Mexico - Hydroelectric Development Project

Document of The World Bank FOR OFFICIAL USE ONLY 4L A 3 0 f 3 - A0 ZE Report N,% P-4R57-ME MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$460.0 MILLION TO NATIONAL FINANCIERA, S.N.C. (NAFIN) WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A HYDROELECTRIC DEVELOPMENT PROJECT May 16, 1989 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency unit Mexican Peso (Mex$) US$1.00 = Mex$ 2326.00 (Exchange rate as of March 15, 1989. The exchange rate is currently being devalued by 1 Mexican Peso daily) UNITS AND MEA'URES ton (T) metric ton - 1000 kg Tcal D teracalories = 98.04 TOE = 1012 calories TOE = ton of oil equivalent = 0.0102 Tcal kW kilowatt = 0 watts MW megawatt = 103 kW GW gigawatt = 103 MW kWh = kilowatt hour = 103 watt hour KWh = megawatt hour 103 kWh GWh - gigawatt hour a 106 kWh TWh - terawatt hour = 109 kWh kV = kilovolt 103 volts MVA = megavolt ampere = 106 volt-ampere bbd - barrels per day ACRONYMS CFE = Comisi6n Federal de Electricidad (Government owned national electric utility) FRA = Financial Rehabilitation Agreement (Between Government and CFE) NAFIN = Nacional Financiera, S.N.C. (Government owned national development agency) FISCAL YEAR January 1 - December 31  FOR OFmFCIAL USE ONLY MEXICO HYDROELECTRIC DEVELOPMENT PROJECT Loan and Prolect Summary Borrower: Nacional Financiera, S.N.C. (NAFIN). Guarantor: The Government of Mexico. Beneficiary: Comisi6n Federal de Electricidad (CFE). Amount: US$460.0 million equivalent. Tcrms: Repayment in 17 years, including five years of grace, at the Bank's standard variable interest rate. Onlending Terms: The loan proceeds would be relent by NAFIN to CFE, under terms and conditions which would include, inter alia, (i) the sub-loan would be denominated in US dollars, (ii) the onlending terms and conditions would be the same as the Bank loan, and (iii) NAFIN would charge a fee amounting to lOZ of the interest charged by the Bank. US dollar to Mexican peso exchange and interest rate risks would be borne by CFE, and NAFIN would bear the US dollar to basket of currencies exchange risk. Financing Plan: US$ million X CFE's own resources 733.0 51 Government contributions 100.0 7 IBRD Proposed Loan 460.0 32 Other Loans 147.0 10 Total 1,440.0 100 Rate of Return: 13% on CFE's Investment Program. Staff Appraisal Report: Report No. 7391-ME. Map: IBRD No. 20849 This document has a restricted distribution and may be used by recipients only in the performance of their offAcial duties. Its contents may not otherwise be discosed without World Bank authorization.  MfMRAWNDUM AND RZCOMMgNDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.N.C. (NAPIN) WITH THE GUARANTEE OF THE GOVERNMENT OF MEXICO FOR A HYDROELECTRIC DEVELOPMENT PROJECT 1. The following memorandum and recommendation on a proposed loan to Nacional Financiera, S.N.C. (NAFIN), for the equivalent of US$460.0 million is submitted for approval. The proposed loan would be guaranteed by the Government of Mexico and would have a term of 17 years, including five years of grace, with interest at the standard variable rate. The loan proceeds would be relent by NAFIN to Comision Federal de Electricidad (CFE), under terms and conditions which would include, inter alia, (i) the sub-loan would be denominated in US dollars; (ii) the onlending terms and conditions would be the same as the Bank loan; and (iii) NAFIN would charge a fee amounting to 10 of the interest charged by the Bank. The US dollar to Mexican peso exchange and interest rate risks would be borne by CFE, and NAFIN would bear the US dollat to basket of currencies exchange risk. 2. Background. Mexico is endowed with substantial and diversified energy resources, both renewable and non-renewable. Electricity service is under the sole responsibility of CFE, the federally-owned national electric utility. The most important problems of the power sector are: (i) pricing of electricity below economic costs, causing a weak financial situation, which in recent years has required large Government subsidies and sizeable external borrowings; (ii) failure to open CFE's procurement to international competition for the supply of goods, works and services; (iii) a relatively low level of investments in new installations in the last four years, caused by 'inancial constraints; (iv) high use of hydrocarbons for electricity generation, despite availability of more economic alternatives, due to a concentration of generation investments in oil fired thermal plants, which require lower capital costs than hydro plants; and (v) delays in investments in the distribution network, which if not corrected could soon cause lowering of electric system reliability, increase of energy losses, and increase in number of customers without meters. 3. Within the context of the National Energy Program, the Government has set out to improve the efficiency of the power sector, expand the use of hydropower, introduce pricing policies based on economic criteria, and reduce the power sector's reliance on Government funding. To achieve these objectives, the Goverment is implementing measures aimed at solving problems of the energy sector through: (i) energy conservation, particularly in the state-owned industries and utilities; (ii) energy diversification away from the current excessive reliance on hydrocarbons; (iii) significant electricity rate increases, with the objective of reaching economic costs; (iv) execution of a Financial Rehabilitation Agreement (FRA) to allow CFE to improve its finances; (v) improved allocation of investments, with important allocations to hydroelectric developments and distribution networks; and (vi) gradual opening of procurement in public enterprises, including CFE, to international suppliers. 4. Rationale for Bank Involvement. The Bank's strategy is to support the early achievement of the Government's objectives for the power sector. The proposed loan would enable the Bank to: (i) discuss with the Government the execution of its existing National Energy Program; (ii) monitor closely the financial rehabilitation of the power sector; (iii) review every year the sectoral medium term investment program and financial plan; (iv) promote measures to  strengthen the sector's capacity to deal with the environmental and aoctal issues arising from the construction and operation of power facilities; and (v) promote the opening of CFE's procurement to internatLonal competition. It is also expected that Bank participation in funding sector investment would help the Government to obtain resources required by the sector from other lending agencies and ccmnercial banks. The hydroelectric plants proposed for Bank financing, represent an important step towards the diversification of energy sources and selection of generation investments on the basis of economic criteria. Execution of the proposed project would reinitiate Bank involvement in the power sector and further l.nding is envisaged in the next five years. The Bank has been absent from the Mexican power sector since 1974, when the Eleventh Power Project was completed, mainly because it was not possible to reach agreement on measures to address CFE's financial problems and on procurement. 5. Project Objectives. The project would assist in achieving the sector's objectives of (a) promoting an efficient use of electricity through realistic pricing policies, energy conservation and improvement of sector operations; (b) diversifying sources of power generation from the now mainly oil-based generation; tc) strengthening CFE's financial condition by implementing a Financial Rehabilitation Agreement (FRA); (d) making electricity available to an increasing number of consumers; ard (e) improving CFE's capabilities to deal with social and environmental aspects of hydroelectric power projects, and ensuring that resettlement under the project is carried out in a satisfying manner. The loan would assist the Government and CFE to meet the power sector financing needs by providing funds to finance 322 of the costs of the Aguamilpa and Zimapan Hydroelectric Power Plants. 6. Project Description. The project, to be carried out in seven years by CFE, consists of: (a) construction of the 960 MS Aguamilpa (66.72 of the total cost) and the 280 MW Zimapan (32.5Z) Hydroelectric Power Plants and resettlement of the affected population; (b) development of a social and environmental program designed to strengthen CFE's capacity to construct and operate hydroelectric projects with due consideration to affected people and the environment (0.32); (c) execution of energy related studies on energy conservation and efficient use of energy, co-generation and optimization of the operation of CFE's power system (0.4X); and (d) management and electricity tariff studies (0.1Z). The two hydropower plants are part of the least-cost program and their engineering designs are at an advanced stage. The total cost of the project, excluding financial charges, is estimated at Us$1,287 million equivalent, with a foreign exchange component of US$515 million !40Z). Financial charges are estimated at US$153.0 million, and the total financial requirements amount to US$1,440 million. The executing agency, CFE, has the technical and administrative capacity to carry out the project. A breakdown of costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and of disbursements, as well as disbursement schedule are shown in Schedule B, a timetable of key project processing events and the status of Bank Group operations in Mexico are given in Schedule C and D, respectively. A map and the Staff Appraisal Report, No. 7391-ME dated May 16, 1989, are also attach3d. 7. Agreed Actions. During negotiations, the following agreements were reached: (a) updated financial goals that would permit CFE to achieve self financing ratios of 612 in 1990; 632 in 1991; 702 in 1992, and 722 in 1993, and to earn rates of return on average revalued net fixed assets in operation of 3? in 1990; 52 in 1991; 72 in 1992; and 82 in 1993 and thereafter; this will entail increases of electricity rates in real terms of 92 in 1990 and 1991, 102 in 1992 and smaller percentages thereafter; (b) CFE to request Bank concurrence for new borrowings if the debt service coverage ratio is lower than 1.5 and (c) CFE to  -3- implement a Ten-year Investment Plan; any revisions to the Plan or inclusions of major generation installations shall be economically justified and agreeable to the Bank; (d) execution of studies on CFE's management practices and operational efficiency, and a second stage of a tariff study; and put into effect their recommendations; (e) execution of an environmental and social program including specific plans for Aguamilpa and Zimapan projects, studies, staffing, training and purchase of monitoring equipment; (f) execution of energy studies and purchase of monitoring equipment related to promotion of conservation and efficient use of energy, and cogeneration; (g) to amend the FRA, setting targets consistent with the proposed financial covenant and to achieve performance targets related with the growth of number of employees, customers per employee, energy losses, efficiency and availability of thermal power plants, and to annually review the above targets; and (h) appointment of a Board of Consultants (including social and environmental specialists) to review the design and to supervise the construction of the Aguamilpa and Zimapan Projects. Condition of effectiveness would be the signature of a satisfactory subsidiary loan agreement with CFE and the satisfactory initiation of implementation of the resettlement plans for both power plants. 8. Benefits. The construction of both projects follows the sequence of least-cost expansion for the power sector. The rate of return on CFE's Ten-year Investment Program has been conservatively estimated to be 13Z. However, this fails to take fully into account the benefits from the project as (a) electricity rates are a poor proxy for benefits and consumer surplus has not been considered, and (b) the returns on the institutional and environtental measures proposed under the project, improved flood control, expansion of the area suitable for agriculture and the economies arising from opening procurement to external competition have not been quantified. 9. Risks. Despite seismic conditions in Mexico, physical risks are expected to be less than average in this type of work, as extensive geological exploration has been conducted and additional preparation studies are being carried out before proceeding with construction of both projects and the Mexicans have successfully implemented similar projects in the past. Independent experts hired by the Bank under a Consultant's Trust Fund have confirmed the technical viability and reviewed the designs and cost estimates of the two power plants, including geological conditions. Resettlement problems involving 3500 persons would be minimized by actions taken before Board presentation and to be taken before loan effectiveness and we are confident of CFE's commitment in this regard. Failure to increase electricity rates as envisioned would adversely affect sector finances and could result in delays of the execution of the CFE's investment program; but this risk is mitigated by the fact that up front rate increases have been substantial (nominal rate increases of 84Z and 24? were approved in December 1987 and 1988, respectively) and inflation has been dropping significantly in the past months. 10. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Moeen A. Qureshi Acting President Attachments Washington, D.C. May 16, 1989  -4- Schedule A MEXIC3 HYDROELECTRIC DEVELOPMENT PROJECT Estimated Costs and Financing Plan Estimated Costa/ Local Foreign Total ---_a Million US$------ Aguamilpa Projectb/ 399.7 266.6 666.3 Zimapan Projectb/ 187.0 124.7 311.7 Social and Environmental Program 2.0 1.4 3.4 Energy Related Studies and Management Studies 3.2 2.1 5.3 Base cost (January 1989) 591.9 394.8 986.7 Physical Contingency 94.2 62.8 157.0 Price Contingency 85.9 57.2 143.1 Total Project Costb/ 772.0 514.8 1,286.8 Interest During Construction 0.0 153.2 153.2 TOTAL FINANCING REQUIREMENTS 772.0 668.0 1,440.0 -6 _9 m Financing Plan: CFE's owr resources 590.0 143.0 733.0 Government contributions 130.0 0.0 100.0 IBRD Loan 82.0 378.0 460.0 Other LoansC/ 0.0 147.0 147.0 TOTAL 772.0 S68.0 1,440.0 -8 - mF a/ Inclusive of taxes and duties estimated at US$135 million. b/ Includes US$12.5 million for environmental and resettlement works for the Aguamilpa Project, and US$17.6 million for the Zimapan Project. c/ Bilateral and/or supplier's credit, to be requested at the time of bidding electromechanical equipment.  -5- Schedule B Page 1 of 3 MEXICO HYDROELECTRIC DEVELOPMENT PROJECT Procurement Method and Disbursement -------Procurement Methodl/-------- I C B2/ L C B21 Other Total Cost -- (Million of current US Dollars) -- Project Element Aguamilpa and Zimapan Projects: - Main civil works contracts 635.5 - - 635.5 (455.0) - - (455.0) - other auxiliary civil works, resettlement, - 116.4 10.0 126.4 environmental and miscellaneous works - (0.0) (0.0) (0.0) - Electromechanical equipment & - - 340.13/ 340.1 transmission lines - - (0.0) (0.0) - Engineering, administration . - 174.0 174.0 and supervision - - (0.0) (0.0) Social and environmental programs, - - 4.44/ 4.4 including training - - (1.0) (1.0) Energy and management studies, - - 6.44/ 6.4 including training (4.0 (4.0) TOTAL 635.5 116.4 534.9 1.286.8 (455.0) (0.'3) (5.0) (460.0) 1/ Figures in parenthesis are amounts financed by the Bank loan. 2/ ICB: International Competitive Bidding; LCB: Local Competitive Bidding. 3/ To be partially procured under international bidding with supplier financing or from specific countries offering bilateral financing. 4/ Includes a total of US$2.0 million to be purchased under Limited International Bidding.  -6. Schedule B Page 2 of 3 Disbursements Percent of Category Amount Expenditures (US$ million) to be Financed 1. Civil works for the river diversion 290.0 851 and main infrastructure works and the construction of the dam, spillway and powerhouse of the Aguamilpa Hydroelectric Project. 2. Civil works for the construction 124.4 85S of the intake works, pressure tunnel, dam and spilling of the Zimapan Hydroelectric Project. 3. Consultant's services related with the Aguamilpa and Zimapan Plants 0.6 100l 4. Goods, consultant's services and staff training related with CPE's Social and Environmental Program: a. Goods 0.4 1002 foreign or local (ex- factory) b. Consultant's services and training 0.6 1002 5. Goods and consultant's services related to SEMIP's energy conservation and co-generation studiess a. Goods 1.1 1001 foreign or local (ex- factory) b. Consultant's services and training 1.4 1002 6. Consultant's services related with 1.5 1002 CFE's management, tariff and system efficiency studies. 7. Unallocated funds 40.0 -- TOTAL 460.0  Schedule B Page 3 of 3 Eat imated Disbursements ------------- million USS -------------------- Bank FY 1990 a/ 1991 1992 1993 1994 1995 1996 Annual 46.0 27.0 72.0 99.0 95.0 67.U 54.0 Cumulative 46.0 73.0 145.0 244.0 339.0 406.0 460.0 a/ Includes deposit of US$35.0 million in the Special Account, and retroactive financing up to US$20 million for eligible expenditures made after August 31, 1988.  Schedule C HEXICO HYDROELECTRIC DEVELOPMENT PROJECT Timetable of Key ProJect Processinp Events (a) Time taken to prepare: One year. (b) Prepared by: CFE (c) First Bank mission: October 1986 (d) Departure of Appraisal missions November 1987 (e) Negotiations: September 6, 1988 and April 17, 1989 (f) Planned Date of Effectivenesss September 30, 1989 (g) List of relevant PCRs and PPARs: No. 859, Third Power Sector Loan (Loan 659-ME) No. 1775, Fourth Power Sector Loan (Loan 834-ME).  -9- Schedule D STATUS OF BANK GROUP OPERATIONS IN MEXICO 1/ Page 1 of 2 A. Statement of Bank Loans (As of March 81, 1989) (USS million) ____________________________.____________________________..___________________________________ Fl)csl Amount Issn Undis- Loan No. Year Borrower Purpose Cancellations bursed _____________. ___________________________________..___________________________________________ 76 loans fully disbursed 6.462.00 1706-6 1979 NAFIN Irriqation 81.00 16.14 18S8-6 190 NAFIN Irrigation 84.40 16.15 1990 1981 BANOBRAS Urban Development tI 144.16 10.01 2043 1982 NAFIN Integroted Rural D-v. 175.00 8.07 2142 1982 NAFIN Capital Goods Industry 162.30 0.40 2154 1982 NAFIN Pollution Control 18.09 4.40 2262 1983 NAFIN Agricultural Marketing 116.00 12.21 2281 1983 BANOBRAS Third Water Supply 100.30 80.34 2326 1983 NAFIN Third So/Mod Industry 17S.00 1.84 2331 1983 8ANCOMEXT Export Development 860.00 4.22 24?8 1984 BANOSRAS Highways 200.00 86.00 2460 1984 BANPESCA Ports 58.80 89.22 2626 19816 NAFIN Chiapas Agric. Dev. 66.00 42.63 2546 1985 NAFIN Sm/Med Scale Mining II 106.00 39.12 2659 1985 NAAFIN Vocational Education 81.00 28.90 2575 1985 BANO0RAS Railways V 800.00 167.34 2812 1988 BANOBRAS Low Income Housing I 160.00 28.07 2668 1986 NAFIN Proderith II 88.380 1.20 2665 19886 BANRAS Earthquake Rehab 400.00 88.56 2666 196 BANOSRAS Municipal Strengthening 40.00 36.62 2869 19"6 SANOSRAS Solid Weste Pilot 26.00 19.68 2746 1987 8ANCOMEXt Trade Policy Loan I 500.00 10.69 2746 1987 NAFIN Industrial Recovery 150.00 65.88 2747 1987 NAF1N Technology Development 40.00 84.67 2777 1987 8ANCOMEXT Export Development II 260.00 88.16 2824 1987 BANOBRAS Urban Transport 125.00 101.12 2887 19"7 NAFIN Agricultural Credit 400.00 61.6S 2868 3/ 1987 NAFIN Sm/Maed Industries Tv ioo.oo IOO.OO 2869 1987 NAFIN Aricultural Extension 20.00 16.96 2876 1987 BANOBRAS Hihway Maintenance 135.00 126.00 2876 1988 NAFIN Manpower Training 80.00 68.68 2916 1988 NAFIN Steel Sector R-struct. 400.00 342.63 2918 19W8 NAFIN Agricultural Sector Loan 800.00 201.99 2919 3/ 1988 NAFIN Fertilizer Sector Loan 265.00 265.00 2946 3/ 1988 BANO0RAS Ports RehabilItation 60.00 50.00 2947 3/ 1988 BANO0RAS Houaing Finance 800.00 800.00 Total 11,459. 6 Of which has been repaid 3,112.86 Total now outstanding ,8346.80 Amount sold 92.84 Of which has been repaid: 92.84 0.00 Total now held by Bank 2/ 8,846.80 Total undiabursed 2,449.18 1/ The status of the projects listed in Part A ir In a separete report on all Bank/IDA financed projects in execution, which Is updated tvice yearly and circulated to the Executive Directors on April 80 and October 31. 2/ Prior to exchange adjustment. 3/ Not yet effective.  10 - Sclhedule D MEXICO Page 2 of 2 i. Statemnt of IFC Investments As March 81, 1989 (USS Million) -----------------------------------_-----_-_----_------_-_-----__---_--------__------.------------------- Flical -----Original Approvals--------- Year Obilgor Type of Susineos Loan Equlty Total