Peru - Petroleum Production Enhancement Project

Document of The World Bank FOR OFFICLAL USE ONLY Report No. 11457 PROJECT COMPLETION REPORT PERU PETROLEUM PRODUCTION ENHANCEMENT PROJECT (LOAN 2195-PE) DECEMBER 21, 1992 Energy and Industry Division Country Department I Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used bv recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  I  FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation December 21, 1992 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Peru Petroleum Production Enhancement Project (Loan 2195-PE) Attached is a copy of the report entitled "Project Completion Report on Peru - Petroleum Production Enhancement Project (Loan 2195-PE)" prepared by the Latin America and the Caribbean Regional Office. Implementation of the project took place during Peru'. mounting economic crisis. As a result, expected local funding and co-financing did not materialize -- 39Z of the Bank loan itself was cancelled -- and the project was only partially completed. Only a third of the recoverable reserve target was proven under the project. The financial performance of the project agency has been poor and the sector policy objectives embedded in the project were not achieved. While useful studies were carried out and training objectives were met, the project is rated unsatisfactory, its institutional impact as partial and its long-term sustainability as uncertain. A separate Project Completion Note will be prepared to cover that part of the loan (US$ 20 million) which was reallocated to finance an emergency infrastructure reconstruction program. As far as the balance of the loan is concerned, the attached report is thorough and informative. Part II was taken from the final report prepared by the Borrower. No audit is contemplated at this time. Attachment I This docunmnt hus a restricted distribution and my be used by recipients only In the perfornnco of I thefr official dutles. Its contents my not otherwise be discLosed without World Bank suthorizatIon.  l  FOR OMCIAL USE ONLY .PROJECT COMPLETION REPORT PERU PETROLEUM PRODUCTION ENHANCEMENT PROJECT (LOAN 2195-PE) TABLE OF CONTENTS PREFACE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i EVALUATION SUMMARY. . . . . . . . . . . . . . . . . . . . . . . . . .ii PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE . . . . . . . . . .1 1. Project Identity . . . . . . . . . . . . . . . . . . . . . . .1 2. Background .1...... .. .. .. .. .. .. .. .. . . . 3. Preparation ......................... . 6 4. Implementation ....................... . 10 5. Results ........................... . 15 6. Financial Performance of PETROPERU . . . . . . . . . . . . . . 17 7. Sustainability ....................... . 19 8. Performance ......................... . 20 9. Lessons to be Learned .................... . 23 PART II: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE . . . . . . . 25 PART III- STATISTICAL INFORMATION .33 1 Related Bank Loans ............. . 33 2 Loan Processing Timetable ............ . 34 3 Actual and Forecast Project Timetable . ... ... . . . . . 35 4 Actual and Forecast Costs and Sources of Financing . . . . . . 36 5 Actual and Forecast Disbursement Timetable . . . . . . . . . . 38 6 Actual, Revised, and Forecast Allocation of Proceeds . . . . . 39 7 Project Results and Net Present Value . . . . . . . . . . . . 42 8 Petroleum Production and Balance .... ...... . . . . . 45 9 Actual and Forecast Financial Results . . . . . . . . . . . . . 46 10 Status on Loan Covenants ............ ..... . 48 11 Use of Bank Resources . . . . . . . . . . . . . . . . . . ... 51 This document has a restricted distribution and may be used by recipients only in the performance of their offcial duties. Its contents may not otherwise be disclosed without World Bankt authorization.|   PROJECT COMPLETION REPORT PERU PETROLEUM PRODUCTION ENHANCEMENT PROJECT (LOAN 2195-PE) PREFACE This is the Project Completion Report (PCR) for the Petroleum Production Enhancement Project, for which Loan 2195-PE in the amount of US$81.2 million was made to Petroleos del Peru (PETROPERU), S.A. with the guarantee of the Republic of Peru. The project was designed to increase proven oil reserves and production at the Laguna- Zapotal fields, located on the north coast of Peru, and to improve capabilities of PETROPERU to prepare and implement petroleum development projects. The project also included training for PETROPERU staff. Although the loan was approved on August 10, 1982 and signed on September 17, 1982, the Bank did not declare it effective until July 28, 1983. Shortly afterwards, the Government requested and obtained Bank approval to reallocate US$20.0 million of the loan proceeds to help cover the cost of an emergency program to reconstruct infrastructure damaged as a result of torrential rains in 1982-1983. The Bank also reallocated US$22 million and US$38 million from Loans 1771-PE and 2091- PE, respectively, to help fund this emergency program. This PCR does not cover the emergency program. Because Peru discontinued payment of debt service, the Bank suspended disbursements on all loans to Peru in May 1987. The loan was closed on June 30, 1987, the original closing date. The last disbursement was on January 26, 1988. The Bank canceled the undisbursed balance of US$31.8 million (39% of the loan amount) on August 23, 1989. The PCR was prepared by the Energy and Industry Division of the Latin America and the Caribbean Regional Office (Preface, Evaluation Summary, Parts I and III). Part II is taken from the final project report prepared by PETROPERU in October 1990. Preparation of the PCR started in late June 1991, and is based, inter alia, on the Staff Appraisal Report, supervision reports, the Loan and Guarantee Agreements, plus correspondence between the Bank and the Borrower, internal Bank memoranda and a short visit to Peru in June-July 1991.   - ii - PROJECT COMPLETION REPORT PERU PETROLEUM PRODUCTION ENHANCEMENT PROJECT (LOAN 2195-PE) EVALUATION SUMMARY Introduction 1. Descriotion. In support of the Petroleum Production Enhancement Project, the Bank loaned Petroleos del Peru (PETROPERU), S.A. , the state-owned petroleum company, US$81.2 million (Loan 2195-PE; 1982). This project aimed at increasing proven oil reserves and production at the Laguna-Zapotal fields by almost 40 million barrels over the life of the project (1983-2002) and improving the capability of PETROPERU to prepare and implement petroleum development projects. In connection with the first objective, there was a drilling (or enhancement) component, involving the drilling of 159 new wells and the reactivation (or recompletion) of 76 old wells (Part A); the second component consisted of consultancy services for studies and training (Part B) (para. 3.04). At the request of the Government and PETROPERU, the Bank redefined (December 1983) the project to include Part C, an emergency repair component; and made a corresponding reallocation (US$20 million) of the loan proceeds. 2. PETROPERU drilled 161 new wells and reactivated 51 old wells (para. 4.02). Actual and expected implementation periods were 77 months and 55 months, respectively; actual and expected completion dates were December 1989 and December 1986, respectively. Project implementation was delayed because there was a huge natural disaster (1982-83), coupled with late compliance with effectiveness conditions (July 1983, almost one year after loan approval). There was further delay due to financial constraints, complex local procurement procedures, and close supervision by a host of Government agencies (1984-85) (paras. 4.06-.15). The pace of implementation was satisfactory in 1986 but slowed significantly thereafter following the Bank's decision to suspend disbursements on all loans to Peru (see below). Results with respect to increased proven recoverable reserves (13.5 million barrels) were marginal (para. 5.01). 3. Cost and Sources of Financino. The actual and forecast pro- ject costs were, respectively, US$164.4 million and US$241.2 million (in current prices); but these values, which did not include the cost of Part C, are not fully comparable because PETROPERU did not complete certain project components due to financial constraints. Further, the shortfall with respect to increased proven reserves (- 66%) makes the completed and expected projects quite different (para. 4.01). The Bank suspended (May 1987) disbursements on all loans to Peru due to mounting arrears, and later canceled the undisbursed balance (August 1989) (para. 4.16). 4. According to PETROPERU, Bank financing for the project (Parts A & B) amounted to only US$42.1 million, 48.2% less than expected (para.  - iii - 4.04). PETROPERU and co-financiers provided the balance of financing, respectively, US$85.8 million (or 114.5% more than expected) and US$37.4 million (or 68.8% less than expected). The shortfall with respect to co- financing was due to the reluctance of foreign commercial bankers to make additional loans to Peru and Latin America in circumstances of financial deterioration (para. 4.05). 5. Although the records of PETROPERU indicate disbursement on Parts A and B amounting to US$42.1 million -- and this figure is reflected in the above project cost data -- the disbursement records of the Bank indicate a sum of US$42.6 million. The difference (US$0.56 million) appears to have its origin in differing understandings with respect to the final use of similar equipment purchased in connection with Parts A and C (paras. 4.17-.18). Including Part c, total disbursements amounted to US$49.4 million. Sector Issues. 6. Role of the Government. At appraisal, the Bank questioned the dual (and sometimes contradictory) role of the Government as sector policy maker/regulator and owner/operator of an enterprise with revenue-earning objectives. The contradiction was (and is) due to the Government's use of PETROPERU, which is a state monopoly, as a vehicle for implementing social policy. In other words, the Government established policy with respect to petroleum price levels, and PETROPERU implemented that policy. i.e., PETROPERU was forced to subsidize the domestic prices of petroleum products. This policy worked to the financial detriment of PETROPERU throughout the 1980s. 7. The Bank did not condition the loan to a clarification of the role of the Government because of the urgent need for increased proven reserves and because of political constraints in Peru (para. 3.09). There was a long history of close Government supervision of the power and petroleum subsectors, and in the early 1980s, the political climate of Peru would not have countenanced free-market reforms: deregulation of petroleum prices, privatization of certain PETROPERU assets, opening of all aspects of sector to private capital, and increased financial and operational autonomy for PETROPERU. The subsequent technical financial and operating performance of PETROPERU was below expectations. To establish the proper framework for recovery, those reforms are the central objectives of a proposed Privatization Adjustment Loan. 8. Domestic Petroleum Prices and PETROPERU Finances. At appraisal, the Bank conditioned loan approval to the implementation of an agreed program to bring domestic petroleum prices in line with international prices by the end of 1982. Further, it repeated the financial covenants of an earlier loan (1806-PE) which established target levels of financial performance for PETROPERU (debt-service coverage, debt-equity and "quick" ratios) (paras. 3.10-.12). The Government complied in substance with this program by January 1, 1983 and made a  - iv - substantial effort thereafter to maintain petroleum product prices in line with international comparators until 1985, when it abandoned this effort altogether (paras. 2.18-2.21). The financial consequences for PETROPERU during the balance of the decade were disastrous. The Bank deferred taking action until 1987, when it suspended disbursements on all loans to Peru. 9. During 1982-1986, the expected period of project implementation, the factors underlying the financial performance of PETROPERU were so different from what had been expected that comparison of summarized revenues and expenses is not a fully useful exercise. For this period, the actual summarized volume of domestic sales was 32% below the expected level; PETROPERU'S summarized production was 11.5% less than expected; and the summarized production of the foreign oil companies, which was shared 50-50 with PETROPERU, was 18.7% less than expected. The shortfall of production directly and adversely affected the financial performance of PETROPERU. Also adversely affecting its financial performance were the declining trends of domestic product prices (after 1985), the increasing share of petroleum revenues taken by the Government, and the decreasing level of export prices. These phenomena occurred in circumstances of very high inflation (para. 6.01). Also limiting the usefulness of comparisons were changes in accounting principles after appraisal to reflect more fully the impact of inflation. Comparison of actual and forecast sources and applications of funds was not possible due to lack of data (para. 6.03). Comparison of covenanted and actual key financial ratios was not always possible. PETROPERU was not in compliance with these covenanted ratios (para. 6.05). Proiect Issues. 10. Proiect Management and Co-financing. To avoid the delays which plagued an earlier petroleum project, the Bank and PETROPERU agreed that a special project unit (PPU) would supervise the operations of a project management service company (PMSC), which would have day-to-day responsibility for implementing the project. The Bank conditioned effectiveness of the loan agreement to the proper staffing of the PPU and the contracting of a suitable PMSC (para. 3.13-.16). Substantial delay attended the selection of the PMSC, contributing to late loan effective- ness (paras. 4.08-.09). The Bank was satisfied with the performance of the PMSC (para. 8.16-.17); PETROPERU did not fully share this satisfaction (para. 8.17, Part II, paras. 13-16, pp. 28-31). 11. As part of a larger effort to assure adequate levels of financing for the project, the Bank conditioned presentation of Loan 2195- PE to its Board to satisfactory progress with respect to arrangements for co-financing. During negotiations, the Government informed the Bank of preliminary commitments for US$60 million from the import-export banks of Japan and the United States. The Bank accepted these commitments as satisfactory progress; and the Board approved the loan (para. 3.17). Subsequently, efforts to obtain co-financing from commercial banks were  not successful due to widespread reservations concerning the deteriorating financial situation of Latin America and Peru (para. 4.05). 12. rocurmont. At appraisal, the procure_ent requirements of the Bank were discussed and agreed upon with PETROPZRU (para. 3.18). However, local procurement regulations proved to be cumbersome and a source of delay (para. 4.12-.14). ResultB. 13. Reserves, Studies, Trainina. etc. As measured by actual and forecast increased proven reserves over the life of the project (13.5 million barrels of oil vs. almost 40 million barrels of oil), results were marginal (para. 5.01). With Bank agreement, PETROPERU assumed the task of studying adjacent fields for similar projects, as it felt the work of the consultant was too general and too theoretical. The Bank had some reser- vations about the studies carried out by PETROPERU (para. 5.02-.03). The training component achieved its objective of strengthening PETROPZRU (para. 5.04). Achievements with respect to other project objectives -- prompting rapid resource exploitation; promoting efficient resource man- agment and realistic pricing policies; and attracting foreign investment to the hydrocarbon sector -- were disappointing due to the macroeconomic and sector policies of the Administration of President Alan Garcia (para. 5.05). Also disappointing was the return on the project. If taxes and other revenue divisions (Government) are no deducted from the stream of net benefits, the return on the project (economic) is 18.4%. The appraisal estimate was 103%. If taxes and other revenue divisions are deducted from the stream of net benefits (amounting to the appraisal estimate of 55% annually), the return on the project is -9.4%. The appraisal estimate of the return on the project (financial) was 35%. The lower levels of proven reserves and petroleum prices (US$20/bbl. vs US$31/bbl.) is the cause of the lower returns. PETROPERU calculated the net present value (financial) of the project at US$15.3 million using a discount rate of 20%, but this calculation, because its includes adjustments to the cost and benefit streams for investment expenditures (only PETROPERU's), interest payments, tax reductions related to depreciation, and loan amortization, does not resemble the Bank calculation (para. 5.06 and Part II, p. 24). Performance. 14. Government and PETROPERU. The performance of the Government and PETROPERU were weak. The macroeconomic, petroleum pricing, and taxation policies of the Government were directly responsible for the deteriorated financial and technical condition of PETROPERU and the non- completion of certain project components. The dual (and contradictory) roles of the Government as sector policy maker/regulator and owner/operator of a revenue-earning enterprise explain the over-staffing and low efficiency of PZTROPERU. The heavy administrative hand of a host of Government agencies together with the complex administrative procedures of PETROPERU materially delayed implementation. The Bank was satisfied  - vi - with the performance of PETROPERU during project preparation and with the performance of the PPU during the later stages of implementation (paras. 8.02-.08). 15. The Bank. The performance of the Bank was mixed -- strong in some areas, weak and tentative in others. The Bank addressed the right issues, sector and project, during appraisal; but during implementation, the Bank was forbearing with respect to the failing financial performance of PETROPERU. Given that suspension of disbursements is a drastic remedy and given the Bank's objective of avoiding arrearage on the part of Peru, it is understandable why the Bank hesitated before taking action; but its forbearance did nothing to reinforce its credibility (para. 8.09-.15). 16. Consultants. The Bank was generally satisfied with the work of the consultants, including the PMSC. PETROPERU did not fully share this sense of satisfaction (paras. 8.16-18; also Part II, paras. 13- 16, pp. 28-31). Lessons to be Learned. 17. There are six major lessons to be learned from this project: (a) Major free-market reforms are necessary to put the sector on a sound financial and technical basis; (b) domestic petroleum prices should be kept in line with changes in international prices; (c) a firm commitment of co-financing in the amounts necessary to complete the project should be a condition for proceeding with the loan; (d) during appraisal, local pro- curment laws and practices should be closely reviewed to identify possible areas of conflict with Bank procurement guidelines. In the event of a con- flict which cannot be resolved, the Bank should consider withdrawing from the project; (e) the Bank should be prepared to suspend disbursements if the need arises as a result of prolonged and serious non-compliance with financial (and other) covenants; and (f) use of a project management com- pany can be effective for reinforcing a borrower with a weak project- implementation capacity (para. 9.01).  I  PROJECT COMPLETION REPORT PERU PETROLEUM PRODUCTION ENHANCEMENT PROJECT (LOAN 2195-PE) PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE 1. Proiect Identity Project Name: Petroleum Production Enhancement Project Borrower: Petroleos del Peru (PETROPERU), S.A.1/ Loan Number: 2195-PE Loan Amount: US$81.20 million Disbursed: US$49.39 million Canceled: US$31.81 million Loan Dates: Approval: 08/10/82; Closing: 06/30/87; Last Disbursement: 01/26/88 RVP Unit: LAlEI Country: Peru Sector: Energy Subsector: Petroleum 2. Background 2.01 Bank Lendina to the Enerav Sector. Since 1960, the Bank has made eight power loans to Peru amounting to US$222.2 million; and since 1980, the Bank has made three petroleum loans amounting to US$119.0 million (Part III, Table 1). The first petroleum loan, 1806-PE (US$32.50 million, 1980) helped the national petroleum company, Petroleos de Peru (PETROPERU), S.A, to increase oil production from existing wells and strengthen its institutional capabilities. This project substantially achieved its objectives and is considered a success. The second loan (2117-PE, US$5.30 million, 1982) helped to finance engineering studies of the refinery operations of PETROPERU. The third loan 2195-PE (US$81.20 million, 1982) helped to finance the project which is the subject of this PCR. As measured by the currently and formerly expected increases of future production (13.5 million barrels vs. almost 40 million barrels), the results of the project are marginal. 2.02 Sources and Reserves. Peru has diverse and as yet largely untapped energy resources consisting of hydroelectric power, crude oil, coal, natural gas, some geothermal power, and renewable resources, such as firewood and bagasse. These energy sources, commercial and non-commercial, constitute the energy sector. Commercial sources include petroleum, hydro- electric power, natural gas, and other (mostly coal). The Government has concentrated its efforts on developing the electric power and petroleum subsectors. I/ Corporacion Financiera de Desarrollo (COFIDE) also signed the Loan Agreement as financial agent of the Guarantor, but played no role during project inplementation.  -2- 2.03 In 1988, total commercial energy uses in Peru amounted to 10.3 millions of tons of oil equivalent (TOE), of which petroleum accounted for 81% (about the same as in 1981) and electricity, 14%. Clearly, petroleum is the dominant source of energy. Among total proven reserves for commer- cial energy sources (407.8 M. TOE), petroleum accounted for only 14%; hydroelectricity, 35%; natural gas, 40.6%: and coal, 10.4%. 2.04 Enerav Sector: Regulation. The Ministry of Energy and Mines (MEM) makes policy, coordinates all energy sector activities, and regulates the energy sector, except for the functions of tariff setting and budget approvals. These functions are the responsibilities of, respectively, the Ministry of Finances (MOF) and the National Development Corporation (CONADE). Under MEM policy guidance, various bodies carry out operational activities in their respective subsectors. PETROPERU is the state oil monopoly, responsible for the petroleum subsector; Empresa Electricidad del Peru, S.A. (ELECTROPERU) -- the national power company -- and associated electric utilities are responsible for the electric power subsector. There is a long history of close Government supervision of both companies. In recent years, with respect to PETROPERU, the policy- maker and regulatory role of the Government have conflicted with its role as owner/operator of a revenue-earning entity (para. 2.07). 2.05 Petroleum Subsector: Oraanization. Established in 1969, PETROPERU is the official body for conducting all government petroleum- related activities, including: exploring, producing, transporting, refining, exporting, importing, marketing, and contracting with private oil companies. It has a virtual monopoly on the retail distribution of petroleum products. It owns a small fleet of petroleum tankers, plus river transport facilities. 2.06 The Board of Directors sets policy which management, headed by a General Manager, implements. The Chairman of the Board is the Executive President. Reporting to him is the General Manager who supervises key managers in the areas of exploring, producing, refining, etc. 2.07 Besides being an integrated oil company, PETROPERU has been an instrument of the Government for implementing public policy. In this latter role, PETROPERU has been (and is) the vehicle through which the Government sets (and subsidizes) domestic petroleum product prices. Managerial and financial autonomy is heavily constrained by Government control re labor policies, pricing of refined products, procurement procedures, operational and investment budgets, etc. 2.08 Subsector Crises. The petroleum and electric subsectors are in crisis, technical and financial. During the last half of the 1980s, in circumstances of near civil war, worsening macroeconomic conditions (high inflation, stagnating domestic investment, and recurrent balance-of- payments crises), both subsectors experienced increasing financial constraint due to low tariffs and prices, which in turn led to inadequate levels of expenditure on maintenance and investment, deteriorated plant,  -3- and declining levels of petroleum production and of service quality and reliability (electricity). 2.09 For example, in 1982, petroleum production amounted to 195,000 barrels per day (bpd). Since 1985, no substantial exploration investments have taken place, and petroleum production has declined to the present level of 132,000 bpd (para. 2.22). This decline has been mainly due to the aging of the fields, but is also due to poor conditions of field equipment and installations and the inability of PETROPZRU to pay for the exploration and development of new fields. 2.10 As set forth at greater length below, the financial and technical crises of the petroleum subsector have their roots in the macroeconomic and sector policies implemented by the Government during the last decade and before. 2.11 Macroeconomic Policies. During the twenty years ended in 1990, a succession of administrations, military and elected, carried out an inward-looking growth strategy relying on nationalization, an array of state economic controls, large public investments, rapidly growing state enterprises, and mounting foreign debt. Together with adverse balance-of- trade developments and natural disasters, the strategy resulted in a failing, "stop-start" economic performance, unserviceable levels of foreign debt, spiraling inflation, capital flight, and declining per- capita income. As part of a larger macroeconomic strategy, the administration of President Alan Garcia (1985-1990) froze and then lowered the prices of petroleum products, thereby undermining the technical and financial health of PETROPERU (paras. 2.08-.09). 2.12 At the time of project preparation and appraisal (1981-82), the economic performance of Peru was approaching the end of one of its "start" phases; implementation commenced (1983-1985) in a "stop" phase and reached its peak in a short-lived "start" phase (1986-1987); and terminated during a profound national depression (1988-1990). 2.13 In 1983, GDP plummeted by 12% and inflation doubled to 100- plus percent in circumstances of recession abroad, expansionary fiscal and monetary policies at home, plus serious natural disasters -- floods in the north and drought in the mouth. In 1984-85, GDP recovered modestly (7.2%) from the low of 1983 and cumulative inflation amounted to 446%. At the same time, the servicing of foreign debt became a problem of such size that the Government engaged in a policy of "undeclared arrears. In 1985- 90, the Garcia administration formalized the arrearag- policy of the prior administration and resorted to an array of non-market mechanisms to stimulate the economy, control inflation, and allocate goods and services. These mechanisms ranged from subsidies, public spending, and tax relief to administrative controls on prices, wages, interest rates, import tariffs, and the structure of exchange rates. Central to this approach were the beliefs that: (i) the economy could be managed and inflation controlled through administrative fiat; and (ii) consumption demand could be fueled by decreeing an increase in real wages, implementing temporary work  -4- programs, and transferring disposable income from the public sector to the private sector. The latter would be effected by reducing taxes and public sector prices and tariffs; and the resources underlying and financing this strategy, it was expected, would be the reductions in payments on external debts. When the Government stopped servicing Bank debt, the Bank suspended (May 1987) disbursements on all of its loans to Peru. The suspension impacted adversely on project implementation (para. 4.06). A short-lived consumption boom peaked in 1986 and ended in 1987. 2.14 Sector Issues: Energv Development Strategy. At the beginning of the 1980s, the stated energy development strategy of the Government consisted of giving priority to accelerated petroleum exploitation and development and expanded hydropower investment with pricing being the main instrument for restraining demand and encouraging efficient use of fuel. With respect to petroleum, the Government wanted to encourage private oil companies, foreign or local, to take the lead in exploration activities and to limit the drilling activities of PETROPERU to relatively less risky activities. To this end, the Government adopted in 1980 tax provisions ("reinvestment tax credit") which generated an initially favorable response on the part of the private oil companies. In 1985, the Government abrogated the "reinvestment tax credit", nationalized the operations of a foreign oil company, and forced the renegotiation of the contract of another foreign oil company. 2.15 During the years 1985-1990, the Government subordinated the above energy strategy to the demands of its larger macroeconomic objectives with disastrous consequences for the sector: declining petroleum production (para. 2.08), the decapitalization of PETROPERU, thereby causing underinvestment and technical deterioration, and decreasing participation on the part of foreign oil companies. 2.16 During the 1980s, the participation of the foreign companies fluctuated in response to: (a) their success or failure with respect to exploration activities, (b) world-wide oil prices and market conditions, and (c) the evolving legal, taxation, and contractual framework -- foreign and national -- under which the companies operated. Concerning the national framework, the foreign oil companies were looking for stability and competitiveness -- that is, they wanted the Government to stand by its contractual commitments and to offer terms for exploration and production which were competitive with worldwide norms. Exploration activity by foreign oil companies peaked in the early 1970s, declined during the balance of the decade, recovered to a low peak in the early 1980s, and then trended downward during the balance of the decade. Underlying this decreasing pattern of exploration activity were somewhat disappointing discovery results in Peru, declining oil prices (especially after 1985) due to a substantial easing of worldwide supply conditions, and a less-than-fully competitive local framework. 2.17 As indicated by the decline of petroleum production since 1982, the Government adopted macroeconomic and petroleum-pricing policies during the years 1985-1990 which were a disaster for the sector. Further,  -5- the strategy of the earlier years -- reliance on PETROPERU and foreign oil companies -- reflected a lack of clear guidelines on the roles of the state (para. 3.12) and the foreign oil companies. Clearly, the strategy did not promote significant and sustained participation by the latter. In connection with a proposed privatization loan, the Bank is attempting to persuade the Government to deregulate petroleum prices, open the sector to free competition in all activities, privatize most or all of PETROPERU, rationalize the operations of PETROPERU, and provide PETROPERU with a large measure of autonomy. 2.18 Pricing and Taxation Policies. The Government uses pricing as the main instrument for influencing the demand for petroleum products (para. 2.14). In connection with a proposed privatization loan, the Bank is seeking to persuade the Government that petroleum product prices should be de-controlled in a competitive market, so that they would reflect economic costs, i.e., international market prices. Adjustment would stimulate economic fuel use on the part of consumers. Clearly, this has not been the case, although some administrations have made more effort to correct distortions to the level and structure of prices than other administrations. 2.19 From the early 1970s to 1976, the Government, to protect the economy from the disruptive effects of rapidly rising prices in international oil markets, held prices at artificially low levels. As this policy stimulated domestic consumption and put a strain on the balance of payments, the Government, beginning in 1976, began introducing price increases over the next seven years which brought the retail prices for gasoline, diesel, and fuel oil close to and then above their respective international comparators, while maintaining a subsidy for domestic kerosene, as shown in Schedule I: Schedule I Domestic and Border Prices, 1982. 1983. 1985. 1988 Date: 01/82 Date: 02/83 Date: 01/85 Date: 07/88 Reg. Dom. Die- FueL Reg. Dom. Die- Fuel Reg. Dom. Die- Fuel Reg. Dom. Die- Fuel Gas Ker. set Oit Gas Ker. set Oil Gas Ker. set Oil Gas Ker. set OiL (in USS/gatton; stated in current prices) Domestic .97 .24 .74 .49 1.09 .46 .93 .77 1.09 .52 .91 .76 .51 .11 .22 .18 BP* .94 .96 .94 .58 .96 1.09 1.09 .58 .77 .82 .81 .66 .60 .55 .57 .36 Domes./ 103 25 79 84 113 42 85 133 142 63 112 115 85 20 39 50 BP (%) *BP: Border price or international price. 2.20 When President Garcia took office in 1985, domestic petroleum product prices had remained more or less steady as stated in current prices expressed in US dollars during the preceding three years while border prices had declined. Beginning in August 1985, the Government froze the prices of petroleum products in circumstances of rising inflation, i.e., aggressively reduced prices in real terms as part of its  -6- strategy for stimulating consumption (para. 2.14). Between December 1985 and August 1988, the price of gasoline declined 75%; domestic kerosene, 46%; diesel, 84%. Part of the reduction reflected movement in international prices, but domestic prices remained well below their border-price equivalent (see Schedule I). 2.21 Also distorting the level and structure of petroleum product prices is the tax scheme, the "Impuesto Selectivo al Consumo" (ICS -- 134%) applied to the net cost to PETROPERU. This scheme differs from the general sales tax (14%) applied to other sectors of the economy. In connection with a proposed privatization loan (para. 2.17), the Bank is seeking to persuade the Government to replace ICS with a tax system as similar as possible to the general sales tax. 2.22 Physical and Operational Characteristics. Current oil production of 132,000 bpd comes from the two state companies: PETROPERU (32%) and PETROMAR (16%), and the remainder is produced by two private companies: OCCIDENTAL (47%) and OXY/BRIDAS (5%). While Peru is still at present a marginal exporter, in 1988-90 it was a net importer. Furthermore, imports of light petroleum products, to provide the required mix for the national refineries, have already started, and were running at about 20,000 bd in 1990. Despite a slight increase in production in the near term, as a result of the planned emergency investments, further decline of domestic production is likely to occur in the medium term. 3. Preparation 3.01 Feasibility. PETROPERU prepared the project with the help of a private consulting firm which completed the first draft of the feasibility study in early 1981. The project would aim at enhancing oil reserves and production at the Laguna-Zapotal fields located on the north west coast. Owned by PETROPERU, these fields formed part of the production complex of the Talara region, which had a long production history. Despite the large number of wells already drilled, it was expected that a considerable volume of crude oil could still be recovered from this area with little or no risk through the reactivation of old wells, and by drilling additional infill wells to tap more effectively known reservoirs. Underlying this expectation was the assumption of uniform distribution of fields and reservoirs. 3.02 Loan Processing Timetable. A Bank mission identified the project in May 1981. Relying on the final draft of the feasibility study, the Bank carried out preparation (June 1981) and appraisal missions (October 1981), identifying a number of difficult issues (paras. 3.09-.18) requiring resolution prior to loan negotiations (June-July 1982) and board approval (August 1982) (Part III, Table 2). 3.03 Obiectives. The identification mission concluded that the proposed project fitted well within the overall development strategy of the Government for the energy sector (para. 2.14) and would provide an opportunity for supporting a high-return, priority project, while  achieving further improvements in the operating efficiency and financial performance of PETROPERU. The project had two basic objectives: (i) increasing proven oil reserves and production and (ii) improving the capability of PETROPERU to prepare and implement petroleum development projects. Other objectives associated with the project included: supporting policies of efficient resource management and realistic domestic petroleum pricing; maintaining Peru as a net petroleum exporter; continuing to strengthen PETROPERU's ability to effectively carry out the role assigned to it by the Government; and assisting the Government in its efforts to attract foreign investment to the hydrocarbons sector. The conceptual foundation for the project was clear and consistent with Bank objectives of supporting the petroleum sector policies of the Government. The timing of the project was also appropriate because of the urgent need to increase proven crude oil reserves and production and to improve PETROPERU's technical and operational capabilities. 3.04 Description. As initially defined in the Loan Agreement (Schedule 2), the project comprised components for: (i) enhancement of existing crude oil production capabilities (Part A); and (ii) technical assistance and training (Part B). Part A included: drilling 159 new wells and reactivating 76 existing wells; and acquiring drilling equipment and materials, surface production facilities, and infrastructure. Under Section 3.02 of the Loan Agreement, PETROPERU covenanted to employ a project management service company to supervise implementation (paras. 3.13-.16). The enhancement component was expected to increase production by about 40 million barrels over the life of the project (1983-2002). Implementation was expected to take about four years: from July 1982 to December 1986. Contracting for this component would be completed between July 1982 and July 1983, including contracting the services of a project management company (August 1982) (Part III, Table 3). Shipment and delivery of equipment, plus drilling/reactivation activity, would continue to December 1986. 3.05 Infrastructure included lodging and office space for the staff of both PETROPERU and the project management service company and storage facilities for equipment. Equipment included: well completion material, pumping equipment, and surface production facilities (flowlines, separators, storage tanks, pumps, and related instrumentations). 3.06 Part B included: (i) technical assistance in the form of consultant services to study better ways for optimizing the exploitation of the Laguna-Zapotal fields and to prepare production enhancement projects in adjacent areas; and (ii) training. It was expected that the contracting of consultancy services would be completed by December 1983. PETROPERU would annually provide the Bank with an updated version of the project feasibility report, as redefined through the studies mentioned above. Also the Bank and PETROPERU would exchange views on these studies. The terms of reference for consultants included the requirement for train- ing PETROPERU staff assigned to work with them. Training would also be made available to staff assigned to the special project unit and abroad.  -8- 3.07 Cost and Financing. The total project cost was estimated at US$240.0 million (including about US$24 million equivalent in local taxes and duties), of which US$150.4 million (63%) would be foreign currency costs. Including a front-end fee of US$1.2 million, total financing would amount to US$241.2 million. Amounting to US$81.2 million, the Bank loan would cover about one-third of the total estimated project cost, including the front-end fee, and about 54% of the project foreign exchange costs. Of the remaining US$160 million required financing, US$120 million would come from cofinancing. Half of this cofinancing was expected to come in the form of exports credits for equipment, spare parts and materials for drilling and for other services needed by the project. The balance of cofinancing would be provided by commercial bank loans. PETROPERU would provide the equivalent of US$40 million in local cost financing for the project. 3.08 Issues. In addition to such project issues as the scope, content, timetable, economic justification, and cost of the project, Bank staff focused on sectoral issues -- namely: domestic petroleum prices, PETROPERU finances, and the dual roles of the Government as sector policy maker/regulator and owner/operator of a revenue-earning enterprise. It also focused on other project issues: project management and organization, cofinancing, and procurement. Sectoral Issues. 3.09 Role of Government: During appraisal, the Bank questioned the dual roles of the Government as sector policy maker/ regulator and owner/ operator of PETROPERU, a revenue-earning enterprise for developing the petroleum sector. The Government used PETROPERU as an instrument for implementing public policies which were sometimes at variance with the revenue-earning objectives of the enterprise. The Government explained to the Bank that the existing political environment in the country did not permit a re-evaluation of the dual roles of the Government. In consideration of this criterium, the Bank did not seek a limitation or clarification of the dual roles of the Government (paras. 2.04 & 2.07). 3.10 Domestic Petroleum Prices & PETROPERU Finances. The level of domestic petroleum prices was a key issue, affecting the financing capacity of PETROPERU. During project preparation, the financial situation of PETROPERU in 1981 was of great concern to the Bank due to a drastic reduction of Government equity contribution, the need to purchase crude oil supplies at international prices from foreign contractors, and the decline of petroleum production as a result of some technical problems. Preliminary financial projections indicated that without measures to cope with its financial situation, PETROPERU would suffer rising operating deficits over the decade and beyond. To address this problem, the Government agreed with the Bank on a financial recovery program which would ensure progressive compliance with certain target financial ratios agreed in connection with Loan 1806-PE.  - 9 - 3.11 The program included: (i) an increase in November 1981 of S/50 per gallon in the average price of controlled products; and (ii) periodic price increases in 1982 totalling 25% in real terms. It was expected that such increases would bring domestic prices of refined products to (or close to) the international price, thus improving the level and structure of domestic petroleum product prices. 3.12 Because restoring the financial health of PETROPERU was important, the Bank conditioned negotiations to the implementation of point (i) of the program mentioned above (para. 3.11) and the first steps of point (ii). By the time of Board approval, the average price of petroleum products was US$30.70 per barrel. The Government confirmed its intention to raise the domestic price of petroleum products to reach international price levels by year end (US$34 per barrel) by a side letter to Loan 2195-PE.2/ To restore the financial health of PETROPERU, the Loan Agreement (LA) for Loan 2195-PE reaffirmed the financial targets established in the LA for Loan 1806-PE: (i) debt-service coverage ratios of 1.9X in 1982 and 2.OX in 1983 and subsequent years (Section 5.05); (ii) ratios of current assets divided by current liabilities of 0.7, 0.9, and 1.0 in 1982, 1983, and 1984 and later years (Section 5.06); and (iii) debt equity ratios of 70/30 in 1982 and 60/40 in 1983 and later years (Section 5.07). There was no covenant in the Guarantee Agreement committing the Government to align domestic petroleum prices periodically with international prices, but there was a covenant (Section 3.03) obligating the Government to take all such action as required to permit PETROPERU to meet the financial targets specified in the Loan Agreement. Project Issues. 3.13 Proiect Management and organization. The Petroleum Production Rehabilitation Project (1806-PE), which preceded the proposed project, experienced long implementation delays because of PETROPERU's unwieldy organization, shortage of technical staff, frequent staff changes, and disruptions caused by its reorganization -- in short, its non-project specific organization. When it became apparent that special implementation arrangements were necessary to carry out the project successfully, the Bank recommended the establishment of an autonomous project entity. PETROPERU agreed but "...the scheme failed to achieve its goal due mainly to difficulties derived from PETROPERU's reluctance to delegate authority and to allocate resources to the project entity.'@/ 3.14 To avoid future implementation delays under the proposed project, PETROPERU proposed the creation of a special project unit (PETROPERU Project Unit -- PPU) which would oversee the operations of the project management service company (PMSC) (para. 3.04). Further, during I/ The ftiles for Loan 2195-PE do not contain this document. ]/ Source: Prolect Performance Audit Report: Petroteun Production Rehabilitation Proiect, page 12, paragraphs 40-42, (Report No. 7944, dated June 30, 1989)  - 10 - appraisal, an action plan to minimize problems in the implementation of the project was designed. The Bank agreed to these proposals. 3.15 The PPU was to be properly staffed and would be solely responsible for supervising the PMSC, which would be contracted to coordinate and supervise day-to-day project activities, including those to be carried out by the drilling and well workover contractors. The PMSC would prepare the detailed project work programs and budgets; prepare and evaluate bids and recommend awards; and administer contracts on behalf of PETROPERU for all equipment, materials and contractor services. The company would be hired under an incentive contract to make the project more attractive. 3.16 Because of the importance it attached to the proper organization for project management, the Bank conditioned negotiations to establishment of the PPU headed by a qualified manager and confirmation by the PETROPERU Board of its intention to contract a PMSC. Further, the Bank conditioned loan effectiveness to the contracting of a PMSC acceptable to the Bank on terms and conditions satisfactory to the Bank (Section 3.03 (a) and 7.01 (a) of the Loan Agreement) (paras. 4.08-.09). 3.17 Cofinancina: During project preparation, the Bank understood that it would take time to mobilize the necessary amount of cofinancing required for the project. However, it was agreed that once the project was under way, and if similar projects for the over-all production enhancement program emerged from the studies contemplated, it would be easier to attract additional cofinancing, since some positive results derived from the project would be available. It was then agreed that as a condition of Board presentation satisfactory progress would be made for cofinancing the project with other banks. During negotiations, the Government informed the Bank, that there were preliminary commitments of about US$60 million of credit cofinancing already approved by the export- import banks of the United States and Japan. 3.18 Procurement: The procurement requirements of the Bank were discussed during appraisal and agreed upon with PETROPERU. This included the contracts for drilling equipment, services for production and for maintenance. Highly specialized services for well completions, recomple- tions, workovers, and drilling were procured under limited international tendering. The selection of the PMSC and the technical consultants were to be effected following Bank guidelines for hiring consultants. 4. Implementation 4.01 Actual and Forecast Cost. According to PETROPERU, the actual project cost was US$164.4 million as compared with the forecast cost of US$241.2 million (Part III, Table 4). These values do not include expenditures for an emergency repair component added to the project in December 1983 (Part C, para. 4.18). Certain project components and their costs, actual and forecast, are comparable (paras. 4.02-.03); however, total actual and forecast costs are not fully comparable because: (i)  - 11 - PETROPERU did not complete certain components for lack of adequate financial resources; and (ii) actual proven recoverable reserves differed from what had been expected (about 65.8% below the target level), making the actual and expected projects quite different. (Because there is some question abut the level of Bank disbursements in support of the project -- para. 4.17-- the actual cost of the project may be US$0.56 million higher than calculated by PETROPERU.) 4.02 The actual and forecast numbers of wells drilled and worked over were roughly comparable -- (i) new wells, 161 and 159; and (ii) work- overs, 51 and 76. Also comparable was the actual and forecast work carried out by the PMSC. The same is true for "infrastructure". But except for surface facilities for production, expenditures for the other elements of the project -- well completion materials and equipment and consultant services -- were less than half of what had been expected. These similarities and differences are not nearly so important as the differences in assumptions and facts underlying actual and target levels on proven recoverable reserves (para. 5.01). 4.03 Roughly comparable are the actual and forecast costs for drilling services: US$98.2 million vs. US$136.0 million. The same is true for the PMSC contract, US$17.9 million vs. US$16.1 million, and infrastructure, US$7.8 million and US$7.9 million. Not comparable were actual and forecast expenditures for surface facilities for production, US$8.3 million vs. US$4.5 million Also not comparable were expenditures for materials and equipment: US$29.2 million vs. US$71.4 million; and other consultancy services, US$1.8 million vs. US$4.2 million. 4.04 Sources of Financing. The following table, which is based on data supplied by PETROPERU, shows that Bank financing for the project (US$42.1 million) was 48.2% less than expected while that of PETROPERU (US$85.8 million) was 114.5% greater than expected and that from of co- financiers (US$37.4 million) was 68.8% less than expected (also see Part III, Table 4). Schedule II Actual and Forecast Financina Plan Actual Forecast Percent (X) Difference Per- Per- from Ahut cent Amount cent Forecast Source (USS M.) (USS M.) PETROPERU 85.8 52.2 40.0 17.0 114.5 1BRD* 42.1 25.6 81.2 33.0 -48.2 Co-fin nc ino 365 22.3 120 0 50 0 -_A8 Export credits 33.0 20.1 60.0 25.0 -45.0 Comnercial Bks. 0.0 0.0 60.0 25.0 NA Other 3.5 2.2 0.0 0.0 NA Jilla 164.4 100.0 241.2 100.0 -31 8 * Bank records Indicate disbursements supporting the project amounting to USS42.6 miliion (para. 4.17).  - 12 - 4.05 Despite informal contacts with several foreign banks, PETROPERU was not able to secure commercial bank financing, mainly due to the general apprehension on the part of those banks about lending to Peru. Because of its harsh terms, PETROPERU rejected the financial proposal (US$20 million) from a Japanese consortium to buy materials and equipment. PETROPERU signed a credit agreement with the U.S. Eximbank for US$26.25 million, complemented by a loan (US$3.5 million) from a commercial bank and the drilling contractor. Additionally, PETROPERU obtained approval to draw US$25.0 million from a line of credit from Argentina to purchase drilling materials and production equipment. 4.06 Timetable and Procurement. The actual and forecast implementation periods were, respectively, (i) August 1983-December 1989 (77 months); and (ii) August 1982-December 1986 (53 months) (Part III, Table 3). After a slow start due to various causes -- delayed effectiveness and a severe natural disaster (para. 4.07), financing difficulties (para. 4.06), Government administrative constraints and complex procurement procedures (para. 4.12-.13) -- considerable drilling progress was made in 1986 and the first part of 1987. After the Bank suspended (May 1987) disbursements on all loans to Peru, PETROPERU carried out the balance of the project at a very slow rate. 4.07 The project experienced a slow start due to: (i) delayed effectiveness of the loan agreement and (ii) heavy rains between January 1982 and July 1983 which caused great damage to the production infrastructure of the entire Talara area. The heavy rains required PETROPERU to use most of its existing equipment for field repairs, including the utilization of those materials already dedicated for the Laguna-Zapotal project. 4.08 At the request of PETROPERU, the Bank postponed the deadline for effectiveness to July 28, 1983 4/, almost a year after loan approval (August 10, 1982) and seven months after the original deadline (December 20, 1982), to allow PETROPERU to negotiate its PMSC contract (which was finally signed in September 1983) and in consideration of the flood- devastated state of the oil fields of the Talara region. Hiring the PMSC was the most important, but not the only, special condition for effectiveness. Also contributing to delayed effectiveness was slow action on the part of PETROPERU in: (a) hiring the technical consultants to undertake studies to upgrade the production enhancement programs; and (b) staffing the PPU (LA, Article VII, Section 7.01 (a), (b), and (c) ). Because PETROPERU could not meet a covenanted financial target, the Bank waived compliance, but this was not a source of delay (para. 4.10). 4.09 The selection of the PMSC was delayed about 10 months because the invitation to submit proposals was made only after loan signature in September 1982, and later the consulting firms requested additional time to prepare their proposals. Of the six consulting firms, only three were V Source: lank telex to PETROPERU, dated April 29, 1983.  -13 - qualified and submitted price bids for their services. Having established the PPU in June 1982, PETROPERU assigned five experienced engineers to the PPU a year later. Later, following Bank recommendations, the selection of five additional staff was accelerated, so that the PPU could be fully staffed before the PMSC started operating in the field. 4.10 Since PETROPERU had been unable to comply with the financial covenant requiring a quick ratio of 0.7 in 1982, the Bank waived this covenant in order to declare the loan agreement to be effective. The actual ratio for operations in 1982 was 0.5. The shortfall was due to price and production declines and the growing reluctance of commercial banks with respect to lending in Latin America 5/. (At negotiations, it had been anticipated that borrowing from commercial banks would permit conversion of some short-term debt into long-term debt.) 4.11 Financed by PETROPERU, a drilling company with two rigs commenced project operations in August 1983 under the direct supervision of PETROPERU. The PMSC contract was signed in September 1983 and normal operations started in March 1984, when the PMSC took over from PETROPERU. The PMSC started work with a seven-months delay after contract signing because of logistical problems caused by the heavy rains and procurement problems related to the acquisition of vehicles, office space, and communications facilities. By July 1984, ten wells had been drilled; by February 1985, thirty-two wells had been drilled. It was not until the end of 1985 that all drilling contracts were signed. This slow progress was due to administrative, financing, and procurement problems. 4.12 Heavy administrative and procurement constraints imposed by the Contraloria General, difficulties in obtaining non-Bank foreign financing, and low levels of internally generated financial resources were among the general factors for slow implementation. The protests of non- selected firms were a cause of delay. During the initial stages of implementation staff of both the PMSC and PETROPERU did not have experience with Bank procurement guidelines and this was a cause of delay. In addition, PETROPERU procurement procedures were complicated, involving many steps and requiring approvals from either CONADE, the Ministry of Energy or the Contraloria General. 4.13 The emergency repair program offers a particular example of the complexity of local procurement procedures. To supervise the contractor carrying out road repair work in the Talara area, PETROPERU needed help from a consultancy firm. This work was performed under a schedule of working rates for service contracts that had to be approved by Ministerial Resolution. For contracting purposes, the Talara oil field area was subdivided into several zones, and the road repair work of each zone constituted a separate contract. Contractors were invited to pre- qualify, at which time they were ranked to become eligible for executing one or more contracts. Awards of contracts were based on the lowest eval- I/ Source: Internal Bank memo, dated July 28, 1983.  - 14 - uated bids; however, PETROPERU retained the right to decide which contract might be awarded to a particular firm, if such firm was low bidder on more contracts than it had capacity to execute. Because of the complexity of procurement procedures for road repair work, serious delays attended the selection of the consultancy firm and the letting of the repair contracts. 4.14 While PETROPERU received bids from Argentina and US suppliers for 180 mechanical pumps, the award to the lowest evaluated bidder was complicated by the uncertainty of availability of financing from commercial banks. PETROPERU awarded the contract for workover services to a local private company. However, this company was not able to provide the required bank guarantee before contract signature. As a result, and after further delays, PETROPERU awarded the contract to another company. 4.15 During 1986 and the first part of 1987, the rate of implementation became satisfactory -- that is, the number of rigs in operation increased from two in 1985 to five in 1987; but after the loan was closed (June 30, 1987), implementation proceeded at a slow rate until December 1989. 4.16 Disbursement and Allocation. Disbursement did not begin for about a year after project approval. At the end of fiscal 1984, only 6% of the proceeds had been disbursed, as compared to the appraisal forecast of 29.6%. The pace of disbursements started to pick up as soon as the consultants for design and supervision and the contractors for project execution began working (Part III, Table 5). In May 1987, the Bank suspended disbursements on all loans to Peru because of debt service arrears. The Bank did not extend the loan closing date beyond its original deadline, June 30, 1987. The last disbursement was on January 26, 1988. Due to the arrears in debt servicing and the lack of progress in normalization of relation with Peru, the Bank decided to cancel the undisbursed balance of the loan of US$ 31.8 million effective September 12, 1989. 4.17 According to PETROPERU, when disbursements stopped in 1988, disbursements for Parts A and B of the project amounted to US$42.1 million, or 52% of the loan amount (Part III, Table 6). Bank records indicated a higher figure: uS$42.6 million, i.e., the sum of disburse- ments in Categories 1-3 and 6-7. The difference (US$0.56 million) reflects a differing understanding as to amounts disbursed for an emergency repair component (Part C) added to the project in 1983 (para. 4.18). As outlined below, this component provided for equipment, some of which was similar to that acquired under Part A (such as flow-lines -- para. 3.05); and this appears to the source of the difference. If PETRO- PERU records are correct, disbursements for the emergency component amounted to US$7.3 million. Bank records indicate a lower figure: US$6.8 million, i.e., the sum of disbursements in Categories 4 and 5. Total disbursements from Loan 2195-PE amounted to US$49.4 million. 4.18 In December 1983, at the request of the Government and PETROPERU, the Bank redefined the project to include an additional  - 15 - component (Part C) for the emergency repair of flood-damaged roads and infrastructure in the project area (para. 4.07). The corresponding reallocation (US$20.0 million) of loan proceeds was expected to cover the cost of road repairs (200 kilometers), about 100 four-wheel drive and other vehicles, earth-moving equipment and accessories, flow-lines, valves and other supplies for the rehabilitation of crude oil production facilities, and consultant services for design work and supervision. This reallocation was part of a larger Emergency Program (also approved in December 1983) including reallocations of other loans. Bank staff did not recalculate the cost of the project to include Part C. The use of the above amount was not expected to affect the normal initial project implementation, as these funds were not expected to be needed until much later. Further it was expected that these funds would be replaced by a B- loan that was being prepared at the end of 1983 to complete the financing package of the project. However, because of the poor economic situation of the country, it became almost impossible for PETROPERU to obtain any additional funds through cofinancing. Only US$6.8 million, according to Bank records, was disbursed from Loan 2195-PE for the Emergency Program. 5. Results 5.01 Recoverable Reserves. Actual results, which are estimated at 13.5 million barrels of proven recoverable reserves, are below the appraisal target of almost 40 million barrels over the life of the project (1983-2002) (Part III, Table 7). The assumptions underlying the appraisal target were not sustained under the project as completed, even though PETROPERU drilled and worked over almost as many wells as expected (para. 4.02). Of the additional production of 13.5 million barrels of proven recoverable reserves, 11.6 million barrels are expected to come from new wells and 1.9 million barrels from existing wells. PETROPERU increased its proven recoverable reserves from the Laguna-Zapotal fields up to approximately 55.5 million barrels. The appraisal target of almost 40 million barrels was based on the assumption of uniform distribution of fields and reservoirs. This assumption was not sustained by what happened. The following table compares actual and forecast annual production related to the project.  - 16 - Schedule III Actual and Forecast Annual Incremental Productlon (in ofIlfone of bbl.) Year 1983 1984 1985 190 111! t98 1982 1990 11 1 199Z I199 Production Actual 0.01 0.44 1.40 2.07 2.43 1.66 1.39 1.04 0.75 0.51 0.44 Forecast 0.90 2.60 4.60 4.50 3.80 2.80 2.50 2.30 2.10 1.90 1.70 Percent tX) - 99 -83 -70 -54 -36 -60 -44 -55 -64 -73 -74 Shortfall from Fore. Year 1994 1995 I 1W7 12111 2 20 2M1 ZDflZ Summr Production Actual 0.35 0.28 0.22 0.17 0.12 0.08 0.11 -- - 13.47 Forecast 1.50 1.40 1.20 1.20 1.00 1.00 0.90 0.80 0.70 39.40 Percent CX) -77 -80 -82 -86 -88 -92 -88 NA NA -66 Shortfall from Fore. 5.02 Studies. The project included adequate financing to prepare studies to increase production by implementing similar projects in areas adjacent to Laguna-Zapotal. The PHSC made a quick evaluation of adjacent areas identifying certain areas of high priority for the purpose of start- ing additional studies for which data gathering were required. However, because PETROPERU felt that it could do the work of the consultants which was considered to be too general and theoretical, it decided to carry out these studies with its own personnel (Part III, Table 7). The Bank agreed with this approach. 5.03 PETROPERU continued work on the studies of areas adjacent to Laguna-Zapotal, which war divided into two groups of fields: (i) El Alto, which included the fields of Verde, Taiman and Central; and (ii) El Sur, which included the fields of Carrizo, Carrizo Este and La Tuna. Studies of these fields have been completed. The Bank had some reservations about these studies. 5.04 Trainina Comoonent. Initially PETROPERU submitted to the Bank a list of five professionals from the Talara area for training on a part time basis to be provided by the technical consultants and the PMSC. Due to Bank recommendations, younger and less experienced geologists and petroleum engineers received additional training on a full basis with the same companies. Two professionals received training at overseas locations and the rest received their training through the PHSC. This project component achieved its objective of strengthening PETROPERU. 5.05 Other Results. Other objectives included supporting Government policies of: (i) rapid resource exploitation; (ii) efficient resource management; (iii) realistic pricing of petroleum products; and (iv) attracting foreign investment to the hydrocarbon sector. As shown by: declining exploration activity by foreign oil companies (paras. 2.16- .17); lowered prices for petroleum products (para. 2.20); falling production and reserves (para. 2.22); and the shortfall with respect to  - 17 - financing from commercial banks (para. 4.05), the project did not achieve expected results. This situation reflected the negative impact of the macroeconomic and sector policies of the Administration of President Alan Garcia. 5.06 Return on Proiect. The return on the project was disappoint- ing. If taxes and other revenue divisions (Government) are not deducted from the stream of net benefits, the return on the project (economic) is 18.4%. The appraisal estimate was 103%. If taxes and other revenue divisions are deducted from the stream of net benefits (amounting to the appraisal estimate of 55% annually), the return on the project (financial) is - 9.4%. The appraisal estimate of the return on the project (financial) was 35%. The lower levels of proven reserves and petroleum prices (US$20/bbl. vs US$31/bbl.) are the causes of the lower returns. PETROPERU calculated the net present value (financial) of the project at US$15.3 million using a discount rate of 20%, but this calculation, because it includes adjustments to the cost and benefit streams for interest payments, tax benefits related to depreciation, loan repayments, and disbursement of only its funds as the cost of the project, does not resemble the Bank calculation (Part II, para. 1, p. 25). 6. Financial Performance of PETROPERU 6.01 Actual and Forecast Data. 1982-1986. An extended comparison of the actual and forecast financial results is an exercise of limited utility because the underlying expectations for the appraisal forecast were materially contradicted by events. For example, for the period 1982- 1986, the original project implementation period, the volume of domestic sales was 32.2% lower than expected (212 MBB vs. 281 MBB) (Part III, Table 8) primarily because of protracted domestic economic difficulties (para. 2.12). Due to reduced investment expenditure, both PETROPERU and the foreign oil companies produced less oil than expected -- for PETROPERU, 11.5% less than expected (119 MBB vs. 107 MBB); for the foreign oil companies, 18.7% less than expected (227.5 MBB vs. 270.1 MBB). Since the foreign oil companies divided their production with PETROPERU on a 50-50 basis, their reduced production directly and adversely affected the revenue of PETROPERU. 6.02 Also adversely affecting revenue were the: (i) freezing (and later downward trend) of domestic petroleum prices; (ii) downward trend of world petroleum prices, and (iii) increasing share of petroleum revenues taken by the Government. At appraisal it was expected that the average revenue for domestic petroleum products would be US$37 bbl in 1983-1986, that export prices would range upward from US$31 bbl to US$40.80 and that the Government share of such revenue would amount to 47%. In 1984, 1985, and 1986, average revenue for domestic petroleum products was, respectively, US$32 bbl, US$37 bbl, and US$30.27 bbl; between 1982 and 1986, the average revenue for exports declined from US$31.77 bbl to US$10.89 bbl and the Government share of domestic revenues rose from 56% to 64%. Cumulative domestic inflation was far greater than expected -- 3,363% vs. 440%. In other words, declining production, frozen domestic  - 18 - prices (after 1985) in circumstances of accelerating inflation, decreasing export prices, and the rising Government share of revenues provided PETROPERU with revenues which did not cover costs, especially after 1985. Based on the foregoing, it is easy to understand why actual and forecast summarized revenues and operating costs for the years 1982-1986 -- respectively, US$4.7 billion vs US$8.0 billion and US$5.0 billion vs. US$6.1 billion -- do not represent comparable operations (Part III, Table 9). 6.03 Factors limiting the utility of asset comparisons include a change in revaluation practices. Prior to 1986, PETROPERU revalued its assets annually only to the extent that there was a corresponding revaluation of long-term debt to be repaid in foreign currency. This revaluation practice led to a significant undervaluation of assets and understatement of depreciation expenses. To rectify such undervaluation of assets and the understatement of depreciation expenses, in 1986, PETROPERU, with Bank prompting, adopted new accounting procedures to take account of domestic inflation on asset revaluation. These procedures were retroactively applied to operations in 1985 but not prior years; these procedures constituted a radical change from what was expected at appraisal, thereby making comparison of actual and forecast balance sheets not fully useful. Actual data is set forth in Part III, Table 9. 6.04 Prior to 1985, the audited financial statements did not include sources and applications of funds or the schedules to permit their approximation. In the course of supervision, Bank missions estimated that PETROPERU invested a total of about US$694.8 million during the years 1982-1986, almost 57% less than what was expected at appraisal (US$1,613 million). The missions also made estimates to compare actual and covenanted financial ratios (see below). 6.05 As indicated by the schedule of actual and covenanted financial ratios below, the financial situation of PETROPERU deteriorated during project implementation: Schedule IV* 1982 1983 1984 1985 1986 Act- Fore- Act- Fore- Act- Fore- Act- Fore- Act- Fore- uat cast ual cast uat cast ual cast ual cast Debt-service coverage (x) 1.7 1.9 1.3 2.0 1.6 2.0 1.7 2.0 1.0 2.0 Quick ratio .4 .9 .4 1.0 .5 1.0 .6 1.0 .8 1.0 Debt-equity ratio (x) 81/19 70/30 82/18 60/40 81/19 60/40 80/20 60/40 59/41 60/40 *t Sources: Project Performance Audit Report: Petroleun Production Rehabititation Project, p. 54. (Report no. 7944, dated June 30, 1989). 6.06 The Bank reminded the Government of non-compliance on the part of PETROPERU with respect to its covenanted financial performance, but did not threaten suspension of disbursements in 1984-1986 due to project and country considerations. Bank files reflect no internal discussion of non-compliance or consideration of suspension prior to 1987.  - 19 - 6.07 About half of PETROPERU equity --which amounted to about US$1.1 billion at the end of 1983 on revalued basis--was lost during the three years from 1985 to 1988. Net losses exceeded US$200 million equivalent at the end of 1988. The continued drain of its resources led to delays in paying its suppliers, to a reduction in the investment program, and to the suspension of payments to the Central Bank on behalf of its debt services. 6.08 Equity at the end of 1989 was a negative US$3.2 million and preliminary estimates for 1990 show another loss of about US$800 million, bringing the accumulate losses over the last three years to more than US$2 billion. 6.09 The cause underlying this dismal financial performance was Government policy with respect to the level and structure of petroleum product prices and the Government's share of petroleum revenues. Domestic prices of nearly all petroleum products (gasoline, kerosene, and fuel oil) are controlled by the Government, leaving only certain special products (mainly lube oils) with uncontrolled prices. Therefore, price-controlled products constitute nearly 95% of PETROPERU's domestic sales. The Government introduced a general price freeze in late 1985, and during the subsequent years no adjustments were made on domestic petroleum products process, despite inflation rates of over 300% annually over the same period. During 1987, the price of gasoline was adjusted upwards by 51%, but leaving the prices of other fuels unchanged. Because of this situation, PETROPERU's operating costs appear to be very high--in the US$20 per barrel range--compared to those in Colombia, Ecuador, Argentina and Brazil. However, the high inflation of Peru makes it very difficult to make a definitive judgement on the issue. Besides these costs reflect the imposed charges for maintenance of the infrastructure of the towns where PETROPERU operates and the direct taxes paid to the Central Government and the regional treasuries. 7. Sustainabilitv 7.01 Since 1984, the financial performance of PETROPERU has been deteriorating and this deterioration is continuing. Management inability to cope with Government impositions have not been solved. At present, the Government roles as policy maker, regulator, and shareholder of PETROPERU are not clearly defined. In connection with a proposed privatization loan, the Bank is seeking to persuade the Government to increase the administrative, operational, and financial autonomy of PETROPERU, to limit its role to reviewing strategic plans within the framework of its larger sector policy objectives, to deregulate prices within a competitive environment, etc. (paras. 2.17; 2.21). 7.02 The hydrocarbon sector requires large size investments, and there are associated technical risks involved. Therefore, the present lack of an adequate level of investment is a major issue that needs to be properly addressed, if Peru is to continue to be an important crude oil producer. Finally, due to the uncertainty of the level and timing of the  - 20 - investment budget allocation by the Government, PETROPERU cannot optimize its investments and continues to operate on a day-to-day basis, and is unable to reduce its deficit and to increase its operating efficiency. For all these reasons, no sustainability of the project can reasonably be expected, unless important and radical changes occur in PETROPERU's financial and management situation and/or appropriate measures are taken by the Government to entice important participation of private capital in the exploration, exploitation, refining and marketing of petroleum resources in the country. 8. Performance 8.01 Government Performance. The performance of the Government was weak, especially in the years 1985-1990. The macroeconomic, petroleum product pricing, and taxation policies of the Government were directly responsible for the deteriorated financial and technical conditions of PETROPERU (paras. 6.01; 6.04; 6.08) and the non-completion of certain project components (paras. 4.01-02; 4.05). The contradictory roles of the Government as sector policy maker, regulator, and owner/manager also explain the over-staffing and low efficiency at PETROPERU (paras. 2.04, 2.07; 2.17; 6.08). With respect to procurement, serious delays occurred due to the interference of non-selected private suppliers, Government agencies (para. 4.12). The Government did not comply with its covenanted obligations to provide PETROPERU with sufficient funds to complete the project and to take such action as required to permit PETROPERU to comply with its covenanted financial targets (para. 6.06 and Part III, Table 10). It is also worth noting that the Government did not provide a consistent and attractive framework for the operation of foreign oil companies (para. 2.17). 8.02 Borrower Performance. The performance of PETROPERU was financially and technically weak, although with respect to the project there were some strong points (paras. 8.06-.07). Judgements on the performance of PETROPERU have to take into account the fact that the borrower operated under the very close supervision of a host of Government agencies which imposed financial and operating policies which were highly deleterious to PETROPERU. Except for financial covenants, PETROPERU complied with its obligations under the loan agreement (Part III, Table 10). 8.03 With adequate Bank assistance, PETROPERU carried out project preparation and design satisfactorily, but PETROPERU did not carry out the project according to the expected timetable. For example, PETROPERU was slow in complying with the main effectiveness condition (para. 4.08-.09 and its complex and time consuming procurement procedures delayed progress (para. 4.12). PPU staff were not familiar with Bank procurement guidelines, which resulted in delays in the hiring of contractors and consultants. PETROPERU on some occasions was also reluctant to hire consultants on the premise that it had the technical capability to undertake the corresponding studies on its own.  - 21 - 8.04 The financial performance of PETROPERU was dismal due to the pricing and taxation policies of the Government (para. 8.01). Lack of sufficient financial resources available to PETROPERU led to non- completion of certain project components and to the deterioration of its operating capabilities in both the downstream and upstream activities. The poor financial performance, high costs, and low efficiency of PETROPERU were (and are) tied to issues related to dual roles of the Government as policy maker, sector regulator, and the owner/operator of PETROPERU. 8.05 PETROPERU was (and is) an inefficient high-cost producer. There were (and are) excessive numbers of poorly-paid, lower-level staff (7,100); and inadequate numbers of professionals (2,100). Salaries of management level staff and highly skilled and experienced staff were (and are) much lower than those paid by the local petroleum industry. 8.06 The implementation of inflation accounting and stock-inventory and budgeting procedures has improved the financial information system, especially allowing a close follow-up of the economies and costs of the project. The planning capabilities of PETROPERU have also been reinforced, and as result PETROPERU has elaborated a long term investment plan. However, a considerable effort remains to be done to implement all consultant recommendations. 8.07 The PPU acquired adequate competence and expertise to ensure suitable evaluation and supervision capacity of the project. This was satisfactorily accomplished by the technical assistance component of the project. Several engineers and technical staff received training abroad. Foreign consultants have transferred to PETROPERU advanced technology -- e.g., reservoir engineering models. 8.08 The monthly and quarterly progress reports submitted by the borrower, though submitted regularly, did not reflect the true financial situation of PETROPERU. 8.09 The Bank. The overall performance of the Bank was mixed -- strong on some points, tentative and weak on other points. At the time of preparation, the Bank correctly highlighted the: (i) weak project- execution capacity of PETROPERU (para. 3.13); (ii) need to improve the financial performance of PETROPERU (para. 3.10); and (iii) institutional shortcomings stemming from the dual roles of the Government as policy maker, regulator, and owner/manager of an enterprise which was used to execute public policy objectives at variance with its revenue-earning objectives (para. 3.09). The Bank did not adequately highlight the technical risks of the project, and with the gift of hindsight, the basis for estimating proven recoverable reserves deserved more attention and a wary eye (para. 5.01). 8.10 If it is clear that the Government was responsible for the failing financial and technical performance of PETROPERU and the non- completion of certain project components, it is not obvious whether the  - 22 - Bank should have pursued at appraisal a clarification and/or limitation of the dual roles of the Government with respect to PETROPERU. Lack of such clarification was not perceived as a necessary condition for successful project completion; and given the political climate in Peru in the early 19809, it is likely that clarification/limitation was not a feasible objective. Currently, the Bank is seeking such clarification in connection with a proposed petroleum privatization operation (para. 2.17). 8.11 The covenants related to improving financial performance and improving project execution through establishment of the PPU, etc., were appropriate (paras. 3.13-.16). In the opinion of the Bank, the PPU and the PMSC performed as expected. As for the financial covenants, the Bank relied upon the Government to implement pricing and taxing policies which would assure the financial performance of PETROPERU (paras. 3.13-.16). When this did not happen, the Bank drew the attention of the Government to the financial losses of PETROPERU caused by the application of negative pricing and taxation policies and the highly dangerous erosion of equity. However, in consideration of country and project conditions, the Bank did not threaten suspension of disbursements for non-compliance in 1984-1986 (para. 6.05). In retrospect, forbearance did nothing to reinforce the credibility of the Bank. 8.12 The Bank was strongly committed to assist Peru to achieve fully its petroleum potential. The Bank, PETROPERU and the Government maintained an adequate relationship and a good understanding concerning some of the constraints affecting the project. The Bank provided extensive technical support to analyze the causes of the Peruvian economic crisis, and most importantly, to identify the steps required to curb inflation and balance the external accounts. To sustain project momentum, the Bank continued to finance most of the project components through December 1987, almost eight months after the general suspension of all loan disbursements to Peru, but without having received any payment on the rapidly accumulating arrears. 8.13 Concerning procurement procedures, to avoid delays, the Bank advised PETROPERU to convince the Government to approve direct contracts with several contractors, even though these had not maintained their original bid conditions. These awards had already been approved by the Bank, and further delays in contracting services would result in postponing revenues. To avoid additional delays in procurement and to start operations sooner, the Bank recommended that PETROPERU: (i) finance with its own resources, or through the Eximbank loan, the drilling rigs needed for the project; and (ii) later invite international bidding for contracting the rigs to be financed by the Bank. 8.14 The number of Bank staff supervision missions appears to have been insufficient for the complexity of the project (Part III, Table 11). There were nine supervision missions, which resulted in an average of 1.5 missions per year. The major supervision weakness was the lack of more decisive action on the financial issues of PETROPERU, and in some respects to procurement, monitoring and supervision procedures, in spite of the  - 23 - more than adequate attention paid in the field to technical matters. The Bank only tried to speed-up project implementation, rather than to assess PETROPERU's reasons for the delays and make the procurement process more efficient. 8.15 The legal agreements and SAR were adequately prepared and generally of a comprehensive nature. Supervision reports provided a good and comprehensive picture of the technical matters concerning the project, but not enough information in relation to the financial and institutional aspects of PETROPERU. 8.16 Consultant Services. Contractors, consultants and suppliers both local and foreign, generally performed well. The PMSC terminated its contract at the end of 1987, but PETROPERU hired 28 staff from the total of 64 from this management company to help the PPU, thus allowing the unit to continue running the project, albeit at a slower pace. 8.17 The PMSC completed the construction of offices and houses for the staff, and a warehouse with a good stock inventory system, and implemented a cost control system that has allowed a close follow-up of the economies and costs of the project. The PMSC established a well-by- well monitoring system of operations and an overall production and reservoir pressure follow-up system which allowed design of measures to reduce mechanical failure in the production equipment, thus avoiding high levels of deferred production. Delays in procurement of equipment and services for drilling and workover of wells forced the PMSC to postpone improvements in production from existing wells, and to give priority to equipping new wells using equipment from old wells. In the opinion of Bank Missions, the PMSC was very competent. In the opinion of PETROPERU, the PMSC was insufficiently knowledgeable about procurement practices in Peru. Further, PETROPERU found it legally impossible to delegate authority completely to the PMSC for supervision of contractors (Part II, pp. 29-30, para. 14). 8.18 In the opinion of the Bank, the engineering firm that was in charge of updating reservoir performance did satisfactory work, especially providing adequate data derived from the wells being drilled or workover jobs done in old and new wells. Also this firm did quality control work and proved to be efficient in providing satisfactory training to PPU personnel in reservoir and production engineering. Cooperation between the engineering firm and PPU was satisfactory. PETROPERU was marginally pleased with the performance of the engineering firm (Part II, p. 29-30, para. 14). 9. Lessons to be Learned 9.01 The principal lessons to be learned from this project experience are: (a) The generally weak performances of PETROPERU and the Government underline the need for reforms in the or-  - 24 - ganization of the sector -- reforms aiming at deregulation of prices, privatization of most or all of PETROPERU, opening the sector to free competition, etc. These reforms are being sought in connection with a proposed privatization loan (para. 2.17). (b) For a revenue-earning borrower in countries experiencing high inflation, efforts to maintain prices should be continued even after the prices are increased to an adequate level. Accordingly, suitable measures, such as linking domestic prices with international prices on a monthly basis, should be included in the conditions of the loan (para. 3.10-.12). (c) For countries which have weak macroeconomic situations such as highly indebted countries, a firm commitment of cofinancing should be a condition for proceeding with the loan to assure viability and successful implementation of the project. Possibility of additional cofinancing currently contemplated at negotiations, could diminish as the country's economic situation deteriorates (paras. 3.19 & 4.04). (d) The Bank should devote special attention and make continuous efforts to assist its borrowers in understanding and using the Bank's procurement guidelines to eliminate procurement delays, accelerate disbursements, and to improve the implementation of the projects (para. 8.03). A close review of country laws, regulations and practices should be made during appraisal to identify problem areas and to seek their solution during loan negotiations. In the event of conflict between local laws, etc. and Bank procurement guide- lines, the Bank should seek Government agreement to a waiver of local laws with respect to the Bank-financed project. If no such waiver is possible, the Bank should consider withdrawing from the project. (e) Although flexibility is needed for adapting financial covenants to changing circumstances, the Bank should be ready to suspend disbursements if the need arises (para. 8.11). (f) When the borrower's capacity is insufficient to carry out a project, the use of a project management service company responsible for day-to-day operations can be very effective and helpful to reinforce the Borrower's capacity. This approach can also be helpful to attract cofinanciers for such a project (para. 8.17).  - 25 - PROJECT COMPLETION REPORT PERU PETROLEUM PRODUCTION ENHANCEMENT PROJECT (LOAN 2195-PE) PART II: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE (Editor's Note: Set forth below are comments of borrower which have been excerpted from the final project report. They have been edited to achieve stylistic consistency with Part I.) 1. Despite smaller reserves than assumed in the feasibility study, the general delay experienced by the project as a result of problems related to the major bidding items (e.g. drilling services) as well as the difficulties that made it impossible to carry out the original financing design, the project was still profitable for the Empresa, reaching a net present value (NPV) at 20% of US$15,347,000 6/ and an earnings/investment ratio of US$9.30 for every US$100 invested. 2. Despite the negative factors indicated above, the two main factors in the favorable financial outcome were lower investment (US$164.4 million versus US$244 million in the feasibility study) and lower operating costs. The lower investment figure resulted from the lower prices obtained through international competitive bidding for the project, both for petroleum services and for materials and equipment. Lower operating costs resulted from an overall increase in operational efficiency throughout the project, making it possible to contain costs for pulling services, mechanical and production maintenance, as well as the consumption of materials and spare parts. 3. During project implementation, 161 new wells were drilled (10 in the Amotape reservoir, 133 in the Mogoll6n reservoir and 18 in the Echinocyamus reservoir, as against the 159 wells projected in the feasibility study (23 in the Amotape, 109 in the Mogoll6n and 27 in the Echinocyamus). The smaller number of wells drilled in the Amotape and Echinocyamus reservoirs compared to the feasibility study was due exclusively to the recommendations based on the economic and technical results achieved in those formations (low success factors). 4. Under the project, a total of 80 wells were reconditioned (29 were new wells or recompletions and 51 existing wells or reactivations), as against the 177 planned in the feasibility study (101 new wells and 76 existing wells). W See Attachment 1 to Part 11. UnLike the Bank, PETROPERU catculated the present value of the project (financial) by making adjustments to the streams of costs and benefits for interest costs, tax benefits related to depreciation, debt repayment, and disbursements of Its own funds only.  - 26 - The lower number of workovers of existing wells was due to the revaluation of the wells proposed in the feasibility study as results became available, thereby eliminating those with less potential or higher risk. The lower number of recompletions was due solely to the delay in the project drilling program, which meant that in the third or fourth year of operations (when funds from the financing were still available), many of the new wells had high production rates as their primary objectives, which prevented recompletions at more frequent intervals. 5. As a result of the intense well drilling and reconditioning program, there will be incremental production of 13,528,000 barrels up to the economic limit, distributed as follows: New wells 11,625,000 Recompletions 531,000 Workovers 1,372.000 Total 13,528,000 6. Six years after project development began (1983-1989), it is still feasible to continue well drilling and reconditioning, in the light of an "individual or differential economy," i.e. without charging the investments made in nonproductive facilities. Thus, in accordance with the geological studies and reserves estimated by this Commission, it was concluded that it is still feasible to continue development of the area. Twenty-three feasible locations for drilling have been identified, with a total of 2.27 million barrels of reserves, in accordance with the following: Formation No. Wells Location Amotape 4 Area of well 2414E Mogoll6n 13 3 in Zapotal 10 in Organos Norte Echinocyamus 6 2 in Zapotal Sur 4 in Zapotal Norte As regards reconditioning, 85 prospective wells have been selected, 24 of which are existing wells (workovers) and 61 new wells (recompletions), which would provide estimated reserves of 1.5 million barrels. 7. The results obtained to date suggest that infill drilling in the Mogoll6n in the Zapotal field is highly risky, particularly between existing wells that have been operating for some time, as this often leads to rapid depletion in the block, which prevents the infill wells from obtaining sufficient final recoveries to justify the investment.  - 27 - Thus, of six infill wells drilled by the project, only one (well 7131) was profitable (NPV = US$264 thousand); in the others, the developed reserves were insufficient to justify drilling. However, from the history of available production it is still not clear whether the production of these wells represents only an "acceleration of reserves" or in fact the mobilization of new reserves. 8. Well drilling contracts on a per-foot basis led to a better drilling yield than contracts based on a daily rate, in both terms of net rate and total drilling (feet/hour), as well as in cost per foot drilled (USS/foot). Thus, in the Laguna Este area (Mogoll6n formation), a net penetration of 20.05 feet/hour and a total penetration of 13.43 feet/hour were achieved, which is higher than the results for contracts based on an hourly rate, for which the respective figures were only 13.36 and 11.42 feet/hour for net penetration and total penetration. Similar results were also obtained in the Zapotal area. In terms of cost, the use of per-foot contracts led to a favorable change in the cost per foot drilled, from US$62.61/foot (hourly contract with Geosource at the start of the project) to US$34.90/foot under the last per-foot drilling contract (Contract PER-LZ-020). 9. The decrease in total deferred production, which fell from an average of