Honduras - Rio Lindo Hydroelectric Project

FILE COPY R ERSTRI CTED Report No. TO- 6 23a This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF THE RIO LINDO HYDROELECTRIC PROJECT EMPRESA NACIONAL DE ENERGIA ELECTRICA (ENEE) HONDURAS May 13, 1968 Projects Department  CURRENCY EQUIVALENTS One Lempira (L) = 100 centavos One Lempira (L) = US$0. 50 One million Lempiras = US$500, 000 One centavo = 0. 50 US cent One U. S. dollar (US$) = 2 Lempiras One U.S. Cent (US cent) = 2 centavos WEIGHTS AND MEASURES One kilometer (km) 3 = 0.6214 mile One square kilometer (km ) = 0. 3861 square mile one meter (m) 3 = 3. 281 feet One cubic Meter (m ) = 35. 31 cubic feet ENEE's Financial Year = Calendar Year  HONDURAS APPRAISAL OF THE RTO LINDO HYDROELECTRIC PROJECT EiPRESA NACIONAL DE ENERGIA ELECTRICA (ENEE) TABLE OF CONTENTS Page SUYMARY i 1. INTRODUCTION 1 2. ELECTRICITY SUPPLY IN HONDURAS 1 3. EMPRESA NACIONAL DE ENERGIA ELECTRICA 2 Facilities of ENEE 3 4. EXPANSION PROGRAM 3 5. THE PROJECT 4 Description of Project 4 Engineering 5 Procurement and Disbursement 6 Construction Schedules 6 Estimated Cost 6 6. JUSTIFICATION FOR PROJECT 7 Power Market 7 Installation Program to Meet Expected Load Growth 9 Choice between Hydro and Thermal Generating Capacity 10 7. FINANCIAL ASPECTS 10 Tariffs 10 Present Financial Position 1U Auditors 13 Earnings Record 13 Financing Plan (1967 - 1971 Program) 13 Future Earnings 15 Future Financial Position 16 8. CONCLUSIONS AND RECOMMENDATIONS 16 This report is based on the findings of a Bank mission consisting of Messrs. Hui Huang and Carel de Beaufort which visited Honduras in September/October 1967 and on information supplied by the Borrower and the Consultants.  LIST OF ANNEXES Annex 1 Detailed Estimated Costs of Rio Lindo Hydroelectric Project Annex 2 Energy Sales - Actual and Forecast (by Districts) Annex 3 Energy Sales - Actual and Forecast (by Classes of Consumers) Annex 4 Interconnected System - Energy Sales, Energy Generation, Maximum Demand and Firm Capability Annex 5 Interconnected System - Maximum Demand and Firm Capability (graph) Annex 6 Actual and Forecast Balance Sheets - 1963-1971 Annex 7 Actual and Forecast Income Statements - 1963-1971 Annex 8 Actual and Forecast Sources and Applications of Funds - 1967-1971 Annex 9 Debt Service Projections - 1968-1971 Annex 10 Actual and Forecast'Financial Ratios - 1963-1971 Map 1 Rio Lindo Hydroelectric Project Map 2 Lake Yojoa-Rio Lindo Hydroelectric Development  HONDURAS APPRAISAL OF THE RIO LINDO HYDROELECTRIC PROJECT EMPRESA NACIONAL DE ENERGIA ELECTRICA (ENEE) SUMMARY i. The Empresa Nacional de Energia Electrica (ENEE) asked the Bank Group to assist in financing a power project which forms the major part of ENEE's expansion program for the five-year period 1967-1971. The total estimated cost of the program is $25.5 million. The estimated cost of the proposed Project is $17.7 miliion of which $11.5 million would be required in foreign currency. It is recommended that the Bank and IDA provide the Republic of Honduras with respectively a loan of $7.5 million and a devel- opment credit of $4.0 million and that the Government relend the total pro- ceeds of $11.5 million to ENEE to cover the foreign currency costs of the Project. ii. The Project would consist., of: (a) the construction of the 40 Mw Rio Lindo Hydroelectric Scheme; (b) the expansion of ENEE's transmission system; and (c) feasibility studies of future hydroelectric development. iii. The Project is needed to meet the growing demand for power on ENEE's main system and is the most economic of alternative means of meeting this demand. It is technically sound, the estimated cost and the construc- tion schedules are realistic, and arrangements for engineering and the super- vision of construction are satisfactory. iv. ENEE is an autonomous government corporation responsible for pro- moting the electric power development of Honduras. Its organization and management, although recently improved, still need strengthening. Steps now being taken should rectify the situation. V. ENEE's financial position is sound and is expected to remain so. vi. The Bank made a loan of $1.45 million in 1959 and another loan of $8.8 million in 1960 to ENEE for the expansion of its facilities. The projects financed by these loans have been successfully completed. vii. The Project would be suitable for a loan of $11.5 million equiv- alent for a term of 25 years including a grace period of three and a half years to be provided to ENEE by the Government of Honduras out of the pro- ceeds of the proposed Bank loan of $7.5 million and the proposed IDA credit of $h.O million mentioned above.  HONDURAS APPRAISAL OF THE RIO LINDO HYDROELECTRIC PROJECT EMPRESA NACIONAL DE ENERGIA ELECTRICA (ENEE) 1. INTRODUCTION 1.01 This report covers the appraisal of a power project which the Empresa Nacional de Energia Electrica (ENEE) has requested the Bank Group to assist in financing. The Project would be the major part of ENEE's expansion program for the five-year period 1967-1971. The total cost of the program has been estimated at $25.5 million, of which the Project would account for $17.7 million with foreign currency requirements of $s1.5 million. 1.02 It is recommended that the Bank and IDA provide the Republic of Honduras with respectively a loan of $7.5 million and a development credit of $4.0 million and that the Government relend the proceeds to ENEE to cover the foreign currency costs of the Project. 1.03 The Bank made a loan of $1.45 million (Loan No. 226-HO) to ENEE in 1959 for the provision of 2.5 Mw of diesel generating capacity and for the improvement of distribution facilities. In 1960 it made another loan of $8.8 million (Loan No. 261-HO) for the first stage of the Lake Yojoa- Rio Lindo development (the 30 Mw Canaveral Hydroelectric Scheme) and for associated transmission. Both projects have been successfully completed. 1.04 This report is based on a feasibility report prepared by ENEE's Consultants, Harza Engineering Company International, and dated May 1967 and on findings by a Bank mission comprising Messrs. Hui Huang and Carel de Beaufort which visited Honduras in September-October 1967. 2. ELECTRICITY SUPPLY IN HONDURAS 2.01 The total electric power capacity for Honduras is about 73 Mw of which ENEE's share is about 64%. ENEE is thus the chief electricity supply authority in Honduras. It operates hydro and diesel plants with a total installed capacity of about 47 Mw. Two private companies, the Standard Fruit Company and the Tela Railroad Company, also supply electric power to several towns in their areas of operation. The combined capacity of their power plants is about 10 Mw. Several municipalities own small diesel plants with a total capacity of about 2 Mw. The capacity of captive power plants belonging to industrial undertakings aggregates about 14 Mw. 2.02 Total electricity production in Honduras in 1966 was about 204 million kwh. For an estimated population of 2,363,000 this represents a per capita annual production of 86 kwh only, the lowest in Central America.- 1/ Per capita kwh production in Central America in 1964 was as follows: Costa Rica 421; Nicaragua 168; El Salvador 133; Guatemala 111; Honduras 59; and Central America 149.  -2- 3. EMPRESA NACIONAL DE ENERGIA ELECTRICA 3.01 The Empresa Nacional de Energia Electrica (ENEE) was established by law in 1957 as an autonomous authority wholly owned by the Government responsible for promoting the electrical power development of the country. 3.02 ENEE is governed by a Board of Directors composed of five members; namely, the Minister of Communications and Public Works, as Chairman, the Minister of National Resources, and representatives of the National Economic Planning Council, the Development Department of the National Development Bank and the National Chamber of Commerce and Industry. The two ministers are appointed ex-officio; the representatives of the National Economic Planning Council and the National Development Bank are designated by the respective agencies; and the representative of the National Chamber of Commerce and Industry is designated by the Minister of Economy and Finance from a list of three candidates reconmended by the Chamber. The term of office of the three representatives is three years and they are eligible for reappointment. A General Manager, appointed by the Board, is responsible for all managerial and administrative functions. The present General Manager, a civil engineer, although lacking in utility experience when appointed in October 1965, has proved to be a good administrator. ENEE has agreed to carry out its func- tions under the direction of a qualified and experienced General Manager mutually satisfactory to ENEE, the Bank and IDA. This is similar to a pro- vision in the 261-HO Loan Agreement. 3.03 The Law governing ENEE's operations is generally acceptable. During the negotiations for the proposed Bank/IDA financing, the Honduran delegation confirmed that ENEE has authority to establish power tariffs. Although the basis for determining tariffs is not stipulated in the Law, a rate covenant will be included in the proposed agreements (paragraph 7.02) and this arrangement would be satisfactory. 3.04 Initially ENEE's operations were unsatisfactory but since the completion of the Canaveral Project in April 1964 the situation has greatly improved. However, ENEE's organization and management still need to be strengthened, especially in view of the large expansion program now to be undertaken. In particular the engineering staff should be reinforced. At the suggestion of the Bank, ENEE has recently engaged at its own expense a firm of management consultants acceptable to the Bank (R. W. Beck and Associates of Seattle) to make a study of its organization and operation procedures and to make recommendations for improvements. The terms of reference for the study have been approved by the Bank. The Consultants' report and recommendations are expected in July 1968. It has been agreed that the report will be sent to the Bank and IDA for review and that the Bank, IDA and ENEE will then agree on which of the recommendations should be implemented and decide on a program and timetable for the implementation. If necessary, such implementation will be assisted by the Consultants.  -3- Facilites of ENEE 3-05 ENEE's main transmission system (the interconnected system) serves the country's most highly populated and important zone which extends from the capital city of Tegucigalpa to Puerto Cortes in the north (see Map 1). The system consists of about 229 km of 138 kv lines, 50 km of 69 kv lines and 58 km of 34.5 kv lines. ENEE also supplies small towns, not connected to the interconnected system, by diesel generating plants. 3.06 The effective generating capacity of the interconnected system is about 44 Mw. This will be increased to 54 Mw by May 1968 when plant now under construction is put into operation. The generating facilities consist of: Hydroelectric Plants Mw Canaveral 30 Two small plants near Tegucigalpa 2 32 Diesel Plants Tegucigalpa-/ 16.7 San Pedro Sula 4.0 Puerto Cortes 1.3 22.0 1/ 10 Mw under construction The combined capacity of diesel plants supplying small towns is 3 Mw. 3.07 All ENEE's systems operate at 60 cycles. The generating plants and transmission and distribution facilities are generally well operated and maintained. Operating costs (including fuel costs) in 1966 were about 1.3 U.S. cents per kwh sold, which is reasonable for systems such as ENEE's. To compensate for higher operating costs in the small tomns supplied by diesel plants the tariff charged is about 18% higher than the interconnected system tariff. 4. EXPANSION PROGRAM 4.01 ENEE has an expansion program for the five-year period 1967 through 1971 to meet increasing power demand. The main work would be the Project pro- posed for Bank and IDA financing and would consist of: (a) the construction of the Rio Lindo Hydroelectric Scheme with an initial installation of 40 Mw, (b) the expansion of transmission system and (c) the provision of engineering services for the study of hydroelectric sources and the preparation of a fea- sibility report for future development. Other works include the installation  of additional diesel generating capacity and other transmission and distri- bution system expansion. The program is considered reasonable and suitable to meet the needs. 4.02 In the financial forecasts the following provisions for capital expenditures during the five-year period have been made: Expenditures in Millions of Lempiras (a) The Proposed Project 35.4 (b) Installation of 10 Mw of diesel capacity at Tegucigalpa 2.6 (c) Electrification of Southern District 1.9 (d) Expansion of distribution systems 10.2 (e) Installation of diesel generating units in Isolated Systems 0.8 TOTAL 50.9 US$ million equivalent 25.5 5. THE PROJECT Description of Project 5.01 The Rio Lindo Hydroelectric Scheme would be the second stage of Lake Yojoa-Rio Lindo Development (see Map 2). It would utilize the total available head of about 400 meters between Canaveral, the first stage of development, and the Sula Valley. The main storage reservoir for both stages would be Lake Yojoa. Although a third 15 Mw generating unit could be installed at Canaveral, such a unit would not be useful at the present time as it could only be used for peaking purposes since nearly all available water is being utilized, whereas the Rio Lindo Scheme with an initial in- stalled capacity of h0 Mw would have an energy capability of about 313 Gwh, corresponding to an annual plant factor of nearly 90%. Water discharged from the Canaveral Scheme would be conducted through a steel pipeline, about 1,370 m long, then through a tunnel, about 900 m long, to a regulating res- ervoir. This reservoir would be formed by an earth dike about 20 m high and 200 m in length. It would have a capacity of about 750,000 m3 and would be used for daily regulation. A short tunnel and a steel penstock about 5,110 m long would bring water from the regulating reservoir to a power station situated near the village of Rio Iindo. The station would be de- signed for remote control from the Canaveral Power Station. Water dis- charged from the power station would flow through an open canal to the Rio Lindo. Initially two generating units, each of 20 Mw capacity, would be installed. Each unit would consist of a vertical shaft hydraulic tur- bine of the h-jet impulse type directly coupled to a three-phase 60-cycle alternator. Two additional 20 IMw units would-be installed at a later date.  The installation of these units and the diversion of water from the Rio Lindo into the Scheme (see Map 2) would only increase energy output by about 20%, and the units would therefore be used chiefly for peaking pur- poses. 5.02 The expansion of the transmission system would include: (a). the construction of a double-circuit 138 kv transmission line, about 2 km long, to connect the Rio Lindo Power Station to the interconnected system; (b) the construction of a single-circuit 138 kv transmission line, about 53 km long, from the Rio Lindo Power Station to San Pedro Sula and the expansion of the substation at San Pedro Sula; (c) the reconstruction of the single-circuit 69 kv transmission line, about 12 km long, from Bufalo to La Lima, the construction of a similar line, about 20 km long, from La Lima to El Progreso and the construction of associated substations. 5.03 Honduras has a number of water resources which could be developed to provide hydroelectric power, probably more than in any other Central American country. ENEE engaged consultants (Harza) to conduct a survey of hydroelectric potential in western Honduras and their report of May 1967 recommends five sources, all reasonably close to the interconnected system, with outputs ranging in size from 60 Mw to 280 Mw, for further consideration. Since a detailed study of these sources will take some time and since con- struction of another hydroelectric scheme would probably have to be com- menced in 1972 in order to have it completed by 1975 (see paragraph 6.08) it is recommended that funds to cover the foreign currency costs of such a study be included in the proposed ProJect. Engineering 5.04 The Rio Lindo Scheme is being designed by ENEE's Consultants, the Harza Engineering Company International, who were responsible for the design and supervision of construction of the Canaveral Hydroelectric Scheme. Harza will be responsible for the supervision of construction of the Rio Lindo Scheme. Harza will also be responsible for the design of the 138 kv transmission lines and substations and will assist ENEE in supervising their construction. The work on the 69 kv transmission lines and substations will be handled by ENEEVs own staff which has experience in this field. 5.05 For the feasibility studies on future hydroelectric development ENEE will engage consultants acceptable to the Bank and IDA to carry out the work on terms and conditions satisfactory to the Bank and IDA. The consultants will be selected before October 1968.  - 6- Procurement and Disbursement 5.06 All contracts except those for engineering services (paragraph 5.05) will be awarded on the basis of international competitive bidding. The basis of disbursements will be the foreign currency costs of imported equipment and services only. Expenditures prior to the date of the loan will not be eli- gible for reimbursement and if savings are made any excess loan funds will be available for cancellation. Construction Schedules 5.07 Detailed design work by the Consultants is well advanced. Most of the specifications and tender documents have been prepared and approved by the Bank and IDA. Major tenders on equipment and civil works have been invited. Contracts for generating plant, the delivery of which could be the controlling factor on the commissioning date, are expected to be awarded by June 1968 and contracts for civil works by September 1968. The station is scheduled to be commissioned by the end of 1970. The transmission lines and the substations are expected to be completed before that time. Fea- sibility studies on future hydroelectric development are also expected to be completed by the end of 1970. These schedules are realistic. Estimated Cost 5.08 The total estimated cost of the proposed Project is L35.5 million ($17.7 million). The estimated foreign exchange cost is L23.0 million ($11.5 million). Detailed cost estimates, mainly prepared by the Consultants, are shown in Annex 1. A summary of the cost estimates is as follows: Ini Lempiras _. In US$ Local Foreign Total Local Foreign Total ~~~ ~(in millTi~ (a) Rio Lindo Hydroelectric Scheme 8.5 14.8 23.3 4.2 7.4 11.6 (b) Transmission System Expansion 0.6 1.2 1.8 0.3 0.6 0.9 (c) Contingencies and Price Escalation 1.4 2.5 3.9 0.7 1.2 1.9 (d) Engineering, Supervision and Overhead 1.0 2.3 3.3 0.5 1.2 1.7 (e) Interest during Construc- tion 0.6 1.4 2.0 0.3 0.7 1.0 (f) Feasibility Studies on Future Hydro Development 0.4 0.8 1.2 0.2 0.4 o.6 Total 12.5 23.0 35.5 6.2 11.5 17.7  -7- 5.09 The cost estimates for civil works and transmission lines are based on the cost of works of a similar nature recently completed in Honduras and El Salvador and on the Canaveral Project costs. Prices for generating plant and electrical equipment are based on preliminary quotations from man- ufacturers. An allowance of about 15% has been included for contingencies to cover unforeseen construction difficulties and for price escalation during the construction period. The cost estimates are reasonable and the allowance for contingencies and price escalation should be adequate. 5.10 The estimated cost of the Rio Lindo Scheme, excluding interest during construction, is L30 million ($15 million)l/ which is equal to a unit cost of $375 per kw installed. This may appear high but as the energy capability of the scheme is very high (90% plant factor) and the second stage, consisting of the installation of two 20 Mw generating units and the diversion of additional water into the scheme, is estimated to cost only L19 million ($9.5 million), it is reasonable. The total estimated cost of stages one and two, with an installed capacity of 80 Mw, is L49 million ($24.5 million) which would be equal to a unit cost of $306 per kw installed which is reasonable for the type of scheme. The estimated cost of energy produced by the first stage of the scheme is 4.7 U.S. mills per kwh, which is low-cost power. 6. JUSTIFICATION FOR PROJECT Power Market 6.01 ENEE's service area can be divided into four groups: The Central District, The Northern District, The Southern District and the "Isolated Systems." The Central and Northern Districts are supplied by the inter- connected system with which the proposed Project would be concerned. The Central District comprises Tegucigalpa and the towns of Comayagua and Siguatepeque in the Comayagua Valley. The Northern District includes San Pedro Sula (the second largest city and the most industrialized area), the Caribbean port of Puerto Cortes and the towns of La Lima and El Progreso. The country's two largest industrial undertakings, the Mochito silver mines and a cement factory, are in the Northern District. The Southern District consists of the towns of Choluteca and Nacaome and the Pacific port of San Lorenzo, which are presently supplied by diesel planta but which by 1974 would be linked by transmission lines to the interconnected system. Under Isolated Systems are eight small towns which are supplied by diesel gener- ating plants. 6.02 Energy sales by ENEE before the completion of the Canaveral Project in April 1964 were low because the system capacity was not adequate to meet all the potential power demands and both the Mochito mines and the cement factory had to depend on their own diesel installations. Sales in 1964 were 94% higher than in 1963 following the completion of Canaveral and a tariff 1/ See Annex 1  - 8 - reduction (see paragraph 7.01) which stimulated consumption. A large part of this increase was in sales to the two industries mentioned. The average rate of increase in the two following years 1965 and 1966 was 30.6% per annum for ENEE as a whole; 16.6% for the Central District; and 40.8% for the Northern District. This very high rate in the latter district was due to considerable economic activity in the prosperous San Pedro Sula area and increased consumption by Mochito mines and the cement factory. ENEE has only recently taken over supply of the three towns in the Southern District and a record of past sales is not available. Sales to the eight small towns comprising the Isolated Systems increased at an average rate of 17.9% per annum. 6.03 In 1966 ENEE's total sales i-were 117 million kwh of which the Central District accounted for 35%, the Northern District 62% and the Southern District and Isolated Systems 3%. The following table shows a percentage breakdowm of sales into categories and the number of consumers in each category: Percent of Total Sales No. of Consumers Residential 21 27,0h3 Commercial 16 2,052 Small Industry 11 665 Large Industry 42 2 Goverrnment and Municipalities 5 449 Street Lighting 3 7 Internal Consumption - 84 Sales to Other Systems 2 2 100% 30,304 6.o4 Annexes 2 and 3 show actual sales for the period 1963 through 1966 and ENEE's forecast of sales for the years 1967 through 1977. Because of the sharp changes in the rate of increase in sales in recent years (see paragraph 6.02), it is not meaningful to extrapolate past trends. Thus the forecast for 1967-1971 is based on information supplied by major industries and on what can be learned from past movements. The forecast is considered rea- sonable and has been used as the basis for the financial projections. 1/ The forecast for the period from 1972 through 1977 must be regarded as ten- tative and has only been used as a basis for system planning. 6.05 Total sales by ENEE are estimated to increase at an average rate of 19.9% during the period 1967 through 1971 and at an average rate of 10.6% per annum during 1972 through 1977. 1/ Even if sales during the next two years fall short of the forecast by as much as 10%, the proposed Project would still be required by the end of 1970 to enable system load to be met, and the adverse effect on the financial projections would be small.  - 9 - 6.06 Sales in the Central District are expected to increase at an average rate per amnum of 15.9% during 1967 through 1971 and ll.9% during 1972 through 1977. In the Northern District sales are expected to increase at an average rate per annum of 18.1% and 11.8% respectively for the two periods, a much lower rate of increase than for the past two years. ENEE has recently taken over the utilities at San Lorenzo, Choluteca and Nacaome in the Southern District, and has increased generating capacity with funds provided by the Government. A number of new factories are being established in the area and energy sales are expected to increase from 1.2 million kwh in 1966 to 20.3 million kwh in 1971 at an average rate per annum of 76%. 6.07 The maximum demand on ENEE's interconnected system increased from 15.4 MT in 1964 to 24.1 Mw during 1966 with a fairly high annual load factor of around 60%. The present demand is about 31 Mw. A forecast of system demand, based on the sales forecast, is shown in Annex 4. The demand is expected to grow to 55.8 Mw in 1971 representing an average increase per annum of 18.3% and to reach 114 Mw by 1977. The combined maximum demand of the Southern District and the Isolated Systems is presently about 1.6 Mw. This is expected to grow to about 6.5 Mw by 1971. Installation Program to Meet Expected Load Growth 6.08 To meet the expected increase in demand on the interconnected system during the 1967-1971 period and through 1977 ENEE plans to install additional genere-ting capacity as shown in Annex 5. Four diesel generating units with a total capacity of 10 Mw will be inzalled at Teaucigalpa by May 1968. The units are being financed by a lo:nn from the Central American Bank for Economic Integration (CABEI). The installation of these uinits is an interim measure to enable demand to be met prior to the completion in 1970 of the Rio Lindo Scheme which with its first two 20 Mw units forms part of the proposed Project. Additional peaking ca--.:.ity is explicted to be re- quired by 1974 and this would be met by the insta2lation of a third 15 Mw unit at the Canaveral Hydroelectric Plant. By 1975 another a'hi tion will probably be required to provide additional energy as well as ataditional peaking capacity and it has been assumed that a new hydroelectric scheme with an initial capacity of 30 Mw would be in commission by this date. 6.09 To meet increasing demands on the Southern District and the Isolated Systems during the period 1967 through 1971 ENEE plans to install about 5 Mw of diesel generating plant in various localities. This would bring the total installed capacity to about 8 Mw. 6.10 The transmission line from the Rio Lindo Power Station to San Pedro Sula will ensure more reliable power supply to this important area and will also be required to meet its futuro load growth. Reconstruction of the existing transmission line from Bufalo to La Lima will enable ENEE  - 10 - to supply the headquarters of the Tela Railroad Company at La Lima, which is presently supplied by the companiy's 3.3 Mw diesel plant, with more eco- nomical power from ENEE's main system. Extension of the line to El Progreso will enable ENEE to provide service to this important municipality. Choice between Hydro and Thermal Generating Capacity 6.11 Various alternative programs to meet the forecast power demand were investigated by ENEE and its Consultants. These included hydro and thermal generating stations. The proposed Rio Lindo Scheme as now recom- mended by Harza was found to be by far the most economic of the alternatives. The rate of. return on the incremental investment 1/ in-the-'Rio-'Lindo'Sche'm'e over a thermal alternative is about 16%, assuming a price of US$2.25 per barrel excluding taxes for heavy fuel oil. At a price of $1.75 per barrel the corresponding return is about 14%. Heavy fuel oil is not marketed in Honduras at this time but $2.25 per barrel is considered a reasonable price at Puerto Cortes where the alternative thermal station would be located. 7. FINANCIAL ASPECTS Tariffs 7.01 When the Bank's previous loan was made in 1960 the tariffs were at a high level which discouraged the use of energy. New tariffs providing for a reduction of about 30% were recommended by a consulting firm and were put into effect in 1964. Since then the tariffs have remained unchanged and the average revenue per kwh sold is now about 7.3 ceintavos (US 3.65 cents). At this level ENEE is obtaining a satisfactory return on plant in operation (paragraph 7.14). In order to enable ENEE to make an acceptable contribution towards the financing of the Project the tariffs should not be reduced during the construction period. During this period ENEE is expected to make an average return on plant in operation of more than 11% per year which is needed in view of its rapid growth. In the long run, however, a minimum return of 10% per year should provide ENEE with a satisfactory level of cash generation. 1/ This is the discount rate which equalizes the streams of capital and operating costs for the Rio Lindo and thermal alternatives.  - 11 - 7.02 In view of the reasons given in the previous paragraph assurances have been obtained that except with the approval of the Bank and IDA: (a) ENEE's annual return on average net fixed assets in operation shall not be less than 10%, and (b) the tariffs will be maintained at their present level during the construction period of the Project. It has also been agreed that upon the completion of the Project the rate of return would be reconsidered in order to determine whether a reduction would then be appropriate. Present Financial Position 7.03 The following is a summary of the Balance Sheet at December 31, 1967: (in millions of Lempiras) ASSETS Utility Plant - Gross 54.o Less: Accumulated depreciation 9 Utility Plant - Net 447 Current assets 6.4 Deferred debits 1.2 Total Assets 52.3 LIABILITIES AND EQUITY Capital and Surplus 21.8 Long-term debt: IBRD Loans 17.6 AID Loan 5.4 Bonds 3.8 Banco Central de Honduras 0.2 Other debt 0.1 Sub-total Long-term debt 27.1 Less: Current maturities 1.3 25-.8 Current liabilities, including current maturities of Long-term debt 4.7 Total Liabilities and Equity 52.3  - 12 - 7.04 ENEE's financial position is sound having improved considerably during the last three years. In 1963 EIEE had to face unexpected increases In construction costs, and was forced to drau down its cash balances and obtained with the Bank's approval a loan of L2 million from the Banco Central de Honduras. As a result the ratio of long-term debt to equity which under the terms of the Bank's previous loan agreements was not to exceed 2 to 1, rose to 2.4 to 1. This situation was rectified during 1965 and 1966, mainly by the addition of undistributed income to ENIEE's equity. On December 31, 1967 the ratio stood at 1.24 to 1. As explained in paragraph 7.24 the test is no longer suitable and should therefore be replaced by a debt service test. 7.05 Another result of the improvement noted in the previous paragraph was the transformation of a negative working capital of L2 million at the end of 1964 into a positive position of LI.7 million at the end of 1967 with a current ratio of 1.36 to 1. 7.o6 During the five years ending December 31, 1967, ENEE's capital increased from L8.6 million to L21.8 million, primarily as a result of un- distributed net income totaling L11.4 million and Government contributions totaling L1.7 million. Since 1961 (just prior to placing the L32 million Canaveral plant into operation) gross Utility Plant rose from L8.3 million to L54.6 million, an increase of 558%. 7.07 At the end of 1967 the two Bank loans, 226-HO and 261-HO, represented 65% of the outstanding long-term debt. Loan 226-HO was made for $1,450,000 in 1959 for a term of 15 years and at an interest rate of 6% to finance the ex- pansion of distribution and generating facilities in the Tegucigalpa area. Loan 261-HO was made for $8,800,000 in 1960 for a term of 25 years and at an interest rate of 6% to finance the Canaveral project. This project was also financed by an AID loan made for L5.6 million ($2.8 million) at an interest rate of 3.5% and for a term of 25 years. 7.o8 The bonds which at the end of 1967 were outstanding in the amount of L3.8 million were issued in 1964 and 1965. Their interest rate is 7% and they are to be amortized in semi-annual installments during the period 1967 through 1976. The Banco Central de Honduras which placed the bonds and guarantees their debt service, charges a commission of 1% per annum on the amount of bonds outstanding excluding those it is holding for its own account. 7.09 Substantially the rest of the long-term debt consists of the following two loans which were obtained to finance the acquisition of electrical systems: Interest Final Amount System Creditor Rate Maturity Lempiras Financed Banco Central de Honduras 7% 1975 162,000 Choluteca Tela Railroad Company 6% 1970 78,ooo Puerto Cortes  - 13 - Auditors 7.10 The financial statements of ENEE are audited by Price Waterhouse and Co., Guatemala. ENEE has agreed that its accounts will continue to be audited by a firm of accountants acceptable to the Bank and IDA, and that it will transmit the accountant's report to the Bank and IDA within four months after the end of each financial year. Earnings Record 7.11 Income statements for the five-year period 1963 through 1967 are included in Annex 7. 7.12 Following the substantial reduction in tariffs made in 1964 and the coming into operation of the Canaveral plant soon thereafter, sales of energy increased at exceptionally high rates which reached a peak in 1964 with an increase in that year of 94%. Since the higher sales volume more than com- pensated for the reduction in tariffs, revenues also showed a substantial increase. 7.13 As was to be expected, the gains in revenue flowed only partly through to net income. As a result of the growth in plant and in spite of savings in fuel costs, maintenance and operating expenses show substantial increases. Because of the growth in long-term debt there were also important increases in interest. 7.14 On balance annual net income rose from L1.7 million in 1963 to L3.8 million in 1967. Since no distribution was made to the Government the profits contributed in a satisfactory manner towards the building up of ENEE's equity. Because of the coming into service of the Canaveral plant return on average net plant in operation declined sharply from 19.4% in 1962 to 6.9% in 1964. Thereafter as sales increased and since the plant increased only moderately, the return improved to 12.8% in 1967. Financing Plan (1967-1971 Program) 7.15 In addition to the Rio Lindo project the 1967-1971 construction program includes the installation of diesel units with a capacity of 10 Mw, expansion of the distribution system and the electrification of the Southern District. Towards the latter, the Government already made a capital contri- bution in 1966 of L1.4 million which is being spent during 1967 and 1968. Provisions for increases in working capital and an expected cash surplus total L3.4 million. The applications of funds during the five-year period 1969 through 1971 may be summarized as follows:  - i4 - (in millions Applications of Funds of Lempiras) Percentage Construction Program (excluding interest) Rio Lindo project 33.4 Diesel units 2.6 Electrification of Southern District 1.9 Distribution and Miscellaneous 11.0 48.9 93.5 Working Capital provision and cash surplus 3.4 6.5 Total applications 52.3 100.0 ENEE plans to finance these requirements in the following manner: (in millions Source of Funds of Lempiras) Percentage Cash earnings 39.4 75.3 Less Debt Service 22.8 43.6 Net internal cash generation 16.6 31.7 Capital contributions by the Government 1.7 3.3 Borrowings: Proposed IBRD/IDA financing 23.0 CABEI Loan DI-5/67 2.0 Local bond issues 5.5 Suppliers' credits 3.5 34.0 65.0 Total sources 52.3 100.0 The Sources and Applications of Funds Statement for the years 1967 through 1971 is shown in more detail in Annex 8. 7.16 Internal cash generation, net of debt service, would finance 31.7% of the application of funds. This percentage is not high but in view of the fact that the installed capacity will be more than doubled, ENEE should not be expected to contribute more. 7.17 Contributions by the Government would be made in the form of parti- cipations in ENEE's capital. The amount involved is expected to be L1,725,000 of which L225,000 will be for a microwave communications system and LI.5 million for the Rio Lindo Project. If ENEE's cash generation does not reach the pro- jected level, the Government may have to increase its contributions. Congress will have to approve these appropriations under its normal procedures. 7.18 Borrowings would contribute L34.0 million or 65.0% of the financing. They would consist of:  - 15 - (a) $11.5 million, the proposed Bank/IDA financing which would be passed on to ENEE as a Government loan for a term of 25 years, including a grace period of 3