Argentina - Electric Power Sector Project

Document of The World Bank FOR OFFICIAL USE ONLY 1SAAi Report No. 1450-AR STAFF APPRAISAL REPORT ARGENTINA ELECTRIC POWER SECTOR PROJECT October 5, 1988 Latin America and Carribean Region Country Department Infrastructure and Energy Division This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents mray not otherwise be disclosed without World Bank authorization.  CURRENC' EQUIVALENTS Currency Unit = Austral (A) A1.00 = US$0.26596 US$1.00 = A3.76 (exchange rate as of January 1, 1988) MEASURES MMTOE : million tons of oil equivalent W t watt Wh : watt-hour V : volt VA : volt ampere k : kilo thousand (103) M : mega : million (106) G : giga : hillion (109) T : tera : trillion (1012) ACRONYMS AyE. Agua y Energia Electrica S.E. (faderally-owned, nationwide electric utility and water supply agency) CFE Consejo Federal de Electricidad (Federal Electricity Council) CNEA Comision Nacional de Energia Atom:!ca (National Nuclear Energy Commission) CTMSG Comision Tecnica Mixta del Salto Grande (Argentinian/Uruguayan commission in charge of the Salto Grande Hydroelectric Plant) DEP Directorio de Empresas Publicas (Public Enterprises Directorate) DUC Despacho Unificado de Carga (Central Dispatch Center) EBY Entidad Binacional Yacyreta (Argentinian/Paraguayan entity in charge of the Yacyreta hydroelectric Plant) HIDRONOR Hidroelectrica Norpatagonica (federally owned, electricity generation utility) ME Ministerio de Economia (Ministry of Economy) MOSP Ministerio de Obras y Servicios Publicos (Ministry of Pub !c Works and Services) SE Secretaria de Energia (Secretariat of Energy, under the MOSP) SEGBA Servicios Electricos del Gran Buenos Aires (federally owned, electric utility serving the Buenos Aires metropolitan area) SIN Sistema Interconectado Nacional (National Interconnected System) UNDP United Nations Development Program FISCAL YEAR January 1 - December 31  FOR OFFICUAL USE ONLY ARGENTINA E!ECTRIC POWER SECTOR PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. 1. LOAN AND PROJECT SUHMARY .......................................... 1 2. THE ENERGY AND POWER SECTORS ...................................... 3 A. THE ENERGY SECTOR ............................................... 3 Energy Resources .............................................. 3 Demand and Supply of Energy ................................... 3 National Energy Policy and Sector Objectives .................. 3 Institutional Structure ....................................... 4 B. THE ELECTRIC POWER SECTOR ....................................... 4 Legal Framework and Regulation ................................ 4 Organization .................................................. 4 The Electric Power Market and Existing Facilities .............6 Planning and Investment ....................................... 7 - Organization .......................... ........... 7 - Expansion Plan .......................... 7 - The Nucleer Power Program ..........................., 8 - Investment .......................... 9 Electricity Pricing .......................................... 10 Sector Finances .............................................. 10 - Past Performance ........................................ 10 - National Utilities Financial Rehabilitation Plan (FRP) ............................................ 12 - Sector Financing Plan (National Utilities and EBY) ...... 13 Bark Participation ........................................... 14 Bank and Country Goals and Sector Lending Strategy ........... 15 Rationale for Bank Involvement ............................... 16 3. THE PROJECT ...................................................... 17 Project Origin and Status of Preparation ...................... 17 Legal Arrangements ............................................ 17 Project Obje"tives ............................................ 18 Project Description ........................................... 18 Estimated Cost ................................................ 18 Financing Plan .. . ............................................ 20 - National Utilities .21 - EBY .22 - SE .23 Financial Covenants .23 Impleme.itation and Monitoring .24 Procurement .24 Disbursement .25 Environmental and Social Aspects .26 Dam Safety and Inspection .27 Auditing .28 Economic Justification .28 Risks .29 4. AGREEMENTS REACHED AND RECOMMENDATION .30 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - ANNEXES 2.1 Energy Sector Organization Chart 2.2 Institutioaal Aspects 2.2.1 SEGBA 2.2.2 AyE 2.2.3 HIDRONOR 2.2.4 EBY 2.2.5 CNEA 2.3 The Electricity Market 2.3.1 Demand Projections 2.3.2 SIN - Installed Capacity Available by End 1987 2.3.3 Draft Terms of Reference for the Power Generation Options St-dy 2.4 Expansion Plan and Investment Program 2.4.1 STN - Evolution of Completion of Net Available Capacity 2.4.2 SIN - Capacity and Energy Balance 2.4.3 Economic Evaluation of the Atucha II Project 2.4.4 1988-1985 Sector Inrestment Program 2.5 Electricity Pricing 2.5.1 Electricity and Energy Funds 2.5.1.1 Electricity and Energy Funds Forecast 2.5.2 Typical Electricity Prices 2.6 Finances 2.6.1 National Utilities 2.6.1.1 Income Statements 2.6.1.2 Flow of Funds 2.6.1.3 Balance Sheets 2.6.2 SEGBA 2.6.2.1 Income Statements 2.6.2.2 Flow of Funds 2.6.2.3 Balance Sheets 2.6.3 AyE 2.6.3.1 Income Stateients 2.6.3.2 Flow of Funds 2.6.3.3 Balance Sheets 2.6.4 HIDRONOR 2.6.4.1 Income Statements 2.6.4.2 Flow of Funds 2.6.4.3 Balance Sheets 2.6.5 EBY 2.6.5.1 Sources and Uses of Funds 2.6.5.2 Financial Plan (1988-1996) 3.1 Project 3.1.1 SEGBA's 1988-1995 Investment Program 3.1.2 AyE's 1988-1995 Investment Program 3.1.3 HIDRONOR's 1988-1995 Investment Program 3.1.4 The Yacyreta Project 3.1.5 Estimate of the Project Cost 3.1.6 EBY's Environmental and Resettlement (E&R) Plan of Action  - iii - 3.2 Performance Indicators 3.2.1 Sector 3.2.2 SEGB 3.2.3 AyE 3.2.4 HIDRONOR 3.3 Economic Justification 3.3.1 Sector 3.3.2 Economic Evaluation of the Yacyreta Project 3.4 Proiect File HAP: IBRD No. 21188 This report is based on the findings of an appriasal mission consisting of Messrs. Hernan Garcia and Nelson de Franco (Power Engineers) and Jose H. Bakovic (Financial Analyst) who visited Argentina in May-June 1988.  ARGENTINb ELECTRIC POWER SECTOR PROJECT STAFF APPRAISAL REPORT 1. LOAN AND PROJECT SUMMARY Borrower: The Argentine Republic Beneficiary: Entidad Binacional Yacyreta (EBY) Amount: US$252.0 million equivalent of which US$250.0 million for EBY and US$ 2.0 million for Secretariat of Energy Terms: Repayment in 13 years including six years of grace, with interest at the Bank's standard variable rate. Project Objectives: The project is designed to help achieve the following sector objectives: (a) ensuring optimum resource allocation by requiring adherence of the expansion program to least- cost principles; (b) implementing a Financial Rehabilitation Plan (FRP) of the national power utilities; (c) promoting rational use of electricity through a tariff system based on economic costs; (d) improving the efficiency of the power utilities; (e) strengthening the structure of the sector so as to bring about better coordination, planning and regulation; and (f) establishing policies and procedures for environmental protection and social aspects in power projects. Project Descriptions The proposed operation would help finance the 1988-1989 time slice of the sector investment program. Loan proceeds would fund civil works and engineering of the Yacyreta hydroelectric plant construction and technical assistance to strengthen the Secretariat of Energy. Project Benefits: The project would enhance the allocation of Argentina's scarce financial resources through an economic selection of projects and setting of electricity prices, which, in turn, would encourage rational use of energs resources. Sector productivity would be improved through efficient operation of existing installations and institution building efforts, including better protection of environmental and social aspects of power projects. Risks: The major risk facing the project would be a lack of funds to execute it under the envisioned time schedule. The main cause for such lack of funds would be the inadequate implementation of measures included in the FRP, particularly the Government's difficulties in keeping tariffs in line with inflation and the complex arrangements for resource transfers within the sector.  -2- Estimated Project Costs 1988-1989 Sector Investment (in millions of current US$) Local Cost Foreign Cost Total Cost 1 AyE 248.3 165.5 413.8 17 SEGBA 178.3 118.9 297.2 13 HIDRONOR 240.7 160.5 401.2 17 EBY 584.6 279.3 863.9 37 SE 1.0 2.0 3.0 - Base Cost 1/ 1,252.9 726.2 1,979.1 84 Physical Contingencies 139.1 80.5 219.6 9 Subtotal 1,392.0 806.7 2,198.7 93 Price Contingencies 45.0 28.9 73.9 3 Subtotal 1,437.0 835.6 2,272.6 96 Interest 2/ - 80.1 80.1 4 Total Estimated Costs 1,437.0 915.7 2,352.7 100 Financing Plan: Net consumer-based funding 991.6 991.6 42 Government contributions 52.2 52.2 2 Proposed IBRD loan 252.0 252.0 11 Proposed IDB loan 250.0 250.0 11 Other borrowing 393.2 413.7 806.9 34 Total financing 1,437.0 915.7 2,352.7 100 Estimated Disbursements: Bank PY 1989 1990 Annual 151 101 Cumulative 151 252 Rate of Return: Economic Rate of Return: 151 1/ January 1988 price levels. 2/ Interest during construction on current and proposed IBRD and IDB loans financing the Yacyreta project.  - 3 - 2. THE EIERGY AND POWER SECTORS A. THE ENERGY SECTOR Energy Resources 2.01 Argentina's energy resources are diverse and abundant. Proven and potential gas reserves are estimated at 880 MMTOE (million tons of oil equivalent) and proven and potential oil reserves at 560 MMTOE. Potential coal reserves are also large, estimated at 220 MMTOE, but the low quality of deposits, as well as their distance from consumption centers, make their commercial exploitation doubtful. Uranium proven reserves are estimated at 400 MMTOE--or the consumption of about 8,000 MW of nuclear installed capacity for 30 years. Hydropower potential is estimated at 44,000 MW, equivalent to about 44 MMTOE p.a.--or 2,200 MMTOE over 50 years. Demand and Supply of Energy 2.02 The country's energy consumptior in 1987 is estimated at 47.4 MMTOE, resulting in a per capita consumption of 1.5 tons of oil equivalent (TOE) p.a., compared with the Latin American average of 1.0 TOE p.a. The country can be considered self-sufficient, although it imports gas from Bolivia under a 1972 contract--which is scheduled to expire in 1992. 2.03 The pattern of energy consumption has changed significantly lately. As proven gas reserves have increased and gas fields have developed, gas has substituted for oil in industry and electricity generation. This trend is expected to continue beyond 1990, with increased use of natural gas in power generation (para. 1.16), industry and households. In anticipation, the Government is expanding the capacity of its gas pipelines. Substitution of oil would also continue with the commissioning of large hydroprojects currently under corstruction (para. 2.17). National Energy Policy and Sector Objectives 2.04 Argentina's energy policies have not fostered efficient use of the country's energy resources. Distorted pricing policies are believed to be the main problem since, for long periods of time, the Government allowed prices of oil derivatives and electricity to decrease in real terms. Additionally, wrong investment decisions have led to the development of an expensive nuclear power program, while the economic criteria traditionally adopted for planning the electricity sector have: (a) promoted the installation of questionable large hydroplants (para. 2.16); and (b) not provided for an adequate balance among generation, transmission and distribution facilities (para. 2.18). 2.05 The Government recently completed an energy plan whose main objectives are: (a) to increase the contribution of gas and hydro resources to the country's energy supply; (b) to increase oil exploration efforts in order to improve the reserve/production ratio; and (c) to correct pricing distortions and foster conservation and substitution. Specifically, the country is expected to maintain its energy independence  -4- through the year 2000 bv increasing the shares of gas and hydroelectricity in the country's energy balance (gas: from 25X in 1986 to 362 in 2000; hydro: from 112 to 15?), reducing oil's share from 47? to 37?. The energy plan is a valuable planning tool which requires systematic updating to ensure cost-effective and balanced use of resources. Institutional Structure 2.06 A chart with the organization of the energy sector is presented in Annex 2.1. The Ministry of Public Works and Services (MOSP) controls the energy sector through the Energy Secretariat (SE) and the Public Enterprises Directorate (DEP). The SE is in charge of defining sector policies. SE is responsible for: (a) overall energy planning; (b) granting of concessions for exploration and exploitation of petroleum and gas fields and for electricity power supply; (c) pricing policies; and (d) policies for energy conservation and development of new sources of energy. The SE has limitations for contracting personnel and usually resorts to borrowing staff from AyE and SEGBA, but still is weak in fulfilling its wide range of responsibilities. The proposed project would support the strengthening of the SE's technical staff [para. 3.06(b)]. The DEP is responsible for supervising the operational performance of the major public enterprises, including those of the oil and gas and electricity sectors. In theory the DEP is also responsible for authorizing tariff adjustments; in practice the Ministry of Economy retains the final authorization because of the Government's price setting policy (paras. 2.21 and 2.22). B. THE ELECTRIC POWER SECTOR Legal Framework and Regulation 2.07 The legal framework of the power sector does not facilitate its comprehensive, coherent regulation. Furthermore, the autonomy provided to the provinces by the Constitution permits them to set rules which often do not foster economy and efficiency (e.g. establishment of royalties on the use of hydro resources, setting of tariffs to the final user which have no relationship with costs, application of taxes and other surcharges over and above electricity rates, etc.). It is expected that a review of the sector organization, currently being carried out by the SE (paras. 2.11 and 2.14), would provide recommendations for addressing the above problems. Additionally, the Government is improving coordination of the sector by making effective use of the Federal Electricity Council (CFE), a coordinating body with representation of the SE, the national utilities and the provincial authorities responsible for the power sector (usually their Ministries of Public Works). Recently, the CFE has played an instrumental role in recommending actions to the Government aimed to correct tariff imbalances. Organization 2.08 The Argentine power sector has a fragmented and complex organization. Most of the power facilities are owned by the federal and the provincial governments, although autogeneration, mainly in the hydrocarbon and mining industries, contributes with an important share of the total country's production (about 102 in 1987). National utilities are in charge of the development, production, transmission and distribution of  - 5 - electricity and of the development of binational hydro resources. There are about 20 provincially-owned utilities mainly in charge of distribution of electricity (para. 2.11). 2.09 The country's utilities owned by the Federal Government and their role in the power sector are the followir.g: Servicios ElEctricos del Gran Buenos Aires (SEGBA), in charge of generation, subtransmission, and distribution in the Greater Buenos Aires area (see Annex 2.2.1). Agua y Energia Electrica (AyE), in charge of nationwide generation, transmission and bulk supply, and also distributes electricity in a few provinces. It has responsibilities in integrated basin development, irrigation, flood control, drainage and land reclamation (see Annex 2.2.2). Hidroel4ctrica Norpatag6nica (HIDRONOR), responsible for developing the hydro resources of the Northern Patagonia region (see Annex 2.2.3). In addition, the Government participates in two binational entities with Uruguay and Paraguay, which are, respectively: Comisi6n Tecnica Mixta del Salto Grande (CTMSG), in charge of the Salto Grande Hydroelectric Plant (1620 MW), operating since 1Q80. Entidad Binacional Yacyreta (EBY), in charge of the construction and eventual operation of the Yacyreta Hydroelectric Plant (see Annex 2.2.4). The Federal Government also owns the Comisi6n Nacional de Energia At6mica (CNEA), an agency in charge of nuclear research and applications. Under this role, CNEA builds and operates nuclear power plants which supply energy to the sector's interconnected system. The CNEA reports directly to the presidency and, since its creation in 1950, has been managed independently from the energy sector (see Annex 2.2.5). 2.10 The MOSP, through DEP, has direct controi of the three national utilities: AyE, SEGBA and HIDRONOR. EBY reports directly to the MOSP, and CTMSG to the Ministry of Foreign Affairs. A national dispatch center (DUC) operated by AyE is in charge of coordinating the operations of the larger electricity producers (AyE, SEGBA, CTMSG, HIDRONOR and CNEA) to ensure reliability and economic use of generation facilities. 2.11 Some of the provincial utilities own generation facilities, but most of them distribute electricity purchased from AyE. The most important are in the provinces of Buenos Aires, C6rdoba, Mendoza and Santa Fe. Most of the provincial utilities were created in 1979, when the Government made arrangements with provinces to transfer distribution responsibilities from AyE to them. The arrangements provided for the transfer of the physical facilities and assets but did not relieve AyE of the corresponding liabilities. The transfer from AyE resulted in the formation of a number of provincial utilities with weak managerial and institutional structures. Also, because of the autonomy which the provinces enjoy, coordination of  system operations and development D tween SE and the national utilities and the provincial utilities is weak. The study of the sector organization agreed upon under the revised covenants of the Yacyreta Project (para. 2.14) and the studies being carried out under the Power Engineering Project, Loan 2751-AR (paras. 2.15 and 2.18), are expected to provide the basis for improving coordination between the Federal Government and the provincial utilities. The Electric Power Market and Existing Facilities 2.12 The degree of electrification in Argentina is high compared to other Latin American countries. About 792 of Argentina's inhabitants ha,ve access to electricity. Almoqt all the urban centers and about 50? of the rural population have electricity service. Electricity per capita consumption was about 1450 kWh in 1987 (compared with 1,100 kWh per year for Brazil and 270 kWh per year for Bolivia). Consumption increased at a rate of 6.1Z p.a. in the period 1970-1980. It slowed after 1980, reflecting the difficult economic situation, reaching 2.8Z in the period 1980-1984 and decreasing by 2.22 in 1985. Consumption growth recovered in 1986 and 1987, however, at a high rate (7.4? p.a.). In 1987 industrial consumption accounted for 48? of total consumption from public service utilities and residential and commercial for 40?. Demand projections prepared in the past tended te be over-optimistic. The SE corrected this bias in the recent revision of the demand projection which was used to define the expansion sector plan (paras. 2.16 and 2.19). The revised projections were found satisfactory by the appraisal mission and show a global electricity demand increase of about 6.0? in the period 1987-1995 which is consistent with expected GDP growth rates of 3.5? for 1989 and 4? for 1990 and beyond (Annex 2.3.1). 2.13 Most of the country's power facilities are installed in the National Interconnected Svstem (SIN), which covers about 90? of the nation's electricity market. The total installed capacity of the SIN by end 1987 was 12,802 MW of which 5,960 MW (46?) was hydro, 5,824 MW (46?) conventional thermal and 1,018 MW (8?) nuclear (Annex 2.3.2). A 500 kV transmission system links the major consumption areas with the production centers and is used for the transfer of large blocks of energy. A network of 230 kV lines completes the grid and permits energy transfers between production and load centers. 2.14 Performance of the national utilities is uneven and reflects the sector's fragmented organization. The utility most affected by the overall sector problems is AYE, whose performance is weak in all aspects: managerial, staffing, operations and finances. This is the result of many years of political interference, high rotation of personnel and financial difficulties. SEGBA, which has been a traditionally well-run utilitv, has lately also been affected by the sector institutional and financial deterioration. HIDRONOR is probably the best sector utility oerformer. EBY is currently a well-organized and well-run institution. The Government is addressing the utilities' operational problems by carrying out a study to improve the sector organization and efficiency and accountability of the national utilities. During appraisal, agreement was reached with the Government on terms of reference and specific timetable to complete this study. During negotiations, it was agreed that completion of the study by March 31, 1989 would be a covenant of the proposed loan (para. 4.01(a)].  -7- Planning and Investmznnt - Organization 2.15 Planning of the generation and transmission systems is under the responsibility of the SE which updates the planning studies every two years. Demand projections are produced by a working group composed of r-nresentatives of the electricity companies under the supervision of the SE; this arrangement is working satisfactotily since it provides for the Government economic policies to be taken into account in the projections and permits an adequate exchange of views regarding methods and criteria. Generation expansion is based on the interactive use of two mathematical models: (a) an investment selection model based on linear programming which defines the optimum final configuration of the system for pericds of three years; and (b) a simulation model which defines more precisely the dates when additions to generatiorn are required. Transmission expansion is defined on the basis of state-of-the-art conventional studies with assistance of foreign consultants. Distribution expansion planning is under the responsibility of each distribution utility. There are differences in planning and design and in equipment standards among utilities which do not permit adequate integration. This problem is being addressed under Loan 2751-AR (paras. 2.18 and 3.18). - Expansion Plan 2.16 Although the sector's methodology in defining the least-cost solution for generation expansion is sound, the Bank has had reservations regarding the assumptions made and economic parameters selected in the past. These reservations concerned, in particular, a discount rate of 82 p.a., lower than the estimated opportunity cost of capital for Argentina (122) and the reluctance to consider gas-fueled thermal plants for operation in the base of the load cycle in future power generation studies. In addition, demand projections were consistently over-optimistic. These assumptions biased the results of planning exercises towards hydro projects with high level of investments while they undervalued the potential contribution to power generation of the sizeable reserves of natural gas available in the country. Demand projections were satisfactorily revised downward by the SE (para. 2.12). Following long discussions on the matter, during appraisal agreement was reached on the adoption of a 12? p.a. discount rate in the expansion plan. This has resulted in substantial changes to the expansion plan; major hydroprojects have been cancelled or postponed while gas-fueled base thermal plants appear as the best option for the future and a sizeable reduction in the investment requirements was achieved. This agreement constituted the first step in the rationalization of sector investments and sets the framework for a sounder approach to the development of electric power resources and services. Additionally, during negotiations it was agreed that the SE would engage consultants, under terms of reference satisfactory to the Bank, to carry out a study on thermal generation options: (i) to evaluate the operating conditions of existing thermal plants and recommend a rehabilitation program for the units deemed to have deteriorated; and (ii) in order to further optimize the thermal-based expansion, examine the merits of introducing the combined cycle alternative and the possibility of achieving utilization factors for existing and future thermal plants in line with international standards for  - 8 - planning and operation. This study should be completed in time to be used in the required April 30, 1989 update of the sector expansion plan [paras. 2.17 and 4.01(b)]. Terms of reference for the proposed study are attached as Annex 2.3.3. 2.17 The 1988-1995 sector expansion program, which provides the basis for the proposed project, was prepared for appraisal under agreed principles and methodologies and constitutes the least cost sequence to meet the demand projections for the period. It includes generation works to be developed by AyE, HIDRONOR and EBY, transmission works by SEGBA, AyE and HIDRONOR, and distribution works by SEGBA and AyE. The generation projects included in the program are among those which originated from expansion plans prepared in the 1970s on the basis of unduly optimistic demand growth expectations and the other inappropriate assumptions already described. This has been corrected subsequently, as noted in para. 2.16, in the course of the Government's recent coming to grips with the macro- economic and fiscal implications of past sector planning. The completion of such projects, and their associated transmission systems in a time schedule compatible with the revised demand projections, was an outcome of the least cost planning exercise. The only two new projects in the period are gas fueled thermal plants with a size module (325 MW) compatible with forecast demand increases. Generation works to be implemented as well as energy and power balances for the SIN are detailed in Annexes 2.4.1 and 2.4.2. Scheduling of ths new projects, especially projects to be commissioned beyond 1995, will be periodically reviewed in the light of (i) updated demand projections; and (ii) results of the studies on generation options outlined in para. 2.16 above. To ensure that appropriate measures to implement the optimum sector expansion program are taken, during negotiations it was agreed with the Government that: (i) by April 30, 1989 and every April 30 thereafter, the SE will update: (a) the sector expansion plan under methodologies and assumptions mutually agreed upon [para. 4.01(c)]; and (b) the financing schemes for major projects to assure that inter alia commiss_'oning dates required by the expansion plan are feasible (para. 4.01(d)]; and (ii) it will authorize the initiation of construction of any major public power generation or transmission project only if such project is in accordance with the sector expansion plan and has an adequate financing plan [para. 4.01(e)]. 2.18 Iavestments in distribution expansion have been neglected during the last few years because of the difficult financial situation of the sector and the priority given to financing of large hydroprojects under construction. The transfer of distribution networks to the provincial utilities (para. 2.11) has resulted in deterioration of distribution networks, poor customer service, a decrease of system reliability and substantial increase in technical losses and energy theft (para. 2.26). The Government is attempting to correct this imbalance through: (i) increasing emphasis on distribution investments, as indicated by the SEGBA expansion program (SEGBA V project financed under Loan 2854-AR); and (ii) defining nationwide reliability criteria for distribution expansion compatible with those used for generation and transmission expansion, as a result of the studies under Loan 2751-AR (paras. 2.15 and 3.18). - The Nuclear Power Program 2.19 Decisions on the nuclear power program have been taken outside the sector for other-than-economic reasons. CNEA has developed the largest  - 9 - nuclear power program in the region, which is much more costly than other power sources. Currently, CNEA has two nuclear power plants in operation with an installed capacity of 1,018 MW (Atucha I, 370 MW and Embalse, 648 MW) and a third plant under construction (Atucha II, 745 MW). A fourth nuclear plant has been planned by CNEA for the year 2000 under an initial agreement with a foreign supplier, but the Government is currently delaying any commitment on this matter due to the high investments involved. Atucha II is a very expensive project whose original high cost has been aggravated by implementation delays and cost overruns. The original project cost was estimated at about US$1600 million (1979 price level). Currently, after completing 60X of the project, investments still to be made amount to about US$1470 million (January 1988 price level). This, together with difficulties to provide further financing, has led the Government to consider cancelling the project. The Bank analysis of this option (summarized in Annex 2.4.3), was based on an economic comparison with a conventional thermal plant and considered that investments already made are sunk costs. It concluded that even though the project should not have been started, there are not sufficient grounds to recommend its cancellation given the advanced status of implementation and the economic costs to be incurred in the cancellation of the contracts for equipment and services with the degree of commitments already made. However, as nuclear power will be clearly an uneconomic choice in Argentina in the foreseeable future, and as during negotiations agreement was reached on criteria for implementation of new projects that allows the Bank to require that the expansion be based upon least cost principles (para. 2.17), the Government could not initiate uneconomic projects, such as a new nuclear power project without Bank's concurrence. Additionally, to ensure that the costs of inefficiencies resulting from the development of nuclear power do not burden electricity consumers, it was agreed that: (i) CNEA would obtain sector-generated funds only after the financial requirements of other sector utilities have been fully met; and (ii) bulk tariff which CNEA charges to DUC will not be higher than the maximum bulk sale price of the generating utilities supplying to the SIN [para. 4.01(f)]. - Investment 2.20 The 1988-1995 sector investment program has an estimated cost of US$7,931 million (Annex 2.4.4) as shown below: 1988-1995 Sector Investment (in constant US$ millions at January 1988 prices) LC FC Total Z AyE 1,950.7 1,300.4 3,251.1 41 SEGBA 900.3 600.2 1,500.5 19 HIDRONOR 562.3 374.8 937.1 12 Total National Utilities 3,413.3 2,275.4 5,688.7 72 EBY 1,464.4 778.1 2,242.5 2!t Total Sector 4,877.7 3,053.5 7,931.2 10l ====2== ===========X:== C=  - 10 - Electricity Pricing 2.21 Argentina's electricity pricing system is quite complex. A substantial part of the revenues of each sector utility is paid to the Federal Government in the form of a value added tax (VAT) and to earmarked Electricity Funds in the form of surcharges which, return to the sector as government equity contributions. Also, a portion of taxes on the sale of petroleum products flows to the power sector to help fund its investment requirements. Annex 2.5.1 gives a description and projection of the electricity and energy funds. In addition to the above taxes the final user also pays provincial and municipal taxes as part of his utility bill which vary substantially throughout the country. 2.22 Tariff structures, except SEGBA's to a certain extent, have not been designed on the basis of economic criteria. While the national average level of tariffs including taxes and surcharges is in line with the estimated national average economic cost, there are significant differences among utilities as similar consumers pay prices which are considerably higher or lower without relation to their corresponding estimated economic costs (see Annex 2.5.2). This has been caused in part by the difficulties associated with the management of utility prices in a high inflation environment and the autonomy of provinces to set their own rates. 2.23 The Bank and the Government have maintained a continuous dialogue on possible ways and means to improve this complex tariff situation with aims to establish a price system (structure and levels) which would reflect the economic costs of the service. Under the 1986 amendment to Loan 1761-AR, the SE is preparing a tariff study based on LRMC principles which is expected to provide the basis for restructuring the tariff system. Major results of the study are expected by February 1989. Under the proposed project, during negotiations it was agreed with the Government that the results of the tariff study would be implemented in a manner satisfactory to the Bank [para. 4.01(g)]. Sector Finances - Past Performance 2.24 Over the past several years the sector has had to bear the impact of changing economic policies and the burden of an investment program decided at a time when demand growth expectations were higher and external financing had been assumed to be easily available. During 1976-1982 the sector incurred a high level of external indebtedness, to a large degree prompted by the Government which in such manner was financing a substantial portion of its foreign currency needs. The major devaluation of the local currency that followed placed a heavy debt service burden on the sector and caused a major deterioration in its financial structure which has subsequently been somewhat corrected by the refinancing of the sector's debt. However, since 1986, the decline in the value of the U.S. dollar, to which the Austral is pegged, is again causing problems because of its effect on the sector's investment and debt service programs which have significant components of Japanese and European hard currencies. 2.25 The recent economic difficulties also resulted in a deterioration of financial discipline among public sector entities. Arrears for the  - 11 - purchase of electricity by national, provincial and municipal agencies and by autonomous agencies mounted. As of December 31, 1987, the balance of accounts receivable from electricity consumers of the three federally-owned utilities was as follows (in US$ million): No. of Of Which: Of Which: Utility Days Balance Overdue Public Sector 1/ AyE 167 223.2 184.4 134.4 HIDRONOR 96 31.1 12.4 12.0 SEGBA 63 107.4 48.7 28.2 1/ Excludes debt from other national utilities As can be seen from the above table, the public sector had overdue accounts of about US$175 million to the power sector. Loan 2854-AR includes commitments to reduce SEGBA's accounts receivable from the public sector and from all customers. Collection of receivables showing a decreasing trend is part of the set of performance indicators agreed upon under the proposed operation (para. 3.18). 2.26 Argentina's recent economic difficulties may have been a contributing factor to the increase in electricity theft which accounts to a sizeable degree for the increase in distribution losses that has been taking place since 1981. The financial problems of the power sector itself, however, were also an important contributing factor for the increase in distribution losses as they resulted in curtailment of expenditures in network expansion and maintenance. SEGBA, under Loan 2854-AR, is to carry out an electricity loss reduction nrogram to address this sector issue and the performance indicators agreed upon under the proposed operation also include targets for reduction of electricity losses (para. 3.18). 2.27 In March 1986, the Federal Government prepared a program to address the various financial problems faced by the sector and the covenants under Loan 1761-AR were amended to reflect the agreements then reached. The key aspects of these agreements are: (a) to increase the internal cash generation of the sector; (b) to reach a prudent mix of self financing and external borrowings; and (c) to review annually the financial targets for the federal utilities for the following year. During 1987, the targets defined for the above objectives were not achieved basically because of a higher-than-expected inflation which reduced revenues, in real terms. In compensation the Government has returned to the sector a larger proportion of taxes collected from it than anticipated.  - 12 - - National Utilities Financial Rehabilitation Plan (FRP) 2.28 Based on the policies outlined above and facing the new realities, in late 1987 the Government, with Bank assistance, started preparation of a Financial Rehabilitation Plan (FRP) which would reverse the dismal financial situation of the national utilities which, at present, have negative rates of return and are significantly dependent on Government contributions (Annex 2.6.1). The FRP relates to the group of national utilities (AyE, SEGBA and HIDRONOR) which account for about 60? of sector operations. The basic principles agreed upon between the Bank and SE for the preparation of the FRP were as follows: (a) each utility and the consolidated group of national utilities would show clear improvement trends to be measured particularly by the cash operating ratio (cash operating expenses as a percentage of revenues) and by the contribution to investment from non- borrowed sources, all within a reasonable level of indebtedness; (b) the required overall tariff increases would be made in a phased manner consistent with the stabilization program; (c) to balance the financial situation among utilities; (d) the investment program for each utility would be strictly in line with the least-cost expansion of the sector agreed with the Bank; and (e) the working capital needs would reflect sound practices of power utility financial management, especially regarding collection and payment periods. 2.29 The detailed financial projections for each of the individual national utilities and the consolidated group are included in Annex 2.6. A summary of the 1988-1995 flow of funds under the FRP is shown in the following table: National Utilities Financial Rehabilitation Plan (FRP) (1988-1995) US$ Million 1/ 2 Financial Requirements Investment Program 5,688.7 96 Working Capital Increase 2/ 251.3 4 Total Requirements 5,940.0 100 Financial Resources Net Consumer-based Funding 3,996.3 67 Government Contributions 30.7 1 Net Non-Borrowed Funding 4,027.0 68 Borrowings 1,913.0 32 Total Financial Sources 5,940.0 100 1/ In constant January 1988 prices. 2/ Includes expected fund surpluses in 1993-1995.  - 13 - 2.30 The PRP is based on a set of assumptions which take into account the limitations imposed by the stabilization program on (i) rate increases and on the corresponding availability of Electricity and Energy Funds (Annex 2.5.1), (ii) Government contributions, to be used mainly for debt service payments, and (iii) borrowings, committed for ongoing projects and to be committed to finance the foreign cost component for future projects. Annex 3.2 gives a detail of the above assumptions. The resulting cash operating ratio (cash operating expenses as a percentage of operating revenues) would have a steady and positive trend as shown by the following tables 1988 1989 1990 1991 1992 1993 Cash Operating Ratio (Z) 91.0 81.0 78.7 68.4 64.4 61.1 The FRP shows in its funding mix that the internal fund generation of the national utilities would increase steadily and with the contribution of ele!tricity and energy funds would show a healthy contribution to inveitment, as shown in the following table: Contribution to Investment (Z) 1988 1989 1990 1991 1992 1993 w/o elec. & energy funds -53.1 -12.3 8.7 24.3 38.7 49.4 with elec. funds -30.2 7.4 25.3 38.5 51.4 63.3 with elec. & energy funds 54.7 50.7 56.3 61.0 72.5 76.5 -Sector Financing Plan (National Utilities and EBY) 2.31 With due regard to the fact that Yacyreta is a binational project belonging to Argentina and Paraguay (Annex 3.1.4), tut considering that the bulk of the funding for the project is channeled through Argentina, a conventional definition of sector as the consolidation of EBY (Annex 2.6.5) and the national utilities FRP (Annex 2.6.1) would result in the following financial plan: Sector Financial Plan (National Utilities and EBY) (1988-1995) US$ Million 1/ 2 Financial Requirements Investment Program 7,931.2 96 Working Capital Increase 295.0 4 Total Requirements 8,226.2 100 Financial Resources Net Consumer-based Funding 3,517.4 43 Government Contributions 1,222.6 15 Net Non-Borrowed Funding 4,740.0 58 Borrowings 3,436.2 42 Total Financial Sources 8,226.2 100 1/ In constant January 1988 prices.  - 14 - The above financing plan is viable and adequate as the assumption, used for its preparation (see para. 2.28) are reasonably conservative and the resulting funding mix is a sound one. Its feasibility during the project execution period (1988-1989) has a high degree of certainty because of commitments already made by the Government during negotiations (paras. 3.13 and 3.14). These commitments refer basically to the assumption of service payments of existing debt and annual increases of tariffs in real terms. Regatding tariffs, during the first eight months of 1988, the Government has given positive evidence of its willingness to increase tariffs in order to comply with the targets of the FRP. Besides the monthly nominal increases that have been implemented to keep up with inflation, in July a 15? average increase in the tariffs of SEGBA was carried ouit with the intention of reducing significant differences between its tariffs and those of the provincial utilities, and in early August a general increase of 30Z was established for all tariffs in anticipation of the so-called 'voluntary' price freeze under the Government's Spring Plan. The following table summarizes the present situation as compared with the December 1987 average tariff levels: SEGBA AyE HIDRONOR December 1987 (A/MWh) 168.0 79.4 66.9 August 1988 (A/MWh) 855.1 316.2 248.6 Increase (Z) 409.0 298.2 271.5 CPI (Z) 1/ 261.1 261.1 261.1 Real Increase (Z) 40.9 10.2 2.9 1/ Including an estimate of 30Z for August It is expected that by year end s.me deterioration ir real terms will occur but that tariff levels will be enough to reach the 1988 targets established under the FRP. Bank Participation 2.32 Since 1962, the Bank has made eight loans to Argentina's power sector; five of which were to SEGBA to help finance an oil-fired thermal generation plant, and transmission, subtransmission and distribution expansions; one to HIDRONOR for the construction of the 1200 MW El Chocon Hydroelectric Plant; and two to the Federal Government, the first one in 1979 to help finance the Yacyreta Hydroelectric Project and the second one, in 1987, for a Power Engineering Project which is expected to provide the basis for improving the efficiency and economy of distribution expansions countrywide. Project performance audit reports have concluded that, while the physical objectives of the first five projects were largely met, their financial objectives were not. The latest of these reports, on SEGBA IV Project (Loan 1330-AR, approved in September 1976 and completed in June 1985), indicates that the project was successful in meeting its technical and physical objectives of providing facilities to meet the growing electricity demand of the Greater Buenos Aires area, and that SEGBA succeeded in improving its overall efficiency during the period of project execution. However, because of the lower-than-eypected demand and also because of the poor financial situation of SEGBA, the project suffered a  - 15 - completion delay of 4.5 years and a 40X increase in total costs. Moreover, the Government's failure to implement adequate tariff increases prevented SEGBA from complying with its financial covenants except for a short period of time, and its financial performance was poor. 2.33 Initial execution of the Yacyreta project suffered significant implementation problems (para. 3.01), while the Power Engineering Project (Loan 2751-AR) is progressing satisfactorily. A US$276.0 million loan to SEGBA which will help SEGBA finance its transmission and distribution expansion program, improve its ope; ional performance and reduce losses, was signed in June 1988. Bank and Country Goals and Sector Lending Strategy 2.34 The Government is seeking to improve resource allocation and the efficiency of national and provincial utilities and restore the financial soundness of the sector by: (a) sharpening the delineation of responsibility for planning and implementing the expansion of electricity services for which: (i) planning for all new investments in generation and transmission facilities will be centralized in the SE; (ii) only the national utilities will implement all new generation and high voltage transmission works; and (iii) coordination between national and provincial utilities will be strengthened. (b) establishing efficiency improvement programs for the national utilities; (c) initiating a medium term program of tariff structure reform and rate increases so as to reflect economic costs over a reasonable period of time; and (d) improving the self-financing capabilities and operating ratios of the major power companies. 2.35 The Bank fully agrees with these objectives and, within such framework, its lending strategy in the sector aims at: (a) ensuring optimum allocation of scarce financial resources through: (i) confining the investment programs to projects which adhere to least-cost principles; (ii) productivity improvements; and (iii) a tariff system based on economic principles. (b) implementing an institution building plan which would streamline and improve the sector's organization and legal structure;  - 16 - (c) promoting the financial soundness of the sector, particularly the improvement of the sector's contribution to investment; and (d) helping the Government meet the large financial requirements of the sector. Rationale for Bank Involvement 2.36 The proposed operation would be the first in a planned series of sector investment loans intended to assist the Government to attain the aforementioned objectives (paras. 2.34 and 2.35). The envisaged loans would address sector issues in a phased manner: conditionality for a single sector loan would concentrate on a few key targets in the short-term (during the two to three year disbursement period), within a long-term strategy. The new approach intends to relate sector and macroeconomic policies more realistically within the constraints of existing country conditions. By improving sector resource allocation, it would also help to rationalize power investments and promote the integration of hydrocarbons and hydropower sectors in investment planning and decisions. Further, in addition to strengthening its direction of the sector and overcoming some of its most severe problems, the Government would be assisted under the proposed operation to maintain the implementation of the Yacyreta Hydroelectric Plant Project, whose financial requirements constitute the most important resource need to be resolved in the short term.  - 17 - 3. THE PROJECT Proiect Origin and Status of Preparation 3.01 The Yacyreta project, for which the Bank approved in 1979 a US$210 million loan (Loan 1?61-AR), has suffered significant implementation problems which have caused an eight-year delay in the completion schedule and i sizeable financial gap. The implementation problems began at its inception, with a protracted dispute between the Government and the Barnk over procurement procedures, and was only resolved by end-1982. Later on, works were stopped because of the South Atlantic War. The country's economic recession and high inflationary trend during 1983-1984 worsened the sector's--and the project's--financial situation. These problems were further compounded by the following events: (a) the Executing Agency, EBY, has been unable to fully secure the financing which had been foreseen at appraisal from foreign commercial banks (US$945 million), suppliers credits (US$830 million) and local banks (US$300 million); (b) the project's seven- year delay caused (i) repayment of principal of most of contracted debt to become due; (ii) increased financial charges; and (iii) foregoing of internal cash generation from energy sales (estimated at US$1,884 million at appraisal). 3.02 For these reasons and in order to seek possible economies, the new authorities, early in 1984, made a thorough evaluation of possible options regarding the fate of the project, including cessation of works. After careful consideration of engineering, economic, internal and international factors, the Government decided to complete the project, and appointed a new management with the mandate to carry out an in-depth revision and optimization of the project. This resulted in changes in project design, renegotiation of contracts with construction and engineering firms and a rescheduling of project execution to adapt the pace of commissioning of the project's units to updated demand projections. Important reductions of cost were also obtained. The Government placed great emphasis on seeking adequate financing for project completion and, in 1986, the Government requested additional IBRD/IDB financing to complete it. 3.03 Processing of a possible Bank loan had been delayed because of the uncertainties emerging from country conditions which had hindered preparation of a comprehensive and viable sector Financial Rehabilitation Plan (FRP). It was subsequently agreed to change the approach to power lending for Argentina from project specific loans to sector investment loans so as to link better Bank lending with the investment needs and financial conditions of the sector. The project was appraised in June 1988. Negotiations were held in Washington from September 26 to 28, 1988. The Argentinian delegation was headed by Mr. Ramon da Bouza, Director for External Economic and Financial Policy, Ministry of Economy. Legal Arrangements 3.04 The Borrower of the proposed US$252.0 million loan would be the Government, which would retain US$2.0 million for SE and onlend the  - 18 - remaining US$250.0 million under the same terms and conditions to EBY, which would bear the risks related to exchange and interest rates. The Bank would enter into the following legal arrangements: (a) a Loan Agreement with the Government of Argentina; (b) a Project Agreement with EBY for the transferring of US$250.0 million; and (c) a Second Owners Agreement with the governments of Argentina and Paraguay which would support obligations contained in the Project Agreement, as EBY is a binational entity. Annex 2.2.4 gives a detailed description of the institutional aspects of EBY. Project Objectives 3.05 The project would initiate a process designed to achieve the following sector objectives: (a) improving resource allocation within the sector through optimization of its expansion program; (b) implementing a Financial Rehabilitation Plan (FRP) of the national power utilities; (c) improving the efficiency of the power utilities; (d) promoting rational use of electricity through a tariff system based on economic costs; (e) strengthening the structure of the sector so as to bring about better coordination, planning and regulation; and (f) establishing policies and procedures for environmental protection and social aspects in power projects. Project Description 3.06 The proposed project consists of: (a) Sector Investment Program. This project component is the 1988-1989 "time slice" of the sector's investment program, under responsibility of AyE, SEGBA, HIDRONOR and EBY, defined on the basis of the sector expansion plan for the period 1988-1995, as presented under paras. 2.16 to 2.20. This program (Annex 3.1), which adheres to least-cost principles, includes only high priority works for the period 1988-1989: (i) ongoing generation and transmission works being carried out by AyE, HIDRONOR and EBY; (ii) generation and transmission works to be initiated by AyE in order to meet dates established in the sector expansion plan; (iii) distribution works--either under execution or to be committed in the period by AyE and SEGBA; and (iv) the carrying out of studies for futu-e works. (b) Institutional Strengthening of the SE. This project component is technical assistance to provide to the SE for a period of two years: (i) 240 staff months of specialized consultants; (ii) up to US$1.0 million equivalent of computer, and office equipment; (iii) a data base/communication link equipment between the SE and the main energy sector institutions; and (iv) miscellaneous equipment. UNDP would help with administrative support for the project. The cost of this component was estimated during appraisal at US$3.0 million of which US$2.0 million would be financed with proceeds of the proposed loan. Estimated Cost 3.07 The 1988-1989 slice of the sector's investment program has an estimated cost of about US$2,350 million (Annex 3.1.5) as shown below:  - 19 - 1988-1989 Sector Investment (in millions of current US$) National (-------Utilities