerosene and Jet Fuel 133 TOE/bblxlO3 Diesel 138 TOE/bblxlo3 Fuel Oil 147 TOE/bblxlO3 GAS Natural Gas 23.4 TOE/CFxlO6 Furnace Gas 60.0 TOE/CFx106 Coking Gas 14.5 TOE/CFx1o6 COAL Imported 730 TOE/TonxlO3 Domestic Anthracite 700 TOE/TonxlO3 Domestic "Goyllar" 593.2 TOE/TonxlO3 BIOMASS Fuelwood 360 TOE/TonxlO3 Charcoal 650 TOE/TonxlO3 Bagasse 150 TOE/Tonx103 ELECTRICITY Main Report 1/ 245 TOE/GWh Annexes 2/ 86 TOE/GWh 1/ Electricity is converted to TOE in this report at a rate based on fuel oil consumption per KWh output - thermal efficiency adopted 34.4%. 2/ Comparable to Energy Balances prepared by MEM4.  I  Table of Contents Page No. SUMMARY AND RECOMMENDATIONS ................................ i Overview ....................................... i Recommended Energy Strategy .................... iii Fuelwood and Forestry ....................... iii Oil and Gas ................................. iv Electricity ................................. vii Coal ........................................ ix Energy Demand Management ....................... x Pricing ......................................... xii I. ENERGY IN THE PERUVIAN ECONOMY . . 1 Country Introduction ........................... 1 Economic Situation ............................. I Economic Prospects ............................. 3 Energy Balance 1981 ............................ 3 International Comparisons ...................... 6 Projections .................................... 7 Energy Sector Organization, Finances and Planning ....................... 10 II. ENERGY DEMAND MANAGEMENT .......................... 16 The Structure of Energy Demand . . 16 Energy Pricing .. 16 Transport Sector ................ 20 Household Sector . . 22 Industrial Sector . . 25 Manufacturing Sector . . 26 Substitution of Coal for Fuel Oil . . 27 Institutional Aspects . . 28 III. BIOMASS ........................................... 30 Resources ......... . .... 30 Regional Disparities ........................ 30 Fuelwood Scarcity in the Sierra Region ...... 31 Deficits and Reforestation Requirements in the Sierra ............................ 32 Current and Planned Efforts .................... 33 Improved Reforestation Efforts in the Sierra... 35 Constraints to Reforestation and Recommendations ............................. 37 Project Possibilities in Biomass Energy for the Sierra .............................. 42 Forestry Priorities in Other Regions ........... 44  Page No. IV. OIL AND GAS ....................................... 48 Petroleum ..................................... 48 Reserves and Production ..................... 48 Attracting Foreign Investment ............... 53 Production Prospects ........................ 55 Refineries .................................. 56 Natural Gas .................................... 58 Reserves .................................... 58 Existing Demand ............................. 59 Potential New Demand ........................ 61 Institutional Aspects ....................... 66 V. ELECTRICITY ....................................... 68 Resource Base .................................. 68 Sector Structure ............................... 69 Demand Growth .................................. 70 Investment Choices ............................. 71 Central North System ........................... 71 Soutlhwest System ............................... 75 Southeast System ............................... 76 Isolated Systems ............................... 77 VI. COAL AND OTHER ENERGY SOURCES ..................... 80 Coal ........................................... 80 Resources ................................... 80 Development Strategy ........................ 83 Coal Markets ................................ 84 Institutional Aspects ....................... 85 Geothermal Energy .............................. 86 Solar and W4ind ................................. 88 TABLES Table 1 Commercial Energy Resources vs. Consumption, 1981 .... ii Table 2 Estimated Energy Savings and Investments Required in the Mineral Industries and Manufacturing Sectors.. x Table 1.1 Overall Energy Balance, 1981 ......................... 4 Table 1.2 Evolution of Electricity Supply. 5 Table 1.3 Economic and Commercial Energy Consumption Indicators in Selected Developing Countries, 1970-1980. 6 Table 1.4 Energy Demand Projections. 8 Table 1.5 Petroleum Exports-Imports, 1985-1990. 9 Table 1.6 Projected Energy Balance, 1990 .11 Table 1.7 Consolidated Budget of Public Service Power Sector, 1982 ................................... 14  Page No. Table 2.1 Commercial Energy Prices ............................. 18 Table 2.2 Road Vehicles, 1976-1981 ............................. 20 Table 2.3 Transport Energy Consumption by Fuel ................. 21 Table 2.4 Energy Consumption in the Transport Sector, 1985. 22 Table 2.5 Residential Energy Consumption ....................... 22 Table 2.6 Cooking Fuel Costs ................................... 24 Table 2.7 Estimated Energy Savings and Investment Mining Sector ........................................ 25 Table 2.8 Total Estimated Energy Savings in the Manufacturing Sector ................................. 26 Table 2.9 Potential for Interfuel Substitution ................. 27 Table 3.1 Forest Resources ..................................... 30 Table 3.2 Wood Balances for the Sierra, 1983 and 2000 .......... 32 Table 3.3 Current Projects in Reforestation With Bilateral and Informational Aid ...................... 35 Table 3.4 Fuelwood and Charcoal Prices, Huancayo (1982) ........ 37 Table 3.5 Wood Balances for the Costa, 1983 and 2000 ........... 46 Table 4.1 Oil Reserves, end-1982 ............................... 49 Table 4.2 Oil Production and Net Exports, 1977-83 .............. 49 Table 4.3 Evolution of Proven Oil Reserves, 1971-82 ............ 51 Table 4.4 Crude Oil Production Projections, 1984-90 ............ 56 Table 4.5 Petroleum Products: Capacity and Demand Balance ..... 57 Table 4.6 Natural Gas Reserves, End 1981 ....................... 58 Table 4.7 Natural Gas Production, MMCFD ........................ 60 Table 4.8 Natural Gas Production in Northwest Peru ............. 60 Table 4.9 Potential Natural Gas Demand ......................... 62 Table 4.10 Alternative Natural Gas Pipeline Schemes ............. 63 Table 5.1 Access to Electricity in Urban and Rural Areas ....... 68 Table 5.2 Installed Capacity (MW) and Energy (GWh) ............. 72 Table 5.3 Additions to Capacity, Central-North System, 1982-86 .............................................. 73 Table 5.4 Autoproducers ........................................ 77 Table 6.1 Mineable Coal Reserves ............................... 80 Table 6.2 Analyses of Coals .................................... 81 Table 6.3 Coal Production ...................................... 82 Table 6.4 Estimated Geothermal Reserves and Resources Sustained Over a Five Year Period .................... 87 Table 6.5 Average Solar Radiation Over Selected Sites .......... 98  Page No. ANNEXES Annex S.1 Technical Assistaace Priorities in the Energy Sector ........................................ 91 Annex 1.1 Economic Indicators .................................. 92 Annex I.2 Energy Balance 1970 ............................... 93 Annex 1.2 Energy Balance 1975 .. 94 Annex I.2 Energy Balance 1931 .. 95 Annex 1.3 MEM - Overall Orgcanigram . . . 96 Annex II.1 Electricity TarifEs .................................. 97 Annex III.1 Forestry Plantations Established As of 1980, By Department . . 98 Annex IV.1 Crude Oil Production - World Bank Forecast ........... 99 Annex IV.1 Crude Oil Production - Petroperu Forecast ............ 100 Annex IV.2 Gas Production Potential Forecast .................... 101 Annex V.1 Central-North Power System ........................... 102 Annex V.1 Central-North Demand Projections ..................... 103 Annex V.1 Central-North - Power Balance - MW . ........... 104 Annex V.1 Central-North System - Energy and Power Balances..... 105 Annex V.2 Power Sector - Description of Some Important Projects ..106 MAPS IBRD 16094R Central-North Interconnected System IBRD 17126 Oil and Gas Operation IBRD 17291 Transport System, Regions and Relief  SUMMARY AND RECOMMENDATIONS Overview 1. Peru is richly endowed with energy resources. Its largest known resource is hydro power, of which less than four percent of the total potential has been devaeGped. 1/ Hydrocarbon resources are represented by about 1.4 billion barrels of oil (836 proven and 538 probable) and 1.9 TCF of natural gas. Coal resources are estimated at about one billion tons (126 proven, but not necessarily economically recoverable, and 871 inferred). Peru also has abundant forest resources which cover almost 60% of the total land area. More than 95% of this resource is located in the thinly populated Selva region; however, fuelwood is scarce in most of the more populous areas. 2. In 1981, per capita energy consumption was 690 kgoe. 2/ Biomass energy sources 3/ met about 32% of the total demand (70% of the energy consumption in the residential sector), with commercial energy 4/ provid- ing the other 68%. Most of the energy consumed in rural areas is bio- mass, 5/ and the annual per capita consumption of commercial energy there is very low -- estimated to be less than 100 kgoe, compared to more than 700 kgoe in the urban population. The modern Peruvian economy is based on liquid fuels, which supply more than 70% of commercial energy require- ments. Petroleum accounts for 60% of energy consumption in the industri- al sector, 67% in the mining sector, and 100% in the transport sector. Table 1 reveals the large disparities between commercial energy resources and consumption patterns. 1/ Less than 2,000 MW of an estimated 58,000 has been developed. 2/ The Latin Amierican average is 1,000 kgoe. 3/ Includes fuelwood, charcoal, animal dung and agricultural residues. 4/ Hydrocarbon fuels, coal and electricity. 5/ 33% of Peru's population lives in rural areas.  - ii - Table 1: Commercial Energy Resources vs. Consumption, 1981 Resources Final Consumption (Million toe) (%) (Million toe) (%) Petroleum a/ 200 4 5.95 73.0 Natural Gas a/ 45 1 0.12 1.7 Coal b/ 84 2 0.06 0.7 Hydro c/ 4777 93 2.0 24.6 Total 5106 100.0 8.1 100.0 a/ Includes proven and probable reserves. b/ Proven reserves. c/ 390,000 GWh/year for 50 years (1 GWh = 245 toe). Source: MEM and Mission estimates 3. Since 1981, the Peruvian economy has faced serious balance of payments difficulties, with a current account deficit averaging US$1.6 billion, or about eight percent of GDP. The international environment has continued to deteriorate, and export prices have dropped even below 1981 levels. The exchange rate was overvalued through most of this period. Economic growth was decelerating and net international reserves dropped to less than two and a half months of imports (US$800 million). The public sector deficit was high, and annual inflation exceeded 70 percent. At the same time, there has been mounting pressure to reestab- lish import prohibitions and price controls, increase subsidies and re- duce interest rates. Peru's economic difficulties in 1983 have been compounded by natural disasters suffered during the first half of the year. These include heavy rains and flooding in the northern part of the country, a severe drought in the south, massive landslides in the central area and a reduction in the fish catch. Since 1981, civil unrest has increased with an expansion of terrorist activities in the highlands and, occasionally, in Lima, making it even more difficult to manage the national economy. 4. Peru's economic crisis h-as forced, or at least coincided with, a reevaluation of investment programs, pricing policies, and institutional arrangements in the energy sector with a view to increasing the efficien- cy with which investment, manpowrer, and energy resources are used. The shortage of financial resources is especially important in the electric power sector, where an unrealistic and to some extent unnecessarily ambi- tious investment program must be, and is being, cut back and rational- ized. Hyper-inflationary conditions have made it difficult to increase real energy prices, but significant progress has been made, especially with respect to petroleum products. A new organizational structure for the electricity sector has been enacted into law and the national oil company is undergoing a substantial internal reorganization.  - iii - 5. Stronger efforts are required to improve the energy situation in Peru. Priority areas for action are discussed below under six head- ings: (1) Fuelwood and Forestry; (2) Oil and Gas; (3) Electricity; (4) Coal; (5) Energy Efficiency and Fuel Substitution, and (6) Pricing. Recommended Energy Strategy Fuelwood and Forestry 6. The majority of the Peruvian population depends on fuelwood and residues for cooking fuel. Fuelwood supplies are becoming more scarce, especially in the Sierra region, which has less than half a percent of the nation's forest resources. Reforestation efforts need to be vigor- ously accelerated in order to slow down the depletion of growing stock. The principal reforestation activity now underway in the Sierra is a five-year project being implemented with the help of the FAO 1/ that will eventually reach a rate of 30,000 ha/yr by 1990. A ten-year follow-up phase is planned but not yet financed. 7. In the Costa, forestry development priorities include erosion control, protection of water catchments, and development of fuelwood plantations in the northern costal area. In the Selva Alta, forestry priorities cover the control of logging operations, improved protection and management of logged-over forest, restoration of limited areas of degraded land, and controlled clearance and settlement of forest areas suitable for agriculture. In the Selva Baja, forest development priori- ties include the preparation and application of plans for forest manage- ment and exploitation, park and wildlife conservation and management, and control of logging operations and clearance for settlement. 8. Building up local capacity to manage reforestation projects is a prerequisite to significantly increasing the scope of the program. There is an urgent need to train more technical staff for field work, and espe- cially non-degree technicians and extensionists. Training could be achieved through the establishment of special training centers and "mo- bile training units" to expand the capacity of central nurseries. There is also a need for short courses to train management-level field staff in social forestry, as their approach to rural afforestation is often too technical to motivate communities to plant trees. Revising the incentive system within INFOR (e.g., through a higher per diem for going into the field) may help to encourage forest engineers to do more "hands-on" work. 9. The division of labor between the two forestry agencies DGFF and INFOR merits reexamination in view of the apparent overlap between their area of responsibility. If reverting to a united forest service is too cumbersome, official consideration should be given to establishing the DGFF and the INFOR as planning and executing agencies for the Selva and 1/ With financial support from Dutch bilateral aid.  - iv - the Sierra/Costa, respectively. Overlapping areas of responsibility among the CENFORS and the forest districts should also be clarified. 10. There is a need for more comprehensive planning in the forestry sector, particularly for the fuelwood subsector, focusing on the needs of the Sierra population. Immediate steps should be taken to formulate a national reforestation plan and work program, delineating the successive phases and components, and strengthening local capacity for rural/social forestry. This activity would require improved coordination of external aid for the fuelwood subsector. 11. Technical assistance projects 1/ that would expand successful ongoing projects or carry them to a more advanced stage could include: (i) evaluation of completed reforestation and coordination of work cur- rently being implemented; (ii) expanded training of sub-professional for- est technicians; (iii) species trials, including research on multipurpose species; (iv) development of improved cooking stoves and more efficient wood burning devices; (v) strengthening of the CENFORs; (vi) protection from livestock; (vii) feasibility study for producing charcoal in the Selva; (viii) identification of the potential for integrated agroforestry activities, the potential for creating small wood products industies with fuelwood or charcoal as by-products, and for stimulating private tree- farming. Oil and Gas 12. Petroleum is the dominant source of energy in Peru, meeting about 70% of the country's commercial energy requirements in 1981. Peru's oil production increased almost threefold between 1976 and 1979, when a pipeline across the AndEs was completed and field discovered in the mid 1970s in the Amazon basin were brought into production. Oil exports have been a substantial source of foreign exchange for Peru since 1979. In 1981, petroleum exports accounted for 24% (US$777.8 million) of the country's exports and about a third of its petroleum production. 13. The present level of exploration is not adequate to maintain existing production levels. The reserves-to-production ratio has been declining since 1976 and is clos e to the limit beyond which present pro- duction levels cannot be sustained. Of the 75 million hectares in Peru considered to be prospective for petroleum, only 15 million are undergo- ing any form of exploration. 14. Petroperu does not have the staff or financial strength neces- sary to mount the needed effort, and modifications to the system of ex- ploration and development contracts with foreign oil companies appear called for. The current system particularly discourages the search for the small and medium scale finds that are the only size fields so far discovered in Peru. Additional incentives may also be needed to en- 1/ Technical Assistance priorities for the energy sector as a whole are presented in Annex S.1  courage the more costly development of heavy oil fields. Finally, the accounting and taxation system for oil companies should be revised to correct distorsions resulting from the high rates of inflation and devaluation of the sol. 15. There have been small discoveries in areas under active produc- tion and secondary recovery, rehabilitation, and other projects in these areas have contributed more to increases in reserves and production since the opening of the Transandean pipeline than exploration and development in new areas. There remains a substantial apparent potential for pro- jects of this type. Petroperu is in a position to undertake some of these projects but probably not all of them; consideration might be given to promoting service or joint venture contracts in secondary recovery or enhancement recovery projects. 16. At the same time as new foreign investment is sought, efforts to enhance Petroperu's capacity should be continued and extended. Routine use should be made of consultants not only to do specialized jobs but also to expedite projects when Petroperu's technical and administrative staffing shortages would otherwise force delays. Although Petroperu is still suffering from the loss of key staff abroad and to the private sector, this phenomenon no longer appears to be a major problem for the company, since some have returned. Emphasis should now be placed on recruiting and holding younger staff and giving them experience working with senior staff and consultants. 17. Consideration should also be given to steps that would reduce the range of Petroperu's responsibilities to a more manageable level and put it on a financial footing such that its accounts would reasonably reflect the success or failure of its own operations as an oil company and depend less on performance of its contractors and Government pricing and tax policy. Such steps could include: (i) allowing Petroperu to operate under the same conditions as other oil companies for exploration and production activ- ities; (ii) operating the refineries on a service basis and transferring subsidies on domestic petroleum prices to the government budget. 18. Natural Gas There are two areas with significant known natural gas reserves. One is the Aguaytia structure (not currently in produc- tion) in the central Selva area about 500 km from Lima in a block assign- ed to Petroperu, where non-associated gas has been discovered. The other is in the northwest (about 1,000 km from Lima) where associated gas is produced in onshore areas operated by Petroperu and offshore by Belco, a foreign-owned private company. While the scale of production and utili- zation is very limited at present, the recent discovery of possibly substantial non-associated offshore gas reserves by Belco has raised interest in the possibility that natural gas could become an important energy source in Peru. However, important uncertainties must be resolved before any project to develop this resource can be implemented.  -vi - 19. One issue concerns the size of the reserves. Data from the wells drilled to date, which were tested at about 5 MMCFD, cannot confirm that sufficient reserves or production potential exist to make a develop- ment project economically viable. A study needs to be made of the size, classification and deliverability of reserves before negotiating any gas purchase agreement with Belco. A, second issue is the market. A prelim- inary assessment of the potential use of natural gas indicates that the most important near to mediuim term prospect lies in replacing diesel in the power sector in the northwest, where 20 MMCFD might be used by 1987. 20. The Government should pursue its plans to develop this resource, as use of natural gas would free petroleum products for export. The short-term plan should focus on a small project for developing the off- shore non-associated gas reserves and transporting this gas to Talara, Piura and, possibly, Chiclayo. The project would serve the power market in the northwest region 1/ and permit some industrial fuel substitu- tion. The preliminary cost estimate of delivering gas to Piura is about US$2.15/N4BTU. 2/ This gas would substitute for diesel oil currently being used as power generating fuel and which has a cost of US$5/MMBTU. 21. The Government should undertake a detailed study of natural gas and electric power supply options in the northwest. The study should determine the optimum timing, location, and type of electric power facilities to be installed to satisfy the load growth in the Tumbes to Chiclayo area. In view of the limited funds available to Electroperu, it would appear preferable to create a regional enterprise with private capital participation to generates electricity. Electroperu and the major industrial consumers in the area, including Petroperu oil companies could be shareholders of such an enterprise. 22. Petroperu should also study the benefits of pursuing potential gas savings which have been identified in the northwest area. In partic- ular, (i) Petroperu should make a field survey to identify the location and extent of inefficient uses of gas in onshore field operations and determine the economics of conservation measures; (ii) steps should lso be taken to reduce residential consumption in Talara to reasonable levels (it is estimated that 90%, the equivalent of about 800 barrels per day, is currently wasted); (iii) a decision should also be taken on whether to continue the operation of the fertilizer plant, given the low price of imported fertilizer. 1/ The northwest region suffers serious power shortages which constrain its economic growth. Alternatives to the present costly isolated generators include small, expensive hydroelectric schemes costing a minimum of US$3000/kW, or connection to the central system by a 500 km transmission line. 2/ Assuming a 13% discount rate.  - vii - 23. For the longer term, the potential reserves in the Central Selva area should be further investigated as a potential alternative to supply- ing the potential natural gas market in and around Lima, and the non- associated gas potential in the onshore coastal area in the Northwest should be further explored. Electricity 24. The electric sector has recently completed an updated Master Plan. However, the projects included in this plan have not yet been financed. A series of projects, primarily hydro, is in various stages of planning, but Electroperu and the regional utilities do not have the financial and management capacity to undertake and complete them all on a timely basis. A strategy for effectively dealing with these problems would need to include steps to: (i) raise and restructure tariffs to give the utilities the resources they need and to bring incentives to consumers into line with the structure of marginal costs; (ii) implement provisions of the 1982 General Electricity Law calling for decentralization in favor of appropriately sized and staffed regional utilities; and (iii) pursue studies of thermal and medium-scale hydro alterna- tives to large hydro schemes in order to maintain choices other than gas turbines in the event that these are found unfeasible or subject to substantial cost escalation or delay. M1EM has received continuing assistance from the West German government in the past few years in the area of hydroelectric project identification and prefeasibility studies. In addition, IBRD has made two loans, which in- cluded financing for studies of several hydroelectric projects. Not all of these studies have been undertaken, however. ME11 or Electroperu should update the catalog of hydroelectric projects, taking into account recent hydro- logical and cost information. This updating would permit a wider selection of plants to be candidates for the power sector medium and long term development plan. 25. The 1982 General Electricity Law aims to decentralize the power sector; entities are to be organized on the basis of existing local and regional enterprises whose radius of action will be enlarged, or regional units of Electroperu, which will be given the appropriate legal form. As of October 1983, four of the eight planned regional utilities have been established. These units should be responsible for all activities in- volved in providing electric service in their respective regions. 26. During the 1970s, the power sector suffered a considerable outflow of professionals and technically skilled personnel, resulting in decision-making problems and inadequate maintenance of regional power systems. While the problem is not severe for the Lima power system, it  - viii - is likely to continue in regional utilities, given the relative attrac- tiveness of Lima for skilled staff and the sector's non-competitive pay scales. 27. Revenues from the 20% special tax on electricity sales and the Electrical Development Fund (EDF) 1/ will be administered by Electroperu. Half of the special tax proceecs are to be used for rural electrifica- tion, while the EDF proceeds are to be used to finance electrification works of a social nature. Although Electroperu would be the appropriate agency to allocate funds among the regions for distribution and rural electrification projects, the regional companies are the executing agencies. Regional entities should be given responsibility for select- ing, designing, constructing ancl operating all distribution works within their areas, including those financed by the EDF and the special tax. 28. Priority in the Central North System should be given to har- nessing the water resources of the basins of the Rimac, Pativilca and Santa rivers, such as the 130 MW Mayush project, whose feasibility study was completed in late 1983. The hydro potential of these rivers has been studied for many years and partially developed, making better use of existing installations and cons-ruction of new medium-size plants (100- 200 MW installed capacity) feasible with reasonable construction periods. In the event that such projects are delayed, Electroperu should make a detailed analysis of the power supply options and decide w-hat type and size of thermal plants to install. 29. The Southwest systems face a complex variety of choices. The geothermal potential of the southwest area could be invest_gated with a view to electricity generation. 2/ The use of existing hydroelectric plants could be improved by means of regulating works (basin of the Chili River). The viability of the Lluta I (210 MW), according to the updated feasibility study, has been established. The Ministry has recently re- quested Bank finance for the engineering studies of this project. How- ever, the Molloco (300 MW) hydroelectric project is undefined; if proven economical, it could be built and equipped in stages. The Arequipa and Tacna-Moquegua systems are being interconnected and their frequencies standardized. 30. Both of the Southeast systems serving the Cuzco and the Puno areas appear to have adequate hydrological resources. The existing power stations should be able to supply these markets by the end of the I/ Up to five percent of total power utility revenue, to be decided by the Tariff Commission. 2/ Data about geothermal energy resources in Peru are insufficient to estimate the size of the potential. Geological studies financed by OLADE have identified six areas in southern Peru. which appear prom- ising. Further investigations are desirable, involving geophysical and geochemical surveys to select the most promising areas and to identify drilling sites.  - ix - 1980s. Ilowever, hydrological studies should be carried out to provide the basis for planning future projects. 31. In the Northwest, isolated electric systems which use diesel sets and gas turbines for thermal generation are being developed in the departments of Tumbes, Piura and Lambayeque. To take advantage of the natural gas in Talara, consideration should be given to linking Talara and Piura by means of transmission lines. Expanding the installed capacity at Piura would be a possible second stage if a gas pipeline carrying natural gas from Talara to the south has been built by that time. Again assuming the availability of natural gas, installed thermal capacity in the second half of the 1980s would be expanded by means of gas turbines. 32. Other isolated systems Because of the difficulties imposed by the country's topography, Peru's abundant, widely-distributed hydro po- tential should be harnessed, where economic, to supply isolated centers and rural areas. To reduce costs and facilitate the maintenance of these projects, technical designs, construction types and materials should be standardized. This would also facilitate greater participation by domes- tic industry in equipment supply. Coal 33. Peru lacks a systematic evaluation of its coal resources, al- though coal deposits ranging from lignite to anthracite are reported in 18 of its 24 departments. Proven reserves are estimated to be 126 mil- lion tons, but economic viability has not been evaluated. Domestic pro- duction, after declining from 200,000 tons in 1950 to 14,000 tons in 1975, is now back up to 106,000 tons. 34. To be successful, efforts to further expand coal production will have to overcome substantial obstacles: (i) a lack of suitable coal- burning equipment for the population and industry to use and a lack of expertise to install and operate it; (ii) inappropriate geological condi- tions for large-scale mechanized mining; (iii) the inability of small and medium-sized mines (100 to 500 tons/day output) to obtain credit in the absence of an assured market; (iv) the difficulty of transporting coal from the mines in the mountains to potential consuming areas on the coast; and (v) an absence of detailed geological surveys examining the occurrences of coal-bearing strata in the mountains. Technical assist- ance should be provided to strengthen the entities responsible for coal exploration and development, INGEMET and Procarbon. 35. According to the available information, coal deposits in Peru are not generally geologically well-suited to the large, highly mechan- ized mines (e.g. Alto Chicama) typically envisaged by the large state corporations and their foreign consultants. A number of small private mines now operate in the Alto Chicama area, taking coal by truck to Trujillo, and consideration should be given to organizing an effort to use small private mines to deliver coal to a power station or other po- tential large-scale user. A pilot program to do this would have to focus first on identifying a suitable combination of mining potential, dual- firing (oil and/or coal) users, and coal transport links.  36. Coal Briquettes Much of the poorer urban population relies on kerosene for cooking, while poor rural areas rely principally on wood. The price of kerosene is heavily subsidized and demand is increasing; much of it is probably being diverted to illegal uses. The demand for kerosene and wood consumption could be reduced if smokeless coal bri- quettes could be provided as a substitute. The manufacture of such bri- quettes could be a local ccttage industry in the neighborhood of the mines, where the dust and fines could be used, or a larger, industrial- scale enterprise as demand develops. It would be necessary to find a suitable binder for the coal, and to decide on the shape and size of a standard briquette, for whichi molds could be made and stoves designed. Potential pollution problems resulting from the sulphur content of coal also should be considered. A prefeasibility study should be done, and bilateral technical assistance has been arranged with South Korea for studying this option. Energy Demand Management 37. The transportation, industrial, and household markets all appear to offer substantial, cost-effective opportunities for energy conser- vation and/or inter-fuel substitution. Most attention to date has been focussed on the principal industrial sectors, mining and mineral indus- tries and manufacturing, which altogether account for 37% of Peru's commercial energy consumpticn. To ascertain with any precision the industrial savings potential would require an energy audit of the in- dustries concerned, and only preliminary studies, principally in the mining and mineral industries sector, have yet been made. However, a general idea of the energy Efficiency improvement possibilities for the manufacturing sector was obtained from visits to major consumers and by comparing energy consumption rates with those in other countries and making hypotheses based on the results obtained by conservation efforts elsewhere. Possible savings from various types of energy conservation measures in the mineral and manufacturing sectors are summarized in Table 2. Table 2: Estimated Energy Savings and Investments Required in the Mineral Industries and Manufacturing Sectors Mineral Industries Manufacturing Sector Implementation Period Improvements (KTOE) (US$Million) (KTOE) US$Million Years Maintenance and Operation 40 10 116 23 2 Application of Available Technologies 72 33 127 63 5 Application of New Technologies 96 66 n.a. n.a. 10  - xi - 38. Possible savings of the same order of magnitude have been iden- tified in a recent study of energy use in the transport sector, 1/ which consumes about 44% of the petroleum products used in Peru. According to this study, between 17% and 25% of the energy used by road transport, the dominant subsector in terms of energy use, could be saved, principally through improved car maintenance. Slightly lower percentage ranges are estimated for air and rail transport. 39. An estimated 60% of the energy used in the household sector is biomass, largely fuelwood, and it may be possible to save a significant fraction of this by improving the efficiency with which it is used through development and distribution of a simple stove to replace the open fires now used for most cooking. Experience in other countries suggests, however, that it is easier to design an improved stove than to get it into widespread use and that any program of this type should be designed with at least as much strength on the extension side as on the technical design and R&D side. 40. The newly created National Energy Council has been given energy conservation as one of the top items on its agenda, and it may be able to sort out the lack of coordination among the institutions involved with energy efficiency in industry (Ministry of Industry, Ministry of Energy and Mines and the Institute for Industrial Technology Research and Tech- nical Standards (ITINTEC)). These three institutions have made parallel efforts to develop an institutional capability to deal with energy effi- ciency in industry. Clearly it is important to coordinate the devel- opment of policies and legislation on energy conservation as well as the use of available resources inside and outside of government. The specialized nature of the work to be performed and the absence of quali- fied staff in the field require a centralized public service or autono- mous national energy conservation center with a separate legal framework and functional and financial autonomy. 41. Substitution of Domestic Coal for Fuel Oil Replacement of fuel oil by coal is becoming more common worldwide in the cement and brick- making industries, thermal power plants, and industries with a high con- sumption of steam such as the paper and sugar industries. In Peru, conversions to burn coal in boilers and furnaces appear feasible from the technical point of view. However, the absence of a reliable supply, price instability, the distance between production and consumption cen- ters, and the lack of a clear government policy to develop the country's coal resources are very important constraints to a major fuel oil switch to coal. Feasibility studies should be done to analyze the economic and financial aspects in specific cases. l/ Trans-Energ, "Conservation de la Energia en los sectores Industria y Transporte," 1982.  - xii - Pricing 42. In a mixed economy such as Peru's energy pricing is probably the most important policy instrument available to encourage energy conserva- tion and appropriate fuel cho:'ces. Between 1970 and 1976, petroleum prices were held at artificially low levels. Since then, the Government has tried to pursue a more realistic pricing policy, and the weighted average price of petroleum products was raised by 60% in 1981, and by 26% in 1982 in dollar terms. In 1983, the Government approved several price increases, bringing the average per gallon price close to international levels, but the aggregate "subsidy" 1/ is still on the order of $380 million annually. The Government's plans to continue dollar price in- creases in 1983 as required for national budget purposes (about half of the retail price is a tax) and its long term policy is to make prices (except for domestic kerosene) reflect the opportunity cost of the fuels. Since July 1983, howe!ver, political pressures have led to a slower rate of increase in energy prices. 43. Average electricity tariffs declined five percent in real terms throug'hout the 1970s. The Government authorized accelerated nominal tariff increases for late 1981 and 1982 which were just sufficient to ke ep pace with inflation. Tariff increases have been applied unequally in the past. A recent marginal cost tariff study 2/ for the principal (central north) system showed substantial daily and seasonal variations in the cost of electricity supply, with costs during the dry season (May to November) exceeding costs during the rest of the year. Analysis of the incidence of hidden subsidies and taxes in the current tariff struc- ture shows that residential consumers are the most heavily subsidized, while small industrial and irrigation pumping customers receive a moder- ate subsidy and commercial cust:omers are overcharged. In order to im- prove the overall financial investment situation in the power sector, the mission recommends that the Government review the present tariff struc- ture with a view to implementing the recommendations of the recent mar- ginal cost tariff study. 3/ l/ Defined as the difference between retail prices and comparator prices estimated as border price plus distribution margins and adjusted for the 16% general sales tax and a 10% foreign exchange shadow value. 2/ Electricite de France/SOFRELEC. Estudio Tarifario para el sistema interconectado Centro-Norte Lima, March 1983. 3/ In August 1983, the new and autonomous Tariff Commission was in- stalled according to the 1982 Electricity Law.  I. ENERGY IN THE PERUVIAN ECONOMY Country Introduction 1.1 Peru has an area of about 1.3 million km2, supporting a popula- tion of 17 million; 29% live in the Lima area, 38% in other urban areas, and 33% in rural areas. The Andes Mountains divide the country into three distinct regions: first a narrow strip of coastal deserts called the Costa, about 2,000 km long and from 17 to 170 km wide, lying along the Pacific Coast, which holds about 46% of the population and most of the modern economic activity; the second mountain region called the Sierra, with 24% of the total population and most of the traditional agricultural activity; and third the sparsely-populated tropical rain forest located in the Anazonas Basin and called the Selva. The rugged topography limits trade between these three regions. Peru's natural resources include large mineral deposits, petroleum, and a significant fishing potential in coastal waters. Only about five percent of the country's land area is suitable for crops, and almost 90% of this agricultural land is already in use. Peruvian agriculture depends heavi- ly on irrigation, especially in the Costa (IBRD Map 18291). Economic Situation 1.2 In 1981, GDP and per capita income totalled US$22 billion and US$1,294 (in 1980 dollars), respectively. GDP growth averaged 3.3 per- cent in real terms during 1970-81. It was higher during 1970-75, averag- ing 4.8 percent, but dropped to 1.1 percent during 1975-78 because of the severe economic and financial crisis in Peru. Real GDP growth resumed in 1979 and continued during 1980-81 at a rate of about 3.9 percent per year. However, international recessionary forces caused a slowdown dur- ing the second half of 1981 which continued through 1982. During 1970- 80, the most dynamic sectors were mining, energy, transport, banking and government, with a combined contribution to GDP growth of about 52 per- cent, compared to 34 percent of GDP in 1970. Agriculture nearly stag- nated, and manufacturing and construction grew only during the first half of the 1970s. 1.3 Functional income distribution in general was characterized by a drop in the share of wages and salaries and other capital income (rent, interest). The larger drop during 1978 and 1979 was partly due to re- strictions imposed on the salaries of government employees. The average remuneration of employed workers declined by 14 percent in real terms during 1970-80, 10 percent for blue collar workers, and 36 percent for white collar workers for the same period. By comparison, the real aver- age salary of the government employee dropped by about 29 percent. 1.4 High inflation is a phenomenom of the 1970s in Peru. Before 1973, annual price changes fluctuated around six to seven percent; after  2- 1973, there was an almost continuous acceleration of inflation measured in terms of the consumer price index (Annex I.1). In 1982, inflation amounted to 72%, and expected inflation for 1983 is estimated to be about 0%. Inflation has caused major distortions in the Peruvian eco- nomy. For example, the marked changes in the relative prices of goods and services and the erosion of real wages and salaries have had a dele- terious effect on income distribution, and have caused a diversion of human and capital resources; negative interest rates for deposits pre- vented the adequate mobilization of financial savings; and negative interest rates for credit did not promote the best use of scarce re- sources. 1.5 FollowiLnE a period of increasing overvaluation of the sol during the first half of the 1970s, there was a strong real devaluation during the 1977-78 financial crisis. Since 1979, the exchange rate policy has been based on periodic mini-devaluations with respect to the US dollar, with the objective of maintaining an approximately constant real exchange rate. However, a slower crawl and the appreciation of the US dollar relative to other currencies resulted in an appreciation of the sol with respect to the weighted average of Peru's trading partners of about four percent in 1980, and an additional 15 percent in 1981. The appreciation fueled imports and made Peru's exports less competitive. 1.6 Peru carried out a stabilization-cum-economic recovery program in 1978-79, supported by an IBRD program loan and an IMF standby arrange- ment. While the economic program was successful in improving the coun- try's external sector and financial situation, several serious structural problems remain, including high inflation, substantial distortions in the incentive system, widespread un- and under-employment, and an ineffective public investment program. Peru entered 1982 with large internal and external disequilibria that required serious stabilization efforts by the Government. Economic activity was slowing down as world commodity prices continued to fall from their a:Lready low 1981 levels, causing a 23 per- cent reduction in Peru's terms of trade. The public sector deficit, partly caused by low export prices, was also increasing because of grow- ing expenditures and delays in some price adjustments. Despite austerity efforts, the 1982 public sector deficit was equivalent to 8.8 percent of GDP. The balance of payments deficit was US$1.6 billion and GDP growth slowed to 0.3 percent, industrial output fell by more than two percent, and inflation continued at 73 percent. Peru's economic difficulties in 1983 have been compounded by natural disasters suffered during the first half of the year. These include heavy rains and flooding in the northern part of the country, a severe drought in the south, massive landslides in the central area, and a reduction in the fish catch. A preliminary esti- mate of the cost of replacing the infrastructure damaged by natural disasters amounts to US$400 million (equivalent to about 2% of GDP or 26% of the 1982 public investment budget.  - 3 - Economic Prospects 1.7 Experience over the past 20 years suggests that the economic situation of Peru is closely related to the economic performance of in- dustrialized countries -- through the price paid for traditional exports, volume growth of non-traditional exports, and the magnitude of capital inflows. The international environment over the medium term is not expected to offer much in foreign exchange availabilities, either in terms of export earnings or foreign capital flows. Peru will have to make adjustments in accepting slower economic growth and less ambitious development efforts. Given the poor medium-term international outlook, and assuming a continuation of present economic policies in Peru (gradual adjustments in the exchange rate and domestic petroleum prices, for ex- ample), the total export volume is expected to grow by about three per- cent per year during 1983-1987, and the purchasing power of exports (import capacity) by about six percent. GDP is expected to fluctuate around 3 to 3.5% during 1983-87. Energy Balance, 1981 1.8 Peru's energy balance for 1981 is shown in Table 1.1. The do- mestic production of primary energy was 17 million tons of oil equivalent (MTOE), of which more than 58/a was oil, 21% fuelwood, 15% hydropower, and 6% gas. Energy exports consisting entirely of oil and petroleum products were 3 MTOE; imports were negligible. The remaining 14 MTOE were used in the domestic economy. A detailed breakdown of the energy balances for 1970, 1975 and 1981 is presented in Annex I.2. Domestic consumption accounts for 81% of gross energy production, leaving 19% for exports of primary energy supplies and petroleum products. The final demand for energy shows that the household residential sector (35%) is the largest consuming sector, with transport and industry following at 23% and 16%, respectively. Table 1.2 shows the evolution of energy trade in the overall commercial balance; the situation changed drastically between 1975 -- when net energy imports cost almost 20% of total exports -- and 1981, when net energy exports paid for almost 20% of total imports.  Table 1.1: Overall Energy Balance - 1981 (thousand toe) Commercial Non Commercial Energy Commercial and Non- Commercial Crude Oil Gas Petroleum Electricity Energy Commercial Energy Hydro Thermal Total Total Total Primary Supply Production 3538 9901 1032 2643 2643 13576 1714 Exports (2117) Flared Gas 278 Total 3538 7784 754 2643 11181 14719 Transformation Refineries (7784) (95) 7673 Thermal Power (82) (458) 540 540 Energy Sector (512) a/ (199) (11) Balancing Item b/ (383) (65) (339) (898) Total Product Supply 3155 6677 2274 8951 12106 Product Trade Imports 10 - Exports (875) Domestic Supply 3155 5812 2274 8086 11241 Final Consumption Industry 377 1085 700 1785 2162 Transportation 2501 2501 2501 Households 2710 882 752 1634 4344 Mining 571 660 1231 1231 Others 68 773 162 935 1003 a/ It includes gas used in the industry. b/ It includes losses and adjustments. Source: MEM Energy Balance, 1981  Table 1.2: Evolution of Electricity Supply (GWh) Hydro Thermal Total 1970 3820 (69%o) 1708 (31%) 5528 1975 5470 (73%) 2016 (27%) 7486 1980 7628 (78%) 2164 (22%) 9792 1981 8631 (88%) 1917 (12%) 10548 Evolution of Installed Capacity (MW) Hlydro Thermal Total 1970 923 (55%) 754 (45%) 1677 1975 1397 (59%) 962 (41%) 2359 1980 1864 (59%) 1320 (41%) 3184 1981 1917 (58%) 1364 (42%) 3281 Source: Electroperu 1.9 Peru's energy sector underwent some fundamental changes during the last decade. (i) The most important event was its shift from being a net importer to a net exporter of petroleum in 1977. (ii) Fuelwood uti- lization stagnated, and this promoted a widespread substitution away from fuelwood by commercial energy, and the substitution of kerosene for fuel- wood in the household sector. (iii) Gas production stagnated as a con- sequence of the low priority given to this source. (iv) Coal production stagnated during the first half of the decade, slowly recovering after 1975. (v) There was a major shift from gasoline to diesel oil in the transport sector because of the high increases in gasoline prices in com- parison with increases in diesel prices, and the participation of gaso- line in the transport sector fell dramatically betwen 1970 to 1981, from 68% to 49%. (vi) Little change occurred in the participation of the household, transport and industrial sectors in total demand. (vii) Hy- droelectric generation more than doubled between 1970 and 1981, due to a harnessing of the hydroelectric potential of the Rimac and Mantaro rivers which supply the central system, including Lima. Table 1.2 shows the evolution of electricity supply and installed capacity in Peru between 1970 and 1981.  - 6 - International Comparisons 1.10 Table 1.3 compares energy intensities and growth rates of per capita GNP and commercial energy consumption in Peru and other developing countries at similar per capita income levels. 1/ It shows that Peru uses relatively large amounts of energy per unit of output. While this is to some extent due to the large, energy-intensive mining sector in Peru, it may also be related to the historically low prices of energy; on a per-capita basis Peru uses more commercial energy in transportation and household uses than either Guatemala or Ivory Coast uses for all purposes combined. 2/ The past decade, beginning with the energy crisis in 1973, was an atypical period for the latin American economy in general, and not least for Peru. Table 1.3 shows that GDP growth was very low in Peru for the 1970-1980 period in compaiison with most other countries in the group. The growth in energy consumption in Peru also was one of the lowest, but at the same time one of the highest in relation to GDP growth. Table 1.3: Econaoic and Conmercial Energy Consumption Indicators in Selected DeveLoping Countries, 1970-1980 (% p.a.) 1980 Energy Intensity 1970-1980 Growth Rates GNP/capita (To0]/US$ Energy Country (1980 $US) million GDP) Consumption GDP Difference Ratio Peru 1080 479 4.0 3.0 1.0 1.3 Colombia 1260 516 4.9 5.8 0.9 0.8 Dominican Republic 1190 275 6.7 6.6 0.1 1.0 Ecuador 1100 350 11.7 9.1 2.6 1.3 Guatemala 1080 196 5.9 5.8 0.1 1.0 Ivory Coast 1110 134 6.3 6.4 0.1 1.0 Jamaica 1090 n.a. 1.7 -1.1 2.8 -1.6 Tunisia 1260 328 8.4 7.5 0.9 1.1 Source: World Bank, Energy Indicators for Developing Countries 1/ The sample comprises all developing countries over 1.0 million in population with per capita incomes within 15% of Peru's for which a reasonably complete set of energy data is available. 2/ The share of industry in Peru's 1980 GDP was 45%, compared to 23% in Ivory Coast and a roughly similar figure in Guatemala.  - 7 - Projections 1.11 The long range projection of future energy supply and demand in any country is subject to a wide margin of error, especially when the economy is as unstable as it is in Peru. However, to provide an analy- tical basis, the mission has considered the following scenarios 1/ for 1982 to 2000: (i) Historic Scenario: this projection is based on historic energy and GDP growth for the past 11 years (3.3% p.a.). Under this assumption, the final energy demand in 1990 and 2000 would be 23% and 54% higher than in 1981, respective- ly. In this case the contribution of biomass energy will decrease from 28% in 1981 to 23% by 1990, and to 19% by the year 2000. During the same period, the coal and coke share will remain very low (1%), the share of electric demand will increase from 20% in 1981 to 27% by the year 2000, and finally, the share of petroleum products will be stable at around 50% of total demand. (ii) Base Case Scenario: this projection is based on a GDP growth of 1.5% from 1982 to 1985, and 3% from 1986 to 2000. Under this assumption, the final energy demand in 1990 and 2000 would be 17% and 47% higher than in 1981, respectively. Even though total demand under this scenario should be 4% lower (year 2000) in comparison with the historic case, the contribution of energy fuels to total demand is similar to the historic case. (iii) Substitution Case: This projection is based on the same GDP assumptions of the base case and it also includes: (1) sub- stitution of coal for fuel oil in the industrial sector: 2/ 15% by 1990, 20% by 1995, and 25% by the year 2000; (2) sub- stitution of coal briquettes for kerosene in the residential sector: 15% by 1990, 20% by 1995, and 25% by the year 2000; (3) substitution of electricity for diesel oil in the transport sector: 10% by 1990, 15% by 1995, and 20% by the year 2000; (4) coal utilization in power generation; in- cludes the installation of 200 MW by 1990, 400 MW by 1995, and 600 MW by the year 2000. Under this scenario, final energy demand in 1990 and 2000 would be 18% and 51% higher respectively, than in 1981. The most important structural changes from the substitution should be: the share of coal will increase from 1% in 1981 to 6% by the year 2000 and the contribution of petroleum products in comparison with the base case will decrease (year 2000) from 53% to 49% and will remain as the most important fuel in energy consumption. 1/ Summarized in Table 1.4. 2/ Assumes the introduction of a total of about 200 trolley buses by 1990, about 400 trolley buses by 1995, and about 600 trolley buses by 2000.  Table 1.4: Energy Demand Projections (thousand toe and % p.a.) 1981 1985 1990 1995 2000 Hist. Base Case Subst. Hist. Base Case Subst. Hist. Base Case Subst. Hist. Base Case Subst. Noncommercial 3155 3157 3022 3022 3234 3096 3096 3317 3175 3175 3401 3256 3256 Coal & Coke 81 98 94 94 105 102 442 113 108 659 120 116 927 Electricity 2274 2652 2538 2538 3237 3098 3113 3889 3718 3746 4636 4434 4480 Petroleum Products 5812 6447 6169 6169 7316 6998 6764 8271 7919 7452 9324 8919 8398 Total 11322 12354 11823 11823 13892 13294 13415 15590 14920 15032 17481 16725 17061 Total Demand Growth Rate p.a. Historic Case 2.2 2.4 2.3 2.3 Base Case 1.1 2.4 2.3 2.3 Substitution 1.1 2.6 2.3 2.6 Source: MEM and Mission estimates co  - 9 - 1.12 Supply Prospects Oil production has been analyzed under two scenarios, the low case with the assumption that 41 million barrels of new reserves will be added each year for the next five years (about the 1979-82 average), and the high level case which is based on finding 82 million bbls/year (the 1975-78 rate). Under these assumptions, produc- tion would peak in 1985 and 1989 respectively. Without any new major development project, natural gas production (mostly associated) will increase by 4.6% p.a. during the 1980s; however, if new gas reserves were to be discovered in the north and gas development take place there and in the Aguaytia field, gas could play a more important role during the 1990s. Hydro power, presently providing 80% of generation, will continue to be the main source of electricity in the country. However, the power sector should improve considerably its present organizational and finan- cial situation in order to develop the hydro power resources. The future of coal development is very uncertain. Coal production, which has had a slow revival since 1975, would require special incentives to increase its contribution to the energy balance. Non-commercial energy, defined to include fuelwood plantations, natural forest and other biomass wastes will probably decrease during this decade as a result of a substitution process (kerosene for fuelwood in urban areas), depletion of the growing stock of trees, slow reforestation rates and a shift in the industrial use of bagasse from energy source to feedstock. Table 1.5: Petroleum Exports-Imports, 1985-1990 1985 1990 High Low High Low Crude Oil Production 200,000 195,000 192,000 140,000 Demand Historic 150,000 170,000 Base 143,000 165,000 Substitution 143,000 157,000 Exports/ (Imports) Historic 50,000 45,000 22,000 (30,000) Base 57,000 52,000 27,000 (25,000) Substitution 57,000 52,000 35,000 (17,000) 1.13 Petroleum Exports-Imports - 1985-1990 An analysis of Table 1.6 leads to the following conclusions: By 1985, under the high level pro- duction case, oil exports will be increased from 40,000 bd in 1983 to 50,000 bd (historic demand case) and 57,000 bd (base and substitution de- mand cases). Oil revenues 1/ will increase correspondingly, from US$438 million/year to US$547.5 million/year (historic case) and US$624 million/ year (base and substitution cases). Under the low level, oil revenues  - 10 - will be US$492 million/year (historic case) and US$569 million/year (base and substitution cases). However, by 1990 the situation may be signi- ficantly different; under the high level production case, oil exports will be reduced to 22,000 bd, 27,000 Bd and 35,000 bd for the historic, base and substitution cases, respectively. Oil revenues will decrease to US$240.9 million/year, US$295.6 million/year and US$383 million/year. The low level production case shows a dramatic situation for Peru: For the three cases analysed, the country will need to import oil, 30,000 bd (historic case), 25,000 bd (base case) and 17,000 bd (substitution case) and will expend US$328.5 million/year, US$273.8 million/year and US$186.0 million/year, respectively. Taking into account that the demand scena- rios considered already correspord to low GDP growth rates, the main con- clusion is the crucial importance of a successful oil exploration in Peru. Energy Sector Organization, Finances and Planning 1.14 The Ministry of Energy and Mines (MEM) is responsible for formu- lating energy policies and regulating the exploration, exploitation, and industrialization of all energy resources except forestry, which is under the responsibility of the Ministry of Agriculture. In practice, many of these responsibilities are delegated to the large state-owned oil and power companies. In addition, MEM has overall responsibility for all mining activities and geological surveys. (Annex I.3) 1.15 In July 1981, the economic (and political) importance of devel- oping a national energy policy was recognized with the establishment of a National Energy Council, the S1:atutes of which were approved by the Government in June 1983. l/ The Council is comprised of the Directing Committee and the Technical Secretariat. The Directing Committee in- cludes 15 respresentatives fro[m the public energy corporations and specialists in the various fields of energy planning. The Technical Sectretariat is the Council's permanent working body and is divided into three offices, covering energy policy, conservation and new and renewable energy sources. The Council's main purpose is to propose the medium and long-term energy policy to the Fiinister. The main permanent activities are (1) preparing energy balances as a means for energy policy formula- tion, (2) promoting the creation of a National Energy Conservation Center and appropriate conservation legislation, (3) recommending financial policies for hydrocarbon and electricity development, (4) coordinating training programs for all energy subsectors, and (5) defining energy planning for rural development, with emphasis on new and renewable energy sources. 1/ This council was officially installed on November 8, 1983 by the Minister of Energy and Mines.  Table 1.6: Projected Energy Balance - 1990 (thousand toe) Commercial Non Commercial Energy Commercial and Non- Commercial Crude Oil Gas Petroleum Electricity Energy Commercial Energy Ilydro Thermal Total Total Total Primary Supply Production 3406 9671 1549 3432 3432 14652 18058 Exports (1379) Flared Gas (300) Total 3406 8292 1249 3432 12973 16379 Trans formation Refineries (8292) (150) 8215 Thermal Power (324) (458) 782 782 Energy Sector (700) a/ (240) (15) Balancing Item b/ (310) (75) (519) (1101) Total Product Supply 3096 6998 3098 10096 13192 Product Trade Imports Exports Domestic Supply 3096 6998 3098 10096 13192 Final Consumption Industry 333 1154 1012 2166 2499 Transportation 3159 3159 3159 Households 2737 1120 1145 2265 5002 Mining 580 701 1281 1281 Others 26 985 240 1225 1251 a/ It includes gas used in the industry. i/ It includes losses and adjustments. Source: MEM Demand Projections  - 12 - 1.16 MEM regulates the hydrocarbon sector through the General Directorate of Hydrocarbons (Direccion General de Hidrocarburos) which has under its jurisdiction the national oil company Petroleos del Peru (Petroperu), and through Petroperu, the foreign oil companies operating in the country. Petroperu was established in 1969, following the nationalization of the production and refining operations of Exxon's Peruvian subsidiary, the International Petroleum Company (IPC). 1.17 Regulatory functions in the power sector are carried out by MEM's General Directorate of Ele!ctricity (Direccion General de Electrici- dad), which has under its jurisdiction eight public service utilities, numerous local systems operatec. by municipalities, and about 600 auto- producers. The government-owned Empresa Electricidad del Peru (Electro- peru) is both an electric utilfty and a holding company for the public ownership of the other seven. 1.18 Both central operating entities in the sector, Petroperu and Electroperu, have encountered financial problems. Petroperu's overall financial performance has been unsatisfactory since the mid-1970s, primarily because of: (i) the high debt service burden resulting prin- cipally from the US$900 million Transandean pipeline project; (ii) low domestic petroleum product prices; and (iii) the high tax burden assumed by Petroperu particularly in its contracts with foreign companies. Prior to 1980, Petroperu had to pay the income taxes of its contractors, and it still pays all of their other taxes, duties and royalties. 1.19 In recent years the Government has taken measures which have helped improve profitability and allow increased investments. (i) the Government has made significant equity contributions and assumed part of Petroperu's medium term debt, wlhich had been originated and increased as a result of subsidized domestic prices. The Government is continuing a program of automatic equity injecCtions which correspond to the oil equiv- alent of the contractors income tax. However, as these contributions are a function of the financial performance of the companies, they recently have been reduced by the implemnentation of the reinvestment tax credit law and the decrease in profitability of their operations. (ii) the Gov- ernment has reduced the tax bur-den of Petroperu by reducing the export duties for crude and petroleum products. (iii) the Government has authorized real price increases which have significantly augmented Petro- peru's revenues from domestic sales. 1.20 Petroperu's current financial performance is not yet fully satisfactory. Although the company generated a small profit in 1981 and 1982, it was not sufficient to cover the increased investment during these years. Investments increased from about US$60 million a year in the late 1970s, to $160 million in 1981, and $200 million in 1982. Petroperu has not contracted any long term debt from commercial banks to cover the insufficient internal cash generation. Instead it has borrowed on the short term market, so the liquidity position of the company is somewhat precarious.  - 13 - 1.21 The increased investments have resulted in higher production. Petroperu's 1982 production was about 27% above the 1981 level. However, in 1982, two external factors prevented Petroperu from improving its liquidity position: Occidental's production, of which Petroperu receives half, decreased by about 10,000 BD, and the export prices of crude oil products decreased by about $3 per barrel from the 1981 level. The pro- spects for 1983 are not very encouraging, as Petroperu's and the overall country's production will decrease as a result of the floods which occurred in the northwest in the first half of 1983. Country production is now forecast at 175,000 BD, compared to 195,000 BD in 1982 and a tar- get of 215,000 BD for the 1983 budget. The export prices of products also have declined. To maintain a viable financial position, the Govern- ment will have to accept lower fiscal receipts from the sector or approve further real price increases to compensate for the decline in the volume and price of exports. 1.22 The financial condition of the power sector is even more critic- al, as illustrated in Table 1.6. The consolidated sales revenues on the public sector electric utilities in 1982 were about $332 million. Wages, fuel, and other operating costs (exclusive of depreciation) were $218 million, leaving a surplus of $114 million, or about $50 per kw of in- stalled capacity. The system's assets, including transmission and dis- tribution, probably have a replacement value of roughly $1500-2000/kw, so a 10-13% rate of return plus 3% depreciation would come to $200-300/kw p.a. in capital charges. On this basis, the sector is subsidizing its consumers in economic terms at a rate of $330-550 million annually (i.e., by at least as much as they are paying in tariffs). Financially, with depreciation charges amounting to only $27/kw-yr, the sector showed an operating profit of $55 million and, after deducting financial costs and adding $30 million in revenues obtained from the DL-163 tax imposed on consumption in excess of 150 kwh/month, the sector had about $102 million available for investment, less than 25% of the cost of its investment program. l123 Tariffs were adjusted three times in 1980, eight times in 1981, and once each month from April 1982 to October 1982. However, the aver- age price for the public service provided by Electrolima in November 1982, 42.4 soles/kWh, did not cover the 12% return on net fixed invest- ment prescribed by the General Electricity Law. 1/ The increase needed at that time to bring tariffs up to the legal requirement for Electrolima is estimated between 30% and 60% of the current average selling price, using the criterion adopted for revaluation of assets used in the service. 1.24 For 1982, the list of investments gives a total of US$415 mil- lion. Of this figure, Electroperu accounts for 94.4%, implying a low 1/ The tariff situation has deteriorated during the last year. Accumu- lated tariff increases between August 1982 and July 1983 amounted to 89 percent while internal inflation during the same period reached 116 percent.  - 14 - utilization of the human and technical resources embodied in entities such as Electrolima, Hidrandina and SEAL. The new General Law on Electricity prescribes a more important role for these companies in the future. 1.25 An investment of US$2.0 billion, or an average of US$400 million a year, will be required in the period 1983-87 to complete the works in progress. The yearly average, about three percent of GDP, is compatible with the size of the public-service electricity sector. However, this investment level only can be met if the companies involved increase their internal generation of resources. Otherwise, there is a danger that, even given external financing, the works will be halted for lack of local counterpart resources. Table 1.7: Consolidated Budget of Public Service Power Sector, 1982 Soles billion US$ million Sales Revenues 233 332 Operating cost 153 218 Wages, etc. 100 140 Fuel 33 47 Other 20 29 Depreciation 41 59 Total Cost 194 277 Net Profit/Loss 37 55 Financial Expenses 30 42 Internal Cash Generation 50 72 DL 163 revenue a! 21 30 Available for investment 71 102 a/ 25% tax on consumption in excess of 150 KWh/month 1US$ = 700 soles. Source: DGE estimates 1.26 For the medium and long term, projects have been identified that would enter into service from 1988 onward, including Huallaga, Ene Platanal and Huaura. A number of these require additional engineering studies and economic appraisals which should focus on improving resource allocation and investment efficiency. These should be carried out with- out delay. 1.27 The financial constraints on the central operating entities in the sector give a special importance to careful investment planning to  - 15 - assure that whatever funds are available are used as effectively as possible. Unfortunately, planning is one of the areas of weakness in both the power and petroleum sectors. Electroperu utilizes a sophis- ticated least-cost system expansion model, but without realistic input data with respect to crucial variables such as project costs and demand growth rates and without taking financial limitations sufficiently into account. The result is a "plan" which cannot be implemented but which could lead the company and the sector to spend time, money and engineer- ing skills on beginning more large projects than it can afford to com- plete in a timely manner. However, some progress in this direction has been made in the Master Plan developed in 1983. 1.28 In September, 1983 Petroperu recieved an overall review of its investment options and priorities from a consultant study (IBRD - financed). This study should help substantially to improve planning in the petroleum sector, but it will need to be periodically reviewed and updated. A general tendency in Petroperu's planning at both the cor- porate and project level that has led to problems in the past is to act on the basis of optimistic assumptions without sufficient contingency plans for dealing with the unexpected.  - 16 - 11. ENERGY DEMAND MANAGEMENT The Structure of Energy Demand 2.1 In 1981, Peru consumed 11.3 million toe of energy (see Table 1.1). Per capita energy consumption was about 690 kgoe, compared with a world average of 1,500 kgoe, and an average for Latin America of 1,000 kgoe. Noncommercial, traditional energy sources met about 32% of the total demand, and commercial energy the other 68%. There is a gap of almost 2:1 in per capita energy consumption between urban and rural areas. The rural population is estimated to be 5.6 million (33% of total) and consumes approximateLy 2.2 million toe (20%), while the urban population at 11.4 million (67%) consumes 8.8 million toe (80%). There is also a qualitative difference; about three-fourths of the per capita energy consumption in rural areas (estimated at 400 koe) is noncommer- cial, while commercial energy accounts for about 90% of the energy con- sumed in the urban sector each year (about 770 koe). 2.2 Total commercial energy consumption in Peru was 8.3 million toe in 1981. The sectoral structure shows the transport sector as the most important consumer of commercial energy (30%), followed by the industrial (22%), household (20%) and mining and metallurgical sectors (15%). The industrial, mining, and transport sectors have continued to depend heavi- ly on petroleum; petroleum accounts for 49% of energy consumption in the industrial sector, 46% in the mining sector, and 100% in the transport sector. 2.3 Non-commercial energy consumption in Peru was 3.3 million toe in 1981. The most important user of noncommercial energy was the residen- tial sector. Traditional energy accounted for almost 70% of energy con- sumption in the residential sector and 21% of energy consumption in the industrial sector. Energy Pricing 2.4 Pricing is the principal policy instrument used to influence energy demand in Peru. Policies in other areas, especially investment decisions in publicly-owned industries and in transportation infrastruc- ture, also have an effect on energy consumption, but energy is generally a minor element in these decisions. Conversely, the effect on demand is only one element involved in energy pricing decisions; revenue require- ments of the Government and the energy suppliers, the real and psycholog- ical effect of energy price inc:^eases on inflation, and income redistri- bution considerations appear to be at least as important. 2.5 The MEM controls the prices of petroleum products and the Tariff Commission sets electricity rates. The prices of coal, fuelwood and charcoal are not controlled. Table 2.1 shows the commercial energy price  - 17 - structure (February 1983) and the relationship between internal prices in Peru and approximations of the economic cost of each product. These com- parators are estimated in the case of petroleum products as the sum of the border price and an allowance for internal handling and distribution costs and in the case of electricity taken from a study of long run average increamental supply costs in the Centro-Norte System. The dollar values of domestic prices and the domestic/comparator price ratios are shown as computed on two different basis. The first, labelled "unad- justed", is based on official exchange rates. The second or "adjusted" basis includes allowances for a 10% overvaluation of the sol and a 16% general sales tax. These comparators are not necessarily ideal or target prices: they do not include any allowances for highway user charges or public revenue generation or adjustments for income distribution objec- tives. Highways are heavily subsidized in Peru and a tax on gasoline and diesel fuel may well be an efficient way to charge road users. Public sector revenue requirements may also justify pricing energy at higher than comparator prices, while income distributin considerations might motivate further increasing prices for some products (e.g., gasoline and residential electricity use beyond some level) while holding other's (e.g., kerosene) at or below their comparators. Petroleum Products 2.6 Petroleum prices were held at artificially low levels from the early 1970s until 1976. Since then, the Government has tried to pursue a tnore realistic pricing policy and, especially during the past three years, real prices have been increasing. The average unadjusted price of petroleum products 1/ was raised from US$0.38/gallon in January 1981, to US$0.61 in January 1982, and US$0.77 in January 1983. In dollar terms, prices increased by 60% in 1981, and 26% in 1982. In February, 1983, the Government approved a 10% dollar increase, bringing the average gallon price close to US$.84. The Government plans to continue dollar price increases in 1983 for national budget purposes (about 50% of the retail price is a tax) and its long term policy is to make prices reflect the opportunity cost of the fuels. 2.7 Kerosene, which is sold for domestic use at about 33% (adjusted) or 42% (unadjusted) of its comparator value is the most heavily subsi- dized fuel. The economic subsidy (price differential relative to the comparator) on kerosene is intended to hold down the cost of living for low-incmae groups, particularly in urban areas, and is worth about $10 per capita per year to people who cook with kerosene. Assuming this includes about 60% of the total population (equivalent to 90% of the urban population), the "efficiency" of the income transfer can be esti- mated at about two-thirds, with the other third (about $50-65 million p.a.) going to individuals and businesses who use "domestic" kerosene for other purposes. 2/ 1/ Weighted petroleum product prices (gasoline, diesel, kerosene, fuel oil and LPG). 2/ Prominent advertisements for kerosene-fueled portable electric generators in Lima newspapers promise an 80% savings in fuel costs.  - 18 - Table 2.1: Commercial Energy Prices Domestic Price b/ Comparator c/ Domestic/Comparator Unadjusted Adjusted Price Unadjusted Adjusted b/ (US$/unit)(US$/toe) (US$/unit) (US$/unit) % % Petroleum products a/ super 1.28 440 1.00 1.05 122 95 regular 1.09 375 0.85 .96 114 89 diesel 0.93 283 0.73 1.09 86 68 kerosene domestic 0.46 145 0.36 1.09 42 33 industry 0.92 291 0.72 1.09 84 66 fuel oil 0.77 22C 0.60 0.58 133 103 LPG 0.30 285 0.24 0.45 66 53 Composite barrel El 0.84 267 0.66 .91 92 72 Electricity d/ Residential 0.036 146 0.028 0.084 42 33 Commercial 0.133 541 0.104 0.084 158 124 Industrial 0.048 195 0.038 0.084 57 45 Coal 38 76 29.78 n.a. n.a. n.a. a/ February 1983 prices at 1063 soles/US$. b/ Including a 10% premium on foreign exchange content and further 16% adjustment corresponding to the general sales tax. c/ Comparators for petroleum prices are Caribbean posted prices minus a shipping differential for those products of which Peru is a signif- icant exporter (gasolines, 5k/gallon; fuel oil, 4.2k/gallon; trade in other products is miarginal in volume) plus estimated cost of internal handling and distribution (gasoline and diesel, 20k/gallon; kerosene and LPG, 30k/gallon; fuel oil, 5k/gallon). Comparator for electricity is the long-run average incremental supply cost for the Centro-NIorte system as estimated by Electricite de France/SOFRELEC for their base case. d/ Composite barrel (1.1% super, 23.4% regular, 25.7% diesel oil, 14% domestic kerosene, 0.9% industrial kerosene, 31.8 fuel oil, 3.1% LPG). e/ November 1982 tariffs at 825 soles/US$. 2.8 LPG, priced at about 53% (adjusted) or 66% (unadjusted) of its comparator value, is nonetheless so expensive to use (it requires heavy and relatively expensive containers and appliances) that only relatively small quantities are used by upper-income Peruvians. The implicit LPG subsidy costs about US$20 million p.a. and appears unjustified.  - 19 - 2.9 Diesel and "industrial" kerosene are sold for 67% (adjusted) or 85% (unadjusted) of their respective comparator values. Because the volume involved is about twice that of "domestic" kerosene sales, the total implicit subsidy is roughly the same, nearly $170-200 million annu- ally. As these are intermediate goods used by transport and industrial enterprises, the distributional effects of this subsidy are probably widely diffused through the modern sector of the economy. Partial sub- stitution by "domestic" kerosene (which has practically taken over the former "industrial" kerosene market) could, however, become a problem for diesel fuel if its price is raised substantially without a parallel in- crease in the kerosene price. 2.10 Regular gasoline is priced about 10% below or 15% above its comparator value depending on whether the adjusted or unadjusted price is used. High-octane gasoline (little used in Peru) and fuel oil prices are both substantially above their respective comparator values on the basis of the unadjusted comparators and about equal on the corrected basis. Electricity 2.11 The level and the structure of Peru's electricity tariff do not reflect the real cost of this public service. In spite of the progress made by authorities to remedy this situation during 1980-82, there is still much left to be done. The average selling prices for energy applied during the first half of 1982 are detailed in Annex II-1. The prices have been classified according to electricity enterprise and con- sumption category and are expressed in current soles per kWh, before taxes. The low spread of the enterprises' average price levels in rela- tion to widely differing cost levels reflects the resource transfers implemented through the Fondo de Compensacion Tarifaria (Tariff Compensa- tion Fund) established in 1976. 2.12 The average tariffs for industrial consumers show the greatest diversity, with a maximum for the Chimbote utility and a minimum for Hidrandina, which sells 95% of its billed energy in the Pativilca Conces- sion to a single industrial complex. The national average of this indus- trial tariff is 65% higher than the average for residential sales. Com- mercial consumers pay the highest prices in most systems, averaging 2.4 times the residential tariff. These differences, which are neither tech- nically nor economically justified, indicate a substantial subsidy to residential consumers on the part of industrial and commercial users; its redistributional intent is thwarted because the implicit subsidies bene- fit large consumers more than small ones, particularly those in the resi- dential category. 2.13 Average tariffs declined five percent in real terms throughout the 1970s. The Government authorized accelerated nominal tariff in- creases for late 1981 and 1982 which were just sufficient to keep pace with inflation. Tariff increases have been applied unequally in the past. For example, residential and public lighting customers benefitted from sharp declines in the real price paid between 1970-80, while indus- tries experienced a 47% real increase. The industrial tariff remains,  - 20 - however, below the price of the fuel oil needed to produce electricity in a thermal power plant. A recent marginal cost tariff study for the principal system (central north) showed substantial seasonal and daily variations in the cost of electricity supply, with costs during the dry season (May to November) exceeding costs during the rest of the year. When analyzing the incidence of hidden subsidies and taxes in the current tariff structure, residential consumers are the most heavily subsidized, while small industrial and irrigation pumping customers receive a mod- erate subsidy, and commercial customers are overcharged. Electricity tariffs appear to average only 40-50% of the corresponding economic cost for residential and industrial consumers while the commercial tariff exceeds its (long-run average incremental costs, LRAIC) comparator. Transport Sector 2.14 Road, rail, sea and air transport are all used extensively in Peru. The road system spans approximately 60,000 kilometers, 6,600 of which is paved. The Panamerican highway which stretches 3,000 km along the coastal plain is the most important road in the system. In 1981, the total road fleet was estimated at about 522,000 units (0.03 per capita), 70% of which are registered in Lima. As Table 2.2 shows, the number of road vehicles has been growing at about 3.2% a year. 2.15 Peru has 3,074 km of railways, almost one-half the length of the paved roadways. The two main railroads in the country link mining cen- ters in the Sierra to ports on the coast; the Central Railway connects Callao-Lima to the central mining areas, and the Southern Railway runs between the port of Matarani, Cuzco and Puno. Five airports, at Lima, Pisco, Arequipa, Cuzco and Talara, are rated as first class, capable of handling Boeing 707 aircraft, and another eight are capable of handling Boeing 727s. The most important seaports in the country are Callao, M4atarani (general cargo), Talara (petroleum products), Chimbote and San Nicolas (iron ore), Ilo (copper ore) and the river port of Iquitos (gen- eral cargo) on the Amazon River. Table 2.2: Road Vehicles 1976-1981 Cars Omnibus Pick Up Trucks Others Total 1976 265,486 17,001 55,370 61,407 46,343 445,607 1979 273,363 27,754 61,499 64,108 45,511 472,235 1981 296,706 18,278 71,162 69,074 66,750 521,970 Source: Direccion General de Transporte Terrestre  - 21 - 2.16 Energy Consumption The transport sector depends entirely on petroleum products; as a whole it contributes 44% (1981 figure) to the national demand for petroleum products. Table 2.3 shows the structural changes in the transport sector over the past ten years. Table 2.3: Transport Energy Consumption by Fuel (percent) 1970 1975 1981 Gasoline 67.9 66.0 49.6 Kerosene 10.1 10.9 12.2 Diesel 16.0 17.5 27.3 Fuel Oil 6.0 5.6 10.8 Total 100.0 100.0 100.0 Percent of Total oil consumnption 40.9 44.7 44.9 Source: fEM - Energy Balances 2.17 The most important change in the structure over the last ten years has been the substitution of diesel fuel for gasoline. Due to the increase in gasoline prices (gasoline prices increased faster than diesel oil prices) and the increase in the diesel oil fleet (especially trucks and buses), gasoline participation fell fran 67.9% in 1970 to 48.7% in 1980, at the same time raising diesel consuraption from 16.0% in 1970 to 27.6% in 1980. In 1981, there was a modest reversal of this trend be- cause of the import car liberalization which increased the automobile (gasoline) fleet. 2.18 Energy Conservation A recent study 1/ has estimated that a savings of 15-22% in fuel could be achieved in the transport sector. This includes a 12-18% savings in road transport, mainly through car maintenance, improved traffic management in Lima and road maintenance; 2- 3% in air transport through fleet maintenance, availability of new equip- ment, and improved traffic management; and a potential savings in mari- time and rail transport of 2% and 1%, respectively. Table 2.4 gives the estimated possible energy savings. 1/ Trans-Energ, "Conservacion de la energia en los sectores Industria y Transporte, 1982."  - 22 - Table 2.4: Energy Consumption in the Transport Sector -1985 Consumption without Possible Energy Savings Energy Conservation (KTOE) (% within mode) (% within sector) Road Transport 1800 307-448 17-25 12-18% Car Maintenance 127-188 Traffic Management 30-60 Driver Education 50 Engine Maintenance 50-90 Road Maintenance 50-70 Air Transport 335 45-75 13-22 1.7-2.9 Engine Maintenance 15-30 New Equipment 15-30 Management 15-30 Rail Transport 57 8-12 14-21 0.3-0.5 Maintenance 6-9 Management 2-3 Maritime Management 365 20-35 5-10 0.8-1.3 Total 2557 380-570 15-22% Source: Trans Energ, Conservacion de la Energia en los Sectores Industriay Transporte, July 1982. Household Sector 2.19 The residential sector depends mainly on noncommercial energy. In 1981, energy consumption in the household sector totalled 4.4 million toe, of which 2.7 million (61a) was from noncommercial sources (mainly fuelwood), and 1.7 million (39%) was from commercial sources. Kerosene accounted for 0.82 million toe and electricity for 0.75 million toe of commercial energy used in households. Table 2.5 shows the pattern of energy consumption in the residential sector over the past ten years. Table 2.5: Residential Energy Consumption (Percent) 1970 1975 1981 Noncommercial 73 67 61 Kerosene 14 15 19 Electricity 10 14 17 Others 3 4 3 Source: NEM - Energy Balances  - 23 - 2.20 In 1981, traditional energy sources accounted for 61% of total energy use in the household sector. Of the 4.4 mtoe consumed, 53% came from wood, 6% from other biomass sources, and 2% from charcoal. The participation of traditional energy sources in the residential sector fell between 1970-1981 from 73% to 61%, while the share of commercial energy sources increased from 27% to 39% during the same period. This trend can be partly explained by the high migration rates to urban areas, a relatively stable overall consumption of traditional fuels, and some substitution of kerosene for firewood in rural areas, as a result of regional scarcities. 2.21 A study of firewood availability in three villages in the southern highland of Peru 1/ strongly suggests that scarcity of tra- ditional fuel is not generalized all over the Sierra but is most serious- ly felt among the poorest households living in the higher altitudes. Land tenure systems contribute to the problems of access to fuels of the inhabitants of high altitude, steep mountain slopes; areas less capable of providing sufficient fuel for their populations are increasingly de- nied traditional access to trees in the more fuel abundant areas near the valleys. 2.22 Developing and promoting more energy-efficient cooking stoves could be of great benefit to rural households by increasing the amount of cooking that can be done with a given amount of wood. There are some reports that "improved" stoves (such as a three-hole stove, a clay stove, and the "biscarra") are in use in isolated parts of the Sierra and in Oxapampa. The efficiency of these stoves needs to be tested and dissem- ination programs explored. As no local research and development work has yet been done, cost figures are not available to determine whether users can afford them. Experience elsewhere (Central America, West Africa) suggests that efficiency improvements in cooking stoves can provide im- mediate, significant reductions in fuelwood consumption (an important benefit to communities most seriously affected by fuelwood penury), re- ducing the areas required for reforestation. However, the design of a program to develop and encourage the use of energy-efficient cooking stoves should be based on the premise that the dissemination process is likely to be more difficult than the technical R&D involved. 2.23 Important options in urban areas include the substitution of coal briquettes and/or electricity for kerosene. Electricity, of course, requires the availability of a network and a minimal demand. Forty per- cent of all households now have access to electricity, a proportion which should increase as a result of the national rural electrification program and the expansion program in other areas. 1/ Sara Lund Skar, Fuel Availability, Nutrition and Women's Work in Highland Peru. Geneva: International Labor Office, January 1982.  - 24 - Table 2.6: Cooking Fuel Costs (US$ per capita per year) Huancayo Lima Wood used in open fire 10.8-15.0 27.5-31.7 with improved stove 5.4-11.2 13.8-23.7 Charcoal 33.9 58.5 Coal Briquettes 9.3-13.3 9.3-13.3 Kerosene with current subsidy 7.7 7.7 unsubsidized 21.0 t8.5 LPG with current subsidy n.a. 10.1 unsubsidized n.a. 21.4 Electricity with current tariffs n.a. 12.1 at long-run average incremllental cost n.a. 28.2 Notes: Cost of stoves not incladed Fuel requirements estiniated on basis of 200,000 kcal per capita per year useful energy and energy content and utilization effi- ciency estimates as follows: wood, 2.4 million kcal/cu m, 10% in open fires, 15-20% in improved stoves; charcoal, 6500 kcal/kg, 20%; coal briquettes, 4-5000 kcal/kg, 30%; kerosene, 34,000 kcal/gallon, 35%; LPG, 21,300 kcal/cylinder (24 lb.), 45%; elec- tricity, 860 kcal/kWh, 70%. Unit costs in Huancayo: wood, $13-13/cu m; charcoal, $0.22/kg; coal briquettes, $0.08/kg; kerosene, $0.46/gallon subsidized, $1.25/gallon unsubsidized; LPG and electricity not idely avail- able in Sierra. Unit costs in Lima: wood $33-38/cu m; charcoal, $0.38/kg; coal briquettes, $0.08/kg; kerosenes, $0.46/gallon subsidized, $1.10/gallon unsubsidized; LPG, $2.95/cylinder subsidized, $4.95/cylinder unsubsiclized; electricity, 3.6k/kUh at current tariffs, 8.44/kIWh at long-run average incremental cost. 2.24 Table 2.6 compares the costs of alternative cooking fuels in Huancayo (an urban center in the Sierra -- one would expect wood to be  - 25 - less expensive and kerosene more expensive in smaller, more isolated Sierra communities) and in Lima. At current price levels, kerosene, LPG, and electricity are the least expensive where they are available, and even without a subsidy kerosene would probably remain the least expensive option for Lima consumers unless a coal briquetting program can be de- veloped. Industrial Sector Mineral Industries 2.25 The minerals sector is a very important part of the country's economy, contributing about 10% to GDP. Peru has a large number of minerals; those of major energy importance are the ores of copper, lead, zinc and iron. In 1980, the mineral industries accounted for 15% of commercial energy consumption, including almost 10% of petroleum products and 30% of electricity. The energy conservation potential for the largest consumers in the sector has been analyzed and the conclusions extrapolated to the whole sector. 1/ 2.26 Taking as a basis the 0.8 MTOE consumption of petroleum deri- vates in 1981, and considering possible energy conservation measures, such as ,maintenance and operation, modernization and/or replacement of equipment and application of new technologies, it appears possible that for the total Mining Sector: (i) a savings of 5%, equivalent to some 40 KTOE, could be reached within two years with low levels of investment; (ii) within five years, a savings of 9% (72 KTOE) could be achieved, but with measures requiring significant investments, and; (iii) by applying new technologies, a savings of 96 KTOE, or 12% of energy consumption, could be obtained. Table 2.7 shows the results of energy savings and the estimated investments and time required to achieve them. Table 2.7: Estimated Energy Savings and Investment Mining bector Reduction in Implementation Energy Consumption Investment Period Improvements KTOE % US$ million (years) Maintenance and operation 40 5 10 2 Application of available technologies 72 9 33 5 Application of new technologies 96 12 66 10 US$1 = 870 soles (November 1982). Source: Based on Sereland, Conservation of Energy in Peru, April 1983. 1/ Sereland, Conservation of Energy in Peru, April 1983.  - 26 - Manufacturing Sector 2.27 The manufacturing sector 1/ in Peru was the largest contributor to GDP in 1981 (24%). In the last five years, its importance to the country has grown, largely because of its participation in labor employ- ment and the commercial balance. The manufacturing sector mainly depends on petroleum products. Total consumption of petroleum products in 1979 was 1,240 Ktoe, comprising 998 Ktoe fuel oil, 205 Ktoe diesel, and 37 Ktoe others. The consumption of electricity accounted for 2500 GWh (613 Ktoe). 2.28 A good estimate of industrial savings potential would require that energy audits be conducted on the industries by using techniques and personnel specialized in energy conservation; however, a general idea of the potential savings in the manufacturing sector can be obtained by com- paring energy consumption per unit in each branch of industry with ana- logous figures for other countries and considering the reductions in per unit energy consumption that have been obtained through various types of measures. Based on such an analysis, the mission estimates that mainte- nance and operation measures could reduce industrial energy consumption by 116 Ktoe (7%) with an estimated investment of only US$23 million. Modernization and/or replacement of equipment require significant invest- ments (but still with payback periods of two to five years) could save 127 Ktoe. The feasibility of making this improvement appears to be theo- retical for the time being and will also depend on the capacity to apply long term investments. Table 2.8 shows the total savings forthcoming from these conservation measures. Table 2.8: Total Estimated Energy Savings in the M4anufacturing Sector Reduction Investment Implementation Period Improvements ICEOE % US$ million (years) Maintenance and operation 116 6 23 2 Application of available Technologies 127 7 63 5 Source: Based on Sereland, Conservation of Energy in Peru, April 1983 1/ The principal subsectors are: Food, Paper, Non-metalic, Metalurgic, Chemical and Textiles Industries.  - 27 - 2.29 The mission's preliminary analysis of the mineral industries and the manufacturing sector for the short run confirms that the efficiency of fuel use, basically for petroleum products and electricity, could be significantly improved. Immediate measures to increase energy efficiency include: (i) good combustion practices and the value of instrumentation leading to improved operation and maintenance practices; (ii) improved performance of heat exchangers, through increasing the heating surface, better controls to prevent overfiring, the installation of baffles and the additional insulation on air ducts; (iii) heat recovery from exhaust gases by the installation of recuperators; and (iv) power factor correc- tion, in most cases the addition of capacitors would be appropriate, but the larger industries could install synchronous motors. 2.30 In the longer run, additional savings could be achieved through more extensive investments. These should be identified in greater detail as part of the energy audit work, but they are likely to include the fol- lowing: (i) modernization and replacement of equipment; (ii) optional use of steam products; (iii) improving the efficiency of storage and con- ditioning of raw materials; (iv) utilization of sensible heat by means of an integrated system applied to the steam network for mechanical driving purposes and to obtain process steam. Substitution of Coal for Fuel Oil 2.31 Substituting coal for fuel oil is becoming more common through- out the world in the cement and brickmaking industries, thermal power plants, and industries with a high consumption of steam such as the paper and sugar industries. In Peru, substantial conversions to burn coal in boilers and furnaces appear feasible from a technical point of view, as shown in Table 2.9, and the economics appear attractive. However, the absence of an established supply, the distance between production and consumption centers and the lack of a clear government policy to develop the country's coal resources are very important constraints to a large- scale switch from fuel oil to coal. A pilot program designed to address these limitations is outlined in Chapter VI (para 6.19). Table 2.9: Potential for Interfuel Substitution Fuel Coal Substitution Oil Potential Industry Equipment (toe) (tonnes) Cement kilns 250,000 385,000 Bricks furnaces 50,000 77,000 Sugar boilers 140,000 215,000 Paper boilers 160,000 246,000 Mining boilers & & Metallurgical furnaces 200,000 303,000 Total 8()