Argentina - Buenos Aires Power Project

FIDLE COPY R E S T R I C T E D Report No. P-274 This report was propared for use within the Bank. It may not be published nor may it be quoted as representing the Bank's views. The Bank accepts no responsibility for the accuracy or completeness of the contents of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO SERVICIOS ELECTRICOS DEL GRAN BUENOS AIRES IN THE REPUBLIC OF ARGENTINA January 11, 1962  ThNI.lT'ONATA ?41BK FOR R`:CONSTRUOCT'ON PND DEITEuOKYENT URPORT AND RECC;zIEADATIONS OF THE PFLE3IDENT TO if HE PE)CUTTVE DIRECTORS ON A PROPOSED LOANi TO SERJICiOS ELECTRICOS DEL GRAJ BUENOS AIRES IN THE REPUBLIC OF AIRGENTINA I submit the following report and recommendations on a proposed Lcan in various currencies, equivalent to 0`95 million, to Servicios Electricos del Gran Buenos Aires (SEGBA), to assist in financing the expansion of power facilities for the Buenos Aires area. PART I. HISTORICAL BACKGROUND 2, The first Bank mission to Argentina in 1957, soon after Argentina joined the Bank, concluded that the development of power, particularly for tha Buenos Aires area, was of nigh priority. Shortly after its inaug- uration. the Frondizi Government asked the Bank to assist in financing essential power development. The Bank and the Government agreed that the first step towards consideration of a specific project should be to survey the entire power sector to determine rela.tive priorities and lay the basis for an orderly program of investmnent. 3.. A survey of this kind, financed by the United Nations Special Fund and carried out under the direction of the Bank, was completed in the sumner of 1960. Its principal conclusions were that Argentina's -ieatest need for pnwer was in the Buenos Aires area., and that the most efficient way of eliminating the snortage there was the prompt completion of' the Dock Sud thermal plant, begun in 1958 by the interim government which s.icceeded Peron. Work on this plant and the related system of inter- ccnnect-ion was being seriously delayed, not only by inadequate planning, but also by the inability of the Government to provide the substantia). sums needed to cover tne 'iocal currency costs in addition to the mayments lue on the short-termr external credits which tile interim gorernment had obtained to finance the requisite imported equipment and supplies. 4 ~ Upon receiving the conclusions of tne Power Survey, the Frondizi Government strongly appealed to the Bank for financial help to complete the Dock Sud project, The Government also expressed its desire to reverve the policy followed by its predecessors and to return power properties to the private sector as rapidly as possible, thereby relieving the Govern- ment of corresponding financial and managerial burdens and perinitting ic to concentrate more effectively upon its other responsibilities. It poonted out that financial assistance for Dock Sud would not only fac'li- tate the completion of this key project, but would also be a prerequisite or any plan for returning to the private sector the responsibility for power in the Buenos Aires area.  5. After careful study of the problem by the Government and the Bank staff, it became clear that sufficient private capital could not be ratsed in Argeritina in time to finance a 3ubstantial portion of the cost cf completing the project, and that a company owning only the Dock Sud generating plant would have littlc basis for growth and, hence, for attracting private investors. On the other hand, a new company having the primary responsibility for both generation and distribution of power in the Buenos Aires area, established on the basis of a financial plan which would permit it to meet debt service out of earnings and to pay a satisfactcry return to private investors, might gradually attract private capital. Mioreover, such a company would provide a basis for achieving a sound technical and economic organization of the supply of power in the Buenos Aires area, In January 1961, President Frondi.zi vested in Dr. Federico Pinedo, an Argentine elder statesman, the responsibility for devising a plan for solving the Buenos Aires power problem along these lines. 6. Because of the arrangements which had already been made by thc interim government for firancing the foreign excnange requirements of the Dock Sud project, it was clear that the Bank could not assist in financing its completion without making some exception to its usual practices. In view of the great importance for Argentina's economic development of the objectives sought by the Government, I felt that the bank should. be prepared to make some exception if these objectives could thereby be achieved. 7. I therefore inforned the Argentine Government in July 1961 ol my willingness to recommend that the Bank, as a very exceptional matter, should assist in financing part of the local currency cost of the Dock Sud projoct, provided the following conditions could be met: a. that responsibility for completion and operation of the project he turned over to a new company whieh would assume primary responsibility for the develop- ment of power in the Buenos Aires area and which would have sound professional management and reason- able prospects of becoming privately owned; and b. that arrangements be negotiated witil tne British creditors to stretca out the existing suppliers' credits and to postpone furtner amortization until the Dock Sud plant could be completed and put into operation. 8. It was not until November 1961 that the work of Dr. Pinedo. and of the many others wao had also participated, provided the basis for a final missicn to appraise the results acnieved. The documents subnxit.ed  - 3 - rith this report indicate the substantial measures which have been taken in Argentina to pave the w-ay for final negotiations of the Loan and Guarantee Pgreements. Corcurrently, Argentine officials are concluding with British creditors final negotiations for refinancing these credits before January 23, 1962, when the next large amortization payment would otherwise become due. 9. Final negotiations began on January 2, 1962, with AmbasEador Enilio Donato del Carril representing the Government, and Ing, Luis Cotclli, Executive Vice President, Ing. Alberto Kurlat and Dr. Augustin Lazaro representing the Borrower. 'O. The Bank has made one loan to Argentina for highway constru)cton and maintenance for the equivalent of Th86 million. The Bank also has under consideration requests to finance part of the foreign exchange cost of the first phase of a program for rehabilitatina the Argentine Railways and the foreign exchanae cost of a privately-owned steel mill. PART II. DESCRIPTION OF THE PROPOSED LOAN 11. Borrow.Ter: Servicios Electricos del Gran Buenos Aires (SEGBA). Guarantor: The Argentine Republic. Amount: The equivalent in various currencies of '95 million. Purpose: To finance (a) part of the local currency cost of cGmplet-ng the Dock Sud thermal plant and the related interconnection, (b) the foreign exchange cost of the distribution system expansion, of engineering services, and of shipping and insurance, and (c) interest and other charges on the Bank loan during the flirst two years of construction. Terms and Amortization: 25 years; 44 semi-annual inotallments from March 1, 1965 to Septembei 1, 1986. Interest 1-l'ate: . 5-3/4;1. Commitment Charge: 3/4 of 1% per annum. Payment Dates: ,i'arch 1 and September 1.  PART III. LECAL INSTRU1ENTS AND AUTHCRITY 12 Attached are a draft of the Loan. Agreement between SEGHA an.d the Dank (No. 1), and a draft of the Guarantee Agree.nent between the Argentine Republic and the Bank (No. 2), proviu'ing for th.e propcsed Lcan. Also attached is the report of the Comnittee provided for in Article IIIu Sec- tion 4 (iii) of the Articles of Agreement of the Bank (No. 3). ]3. The draft Loan Agreement follows the general fcrm of Bank Loan Agreements for power projects but contains a number of special provis.ionr and conditions of effectiveness to wihich attention is directed in Part IV of th4s report, Particular attention is drawn to Secticn 5.15 which con- tains the security arrangements. Because SEGBAts assets are at this time free of any lien whatsoever, Section 5.15 provides only that if SEGBA should wish to give a lien to a subsequent third party creditor SEGRA must give a prior lien to the Bank and that this undertaking must be recorded in the proper registries in the Argentine in order fully to protect the Bark0 Bcfo;'e the Loan becomes effective, the Bank will wish to be assured that A,rgentine law permits, as is understood to be the case, the registra- tiorn of this undertaking and that the registration fully protects the Bank from any subsequent third party mortgagees. 14j. The standard withdrawal provisions in the Loan Regulations have becn modified to permit disbursements on the basis of a percentage to be aqreed from time to time between the Borrower and the Bank for the part of thle Loan to finance lccal currency expenditures to complet'e the Dock Sud -lanL and the interconnection bystem, 15, Special attention is drawn to Sections 2.02, 3.06 and 3.07 of the dlafir Guarantee Agreement. Because SEGBA is treated as a private entity, the guarantee of the Guarantor is a guarantee of repayment and not of performance. Howevei, the Guarantor, as sole sharehold.er oIf SEGBA. undertakes in Section 2,C2 to provide any additional funds needed to com- plete the Projects, either in the form of equity or otherwise. Section 3,o6 contains an undertaking by the Government to take any action both as Go-vernment and as shareholder to enable SEC-BA to perform its obligatioris, Section 3.07 contains the principles with respect to the gradual achieve- m3nt of private ownership and control of SEGBA through the sale to the public of SFGBA stock. 16v The Government of Argentina is authorized to incur the proposed loan under Law No. 16432 of November 31, 1961. PART IV. APPRAISAL OF THE FROPOSED LOAN Justification of the Project 17e A detailed appraisal of the Project (TO 306a) is attache'd (lo. 4).  - 5 - 18, The Greater Buenos Aires area is the residence of clcse to seven million people or about one-third of the total population of Argentina, This area is the most important industrial and commercial center of the coantry. 19. The shortage of electric power in the Buenos Aires area has become increasingly severe during the past decade and has seriously limited the ability of industry and co,mmerce to operate, much less to expand. For years power consumption by connected consumers has -been sharply restricted and prospective consumers have been unable to obtain service. In 1960 the peak load on the public utility system of 900 1MW was estimated to be 300 ITP1 belcw actual system demands. That the shortage is much larger is evidernced by the existence of some 500 T1Wl of generating capacity which has been installed in consumer-owned plants during the past decade because of inability to obtain service from the public system. Difficulties have been compounded by the inadequacy of the transmission and distribution system) which results in sizeable voltage drops. 20., The new generating and distributing facilities included in the Project will eliminate the power shortage in the Buenos Aires area by 1964. The Dock Sud power station, togetner ,vrith additional generating units to be added to two existing generating stations, should be adeouate to serve the rapidly growing needs of the area until about 1970i While the cost of the station is somewhat higher than it would have needed to be, because of the unsatisfactory manner in w1hich the work has hitherto been conducted, the proposed installation still constitutes the most efficient and economical method of providing this additional capacity. 21. Aside from dealing with the immediate power shortage, the Project lays the basis for a new approach to a rational growth of facilities to meet tl-e ever-increasing needs of the Buenos Aires area. Except for the tacilities of one foreign--o.ned company, responsibility for all c'enerating, transmission and distribution has been vested in a single company, -vith the managerial resources capable of planning, executing and operating the facilities the area will need and with growth prospects sufficient to attract private capital, The _orrower and Arrangements for Management 22. The proposed Borrower would be Servicios Electricos del Gran Buenos Aires (SEGBA) reorganized by the Government by Resolution 3259 of December 29, 1961, in order to achieve the objectives set forth in para- graph 4 of this Report. The basis for the new company was laid when the Government bought out the remaining foreign,-held shares in the rreviously existing company of the same name. In addition to the generating, trens- mission and distribution facilities it inherited from its predecessor, OEGBA would be given title to the Dock Sud thermal plant, the related interconnection, and the distribution system in fourteen districts of the  - 6 - northwest sector of Buenos Aires. Completion of arrangements for these transfers would be conditions of effectiveness of the Loan. (Section 701 /Fb_/ of the draft Loan Agreement)., 23. The Government has agreed to the terms of the concession to be given to SEGLA and the steps required to put it into effect are being taken. ComDletion of these steps wTould be a condition of effectiveness of the Loan (Section '7.01 Fc 17). Section 6.02 (b) provides that a change in the concession without prior bank consent would be an event of default. The concession would give SEGBA the right to tariffs wvhich wTould allow a return of 8% on the value (expressed in dollars) of net fixed assets in service at the end of each year. T'he company would be able, with prior notice to the Government, to alter its tariffs to meet this test should there be any change in its conditions of operation. The soundness of' the new concession is evidenced by the fact that SEGBA would be able to finance from internal resources 37% of its expansion program for the period 1962-64, which would practically double the capacity of the ccmpany in that period. The provisions on dividend policy (Section 5.12 is cf special interest) and on limitations to additional indebtedness beyond the proposed Bank Loan (Section 5.14) are intended to protect the strong financial position emerging f'rom these arrangements. SEGBA's concess3ion would prot-ct the company against being required to purchase power from other sources at higher cost than it would cost to generate power from its owln f'acilities. In addition the Argentine Government has given assurances that it will consult fully with the Bank before undertaking any substantial power pruject for supplying power to the Buenos Aires area. (See attachment No. 5). 24. Although all of the common stock of SEGBA is now owned by the Argentine Governmenit, it will be placed in escro7 writh the Banco Industrial of Argentina which will have instructions to sell it to the public as market conctitions permit. Completion of satisfactory arrangements to this end would be a condition of effectiveness of the present Loan and changes in these arrangements. wirthout. prior Bank consent, would be a condition of default (Sections 6.02 /-a 7 and 7.01 rd 7 of the Loan Agreement). SEGBA's capital is so large that there is little hope that a majority of the shares can soon be sold to private investors. However, the principal objectives which the Government seeks in returning the power industry in the Buenos Aires area to the private sector have been largely achieved by establishing the financial independence of SEGBA and the arrangements made for its managemr.ent. 25, Responsibility for operation of the company has been vested in a highly-qualified group of Argentines under institutional arrangements designed to ensure their freedom of action in the executive direction of the company. The draft Loan Agreement would provide for continuation of these arrangements. (Section 5.04, Section 6.02 /_b 7 of the Loan Agreement)  - 7 - Source of Financing for the Project and Method of Procurement 26. The total cost of the program (from January 1, 1962 to comple- tion) is estimated at about :;292 million. SEGBA plans to meet 12 million of the cost out of sales of new comlmon stock and G109 million from internial cash generation. The balance of the financing required ..ill be met by the British and other supplier credits already obteined in the amount of 1$76 million and by the proposed Bank Loan of $V95 million, Although these sources should provide funds adequate to complete the project, the Govern- ment w-Jould agree in Section 2.02 of the Guarantee Agreenent to make aidi- tional funds available if they are need.ed for the purpose. 27. Of the $95 million provided by the proposed loan, T60 million would finance part (presently estimated at 71%) of the cost of local l.abor and services needed to complete the Dock Sud plant and the relat.ed inter*- connectlon, for which all equipment and material has already been procured. 3-5 niillion would finan-ce the renaining foreign exchange cost of tile pro- ject, including 0-$24 mil]ion to finance the importation of equipment for the expansion of the distribution system, 0$h4 million for shipping and Lrsur:ance, .$2 million for engineering and $5 million f,or interest on our lcan during the first two years of construction. 28. Imported equipment financed by the proposed Loan would be pro- cured on the basis of international competitive bidding. The Government has agreed to permit SEGBA to inport such equipMent paying only customs duties, iwhich are low, but not the very highi custoras surcharge. Justification for Local Currency Financing 29. The special circumstances which justify the Bank in assisting in finarncing the local currency costs of the Dock Sud plant and related inter- ccnnection, already indicated in previous sections of this report, ma- se hmiefly recapitulated as follows: (a) Prompt completion of the Dock Sud plant and the related interconnection, as well as expansion of the distribution system, was found by the Power Survey to be of highest priority in the economic recovery and development of Argentina, and this is still the case., (b) The normal ccUrse of action by the Bank in such a case would be to provide financing for the foreign exchange component of the investment, but in the case of the principal works included in this project (the Dock Sud plant and related interconnection) this function has already been discharged by supplier credits.. Hence the only effective way for the Bank to help these vitally important works is to cover part of their local currency cos tsC;  - 8 - (c) The newST arrangements ..hich have been made an integral part of the proposed loan operation TTould give the Buenos lires area a sound and well administered power organiza- tion capable of planning and efficiently carrying out a long-rarge, financially self-sufficient program of power development. These arrangements are essential if the Government is to implement its policy of returning to the private sector responsibility f'or pow;er production and distribution in the Buenos Aires area. Economic Situation 30. A report on the "Current Economic Position and Prospects of Argent-nal (JH-lla) is attached. (No. 6). Dl. The report points to the fact that under the "new economic policy" wihich the Government initiated three years ago, the Government's fina.cos have been improved and important steps are being taken to reduce the deficits of the state enterprises. In the much improved financial and political environnment which has been developed in this period, large sectors of the economy have been restored to more effective working order and output levels have beern raised. Some of the acute financial problems of the moment can be traced to the very pace at which investment and economic activity have been expanding. But difficult and fundamental economic problems still remain. Among them the most crucial are these: Agr-culture, from whichl virtually all of Argentina's exports derive, has not been expanding; industry continues to cperate on a high cost, highly protective basis; and much remains to be done to put state enterprises on an efficient and financially sound footing. 32. To make up for the capital consumption and misguided economic pclicies of years past, Argentina must now make a major investment effort. Grossly deficient ernergy and transportation facilitics Imlust be improved and vworks in progress to enlarge the industrial base must be completed. The newb investments, if wisely chosen and supported by proper policies, wi11 help bring about the increased growth and economic strength needed to enable Argentina to meet the obligations incurred and to provide the resources fo. further development. However, the existing external debt is already a heavyy burden, requiring payments during the next three years amounting to some 25-30% of current foreign exchange earnings. This would drop to about 11% by 1967, but, in addition to thne proposed loan, other large new externa'l borrowings to finance investment in the public sector are in prospect. Althcugh the full burden of service on these new loans would be felt only aftei some years, new commintments on this scale threaten to extend further and further into the future excessively high levels of external debt ser- vice.  - 9 - Prospects of Fulfillment of Obligations 33. The fi.nancial strength and the arrancements for sound administra- tion of the new SEGDA should enable it to carry out the project efficiently and on time. SEGBA should also be adle to -provide the local c-urrency equivalent of service on the proposed Loan and its other obligations. 34t IUhiie it will not be easy for Argenti.na to provide th-e foreign exchange needed to service the proposed lo;n and its other external obliga- tions, I believe she will be able to do so, notwithstanding the high level of debt service and the difficult position described in ,he economic re-ort. Argentina has an excellenit past record of debt service and I am impressed by the resolute manner in which the Goverr-nent is facing un to its basic economic problermis. However, if Argentria is to maintain her external exedib. the Government must take even more vigorous and effective -measures to deal with its remmaininn fundamental econornc ;problems, with increasing emphasis on the development of agricultural and othi-er exports, and miulst direct its investments to high priority projects wvithin the framework of a soind overa'l financing plan. A recormiendation from me for further Bank lending would depend uz.on my conviction thrat the Argentine authorities are follo-.Fing this patn, PARTn 1J. GOPLIMCE JWIT-i ARTTCLE.S OF AGREEI134T 35S I a2r satisfied that the proposed Loan would conply with the '.iticles of agreement of the Bank. PALT VI. R100DOKB-DATICON- 36. I recommend that the Bank make a Loan to Servicios Blectricos del Gxan EBuenos Aires (SEPIA) in an amount in various currencies equivalent to 09 million for a term of 25 years including a grace period of about 3 years, with interest (including comnission) at 5-3/4% per annum, and on such other terms as are specified in the attached Loan and Guarantee Agreements and that the Executive Directors adopt a resolution to that effect in the form attached (Nt. 7). Eugene R. Black President lWashington, D.C. uanuary 11, 1962