Argentina - Oil and Gas Credit Project

IDocument of The World Bank ORtOCl, USE ONrv Report No 10707 PROJECT COMPLETION REPORT ARGENTINA (LOAN CREDIT PROJECT (ON2031-AR) JUNE 8, 1992 MI CROF I CHE C()PY Report No. 10707-AR Type: ( PCR) TWEDDLE, E/ X31707 , T 07:3/ OEDD3 Infrastrcutur and nrg jvso country Depergy LatinAz Depa t TV ~ io Aerica and the Caribbe8 ein,Ofc their Orrlcial d. s " "estricted d tis t cnet"ti'tOn8d=%  ABBREVIATIONS AND ACRONYMS BANADE Banco Nacional de Desarrollo GdeE Gas del Estado PCR Project Completion Report YPF Yacimientos Petroliferos Fiscales  THE WORLD BANK FOR omc USE ONLY Washington, D.C. 20433 US.A. OffiCe P4 '>ieCtoqf-CA*f&I Op(*imons Evaluation June 8 . 1992 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Argentina Oil and Gas Credit Proiect (Loan 2031-AR) Attached, for information, is a copy of a report entitled "Project Completion Report on Argentina - Oil and Gas Credit Project (Loan 2031-AR)" prepared by the Latin America and the Caribbean Regional Office. No audit of this project has been made by the Operations Evaluation Department at this time. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICL41 USE ONLY flQJ7.CT COMPLETI-ON REPORT ARGEMNTA OIL AD GA CREDIT PROJECT (Lomz 2031-AR) Table of Contents SPate No. Preface............................ i Evaluation Sumary . . . . . . . . . . . . . . . . . . . . * l Part I 1 Project Identity . . . . . . . . . . . . . . . . . . . . . 1 2e Background .... . . . . . . . . . . . . 1 3. Recent Sector Development Objectives . . . . . . . . . .. 3 4. Project Objectives and Description . . . . . . . . . . . 3 5. ProJoet Design and Organization .. . .. . . . . . .. . 4 6. ProJet Implementation .... ............ .................. 5 7. ?ro1ect Resalts . . . . . . . . . * * * * , * * * * * * * 7 8. B Perforamnce . .. . . . . . . . . . .. * * * a * *. 9 9. Borrower Performance *. 11. .s...... 0 011 10. Lessons Learned . .. . . . . . . . . . . . . . . . . . . . 12 11. Project Relationship . . . . . . . . . . . . 12 12. Consultancy Services . . . . . . . . . ......... 13 13. Project Documentation and Data . . . . . . . . . 13 Part II 1. Borrower's Covaents . . . . . . . . . . . . . . . . 14 Part III 1. Related Bank Loins . . . . . 15 2. Project Timetable . 0 0 .00... 0. 0. 00000. 16 3. Cumulative Estimated and Actual Loan Diaburemnts . 17 4. Allocation of Loan Proceeds . . . . . . . . . . . . . . 18 5. Project Costs and Financing . 000. 19 6. Suary of Subloans 000. 0 * * * * 0 0 0 20 7. Financial Statements of BANADE 0 .0... 0...0. 21 8. BANADE'o Staff . * . . . . . . * * 0 0 0 * * * 0 o o 0 0 24 9. Status of Covenanta . .000000 . . . . . 0 . . . . 26 10. Use of Bank Resources . . . o . .... * * * * *.. . . .. 29 Map No. IBRD 22330 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  i PROJECT COMPLETION REPORT ARGENTINA OIL ANrD GAS CREDIT PROJECT (Loan 2031-AR) PREFACE This is the Project Completion Report (PCR) for the Oil and Gas Credit Project in Argentina, for which Loan 2031-AR in the amount of US$ 100.0 million was approved on July 7, 1981. The loan was closed on December 31, 1988, three years behind schedule, and the undisbursed balance of US$ 23.1 million was cancelled. The last disbursement was on May 30, 1989. The PCL was prepared by the Infrastructure and Energy Division of Latin America and the Caribbean Regional Office (Preface, Evaluation Summary, Parts I and III). On September 28, 1989 the Bank sent the Borrower Parts I and III with the request to prepare Part II. The above request was reiterated during the visit to BANADE in March 1990, but no reply was received. Preparation of this PCR is based inter alia, on the Staff Appraisal Report, Project and Guarantee Agreements for the loan, Project Supervision Reports, correspondence between the Bank and the Borrower, and internal Bank memoranda.  ii PROJECT COMPLETION REPORT ARGENTINA OIL AND GAS CREDIT PROJECT (Loan 2031-All EVALUATION SUMMARY Obiectives The project objectives were to support the Government's policy of increasing private sector participation in oil and gas exploration and development and to improve sector efficiency. It provided long-term financing for exploration and development projects, including pipeline and gas treatment lants. The project included a technical assistance component for BANADE to uild up its appraisal and supervision capability of oil and gas projects. Furthermore, the project was expected to act as a catalyst for attracting comuercial banks to provide financing for the oil and gas sector. Implementation Exoerience The loan was approved on July 7, 1981, sCined on October 2, 1981 and declared effective on December 30, 1982. The Closing Dtte originally scheduled for December 31, 1985 was postponed untll December 31, 1988, because of repeated delays in project implementation. The Bank canceled the remaining loan balance of US$23.1 million. Among the factors that seriously hampered project implementation were: (i) BANADE's lack of decision regarding the hiring of foreign consultants needed to help appraise subprojecta and train BANADE's staff; (ii) Government decisions and policy framework that overregulated petroleum exploration and development activities; (iii) disputes between Government and private companies over the price of the hydrocarbons produced by the private sector; (iv) frequent and lengthy delays in procurement decisions and approvals by BANADE and; (v) the financial crisis in the country (para. 6.1-6.4). BARADE's financial situation started to deteriorate soon after the project commenced. The introduction of regulated interest rates in 1983, and the obligation imposed by the Government to finance assets (loans) with BANADE's own resources at negative interest rates, contributed enormously to its decapitalization. Major causes of BANADE's financial crisis were also its deteriorating loan portfolio and its poor collection performance (para. 7.4). Results Loan Component. Under the loan, BANADE financed a total of eight subprojects among four private enterprises; seven of these projects are still in BANADE's portfolio. One project has been fully paid, the rest do not have payment problems, and none represent a risk vith respect to the soundness and efficiency of the petroleum development subproject financed. The total amount that the Bank financed was US$76.3 million (58Z) and the remainder US$56.3 million was financed by internal sources. The average size subloans was US$9.5 million and the total average subproject size was US$16.5 million. All  iii the subprojects have demonstrated financial-economic viability, with an average ERR above 302 (para. 7.1). Technical Assistance Comonent. The project contributed to institutional building by developing BANADE's capacity to identify, appraise and supervise oil and gas projects. But BANADE'Os effectiveness was hampered by inadequate management information systems and rigid personnil policies (para. 7.2). Under the project, a special department in BANADE for oil and gas was established and its staff received on-the-job training (para. 7.5). Sustainabilitv BANADE's financial situation has been staadily deteriorating. BANADE is under an overall process of reorganization and its future is not clear. Project sustainability cannot reasonably be expected, unless radical changes occur within BANADE's management. Findings and Lessons Learned The project was somewhat successful in encouraging private firms to participate in oil and gas sector development and partially met the objective of providing long-term financing for sound oil and gas projects. This was a "first of its kind" project for the Bank, ;hich carried with it the risk of dealing with an institution with no experience in oil and gas lending. This risk was well met by the project technical assistance component. The project did not meet its other objectives of: (i) strengthening BANADE institutionally and financially so as to ensure project sustainability; and (ii) attracting coummercial Banks to provide subproject financing. Major lessons learned from this project include: (a) More attention shr-ld have been given to the quality of BANADE's overall management and financial capacity. A comprehensive plan of action addressing BANADE's institutional problems (status of loan portfolio, arrears, etc.) should have been developed. It should be noted, however, that the Bank and BANADE had developed, via other ongoing projects, a number of "action plans" which were not met. (b) In its overall dealings with BANADE9 the Bank should have been firmer in seeking compliance with institutional targets, and remedies should have been considered. (c) Private sector participation was limited by an inconsistent and inadequate policy framework. More recent developments which aim at implementing far reaching sector reforms should make a more lasting contribution to aehieving sustainable energy sector development. (d) In the future, lines of credit shou:d be established with non- governmental bankia. (a) Sector training agencies should encourage adequate staff training units with broad mandates, not only to assess needs, but also to define and fund long term plans to address them.  PROJECT COMPLETlON REPORT ARGENTINA OIL AND GAS CREDIT PROJECT (Loan 2031-AR) Part I 1. .'ro1ect Identity Project Name: Oil and Gas Credit Project Loan Number: 2031-AR RVP Unit: Latin America and the Caribbean Country: Argentina Sector : Energy Subsector: Petroleum 2. Background 2.1 The abundant and diverse potential energy resources of Argentina include: crude oil, natural gas, hydropower, nuclear, biomass and coal. Argentina's energy sector historically has been characterized by a limited capacity to produtce crude oil and natural gas needed to meet the demand required for the country's internal consumption. The supply of electricity, which used to be reliable, has been characterized recently by frequent shortages. Over the last decade, natural gas production increased 51 per year and is projected to grow 4% per year to the year 2000. This reflects an energy resource strategy shift from crude oil to natural gas, as well as hydropower and nuclear energy based on a reassessment of the resources. At the current production rates, the proven reserve/production ratio for crade oil is about eight years and for natural gas about twenty years. Projected future demand for liquid hydrocarbons will be much more difficult to supply from known sources, which means further exploration will, be required. Given the constraints on public sector resources, most of the exploratory work will have to be done by the private sector. 2.2 Production of crude oil fell 14S between 1981 and 1987, caused mainly by a consistent decline in YPP's (Yacimientos Petroliferos Fiscales) crude oil production, which accounts for two-thirds of all crude oil production in the country. There were two main causes for this decline: (i) natural depletion of older reservoirs; and (ii) fewer wells were drilled during the above period, because of limited funds for new investments. YPF was forced to cut its planned investments because the Government, facing major fiscal constraints, did not authorize all the funds required for new investments in exploration and production of crude oil. Also, Government policies restricted private sector exploration and production investments in YPF's producing areas, under production service contracts with private companies. In 1985, the Houston Plan was devised tV attract further private sector participation. The plan has provided the country with the  2 participation of international petroleum companies through coiperative ventures with local private oil companies. The imain characteristic of the Houston Plan is a guarantee that payment of services would be made in exportable crude oil, in the event that YPP is unable to make timely payments in foreign exchange. However, it is noteworthy that about 75Z of the drilling effort to explore and develop new reserves of crude oil and natural gas is carried out solely by YPF with public funds. The remaining 252 is done by private oil companies, both national and foreign. While this effort has been adsqntate to maintain Argentina's policy for ealf-sufficiency in the past, and in meeting present consumption needs in crude oil and natural gas, proven oil and gas reserves will clearly be insufficient when measa-"--' against the rapid growth in demand for crude oil and natural gas expecto ter the next 20 years. 2.3 Dwiring the period 1981-1989, the finances and operations of the energy sector were heavily influenced by macroeconomic factors and certain economic developments affect:ing public finances. The economic system dominating the energy sector was characterized by a high level of taxation imposed on all energy sector activities. There were many distortions in the composition, structure and coord:nation of the various energy subsector investments. In particular, the investment strategy and policy framework guiding the hydrocarbon sector discouraged exports of crude oil. Financial distortions were particularly large in the energy sector; it has estimated that indirect subsidies by Y'F and GdeE (Gas del Estado) were about US$1.5 billion a year for thA past ten y-e..s 2.4 Key public sector enterprises in the hydrocarbon sector are YPF (the state oil company) and Gde! (the state gas company). YPP wae established in 1922 and structured as a corporation, and over the project period accounted for about 701 of total crude oil and more than 802 of all natural gas production. Additionally, it maintained a controlling relationship over the private sector companies that produced the remaining hydrocarbons. YPF generated important revenues for the Government, which in 1988 totalled about US$7.0 billion (grora revenue, including fuel taxes). YPP was the only institution that holds petroleum rights for exploration and production areas in Argentina and controlled the majority of refining and marketing activities. All private companies, both local and international that participated in the exploration for or production of hydrocarbons performed their activities under service contracts with YPP. GdeE was established in 1946 as a Government enterprise to provide natural gas distribution as a public service, and this role was reiterated in 1978, explicitly ruling out any economic purpose. Gde! purchases natural gas from YPF (although important amounts are still imported from Bolivia). GdeE processes natural gas to remove hydrocarbon liquids, then transports the gas to distribution centers, where it is marketed to end users. GdeE also produces and markets LPG (propane and butane) and other byproducts, such as ethane and natural gasoline. A multiplicity of Government agencies oversee the operations of YPF and GdeE, as well as those of other state energy enterprises, which have contributed to create institutional sector inefficiency.  3 3. Recent Sector Develorment Obiectg%es 3.1 Although self-sufficiency in energy has been a long-term major Government objective, this goal has not always been achieved. Crude cil production rates in recent years have exceeded additions to the resource base. Still significant potential exists to increase crude oil production and to uind addxtional volumes of natural gas. The objective is to achieve least- coat energy supply to the consumer. Begivning in 1989, the Government of Argentina initiated a two-pronged approach to revitalize the hydrocarbon sector by: (1) deregulation of the hydrocarbon sector, which will result in a system of price competition and economic efficiency, and (ii) restructuring YPF and GdeE. 3.2 The following measures have already been enacted to achieve the Government objectives in the hydrocarbon sector: (a) reduction of crude oil and natural gas royalty payments to 122 of their international value (Law 23696); (b) increase incentives for private sector investment in crude oil and natural gas production (Decrees 1055, 1212, and 1589); (c) increase private sector involvement in the retail distribution of petroleum products; (d) adoption of a plan to deregulate prices of crude oil, petroleum products and natural gas, and allowing free availability of crude oil and refined products by January 1, 1991; (e) elimination of preferential prices for electric power; (f) virtual elimination of refinery taxes by their reduction from 101 to 0.2?; (g) extending the vilue-added tax uniformly to all fuels; (h) simplifying the system of earmarked funds; (i) increasing natural gas prices to 902 of fuel oil for industry and power, and establishing netback pricing principles for natural gas producers (Decree 1212); and (j) reduction of some subsidies benefitting the private sector. 4. Proiect Objectives and Doscriltion 4.1 The primary objective of the project was to support the Government's efforts to strengthen the role of the Argentine private sector in an accelerated program of oil and gas production by: (a) providing long-term financing for sound exploration, primary and secondary recovery projects, including pipelines and gas tre<atment plants; and (b) providing technical assistance to develop BANADE's institutional capacity to identify, appraise and supervise oil and gas projects. The project was also expected to act as a catalyst, through BANADE, to mobilize resources from foreign and local banks for properly screened subprojects and would be a vehicle for sectoral policy discussions with the Govam- ent. 4.2 The project would provide US$99 million of long-term funds to finance subprojects in oil and gas sector development. Subloans would help finance the foreign exchange component of eligible subprojects, to be undertaken by private Argentine companies, which had been awarded an exploration or development contract by YPP. A US$1 million technical assistance component would help increase BANADE's appraisal and supervision capacity for petroleum lending.  4 4.3 The total subproject Investment was estimated at US$500 million, and the total incremental crude oil production to be obtained was estimated at 50 million barrels over the life of the subprojects. The estimated financing would be from equity contributions of about US$125 million, the Bank loan of US$99 million and the remainder from commercial sources and BANADE. ..fter a slow start and limited project implementation, the Bank canceled the remaining loan balance of US$23.1 million. 5. Proiect Design and Organization 5.1 The project Was prepared in line wi.h the Government of Argentina main objectives for the hydrcG-rbon sector. It was aimed at overcoming the financial and institutional constraints that were inh,' iting increased participation by the Argentine private sector in the develo mtant of Argentina's promising hydrocarbon resources and to help the country move towards petroleum self-sufficiency. The project, which was the first the Bank had designed involving private oil and gas companies, was expected to act as a catalyst to attract parallel financing from other sources. The conceptual foundation for the project was thus clear and consistent with newly established procedures for industrial credit projects. 5.2 The project was identified by a Bank mission in August 1979. In mid-November 1979, the Government of Argentina requested the Bank assistance in financing an oil and gas project. The Bank reacted favorable and sent a project preparation mission in late June 1980. Close coordination was required between BANADE and YPF at the policy and operating levels to enable BANADE to program its oil and gas lending on the basis of YPF's plan to award contracts, and to give BANADE access to bidding and technical information necessary in the appraisal of specific subp-ojects. Negotiations took place in May 1981 and the loan was approved on July 198. and signed in October 1981, but did not become effective until December 1982. 5.3 Loan disbursements were projected to take up to five years from mid 1982 through 1986. This included provisions for retroactive financing of up to US$5.0 million. The disbursement period, relatively short when compared to other Bank supported oil and gas credit projects in Latin America, was supported by the experience of the Argentine petroleum firms and of the foreign suppliers and service firms operating in Argentina that are well represented in the country. However, the disbursements were slow because of political and economic problems affecting Argentina and inefficiencies of BANADE's management (para. 6.4). 5.4 All the pi..curement was to be in accordance with Bank guidelines. Oil fields contracts were awarded in accordance with established commercial practices in the petroleum sector, which are acceptable to the Bank. she exploration and deveiopment subprojects were based on contracts awarded by YPF through international competitive bidding. The project was scheduled to be cmpleted 'Uy June 30, 1985 with a Closing Date of December 31, 1985. 5.5 During the preparation and the appraisal of the project, several important issues arose: (a) institutional arrangements; (b) external  5 auditing; (c) price of hydrocarbon products; and (d) interest rates on subloans. These issues are discussed below. 5.6 Institutional Arrangements: During the preparation of the project, BANADE had to prepare a statement of policy on oil and gas operations. BANADE had to establish an oil and gas section within a division which could deal with energy projects in general. MANADE contracted several petroleum geologists and petroleum engineers to help in the evaluation of projects, and hired a consultancy firm to train BANADE's itaff on technical aspects of oil and gas lending. The main objective was to develop sustainable general oil and gas project appraisal and supervision skills within BANADE. The Bank suggested the possibility of using the project's technical assistance to establish a broad-based training program that would supply a large number of qualified personnel to the banking sector. 5.7 External Auditing: BANADE had been audited by a special unit of the Central Bank. However, during preparation of the project, the Central Bank was no longer able to allocate adequate staff for this task. Therefore, BANADE requested that the Bank should accept an alternative arrangement, involving an independent Government auditor. During the negotiations, the Bank agreed to the contracting of auditors and supervision through SIGEP, and that an audit report be prepared for 1980 as a condition for Board presentation. Also, it was rireed during the same negotiations both the scope and timing of the audit, as well as the establishment of separate accounts for the proposed loan. 5.8 Price of Hydrocarbor- Products. At the loan negotiations, the Government agreed to provide a letter of intention in which it agreed to adjust petroleum products prices peziodically to reflect adequately changes in internal price levels, taking into account the results of the natural gas optimization study financed under Loan 1880-AR. Aloo it was agreed that final consumer prices of petroleum products would, at the minimum, be maintained in real terms at the March 31, 1981 levels, as measured in constant dollars. These covenants were only met partially by the Government of Argentina. 5.9 Interest Rates on Subloans. During appraisal, interest rates on subloans were set at the Bank rate (at that time 9.6S) with a minimum of 22 for BANADE's spread, and an additional 2.02 minimum fee to cover the cross- currency risk. At loan negotiations, the Bank recommended a minimum on lending rate of 13.52 in dollars, since BANADE indicated tnat it would prefer to lend only in US dollars. However, since the beginning of the project's life, this level of interest rates and the fact that interest rates were fixed, caused problems in obtaining the agreement of interested companies for taking any loans under the project. 6. Project Implementation 6.1 Completion of the project exceeded appraisal estimates by about 602 of the original completion date, and by about 502 of the loan Closing Date. The project experienced delays throughout its implementation, and especially at the beginning of the project execution. For more than a year, BANADE failed to meet the loan conditions of hiring technical consultants to  6 help appraise projects and to train BANADE's staff on the technical aspects of oil and gas lending. Argentine Law 18775 prevents public institutions from hiring foreign consultants without local participation in the form of partnerships or consortia, unless it can be proved that there are no local companies capable of meeting these requirements. BANADE mistakenly believed that the Bank's procurement guidelines were irreconcilable with the Argentine legal requirement of foreign consulting firms. The Bank clarified that those legal requirements were acceptable to the Bank, provided that the association with local partners would be on a voluntary basis, that sufficient firms would bi availab'e in the country from whom foreign consultants could chose their local partners, and that the respective scope of responsibilities of the partners would be freely agreed upon. Ad&itionally, implementation of the project was hampered by the financial crisis affecting the whole country and virtually all its private and public institutions, primarily in the form of a large fiscal deficit, absence of foreign exchange reserves, inability to service foreign debt and high rate of domestic inflation. These resulted in two extensions of the Closing Date from December 31, 1985 to December 31, 1988. L.2 A factor that accounted for the slow use of loan proceeds was the Government's policy framework that regulated petroleum exploration during the project implementation period. Until 1982, official Government policy was to rely increasingly on the priva-e sector for exploration and development of new hydrocarbon resources. After 1982 and during 1983, political uncertainties regarding economic policies of the new civilian Government and attitudes towards the role of the private sector, made it difficult to persuade the private sector to commit major new investments for exploration and development of hydrocarbon resources. An additional factor that contributed to the slower use of loan proceeds was the constant disputes between the Government and the private firms over the price of the crude oil that they produced, which was totally divorced from the price paid b'y the public for petroleum refined products. Also, the bad experience acquired by several investors, made them wary of the arrangements under the plan that called for repayments denominated in US dollars related to investments denominated in local currency. Later, a revision was requested by BANADE, and the project was amended to meet these problems. 6.3 Procurement-related problems also slowed down project implementation. BANADE's Energy Department had no prior experience with the Bank's procurement procedures. At the beginning of the project implementation cycle, subproject approval often took more than three months. However, subproject approval started to speed up in 1984,when exploration contracts were awarded by YPF through international competitive bidding, and also because most Argentine firms had good experience in the preparation of bidding and tender documents. Also, most companies normally formed ad hoc consortia to bid on YPF9s contracts and procurement decisions of the operating partner in the consortium usually were the subject of scrutiny by the other partners. 6.4 Disbursements of the loan did not take place for almost two years after project approval. In the meantime, BANADE's financial situation deteriorated significantly. To encourage and accelerate the use of the loan, an additional amendment was introduced to allow working capital financing for  7 industrial firms for imported goods. A working capital facility of US$25.0 million was established, as well as provisious for the use of funds for working capital purposes, which would be for two years and with repayment for up to three years. Later in 1985, the Bank approved BANADE's request to adjust the amortization scheduled in line with the repayment schedule of its subloans. Maturity already due was reduced from US$4,165,000 to US$695,000. It was envisaged that BANADE would service the Bank loan with subloan repayments, but at that time, BANADE had not yet received any service payment from its sub-borrowers. This was due to the slow project implementation, as a result of the prolonged recession and total disarray of the country's financial system, which affected BANADE's cash flow as well as the sub- borrowers ability to repay BANADE. 6.5 The Technical Assistance Component. The main objectives of the technical assistance were accomplished. There was a slow initial implementation in setting-up the specialized Energy Department within BANADE for oil and gas projects, due to delays in hiring a foreign consulting firm (para. 6.1). The development of suitable appraisal and aupervision procedures for the newly created Energy Department and the training of the department's staff was eventually accomplished. After that the Energy Department staff acquired sufficient competence and expertise to ensure suitable supervision of subprojects. BANADE and the Bank agreed not to retain the foreign consultant firm on a permanent basis. However, the Bank requested BANADE to continue retaining foreign consultants on an ad hoc basis to cover specific aspects of the subprojects, such as: determining the adequacy of the exploration programs, certification of the feasibility of the production plans, professional judgement on the capacity of the investment enterprise's technical services for properly implementing the subprojects, etc. The Bank also agreed that the cost of the consultants could be assigned to the sub- borrowers (amendment 3.02 of Loan Agreement). 6.6 Proiect Cost. Based upon data supplied in March 1990, the total cost of the project reached US$132.1 million, of which US$76.3 million (58.02 was financed by the Bank). In 1987, after seven years of implementation, total disbursements reached only US$27.7 million, 27.7Z of the loan amount. The Bank approved two consecutive one year extensions from December 31, 1986 to December 31, 1988. The final disbursement waa made on May 30, 1989. 7. Proiect Results 7.1 The Loan Comvonent. The project was closed on December 30, 1988, after the loan account was closed, with the cancellation of the undisbursed balance of US$ 23.1 million. The project's objectives of providing long term financing for sound primary and secondary recovery and exploration projects, and to develop BANADE's institutional capacity to appraise and supervise oil and gas projects, were partially achieved. Under the loan, BANADE financed a total of eight subprojects, including four private enterprises (BRIDAS, ASTRA, PLUSPETROL and CADIPSA). The total cost of the project was US$ 132.6 million, out of which Bank financing was US$76.3 million (58Z) and the rest US$56.3 million (42Z) was provided by internal sources. Private banks were reluctant to provide financing for this type of project because the guarantee provided by the contract between YPF and the private hydrocarbon producers  8 were deemed insufficient. Large enterprises were the beneficiaries of the subloans and most of them financed their subprojects using internal resourcep. The average size of the subloans was US$9.5 million and the average total investment size of the subprojects was US$16.5 million. Subloan terms were between three and eight years, including the grace period. The largest subloan approved (US$20.0 millicn) was to the Cahiadon Sico and Meseta Espinoza project (ASTRA), which involved the drilling of 30 nei. wells, repairs in 54 existing wells, and also construction of roads and surface installations. One subloan has been fully paid, and the rest are still in BANADE's portfolio. None of the subprojects are having re-payment problems and neither represent a risk with respect of the soundness and efficiency of the petroleum development subprojects being financed. All the subprojects have demonstrated financial and economic viability. Preliminary data has shown an average ERR of above 30% for all subprojects, except the single exploration subproject. Part III, Section 6 provides a listing of all subprojects financed under Loan 2031-AR. 7.2 The project contributed to institutional building by developing BANADE's capacity to identify, appraise and supervise oil and gas subprojects. Although this main objective has been achieved, BANADE is still hampered by some fundamental problems. BANADE is a development bank with severe decapitalization and other financial problems. Frequent political interferences contributed towards the deterioration of BANADE's total portfolio. 7.3 BANADE improved substantially its capacity to appraise and supervise oil and gas projects, biut the project did not improve BANADE's financial position; it even deteriorated significantly during implementation (pars.7.4). During the last few years, BANADE's resource allocation function was heavily distorted and negatively influenced by the Government. 7.4 The 1981-89 financial situation of BANADE is shown in Part III, Section 7. Net equity decreased from US$138.4 million in 1981 to US$34.7 million in 1989, a deterioration of 752. BANADE's total assets grew only 1.32 compared with a 36.7% increase of its portfolio. This severe decapitalization of BANADE has been the result of increased arrears of the current overall portfolio resulting from the financial-economic crisis of Argentina during the last years, aggravated by BANADE's poor collection efforts. Additionally, the introduction of regulated interest rates since 1983 and the need to finance assets (loans) with BANADE's own resources at negative interest rates have contributed enormously to its decapitalization. Profitability of BANADE has been weak during the same period, as a result of higher provisions and administrative expenses, which increased more than 502 during 1981-88. On an annual basis, administrative expenses (of which personnel is about 702) represent on the average about 1.2Z of the assets, somewhat above the 0.5-1% benchmark normally used for development banks worldwide. This deterioration of BANADE's financial position is clearly reflected in its debt/equity ratio of 17.7:1 in 1988, greatly exceeding the limit of 10:1 established in the Loan Agreement. However, as stated earlier, the major cause of BANADE's financial crisis has been its deteriorating loan portfolio and its poor collection performance. During last year BANADE, has put great priority in a process of accelerated collections and debt cancellations through prepayments and debt swaps involving significant  9 discounts. BANADE's almost negligible net worth as of December 31, 1989, coupled with the uncertainties concerning loan guarantees and its overall portfolio, plus the foreign exchange risk provisions, have made it almost certain that the institution is, technically speaking, bankrupt. Recently, BANADE has embarked on a profound restructuring aimed at converting it into a second tier bank. However, it is still unclear if the new BANADE will be financially viable. 7.5 The Technical Assistance Comoonent. The objective of this component, which was to help strengthen BANADE's appraisal and supervision capacity for petroleum and gas lending, was achieved through the contract of a foreign consultancy firm. Additionally, a special division for oil and gas projects was established in BANADE and its staff received on-the-job training. Only US$0.6 million was used from the US$1.0 million allocated for technical assistance, due to BANADE's decision to discontinue this assistance. BANADE demonstrated to the Bank that its staff had already acquired sufficient competence and expertise to ensure suitable supervision of the projects. Three Argentine geologists and three petroleum engineers were hired by the Energy Division in the framework of tha project. The technical assistance program was regarded as acceptable by the supervision missions. 7.6 Proiect Sustainabilltv. No sustainability of the project can reasonably be expected, unless tremendous and radical changes occur in BANADE's management. From 1982, BANADE's financial situation has continuously deteriorated and this tendency iG still continuing. Weakness in management had not been addressed, until the Government intervened BANADE in May 1990. 3BANADE is currently under a process of reorganization and its future role is still not very clear. BANADE's impact on the industrial sector is limited since it has become a paralyzed institution with a rigid structure and inadequate procedures, not capable of performing a useful role as an adequate tool for industrial financing in Argentina. Obviously, any analysis of BANADE is determined by the present situation and role of the financial sector in this country. 8. Bank Performance. 8.1 Taking into consideration that this project was the first Bank project involving private oil and gas firms in Argentina, overall Bank performance was satisfactory. The Bank maintained its dialogue and close relationship with BANADE throughout the life of the project. The Bank reacted fast to the Government of Argentina's request to improve sector efficiency by strengthening the role of the local private sector firms in oil and gas exploration. At the time of preparation and appraisal, the institutional arrangements for project implementation were weak; therefore, appropriate steps were taken during the appraisal and subsequent stages to strengthen BANADE's Energy Division. The Bank's performance in bringing about institutional changes during supervision was less convincing, despite the fact that the policies for change had been set out by the Government. During appraisal, the Bank adequately highlighted the need to improve BANADE's financial performance.  10 8.2 The Bank's assistance was instrumental in improving the execution of the project. Since the beginning of the project implementation, the Bank played a major role in strengthening the Oil and Gas Division within BANADE's Mining Department and in streamlining bidding and disbursement procedures. Only after Bank missions had reviewed in detail BANADE's procedures in processing disbursoements (not only for the World Bank financed subloans, but also for all BANADE's loans), did the Bank accept from BANADE the submission of the same documents that are usually prepared for BANADE's own internal control. The Bank, in order to speed up disbursements at the beginning of the project implementation, accepted the statement of expenditures as a basis of disbursements for subloans. A very positive contribution regarding Argentina's high inflation rate was showed when the Bank ac:epted the historic parity procedures" It to determine the percentage of eligible local purchases that the Bank would agree to reimburse in current local currency. BANADE justified to the Bank the use of loan funds not only to f4nance directly oil and gas exploration, production and related transpott and treatment facilities, but likewise for the purchase of equipment for oil and gas exploration and production by service contractors. Many local firms are engaged in this activity, as contractors to both private oil companies and to YPF. Several oil production companies directly involved in exploration and production also provide their services to the industry as contractors. As a result, the Bank agreed to the amendment of the Loan Agreement and redefined the meaning of "Investment Project". In view of the low rate of applications and disbursements, and the financing needs arising in connection with some sub-projects during the project implementation, the Bank broadened the definition of eligible sub-borrowers. This allowed BARADE to finance consortia, in which Argentine firms only participated with a minority interest, but which in turn were seeking out sources of external financing for the development of their respective areas in Argentina. An additional positive contribution by the Bank was its acceptance cnd corresponding amendment for the provision of working capital financing to eligible sub- borrowers. 8.3 The number of supervision missions appears to have been sufficient. Supervision efforts were sustained through full or partial missions from project effectiveness to Closing Date. There was an average of 2.2 missions per year. The major supervision weakness was the lack of attention paid to BANADE's financial situation and in some respects to its internal project approval and supervision procedu as. Furthermore, of the total 17 missions, only four missions included a financial analyst, reflecting the Bank's lack of attention to BANADE's need for institutional help during the period of financial crisis. The Bank only tried to speed up procedures of sub-loan approval, rather than to aasess BANADE's reaosons for the delays, and making the system more efficient. Supervision reports focused mainly on the 1// This procedure is the following: (a) converting the original documented expenditures into US dollars at the historic exchange rate prevailing at the time of payment; (b) reconverting the US dollars amount so obtained into local currency at the exchange rate prevailing when the disbursement ap4lication is being processed; and (c) applying the permissible rate of Bank financing to the latter amount.  11 technical evaluation of the sub-project, but were brief on the analysis of the financial issues of BANADE. They made no references to the worsening macroeconomic situation, insofar as it affected the project objectives. Comments on the economy were only made in relation to loan disbursement flows. No analysis was performed of the cash flow situation and quality of BANADE's portfolio. 8.4 During the supervision phase, the Bank appears to have been too lenient in accepting delays in the submission of inadequate progress reports, sub-project indicators, procurement and approval procedures information from BANADE. However, the Bank supervision missions provided a good opportunity to supply specialized techn4cal assistance to BANADE's staff, which was helpful during the project implementation. 9. Borrower Performance 9.1 The project was properly identified and prepared. Project preparation and design were satisfactorily carried out by BANADE's staff and with adequate assistance from the Bank. Over the implementation period, BANADE developed accepcable sub-project appraisal procedures and capabilities for this kind of cred-.t operation. The sub-projects were evaluated by teams of financial analysts, geologists, engineers and accountants, who devoted most the their time to analyzing the technical merit of the sub-loans, as well as the past and present economic-financial situation of the enterprises. However, BANADE's supervision during project implementation was weak, limited to physical inspection, with the purpose of verifying expenditures. BANADE's performance was slow in implementing the overall project and reportedly failed to respond to the Bank's request for improved and faster project iplementation. 9.2 During the project implementation period, BANADE's Energy Division acquired adequate competence and expertise to ensure suitable evaluation and supervision of the sub-projects. This was satisfactorily accomplished by the technical assistance component of the project (see para. 7.5). BANADE hired three geologists and three petroleum engineers, which were incorporated to its Energy Division in accordance with the guidelines for the project. As of today, BANADE is well equipped to appraise oil and gSa projects. 9.3 BANADE's recommendations were instrumental in establishing the accounting procedure. needed for the re-evaluation of assets of the sub- borrowers (BRIDAS, ASTRA, CADIPSA and PLUSPETROL). Due to the large devaluations of the Argentine currency with respect to the US dollars and because of high rates of domestic inflation, the Argentine Government had created a complex array of regulations pertaining to dollar-denominated liabilities hold by Argentine companies. BANADE's provision of funds was positive in reaching those investment projects, in an environment where access of term financing was limited although demand was great, in spite of the increased risk of borrowing dollars or dollar-indexed pesos, because of the political uncertainties of the country.  12 10. Lessons Learned 10.1 A lesson from this project is that sensitive issues such as the development of an efficient financial intermediary with a sound financial discipline and relevant influence within the sector, cannot be solved during the appraisal of a credit project targeted to a single sub sector. Further, the Bank should devote special efforts and continuous attention to the institutions it finances, and for this purpose the technical assistance resources should be sufficient and clearly targeted. This is particularly important in the case where the Bank is supporting an already well established institution like BANADE, with built-in resistance to changes in procedures that have been operating for more than forty years. BANADE was selected as the Borrower because it was the oaly large financial institution in the country dealing with the energy sector. Furthermore, the Government had pledged to put it on a sound basis. The Bank should have continued to stress the need for the achievement of financial self-sufficiency as a majo' objective for BANADE, and should have established clear financial performance targets to monitor the development of BANADE as a sound financial institution. The debt/equity ratio alone is not an appropriate tool to evaluate the evolution of the cash flow of a financial institution. 10.2 The Bank should insist on a better and more comprehensive preparation of some institutional building components, especially those related with management and financial issues. In future loans, the Bank should continue to be flexible, where necessary, in adapting financial covenants to changed circumstances, but also should be ready to make difficult decisions needed to enforce them. 10.3 A final lesson is that achievement of the project's main objective, to increase private sector participation in oil and gas exploration, was ultimately undermined by an inconsistent and inadequate policy framework. More recent policy initiatives, which aim at implementing far reaching sector reforms, should make a more lasting contribution to achieving sustainable energy sector development. 11. Proiect Relationship 11.1 Over the full period of the loan implementation, BANADE, together with the Bank and the relevant Argentine authorities maintained an adequate relationship and good understanding concerning some of the constraints for project implementation. The relationship was characterized by the lack of continuity of both staff and managers working on the project both in Argentina and at the Bank. However, the open working relationship was beneficial to the achievement in some degree of the project' objectives, where the Bank responded in a flexible way to BANADE's requests. However, the Bank should have been firmer in its efforts to strengthen BANADE's financial performance and should have put more stress on building up BANADE's institutional capacity needed for addressing adequately its increased involvement in the hydrocarbon sector.  13 12. Consultancy Services 12.1 In general, the consulting services for the technical assistance to BANADE were satisfactory. The consultants were contracted to help appraise sub-projects and to train BANADE's staff on the specialized technical matters related with oil and gas lending (parae 6.5). The quality of the consultant work vas good and they proved efficient in assisting BANADE's Energy Division. 13. Proiect Documentation and Data 13.1 Project documentation and data include legal documents, the staff appraisal report (SAR), the missions' back-to-office reports, supervision reports, and progress reports provided by the Borrower. 13.2 Legal agreements and SAR were adequately prepared and generally comprehensive and did serve adequately during project implementation. However, the progress reperts were submitted sporadically and did not reflect financial aspects or the Borrower. Supervision mission reports did provide a good comprehensive picture of the technical matters of the sub-projects, but rarely of the institutional-financial aspects of the Borrower. There is a lack of continuity between them, and it is sometimes difficult to get an idea of the evolution of the situation between two supervision missions. This problem should no long occur with the newly adopted Form 590.  14 PROJECT COMPLETION REPORT ARGENTINA OIL AND GAS CREDIT PROJECT (Loan 2031-AR) PART II. PROJECT REVIEW PROM BORRoWER'S PERSPECTIVE 1. Following old procedures for the preparation of Project Completion Reports, the Borrower preparsd a brief suamry report describing the work undertaken by the consultants, and including information of the office equipment procured, recomaendations made by the Energy Division to Banade's Board of Directors for sub-projects approval, chronological progress, and allocation of loan fun.o Tho observations of that report have been essentially summarized in Part I of this report, and the original version in Spanish is in files at the LAC Information Center. 2. To prepare Part II of the PCR, the Borrower was again requested but responded by authorizing the release of the report without Part II.  15 ARGENTINA PROJECT COMPLETION REPORT OIL AND GAS CREDIT PROJECT (LOAN 2031-AR) PART III bASIC DATA 1. Related Bank Loans Year of Loan Title PurDose AnDroval Status Comments Oil and Gas To improve 1980 Closed The study for the Engineering information on oiJ optimization of Project and gas reserves. natural gas Loan 1880-AR To study the utilization was optimum successfully development and oompleted, and a utilization of computerized natural gas. model was developed, but the model was never used. Refinery To assist YPF to 1981 Closed Project has been Conversion Project redress the successfully Loan 2032-0-AR imbalance in the completed,but product slate of with delays on its two main project execution refineries - La caused by Plata and Lujan de political and Cuyo, mainly be economical eliminating fuel- instAbility, lack oil from refinery of counterpart output. funds and inadequate staffing. Refinery Same as above 1986 Closed Conversion Project Loan 2032-1-AR (Supplemental) Gas Utilization To increase tha 1985 In There are some and Technical production of progress delays due to Assistance Loan crude oil and p rlitlcal au d 2592-AR condensates and to financial expand the use of difficulties, natural gas. mainly lack of counterpart funds.  ARGENTINA PROJECT COMPLETION REPORT OIL AND GAS CREDIT PROJECT (LOAN 2031-AR) 2. Prolect Tletable Date Date Date Item Planned Revised Actual - Identification 08128/79 - Preparation 07124/80 - Appraisal Mission 10130180 10/30180 Loan Negotiations 01101/81 03/09/81 06/16/81 Supplementary letters were requested by the Bank, regarding BANADE Audit procedures, YPF's biddlng conditions, pricing of petroleum productsa - Board Approval 05122/81 07107181 - Loan Signature 10102/81 10/02/81 - Loan Effectiveness 01105/82 04102/82 12130/e2 Effectiveness was delayed due to BANADE's non-compliance on hiring foreign consultant firms to help BANADE's appralsal procedures and training of its staff. _ Loan Closing 12/31/85 12/31/88 Closing Date was extended due to lmplementation delays. - Loan Completion 06/30/88 06/30/89 04/30190 Last Bank disbursement on 05/30/89. Coments: Issues Raised at Different Statess 1. In mid-November 1979, the Government first expressed its Interest In Bank Involvement. The Bank attachet a high priority to dealing with the Oil and Gas Credit Project. In August 1979, the Bank organized an Identification mission. 2. A reparation mission followed in July 1980. At this stage some of the main issues were: (a) weak management of BAlADS; (b need of training program for BAKADK's staff; (c) supervision capabilities of BAnE; (d) quality of portfolio. 3. Project Appraisal was carried on from October to November of 1980 that allowed the Bank and the Borrower to agree on (a) final defluition and scope of the project; (b) retroactive financing up to US$6.0 million; (c) level of consumer prices for petroleum productsl (d) terms and conditions of subloana; and (a) auditing arrangements for BANADE.  17 ARGENTINA PROJECT COIHPLETION REPORT OIL AND GAS CREDIT PROJECT (LOAN 2031-AR) 3. Cumulative Estimated and Actual DisbursementiA' FY82 FY83 FY84 FY85 M86 Y8Z FY88 FY89 Appraisal Estimate 14.00 38.00 69.00 96.00 100.00 Actual (9130189) -- 0.05 15.58 20.28 27.72 61.47 76.86 76.86 Actual -- -- 22.60 21.12 20.28 27.72 61.47 76.86 Date of First Disbursement 01/11/83 Initial Loan Closing Date 12/31/85 Actual Closing Date 12/31/88 Date of Last Disbursement 05/30189 1/ A total of 23.14 million was cancelled from the undisbursed portion of the loan.  18 ARGENTINA PROJECT COMPLETION REPORT OIL AND GAS CREDIT (LOAN 2031.AR) 4. Allocation of Loan Proceeds (US$Mill