Document of The World Bank FOR OFFICIAL USE ONLY FILE UD?Y Report No. 2007-BR STAFF APPRAISAL REPORT BRAZIL VALESUL ALUMINUM PROJECT February 20, 1979 Industrial Projects Department 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. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT BRAZIL VALESUL ALUMINUM PROJECT STAFF APPRAISAL REPORT CURRENCY EQUIVALENTS Except where otherwise indicated, all figures are quoted in Brazilian Cruzeiros (Cr$) and US. Dollars (US$) (Exchange Rate as of November 24, 1978): Cr$1.0 = US$0.0509 Cr$19.64 = US$1.00 Cr$1,000,000 = US$50,916 ABBREVIATIONS AND ACRONYMS ABAL - Associacao Brasileira de Aluminio ALBRAS - Aluminio Brasileiro S.A. ALCAN - Aluminum Company of Canada ALCOA - Aluminum Company of America ALCOMINAS - Companhia Mineira de Aluminio ALUNORTE - Aluminio de Norte S.A. BD-RIO - Banco de Desenvolvimento do Estado do Rio de Janeiro BIDCO - Bauxite Industry Development Company, Ltd. BIM - Billiton International Metals BNDE - Banco Nacional de Desenvolvimento Economico CACEX - Carteira do Commercio Exterior do Banco do Brasil S.A. CBA - Companhia Brasileira de Aluminio CIR - Companhia Internacional de Engenharia CIP - Conselho Interministerial dos Precos CONSIDER - Conselho de Nao Ferrosos e de Siderurgia COSIGUA - Companhia Siderurgica de Guanabara S.A. CPE - Centrally Planned Economy CVRD - Companhia Vale do Rio Doce EC - European Communities ELETROBRAS - Centrais Eletricas Brasileiras FINAME - Agencia Especial de Financiamento Industrial TPY - Tons Per Year (metric, until otherwise stated) VALESUL - Valesul Aluminio S.A. WEIGHTS AND MEASURES 1 Metric Ton = 2,205 pounds 1 Kilometer (km) = 0.62 miles BRAZILIAN FISCAL YEAR January 1 - December 31 Industrial Projects Department February 1979 FOR OFFICIAL USE ONLY BRAZIL VALESUL ALUMINUM PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. I. INTRODUCTION ............................................ 1 II. THE BRAZILIAN PRIMARY ALUMINUM SECTOR ................... 2 A. Structure of the Sector ............................ 2 B. Sector Development Program ......................... 4 1. Background .................................... 4 2. Expansion of Existing Sources of Aluminum, Alumina and Bauxite ........................... 4 3. Development of New Aluminum and Alumina Plants. 5 4. Development of New Bauxite Mining Projects .... 6 C. Sector Priorities .................................. 6 D. Government Regulations and Incentives .... .......... 7 E. Contribution to the Economy ........................ 8 III. THE ALUMINUM MARKET ...... ................ 9 A. The International Market for Aluminum .... .......... 9 1. Consumption/Demand ............................ 9 2. Supply ........................................ 12 3. Supply/Demand and Price Outlook .... ........... 15 B. The Market for Aluminum in Brazil .... .............. 18 1. Consumption/Demand ............................ 18 2. Supply ......... ............................... 20 3. Supply/Demand Balance ......................... 21 4. Pricing Policy and Outlook ..... ............... 21 5. Marketing ........ ............................. 23 This report has been prepared by Messrs. W. Bertelsmeier, J. Carbonnelle, L.O. Maraboli and H.E. Wackman of the Industrial Projects Department and Mr. J. Loyer (Consultant). 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. Page No. IV. THE COMPANY AND THE SPONSORS ............................ 23 A. Ownership .......................................... 23 B. The Sponsors ....................................... 25 1. Companhia Vale do Rio Doce (CVRD) .... ......... 25 2. Shell/Billiton ................................ 26 3. Reynolds Metals Co./Reynolds International, Inc. (RII) .................................. 27 C. Organization and Management ........................ 27 D. Financial Situation ................................ 28 V. THE PROJECT ........ .............. ....................... 28 A. Project Scope and Objectives ....................... 28 1. Basic Objectives ....................... .... 28 2. Plant Location ................................ 29 3. Project Description ........................... 30 (a) Plant Components ......................... 30 (b) Raw Materials Handling Facilities at the Plantsite ......................... 30 (c) The Carbon Plant ......................... 30 (d) The Potline .............................. 31 (e) The Cast House ........................... 32 (f) The Rectifying Substation .... ............ 32 B. Raw Materials ...................................... 32 1. Alumina ....................................... 33 2. Petroleum Coke and Coaltar Pitch .... .......... 33 C. Infrastructure ..................................... 33 1. Power Supply .................................. 33 2. Port .......................................... 34 3. Road .......................................... 34 4. Water ......................................... 34 5. Housing ....................................... 35 D. Ecology ............................................ 35 E. Employment and Training ............................ 35 VI. PROJECT IMPLEMENTATION ..36 A. Project Management and Organization .36 B. Implementation Schedule .37 - iii - Page No. VII. CAPITAL COST, FINANCING PLAN AND PROCUREMENT .... ........ 37 A. Capital Cost .37 B. Financing Plan .40 C. Procurement .42 D. Allocation and Disbursement of Bank Loan ........... 43 VIII. FINANCIAL ANALYSIS .43 A. Revenue and Operating Cost Estimate .43 B. Financial Projections ..45 C. Financial Rate of Return . .47 D. Financial Covenants ..47 E. Major Risks ..48 IX. ECONOMIC ANALYSIS .49 A. Economic Costs and Benefits .49 B. Foreign Exchange Benefits ..................... .... 49 C. Economic Rate of Return .50 D. Plant Location .50 E. Employment Effects .51 F. Other Benefits .51 X. AGREEMENTS .51 LIST OF ANNEXES 3 Projected Brazilian Primary Aluminum Demand/Supply 4 Projected Organization Structure 5-1 Reduction Plant Flowsheet 5-2 Plant Layout 6 Implementation Schedule 7-1 Detailed Capital Costs 7-2 Working Capital Requirements 7-3 Category Allocation of Bank Loan 7-4 List of Equipment to be Financed out of the Proceeds of the Loan 7-5 Disbursement Schedule 8-1 Breakdown of Production Costs per Ton 8-2 Projected Production Costs 8-3 Projected Income Statements 8-4 Capital Expenditures 8-5 Projected Sources and Application of Funds 8-6 Projected Balance Sheets 8-7 Assumptions for Financial Projections 8-8 Financial Rate of Return 9 Economic Rate of Return - iv - MAPS IBRD No. 13222 IBRD No. 13211 SELECTED DOCUMENTS AND DATA AVAILABLE IN THE PROJECT FILE Reference Title Date and Authors Referred to Under Paragraph A Feasibility study of "ALUSUL" Pro- ject prepared by Montreal Engenharia S.A. in 1975 4.02 B Shareholders' Agreement between CVRD and Reynolds dated June 13, 1976 4.02 C Supplemental Shareholders' Agreement between CVRD and Reynolds dated June 13, 1976 4.02 D Agreement on Technical Assistance between Valesul and Reynolds 4.02 E Technology Agreements Between CVRD and Reynolds International, Inc. dated October 1976, and April 1977 4.02 F Valesul Shareholders Agreement (CVRD, Shell, RII) dated February 1979 4.03 G Feasibility study prepared by Valesul Aluminio S.A. in October 1977 and revised in December 1977 5*03 H Alumina Supply Contracts between Valesul and Engelhard Minerals and Chemicals Corporation, dated January 22, 1979, and Billiton Alluminum B.V., dated February 1979 5.15 I Power Supply Contract between Valesul and Rio Light S.A., dated February 1979 5.18 J Project Management Contract between Valesul and Companhia Internacional de Engenharia, dated December 1977 6.02 I. INTRODUCTION 1.01 The Government of Brazil and Valesul Aluminio S.A. (Valesul) have requested a Bank loan of US$98 million equivalent to assist in financing a new plant for the reduction of alumina with a capacity of 86,500 tons per year (TPY) of aluminum ingots, slabs and billets, to be erected at Santa Cruz, Rio de Janeiro (Map IBRD 13211). Alumina will initially be imported and eventually supplied from alumina refineries planned for the Amazon region. Santa Cruz has been designated as an area of future industrial development. Located 54 km. west of the centre of the city of Rio de Janeiro, it is near the Bay of Sepetiba, the site of the Mineracoes Brasiliera Reunidas' (MBR) 1/ iron ore loading terminal, future bulk unloading port facilities, and the present site of Companhia Siderurgica de Guanabara S.A. (COSIGUA), a privately-owned steel plant 2/. 1.02 Valesul's capital will initially be 61% owned by Companhia Vale do Rio Doce (CVRD), a public sector enterprise primarily engaged in the mining and export of iron ore, but it is intended that steps be taken to make the Valesul venture simultaneously controlled by Brazilian and private owners. A 35% participation is to be taken by Shell Brasil, a subsidiary of Royal Dutch Shell (UK/Netherlands), and a 4% participation by Reynolds International, Inc. (RII), a subsidiary of Reynolds Metals, Ltd. of the US (Reynolds), whose prebaked-anode reduction process is being used in the plant. Brazilian private participation is eventually expected through the sale by CVRD of part of its shares. 1.03 The project is expected to be completed by December 1981 and is estimated to cost about US$370 million equivalent, including US$186 million in foreign exchange. It will be financed with 40% equity from CVRD, Shell and Reynolds; local credits from FINAME 3/ and a commercial bank loan, as well as the proposed Bank loan. 1.04 The project was appraised in November 1977 by a mission consisting of Messrs. H.E. Wackman (Chief), L.O. Maraboli and W. Bertelsmeier of the Industrial Projects Department, and J. Loyer (Consultant). Follow-up missions took place in May and July, 1978. 1/ Partly financed by IBRD Loan No. 787-BR of August 31, 1971. 2/ Partly financed by IFC Investment of November 23, 1976. 3/ Agencia Especial de Financiamento Industrial; a subsidiary of Banco Nacional de Desenvolvimento Economica (BNDE). - 2 - II. THE BRAZILIAN PRIMARY ALUMINUM SECTOR A. Structure of the Sector 2.01 With its substantial reserves of bauxite, abundant hydropower and an aluminum market with enormous growth prospects, Brazil is particularly well placed for the long-term development of an integrated, large-scale aluminum industry. First significant aluminum production commenced over 25 years ago, and the Brazilian primary aluminum sector is now comprised of three private companies that operate bauxite mines and facilities to produce alumina and aluminum. These companies are: (i) Alcan Aluminio do Brasil, which is a wholly owned subsidiary of Alcan Aluminum Limited of Canada; (ii) Companhia Mineira de Aluminio (Alcominas), 1/ which is owned by the Aluminum Company of America (Alcoa-US) 50%, the Hanna Mining Company (US) 42.5% and by local investors 7.5%; and (iii) Companhia Brasileira de Aluminio (CBA), fully owned by the Brazilian Votoratim family enterprises. These companies are presently producing at installed capacity, and their output has been approximately as follows: Brazilian Primary Aluminum Output by Company, 1967-1977 ('000 tons) Average Annual Growth 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1970-1977 (%) Alcan 19.3 22.1 22.8 25.1 27.2 35.8 41.7 45.6 55.6 59.4 59.3 5.2 Alcominas - - - 7.9 24.9 31.3 30.4 29.5 30.0 41.3 59.4 12.6 CBA 18.2 19.3 20.1 23.1 28.6 30.5 39.6 38.5 35.7 38.5 48.4 4.5 Total 37.5 41.4 42.9 56.1 80.7 97.6 111.7 113.6 121.3 139.2 167.1 6.6 Source: Associacao Brasileira de Aluminio (ABAL). 2.02 Alcan is the oldest primary aluminum producer in Brazil. Its opera- tions were started in Ouro Preto, Minas Gerais (Map IBRD 13222) in 1951, in a plant of 2,000-TPY capacity, which had been operated briefly by Electro Quimica Brasileira in 1945. At present, it has capacity to produce 32,000 TPY in Ouro Preto and 28,000 TPY in Bahia. All the primary aluminum output is consumed by local, downstream fabricating plants also owned by Alcan. Alco- minas has been operating at Pocos de Caldas in Minas Gerais since 1970. It is not involved in fabrication and is the sole supplier of local, primary aluminum to independent fabricators. Finally, CBA started to operate in 1/ The Alcominas plant, with an initial capacity of 25,000 TPY, was partly financed by IBRD Loan No. 526-BR of January 1968 for US$22 million equivalent. Completion report is dated July 28, 1972. Sorocaba, Sao Paulo, in 1955. Its level of integration includes fabrication of all output and self-generation of hydropower. At present, apart from the Alcan and CBA fabricating facilities, semi-fabrication of slabs, ingots and billets into extrusions, sheet and coil is also carried out by a number of independent companies, 44 of which consume approximately 80% of non-integrated, primary aluminum output. Semi-fabricating capacity is at present significantly underutilized, owing partly to insufficient supplies of primary aluminum, which are restricted partly by import deposits and licenses (para. 2.22). 2.03 Production of local alumina and bauxite, as shown below, is vir- tually sufficient to supply all present demand from the Brazilian aluminum industry. During 1977, however, Alcominas produced 50,000 tons of alumina above its own requirements, in order to supply Alcan with 20,000 tons and CBA with 30,000 tons. Production and Consumption / of Brazilian Alumina and Bauxite by Company, 1977 ('000 tons) Bauxite Alumina Company Production /b Consumption Production Consumption Alcan 350 350 100 120 Alcominas 425 425 170 120 CBA 243 243 90 120 Other _ _ _ 30 Total 1,018 1,018 360 /c 390 /c /a The production of one ton of aluminum requires about two tons of alumina; one ton of alumina requires between 2.6-3.5 tons of bauxite of approxi- mately 40% Al203' /b Exports have been limited to very small quantities, valued under US$1.0 million p.a. (para. 2.24). _c Deficits of alumina were supplemented with imports and from stocks. Source: CVRD. 2.04 Profits of the existing companies in the industry have attained quite high levels, given the continuing shortage of metal, growing demand and the integrated nature of the industry, from the mining of good-quality bauxite through to fabricated products. Profitability has been higher among the longer-established companies (Alcan and CBA), reflecting the greater profit- ability of fabricating operations, the output of which, unlike primary alumi- num, is not subject to Government price control. Also, the older companies' - 4 - assets were acquired mainly prior to the substantial increase in capital costs for plant in the early to mid-1970's; and in the case of CBA, its captive power costs are very low, as are its financial expenses, given its policy of minimum debt financing. B. Sector Development Program 1. Background 2.05 In spite of the rapid growth of output of about 16% p.a. during the 1970's, the local, primary aluminum industry has not kept pace with the rising demand. Further growth is favored by expected increases in the presently low per-capita consumption, which has been restricted by the limited range of aluminum applications in Brazil, in turn a function of the limited avail- ability and high cost of importing primary aluminum. 2.06 Current plans to develop the sector are oriented to substituting for imports and saving foreign exchange. The industry's development is also envisaged as having a significant role in developing the Amazon region near Belem, because its major development thrust will eventually be focused in that area, close to large deposits of bauxite and hydropower sources. 2.07 The major elements comprising the sector's investment into the mid-1980's are: (i) expansion of all existing private alumina and alumi- num facilities; (ii) implementation of new alumina and aluminum plants mainly promoted by CVRD; and (iii) development of new bauxite mines by CVRD and private interests. 2. Expansion of Existing Sources of Aluminum, Alumina and Bauxite 2.08 Plans for the expansion of existing aluminum plants by the exist- ing producers also encompass development of increased capacity to produce alumina and bauxite. Some of these projects are already under execution, and the completion of these and the other planned expansions are projected to result in expanded output as follows: Brazil: Planned Expansion of Existing Sources of Aluminum, Alumina and Bauxite ('000 tons) Primary Aluminum Alumina Bauxite 1978 1980 1985 1978 1980 1985 1978 1980 1985 (Actual) (est.) (est.) Alcan 59 88 148 100 120 120 350 420 420 Alcominas 59 90 90 170 220 220 425 550 550 CBA 49 80 120 90 220 220 243 594 594 167 258 358 360 560 560 1,018 1,564 1,564 Source: CVRD. - 5 - 2.09 According to studies prepared by CVRD, investments between 1977- 1980 for the above-mentioned expansions of production amount to approximately US$270 million in 1977 terms, broken down as follows: Alcan, US$90 million; Alcominas, US$80 million; and CBA, US$100 million. 2.10 Given that domestic primary aluminum production still only satis- fies less than two thirds of consumption and the fact that aluminum can be produced economically in Brazil, the local market will absorb substantial further expansion of the existing producers, and with the continuing strong growth in demand, there is ample room for more local production. Rather than market potential, the main constraint to growth of the industry continues to be access to capital. This is especially true of CBA, which unlike the for- eign-owned Alcan and Alcominas, is more dependent on local sources of funds. Furthermore, it has followed a policy of expansion largely through self-gener- ated funds. Its ultimate growth constraint at its present site is its own power-generating potential. 3. Development of New Aluminum and Alumina Plants 2.11 New aluminum and alumina projects being promoted by CVRD encompass investments of approximately US$3.0 billion in 1977 prices. They include the 320,000 TPY ALBRAS (Aluminio Brasilieiro, S.A.) aluminum reduction plant; the 800,000 TPY ALUNORTE (Aluminio do Norte, S.A.) alumina refinery and the 86,000 TPY Valesul reduction plant (Chapter VI - The Project). The first two projects would be established near Belem in the Amazon region (Map IBRD 13222). Their ownership and development have been under negotiation for about three years between CVRD and a consortium of 32 Japanese companies under the sponsorship of the Governments of Brazil and Japan. According to present plans, ownership of ALBRAS would be 51% by CVRD, and 49% by the Japanese. Production would be distributed in equal portions between both partners. ALUNORTE is envisaged as having a 63% CVRD/377% Japanese ownership. Its alumina output would be consumed entirely by the ALBRAS and Valesul smelters. 2.12 The feasibility study for ALBRAS was prepared by CVRD, Montreal Engenharia, Mitsui Aluminum, and NIPPON Light Metal (Japan) in 1976. It indicates that the project could start production by 1981 if implementation had started in 1977. The feasibility study for the ALUNORTE project, pre- pared by CVRD, Alcan (Canada) and Montreal Engenharia also in 1976, indicates that production of alumina could start in 1982 if implementation had started in 1977. Both schedules are no longer attainable because CVRD has only recently concluded certain agreements on these projects, and only engineering work has commenced. Based on present data, it appears that both the ALBRAS and ALUNORTE projects will yield very low economic rates of return. The estimated total investment requirements for the ALBRAS/ALUNORTE projects and associated infrastructure are presently estimated to be at least US$2. 7 billion equivalent, at 1977 prices, to be spent over a nine-year period. 2.13 Plans for a fourth project (i.e. in addition to ALBRAS, ALUNORTE and Valesul), the Aluminio de Pernambuco (ALUNE) smelter proposed for Recife, in the northeast, have been halted largely due to lack of Government support - 6 - and the uncertain availability of adequate power; it is not clear whether the project will be developed. An aluminum reduction plant similar to Valesul, this project would have an annual capacity of 80,000 tons. No operating sponsor exists, although Pechiney-Ugine-Kuhlman (France) has shown some interest, and the plant has the support of BNDE and SUDENE (Superinten- dencia de Desenvolvimiento do Nordeste). Aluminio S.A. (ASA), an aluminum fabricating plant in Recife, which has experienced financial difficulties and with some modifications could reach a capacity of 60,000 TPY, would supposedly benefit from the proximity of a smelter. 4. Development of New Bauxite Mining Projects 2.14 The most important bauxite prospects are located in the Amazon region (Map 13222). According to CVRD, this region has approximately one billion tons of proven reserves plus 3.2 billion tons of probable reserves, as compared to present domestic bauxite output of about 1.0 million TPY. The first project in the Amazon Region, already nearing completion, is Mineracao do Rio Norte's Trombetas mine, which is owned 46% by CVRD and 54% by the following firms: Alcan (Canada) 19%; A/S Aardal og Sunndal Verk (Norway) 5%; Billiton International Metals (Netherlands) 5%; CBA (Brazil) 10%; Empresa Nacional del Aluminio S.A. (Spain) 5%; Norsk Hydro A.S. (Norway) 5%; and Reynolds Metals (US) 5%. Planned initial production is 3.35 million TPY of bauxite with the first shipment scheduled for 1979. The mine and ore processing facilities are located near the Amazon River. Ore will be shipped down the Amazon to the Atlantic, and later possibly to the port of Belem. Total project cost is estimated at about US$350 million, of which US$15 mil- lion is being financed by IFC 1/. An alumina plant to be implemented at the Trombetas mine is also being considered. 2.15 Several other bauxite projects also in the Amazon are now being studied. The most important ones are: (i) Sociedad Mineracao de Santarem (SOMISA), a 100% Alcoa (US) prospect located northeast of Trombetas; this could become an Alcoa/Ludwig joint venture with the Brazilian Ludwig group contributing its Mineracao Santa Monica reserves, which are located in the vicinity of Trombetas; and (ii) Mineracao Vera Cruz (Paragominas), a prospect located south of Belem, which is being promoted by CVRD and Rio Tinto Zinc (UK). Paragominas, however, is unlikely to be developed in the near future because of difficulties in transporting the bauxite at reasonable cost either to the Amazon river, or to the Atlantic. C. Sector Priorities 2.16 Historically, the aluminum sector has been privately owned. Hence, at present, the ownership of Valesul and other public or mixed public/private sponsored projects to be developed in the North is a matter of some controversy within the industry and within the Government. To reassure existing producers of its intentions to leave new sector projects under private control, the Government has authorized CVRD to develop Valesul on the condition that its ownership includes substantial private Brazilian participation and that simul- taneous Brazilian and private control be established as early as possible. 1/ IFC investment approved on June 7, 1977, Appraisal Report IFC/T-201. - 7 - 2.17 Another matter of some current controversy is the location and the timing of the various proposed projects. In this connection, the development of Valesul in the south, close to major markets but, therefore, also to populated areas with high demand for electrical power, has been justified not only on the basis of the project's economic attractiveness, but also on account of speedy execution and resulting faster import substitution which is important until the northern projects come on stream, although even then aluminum imports are expected to continue (para. 3.31). This approach is realistic because, as noted above, the schedule of the northern projects is not yet firm and current plans are still subject to potential delays. These projects are highly unlikely to start producing before the mid-1980's given the substantial issues still to be resolved by the sponsors, the construction difficulties to be faced in the Amazon, and the enormous financing requirements. Moreover, economic projections made on the basis of information from the respective feasibility studies show that their return on investment is likely to be low. 2.18 Therefore, development of Valesul is well justified because its economic and financial returns are satisfactory (paras. 8.11 and 9.05), its location is advantageously close to aluminum consumers and sources of labor, and its substitution for imports at an earlier date can be predicted realis- tically (para. 5.01). Furthermore, since CVRD will be involved in both Valesul and the northern plants, the project will also serve as a training ground to prepare skilled management and manpower needed in the future for the execution and operation of the northern projects. Finally, market projections (para. 3.31) indicate that there is room for both Valesul and the northern projects, in accordance with a more realistic schedule of implementation, as well as in the expansion of the existing plants. There is, however, the problem of the availability of local financial resources to cope with the enormous investment requirements for all these plants. D. Government Regulations and Incentives 2.19 In January 1975, the Government set targets to develop non-ferrous industries. According to these, production of aluminum was to reach about 1.3 million TPY in 1983, with a total investment of approximately US$3.9 billion. These ambitious targets were based on very optimistic assumptions for project timing and capital costs, and aluminum production in 1983 is more likely to be on the order of 0.4 million TPY. 2.20 Primary aluminum prices are set by the Inter-Government Price Council (CIP), and are adjusted according to cost changes, supposedly allow- ing for a reasonable return on assets for the industry. There are no indica- tions that current pricing policies will be modified in the near future al- though this is always a possibility, given the Government's efforts to control inflation. It is expected that aluminum prices will increase in real terms as additional production will have to be attracted from new projects with higher investment costs. Future price assumptions are discussed in Chapter VIII. 2.21 At present, several incentives are being studied to interest in- vestors in developing aluminum projects in the Amazon region. Potential - 8 - incentives under consideration are: (i) tax exemptions for periods of 10-15 years; (ii) availability of lower-priced subsidized electricity; and (iii) tax incentives to favor purchasers of aluminum. These would be similar to the IUM 1/ tax presently applied to local consumers of bauxite and would be applicable for periods of 10-15 years. An incentive already 4n use by the aluminum sector is a 98% discount on the compulsory bonds which power-consuming industries must buy from ELETROBRAS, which reduces the effective cost of power by about 20%. Another major incentive for establishing aluminum projects in the Amazon is the current development of the 4,000 MW Tucurui hydroelectric project, which is expected to start generating power by 1982. 2.22 Aluminum imports are free of import duties (Resolution 2841 of Customs Policy Council). They are, however, regulated by CACEX (Carteira do Comercio Exterior) which requires an advance deposit in cruzeiros, of an amount equivalent to the FOB port of shipment price, to be paid at least 360 days before the delivery of aluminum in Brazil. This deposit has the effect of an indirect tax of approximately 45%, because it does not gain interest, and because it is not corrected to compensate losses Erom inflation. Addi- tionally, there are nonmonetary restrictions to metal imports: each importer needs a CACEX license which, in turn, is contingent upon CONSIDER approval. Independent manufacturers have two sources for their supplies of primary aluminum: imports and the output of Alcominas, which as mentioned previously is the only non-integrated local producer. Such a situation is expensive, risky, and inflexible for independent fabricators. They thus have a consider- able interest in seeing the establishment of an additional non-integrated primary metal producer. 2.23 Environmental regulations and controls on the aluminum sector are the responsibility of the Secretaria Especial Do Medio Ambiente (SEMA). SEMA's guidelines on industrial effluents are still not very specific for the aluminum sector. This is expected to change before long, however, because residents and authorities of aluminum producing regions, such as Ouro Preto where Alcan has a smelter, are expressing growing interest in the need to regulate and control the disposal of effluents. E. Contribution to the Economy 2.24 The sector has played a significant role in saving foreign exchange by substituting for imports. These savings are estimated at approximately US$200 million in 1977. All aluminum production has been for local consump- tion, supplying an increasingly larger segment of the Brazilian market, from approximately 47% in 1966 to 64% in 1977; this trend is expected to continue 1/ The IUM Tax (Impuesto Unico Sobre Minerios) is the sole tax applied to mineral products. In accordance with Decree 66,694 of June 1970, bauxite produced for export is taxed at 4% of its FOB value. Bauxite ores for local consumption are taxed at 15% of FOB, in accordance with Decree 1172 of June 1971. This latter tax, however, is refunded to the purchasers. - 9 - (Chapter III - The Aluminum Market). On the other hand, exports have been limited to relatively small quantities of bauxite valued at about US$1.0 million p.a., which have been shipped mostly to Argentina. The foreign exchange used for importing in 1977 is estimated approximately at US$150 million for aluminum and at US$10 million for fluorides and carbon needed as raw materials to produce primary aluminum in Brazil. 2.25 The sector's contribution to Brazil's gross domestic product (GDP) is relatively small, reaching approximately 3% in 1977. There has been, however, a slow and steady increase in this share in real terms since 1966, illustrating the relative growth of the aluminum sector in Brazil's economy. It is expected that this increase will continue following the proposed sector expansion program. 2.26 The primary aluminum sector makes a relatively small contribution to fiscal revenues. In 1977, taxes paid to the Government were only about 0.1% of Government revenues, a much higher contribution than in previous years, owing to the increase of producing capacity as well as to the improved metal prices and the resulting impact on sector profits and income taxes. 2.27 Although the primary aluminum sector (i.e., bauxite, alumina and aluminum, but excluding fabrication) has been a very modest source of employment of Brazil's labor force, it is particularly important in the Ouro Preto region. In 1977, direct employment in the sector was slightly over 4,000, with approximately 1,200 employed by Alcan and 1,800 by Alcominas. The proposed sector expansion program should expand direct employment by about 6,000 jobs by the mid-1980's. III. THE ALUMINUM MARKET A. The International Market for Aluminum 1. Consumption/Demand 3.01 Due to its specific properties of light weight, recyclability, corrosion resistance and high thermal and electrical conductivity, aluminum is being increasingly used in construction, transportation, packaging and for consumer durables, electrical installations and machinery. Aluminum consump- tion by sector in major countries is shown below: - 10 - Ia Consumption of Aluminum in Japan, Western Europe/ and the U.S. 1961 1971 1977 Growth Rate '000 '000 '000 (1961/1977) tons % Tons % Tons % % Building and Construction 690 19.4 1,720 21.9 2,774 23.8 9.1 Electrical 435 12.2 1,080 13.8 1,178 10.1 6.4 Transportation 890 25.0 1,700 21.7 2,847 24.5 7.5 Consumer Durables 435 12.2 640 8.2 879 7.6 4.5 Packaging 280 7.9 945 12.0 1,886 16.2 12.7 Machinery and Equipment 285 8.0 515 6.6 725 6.2 6.0 Other 545 15.3 1 240 15.8 1,349 11.6 5.8 Total 3,560 100.0 7,840 100.0 11,638 100.0 7.7 /a Federal Republic of Germany, France, Belgium-Luxembourg, Italy, Netherlands, UK, Austria, Switzerland. Source: Metallgesellschaft, The Aluminum Association (N.Y.) and OECD. 3.02 The fastest-growing market for aluminum products has been packaging, particularly in the US which accounted for about two thirds of consumption in that sector in the countries mentioned above. Consumption of aluminum in building and construction and in electrical applications also rose faster than the average. In addition to its physical properties, aluminum's rela- tively low and stable prices (prices in current terms remained virtually unchanged between 1956 and 1973) in comparison to competing materials have increased the incentive to use aluminum. As a result, aluminum has become the fastest-growing metal, with consumption increasing after World War II at an average rate of 9% per annum until 1973, before the start of the recession of 1974-75. The income elasticity of demand for aluminum in developed countries averaged 1.8 between 1960 and 1977. World aluminum consumption more than tripled from 5.2 million tons in 1960 to 18.2 million tons in 1977. 3.03 Aluminum consumption is concentrated in the industrialized coun- tries, which accounted for 75% of the world total in 1960 and 71% in 1977 (excluding CPE's). The geographical distribution of aluminum consumption is summarized below: - 11 - World: Geographical Distribution of Aluminum Consumption /a ('000 metric tons) Average Annual Growth Rate 1960 1965 1970 1977 (1960-1977) (%) Europe /b 1,580.8 2,041.9 3,245.1 4,388.4 6.2 Japan 200.0 403.8 1,187.4 1,801.8 13.8 USA 1,942.6 3,626.1 4,425.4 6,087.7 7.0 Other Developed /b 164.8 297.4 456.5 641.2 8.3 Total Developed /b 3,888.2 6,369.2 9,314.4 12,919.1 7.3 South America 67.2 133.3 219.6 413.8 11.3 Other LDC's 101.7 211.5 436.4 970.5 14.2 Total World 4,057.1 6,714.0 9,970.4 14,303.4 7.7 (excluding CPE's) CPE's 1,100.0 1,650.0 2,600.0 3,900.0 7.7 Total World 5,157.1 8,364.0 12,570.4 18,203.4 7.7 /a Primary, secondary and direct use of scrap by manufacturers. /b Excluding Yugoslavia and Turkey. Source: IBRD, Metallgesellschaft. 3.04 The expected, sustained slowdown of world economic growth will con- tinue to affect future demand developments. Economic growth rates for the next 5-10 years are expected to remain at rather modest levels, barely exceed- ing 4% per annum on the average for developed countries. Additionally, factors indicating that the income elasticity of demand for primary aluminum might decrease include increasing market saturation and scrap recycling as well as lower competitiveness with other materials like steel, copper, tin- plate, glass and plastics due to recent increases in relative aluminum prices. Past long-term trends of the price ratios of aluminum to steel and to copper for selected years since the late 1930's are shown below: World: Price Ratio Trends 1939 1949 1959 1964 1969 1974 1975 1977 Aluminum to Steel /a 7.58 3.46 3.04 2.83 2.97 2.21 2.52 3.37 Aluminum to Copper 1.82 0.83 0.79 0.75 0.61 0.44 0.62 0.77 /a Composite Finished Steel Prices. Source: Reynolds Metals Co., IBRD, Iron Age. - 12 - 3.05 The recent increase in the relative aluminum price might reduce future demand increases, given the substitutability in a number of applica- tions. However, efforts to conserve energy and to increase fuel efficiency are expected to open new markets for light-weight aluminum products, espe- cially in the automotive industry and in construction. These conflicting factors are projected to result in a somewhat lower-average income elasticity of demand of 1.6 into the mid-1980's (as compared to the historical 1.8). Projecting total world aluminum consumption from the 1977 level of 18.2 million tons according to the assumptions of about 4% per annum economic growth and the 1.6 elasticity factor results in an annual growth rate of 6.4% and a 1985 consumption level of about 30 million tons. 2. Supply 3.06 Primary aluminum, i.e., aluminum in its non-fabricated forms of ingots, slabs and billets, is produced mainly by smelting or reducing a basic semi-processed raw material, alumina, which is in turn produced by refining bauxite. About 20% of total aluminum production is obtained by melting scrap and known as "secondary aluminum". Primary aluminum is pro- duced in highly capital-intensive reduction plants, most of which are owned by large multi-plant, integrated aluminum groups (para. 3.07), while secondary aluminum is mainly produced by small and medium-size companies. Total in- vestment costs per ton of annual capacity of primary aluminum in 1977 prices (excluding the stages of alumina and bauxite) was about US$3,000. Although it can vary with local conditions, the present minimum economic size of a greenfield aluminum reduction plant of, say, approximately 70,000 TPY has required large investments of at least US$200 million per project and contributed to the predominance of big multinational corporations. 3.07 The six major multi-national aluminum companies 1/ are vertically integrated from production of bauxite to manufacturing aluminum and fabri- cating aluminum products. These corporations account for between 50% and 60% of world production capacities of bauxite, alumina and aluminum. 2/ The balance is distributed among other private companies, publicly-owned enter- prises and state enterprises of the centrally planned economies. 3.08 World production of primary aluminum increased from 4.5 million tons in 1960 to 14.2 million tons in 1977, an average annual increase of 7%. The geographical distribution of aluminum production for selected years is summarized below: 1/ Aluminum Company of America (ALCOA); Reynolds Metals Company, and Kaiser Aluminum & Chemical Corporation all of the US; Alcan Aluminum, Ltd. (Canada); Pechiney-Ugine-Kuhlman (France); ALUSUISSE (Switzerland). 2/ IBRD Commodity Paper No. 24 (3/77). - 13 - World Primary Aluminum Production ('000 metric tons) Average Annual Growth Rate 1960 1965 1970 1977 (1960-1977) (%) Brazil 18.2 30.4 56.1 167.5 14.0 India 18. 2 63. 7 161.1 183.8 14.6 Other LDC's 77.3 130.9 368.2 916.6 15. 7 Australia 11. 8 87. 8 205.6 247. 6 19.6 USA 1,827.5 2,498.8 3,607.1 4,117.5 4.9 Canada 691.3 753.4 962.5 9 76. 4 2. 1 Europe 840.1 1,238.1 1,967.2 3,292.8 8. 4 Japan 133.2 292.1 727.9 1,188.2 13. 7 Other Developed - - - 223.1 - CPE's 910.6 1,490.9 2,201.1 2,907.3 7.1 Total World 4.528.2 6,586.1 10,256.8 14,220.8 7.0 Source: IBRD, Metallgesellschaft. 3.09 The lowest growth rates during 1960-77 were recorded in North America while the fastest increase in production took place in Australia, the country with the largest bauxite reserves. The developing member coun- tries of the International Bauxite Association (IBA) 1/ and important non- members like Brazil and India accounted for the fast rise in LDC aluminum production. Primary aluminum production in LDC's increased by nearly 10 times over the 1960-77 period, pushing their share of world production from 2.5% to 7.5%. This trend reflects a tendency to install facilities closer to raw material and energy resources and to evolving markets in developing countries. 3.10 The trade pattern of the international market for primary aluminum has been characterized by the predominance of North American exports but these have decreased in relative terms over the past 15 years as shown in the table below: 1/ Membership in 1978 was: Australia, Dominican Republic, Ghana, Guinea, Guyana, Haiti, Indonesia, Jamaica, Sierra Leone, Surinam, Yugoslavia. - 14 - Exports of Primary Aluminum by Volume for Selected Countries ('000 tons) 1967 1975 Country Tons Tons % USA 190.0 9.9 168.6 5.3 Canada 690.0 35.8 509.2 16.1 Norway 315.0 16.3 451.5 14.3 Fed. Rep. of Germany 22.0 1.1 159.7 5.1 Netherlands 26.0 1.4 264.2 8.4 USSR 253.0 13.1 502.4 15.9 Other Developed Countries 315.0 16.3 814.1 25.8 LDC's 118.0 6.1 290.0 9.1 Total World (including CPE's) 1,929.0 100.0 3,159.7 100.0 Source: World Metal Statistics. 3.11 While the US and Canada provided nearly half of world exports in 1967, this percentage had decreased to about 21% in 1975. Simultaneously, Norway, the Netherlands and Germany began emerging as major exporters, reach- ing a combined market share of 27.8% in 1975 compared to 18.7% in 1960. The USSR has been a fairly steady major source of supply. The rise in the export market share of "other" developed countries reflects the spreading of reduction facilities over a larger number of countries. Several countries that did not have production facilities in 1960, such as Greece, Turkey and the Netherlands, became exporters in the 1970's. More than half of the 1975 exports of "other" developed countries came from the EC (excluding Germany and the Netherlands) and about one fourth from Eastern Europe (excluding the USSR). The pattern of trade among developed countries shows primary aluminum flowing mainly from Canada and Norway to the main fabricating areas of the US, Western Europe and Japan. The participation of LDC's in world exports remained at a rather stable rate of roughly 10%, indicating that most of the increase of the LDC share in world production (para. 3.09) was for domestic markets. 3.12 The aluminum industry has traditionally developed in the industrial- ized countries and particularly close to sources of bauxite and low-cost hydropower. Thus, even countries with comparatively small markets, e.g., Canada, Norway, Australia, have become important alumina and aluminum pro- ducers and exporters. Other countries, such as Japan, have become important producers by virtue of the large and growing local demand. Certain developing countries, such as Brazil and India, have combined at least one of the major two manufacturing inputs (bauxite and power) with a substantial market potential to form the basis for a growing local industry. 3.13 Apart from market and natural resources, the major constraining factors on aluminum industry development in the LDC's have been the sizable - 15 - investment funds required and the need to acquire the closely held production technologies. Such a situation has led to more extensive involvement of the major integrated multi-national companies, which are particularly well equipped to combine their technology with access to capital and the ability to coordinate widespread bauxite mines, alumina refineries, aluminum smelters and fabricating facilities with the varying needs of international markets. The recent upsurge in energy prices, the worldwide economic slowdown, and dramatic increases in equipment and construction costs have made the search for expansion opportunities in the industry particularly difficult, competi- tive and widespread. The search has led to an industry trend towards the LDC's and particularly those with bauxite, competitive energy sources and substantial market potential, such as Brazil. LDC share of world primary aluminum production is projected to increase from 8% in 1977 to 17% in 1985. 3. Supply/Demand and Price Outlook 3.14 About two thirds of world primary aluminum production are moved within the large multi-national aluminum corporations. The balance is mostly traded under long-term contracts at a reference or posted price. The reference price most widely used is Alcan's posted price ("ALCAN's World List Price"). The remainder of primary aluminum production (perhaps 5%), together with quantities of secondary metal, is traded at the "spot price" fixed at the London Market and published in the "Metal Bulletin." Historically, the spot price has tended to be below the "posted price" with an extreme sensi- tivity to market forces, such as heavy variations as a reaction to relatively small over-supplies or shortages. However, changes in the trend of the spot price have often anticipated and preceded similar developments of the posted price. In October 1978, the London Metal Exchange (LME) commenced trading in aluminum. It remains to be seen to what extent the LME price will be used in international trade, but the introduction of LME trading does provide a market of last resort and may become used by aluminum traders for hedging. Past trends of Alcan's posted price in current and constant 1975 US dollar terms for selected years are given below: World: Aluminum Ingot Posted Price Trend (US$/lb) 1950 1955 1960 1965 1970 1975 1977 1978 Constant 1975 US dollars 0.49 0.56 0.58 0.53 0.54 0.40 0.44 0.45 Current US dollars 0.18 0.24 0.26 0.24 0.29 0.40 0.51 0.54 Source: UN Statistical Yearbook. - 16 - 3.15 The behavior of the aluminum ingot posted price has historically been characterized both in constant and in current terms by considerable stability, except for extraordinary situations, such as the Korean War boom in the early 1950's, or the energy crisis of the 1970's. In constant terms, the price remained virtually unchanged between the mid 1950's and the beginning of the 1970's. In current terms, compared to 1956, the ingot price in 1970 was only US$0.04 higher, an increase of less than 1% p.a. The disruptions of rapid inflation, world wide recession and the energy crisis of the early and mid-1970s caused a steep price increase in 1972, followed by a breakdown in 19 75. Between 1974 and 1975 the spot price--which as noted reacts most sensitively to market forces--fell by nearly 30%. Still, compared to other commodity prices, the aluminum price has shown considerable stability and few heavy fluctuations. The principal factor limiting downward movements of aluminum prices in periods of sluggish demand is the industry's relative concentration and ability to reduce output. 3.16 Resistance against excessive price increases, on the other hand, results from the relative prices of such competing materials as steel, copper, glass and wood. Besides the technical advantages of aluminum and several new uses successfully introduced, the basis for the penetration of aluminum into various markets has been its low relative price resulting from technological advances after World War II and subsequent cost reductions. 3.17 The main factors determining the price level are the demand/supply balance and the cost structure of the industry. The influence of the demand/ supply balance prevails in the medium term. After tight supplies or even a shortage have led to increased prices, incentives are created for new facil- ities; and, after the time necessary for project implementation, a new equilib- rium is restored at a new price level. In the longer run, however, trends in production costs tend to determine the price level. 3.18 The high investment cost in the aluminum industry, coupled with sagging demand and a cost/price "squeeze," have held back expansion projects over the last few years. Taking into account a normal lead time of three to four years for an aluminum project, known investment plans indicate that capacities would increase until 1980 by only about 3% per annum and by a slightly higher rate of about 4. 5% thereafter, compared to average demand growth rates estimated at about 6. 8%. By mid-1978, capacity utilization rates averaged about 87.2% worldwide, compared to a normal industry objective of 95%. It seems unlikely that the industry is able to produce at more than 95% of capacity over sustained periods of time. Demand is expected to exceed total world capacity by 1980, thus exerting considerable upward pressure on prices. Based on the assumption of a 95% capacity utilization on average, the long-term supply/demand situation is projected to be somewhat tight, as shown below: - 17 - World: Projected Supply - Demand Balance of Primary Aluminum ('000 metric tons) Annual Growth Rate 1977 1980 1985 (1977-1985) (actual) % Consumption/Demand /a Developed Countries 10,091.3 12,686 17,119 6.8 LDC' s 1,282.0 1,471 2,704 9.8 CPE's 2,983.8 3,469 4,427 5.1 Total Consumption/Demand 14,357.1 17,626 24,250 6.8 Production Developed Countries 10,046.0 11,707 15,600 5.7 LDC's 1,267.5 2,113 4,000 15.5 CPE's 2,907.3 3,600 4,600 5.9 Total Production 14,220.8 17,420 24,200 6.9 Inventory Changes (136) (206) (50) /a Indicating consumption/demand of primary aluminum only and is therefore not comparable with the table in para. 3.03 which includes use of sec- ondary aluminum. Sources: IBRD, Metallgesellschaft. 3.19 The projected supply/demand situation thus indicates that aluminum prices are likely to rise in real terms during the next few years, until price increases have attracted enough new capacity to restore an equilibrium situation. This is expected to occur in the early 1980's after which prices are expected to stabilize. 3.20 The aluminum ingot price, 1/ which was US$0.56 per pound in December 1978, is projected to be US$0.61 in 1978 constant US dollars by 1981, which would be equivalent to US$0.73 in current terms. Thereafter, the price is projected to remain constant in constant US dollar terms, as follows: World: Estimated Trend in Aluminum Ingot Prices (FOB New York) Year Constant 1978 US$/lb. Current US$/lb. 1978 0.54 0.54 1981 0.61 0.73 1985 0.61 0.93 1990 0.61 1.24 The price and demand/supply projections presented here are supported by recent studies carried out by Chase World Information Corporation, Arthur D. Little, Baylaucq-Gaucher and Bank of America. 1/ FOB-New York Alcan World List price. - 18 - B. The Market for Aluminum in Brazil 1. Consumption/Demand 3.21 Aluminum consumption in Brazil grew at an average rate of 14% p.a. between 1967 and 1977 and somewhat more than 16% p.a. between 1970 and 1977. Brazil: Apparent Consumption of Aluminum ('000 tons) Year 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 69.6 85.3 97.4 104.6 127.4 160.1 187.8 22 8.7 251.2 258.9 292.3 Source: ABAL. 3.22 The Brazilian aluminum industry is characterized by the predominance of two, fully-integrated aluminum companies (ALCAN and CBA) which account for more than 60% of primary aluminum production and 40% of primary consumption in Brazil. The remainder of primary supply is consumed by independent fabrica- tors, of which the biggest 10 non-integrated consumers accounted for 27% of total ingot consumption and the 34 next largest consumers for another 13%. The two, integrated aluminum companies and the 44 main independent fabrica- tors together process more than 80% of Brazil's primary aluminum. About 90% of fabricating capacity is located in the southeastern area of Brazil, within 300 km of Rio de Janeiro or Sao Paulo. About 90% of fabricated products are consumed in the Rio/Sao Paulo region. 3.23 The sectoral distribution of consumption of fabricated or semi- fabricated aluminum products in Brazil shows that construction, transporta- tion and the electrical industry have been the main users of aluminum, with construction becoming the most important consumer as shown below and compared to the consumption pattern in developed countries (para. 3.01): Brazil: Sectoral Distribution of Aluminum Consumption (in %) Developed Countries Sector 1972 1974 1976 1977 1977 Construction 1& 8 23.2 25.8 24.4 23.8 Transportation 17.1 19.9 18.2 16.7 24.5 Electrical 29.5 21.4 21. 8 24.9 10. 1 Consumer goods 1&81 16.4 16.5 14.6 7.6 Packaging 8. 3 7.9 7.5 8.5 16.2 Machinery 2.3 3.4 3.6 4.1 6.2 Other 5.9 7.8 6.6 6.8 11.6 Total 100.0 100.0 100.0 100.0 100.0 Source: Montreal Engineering, Prefeasibility Study (1975), ABAL and sources listed in para. 3.01 (Developed Countries). - 19 - 3.24 Rolled products accounted for about a third of total consumption, and extrusions as well as cables and wires for more than a fifth each. While consumption grew for every type of aluminum products, extrusions were the fastest-growing aluminum product between 1972 and 1977, reflecting the fact that more than half of these were consumed in construction applications, which grew rapidly in the first half of the 1970's. 3.25 In spite of the fast development of the Brazilian aluminum industry, consumption levels are still low compared to other countries, as shown below: Per Capita Aluminum Consumption and Income in Selected Countries (1976) /a Country Primary Aluminum (kg) GNP (US$) Korea 1.4 670 Brazil 2.2 1,140 Taiwan 3.9 1,070 Argentina 2.6 1,550 Hong Kong 5.4 2,110 Japan 17. 4,910 Germany 20.4 7,380 USA 26.7 7,890 /a Total aluminum consumption including secondary metal. Source: Metallgesellschaft, World Bank Atlas, UN Statistical Yearbook. 3.26 Foreign exchange constraints and the shortage of metal have limited aluminum consumption in Brazil and constituted a disincentive for new appli- cations. Compared to the present consumption structure in industrialized countries, the penetration in Brazil of aluminum into such sectors as pack- aging and machinery and equipment is very low, whereas in other countries in these sectors aluminum products such as beverage cans, packaging foil and equipment applications are highly used. In view of the low per capita consumption of aluminum, the limited extent of new applications in a number of sectors, and expected continuing growth in the aluminum-consuming sectors of the economy, there seems to be considerable room for future aluminum growth in Brazil. 3.27 The potential of future aluminum demand growth in Brazil has been analyzed by CONSIDER in a market study conducted during 1977. This study projected the historical 1.7 income elasticity of demand for aluminum into the future which seems reasonable, particularly since 1.7 has been close to the average international income elasticity of demand of 1.8 for aluminum observed between 1960 and 1977 (para. 3.02). Brazil's economic growth rate is expected to return from the 6.3% average estimated for the late 1970's to a growth trend of about 9% p.a. after 1980. This assumption is supported by the Bank's latest Economic Memorandum. 1/ The assumptions outlined above result in an 1/ IBRD Economic Memorandum on Brazil, October 13, 1977. - 20 - increase in the Brazilian aluminum demand of nearly 11% per annum to 1980 and about 15% per annum in the 1980's as compared to 16% annual consumption increase during the 1970-77 period. However, the study done by CONSIDER in cooperation with CVRD and Valesul covers only the overall demand for aluminum and does not provide detailed analysis by product and sector. Valesul and its shareholders have agreed that a more detailed study will be done on future demand and be submitted to the Bank by December 31, 1979. 2. Supply 3.28 A large part of Brazil's aluminum consumption has been and con- tinues to be supplied from foreign sources as shown below: Brazil: Supply of Aluminum (1967-77) ('000 tons) Year 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 Primary Production /a 3 8.1 41.4 42.9 56.2 80.7 97.6 111. 7 113.6 121.3 139.2 167.1 Secondary Production 3.7 4.4 6.5 8.0 10. 5 13.0 1 &5 22.4 20.6 2& 0 33.5 Domestic Production 41. 8 45. 8 49.4 64.2 91. 2 110. 6 130.2 136. 0 141. 9 167. 2 200.6 Imports 29.4 36.7 54.2 40.5 36.6 53.3 64.1 125.8 94.4 92.5 112.1 Total Supply 71. 2 82. 5 103.6 104. 7 127. 8 163. 9 194. 3 261. 8 236.3 259. 7 312. 7 Imports as percent of Total Supply 41.3 44.5 52.3 3 8.2 2 8.6 32.5 33.0 48. 0 39.9 35.6 35. 8 /a Output by producers is given in para. 2.01. Source: ABAL. 3.29 Aluminum is imported by the main fabricators and by the integrated aluminum companies. However, the only non-integrated primary aluminum producer, Alcominas, does not import aluminum. Since the prices (even without consider- ing the cost of the compulsory deposit) for imported aluminum, which is exempt from direct import duties, are generally higher than the Government regulated prices for ingots, slabs and billets, primary aluminum imports are only interesting to companies producing semi-fabricated or finished goods not subject to price regulations. 3.30 A breakdown of Brazilian imports during 1977 shows that the nine main importers accounted for over 90% of all foreign purchases. Among the nine largest importers are the two integrated companies (Alcan and CBA), six fabricators and CVRD. Two of the six, Aluminio S.A. Extrusao e Laminasao (ASA) and Aluminio Ind. S.A. produce mainly extrusions, while two others, Kaiser/Furukawa and Termocanada fabricate cables. The other two companies are engaged in a wider range of products. The second largest aluminum importer during that period was CVRD, which through the Valesul project is expanding into the aluminum business and considers its entry into trading as a means of gaining experience under its longer-term strategy to become more extensively involved in the production and marketing of aluminum. - 21 - 3. Supply/Demand Balance 3.31 The comparison of the future demand potential and the plans for capacity expansions shows a continued gap between supply and demand which would have to be filled by imports, as illustrated below for a few selected years and shown for all years through 1990 in Annex 3: Brazil: Aluminum Market Projections 1977-1990 ('000 tons) 1977 1980 1985 1990 (actual) Demand 313 385 768 1,531 Production Alcan 59 88 148 148 ALCOMINAS 59 90 90 90 CBA 49 80 120 120 Existing Producers 167 258 358 358 Valesul - - 86 86 ALBRAS - - 90 324 Total Domestic Primary Production 167 258 534 768 Secondary Metal 34 38 77 88 Domestic Supply 201 296 611 856 Imports 112 89 157 675 3.32 The projections of the supply/demand balance are based on the pres- ently known plans for new projects and expansions with a two-year slippage assumed in the startup of the ALBRAS project from the originally intended 1982, and on an annual growth of aluminum consumption of about 11% to 1980 and of about 15% in the 1980's (para. 3.27). However, even an annual growth rate of 10% would be sufficient to absorb the output of the planned projects and still leave Brazil with a net import position. Even an 8% demand growth rate would--in view of the intended Japanese export marketing contracts for 160,000 tons of ALBRAS aluminum--not result in oversupply, so that Brazil still would have to import metal. Under the above assumptions, the Brazilian aluminum market would be large enough to sustain at least one other large project in addition to Valesul and ALBRAS by the mid-1980's. In the long term, there appears to be ample scope for the continuing growth of the exist- ing suppliers as well. 4. Pricing Policy and Outlook 3.33 Present Government price regulations only control primary aluminum products such as billets, slabs and ingots, whereas semi-fabricated products (extrusions, sheet, etc.) are not subject to price control. Prices are fixed by the Inter-Government Price Council (CIP) on an ex-factory basis for the industry as a whole. Prices are adjusted according to cost changes up to six times a year. The average production cost is derived by weighting the opera- ting cost per ton of each producer with his market share. Additionally, an average 15% return on assets for the industry as a whole is supposedly allowed. - 22 - 3.34 Historically, the Brazilian ingot price has been above the interna- tional posted price as shown below: International and Brazilian Aluminum Ingot Prices (US$/lb) 1963 1967 1970 1973 1974 1975 1977 1978 ALCAN's World List 0.23 0.25 0.28 0.27 0.39 0.39 0.51 0.54 Price (FOB New York) Brazilian Price 0.38 0.37 0.30 0.32 0.38 0.52 0.53 0.59 Sources: CVRD, IBRD. 3.35 Through the 1960's, Brazilian prices (on the basis of the official exchange rates) were about 30% above international prices; but due to the rapid increases of the international aluminum price in the 1970s, the difference had virtually disappeared by 1977. Subsequent price adjustment by CIP again resulted in a national price level being 10% above the international price by January 31, 1979. The international price increase of 1973/74 from 25 to 39 cents/pound was not matched by comparable Brazilian national price adjustments, so that the CIP price was below the FOB-Alcan price in 1974. Furthermore, the cost of imported metal in Brazil, which is exempt from import duties-- including freight, insurance and port handling, but exclusive of the compulsory deposit--has exceeded the posted FOB ingot price in New York by an average of 16% over the past four years. Since on average the Brazilian ingot price has been roughly 10% above the posted price (FOB New York) the CIF cost of imported metal has generally been about 5% higher than the Brazilian price (excluding the compulsory deposit). 3.36 As noted in para. 2.19, there is no indication that the pricing pol- icy applied in Brazil in the past would be changed. Furthermore, in view of the Brazilian demand/supply imbalance, a deregulation of prices would tend to drive prices up. Since an increasing part of the Brazilian aluminum demand will be supplied from new plants or expansion projects which have higher capital costs in real terms per ton of capacity compared to existing plants, the expected continuation of the present price policy will tend to increase aluminum prices in real terms. 3.37 The Brazilian ingot price is projected to increase in constant 1978 US dollars by 8.5% from US$0.59 per pound to US$0.64 per pound by 1981. A 13% increase in the international price is projected over the same period, which would result in the Brazilian price being about 5% higher than international price, or roughly in line with the policy over the last two years. After 1981, it has been assumed that the price will be maintained in real terms, as shown in the table below: - 23 - Projected Brazilian Ingot Prices /a Year Constant 1978 US$/lb. Current US$/lb. 1978 0.59 0.59 1981 0.64 0.77 1985 0.64 0.97 1990 0.64 1.30 /a Ex-factory. The Government has agreed to take all action required on its part regarding price levels which will enable Valesul, operating efficiently, to achieve a reasonable return on its invested capital. 5. Marketing 3.38 Since a company limited to production without any marketing would be restricted in its managerial and financial independence, and since this would make the company less attractive to prospective investors, it has been decided that Valesul would handle its own marketing. Any purchasing of aluminum from Valesul by its shareholders will be done on an arms-length commercial basis. 3.39 Apart from this basic decision, little detailed planning has been done regarding Valesul's marketing organization and strategies. Valesul has recognized the need for the development of a more detailed plan and has begun to carry it out. The organizational structure for this activity will be simple and straightforward, but the formulation of strategies will be important, given the propensity of the industry to tie its markets through forward integration, and the risks this presents for a non-integrated new- comer to the market like Valesul. Valesul and its shareholders have agreed to prepare a detailed marketing plan on the basis of a detailed market study (para. 3.27) for the Bank's review by December 31, 1979. IV. THE COMPANY AND THE SPONSORS A. Ownership 4.01 Valesul Aluminio S.A. has received a high priority status by the Non-ferrous and Steel Council (CONSIDER) for its project. The Government authorized its sponsor, CVRD, to proceed with the project on the condition that Valesul be simultaneously controlled by private'and Brazilian capital. Although no specific timing was specified to achieve this type of ownership, it had always been envisaged that control of the company would be roughly divided into one-third State, one-third private Brazilian and one-third foreign private and that this ownership pattern would be achieved during the early operation at the latest. - 24 - 4.02 CVRD's decision to promote the development of the Valesul plant was largely based on the results of a pre-feasibility study prepared by the Brazilian firm, Montreal Engenharia S.A., in 1975. In connection with that study, proposals to supply technology to produce aluminum were invited from 12 international aluminum companies. 1/ In total, nine firms 2/ responded and, following lengthy negotiations, a series of agreements were finally reached with Reynolds International, Inc., (Reynolds) to have a 30% ownership in the project. The initial subscribed capital was Cr$1.5 million (US$127,000) paid 70% by CVRD and 30% by Reynolds. In October 1976, Reynolds agreed to supply CVRD with its technology and technical assistance to implement the Valesul plant. Subsequently, in April 1977, a supplemental agreement was reached between CVRD and Reynolds on the details of Reynolds' services, but also agreeing that Reynolds' ownership position would be held in abeyance for a year, pending the conclusion of a financing plan, arrangements for alumina and power supply and confirmation of the project's viability. At that time, it was also agreed that the project would be developed using a long-term debt-to-equity ratio of 60:40 and that Reynolds would have a conditional option until April 1978 to acquire a minimum interest of 15% in common and preferred shares. Part of this interest was to be paid by reinvesting Reynolds' fee for technology. Reynolds has reinvested the first two payments, which amounted to US$1.5 million each, and has decided to take a share of Valesul's equity of about 4%, represented by the full reinvestment of its US$6 million technology fee. Reynolds has for the time being decided not to take a larger share in the project in light of its overall investment priorities related to its medium-term cash flow expectations. 4.03 Negotiations have been concluded with Billiton International Metals (BIM), and Shell Brasil, subsidiaries of Royal Dutch Shell (UK/Netherlands). It has been agreed that Shell Brasil will subscribe common shares equal to 35% of Valesul's total capitalization. An agreement between the principal shareholders has been negotiated and reviewed and approved by the Bank. Any change in the agreement not approved by the Bank will be a condition of default. Registration of the Company by-laws will be a condition of loan effectiveness. 4.04 Various alternatives to attract Brazilian investors to the project have been studied over the past two years, including some form of underwrit- ing of private share placements by Brazilian banks, a CVRD/IFC underwriting of a convertible debenture issue and participation by prospective customers who might wish to secure a local source of primary aluminum. There are various practical problems, however, in finding private Brazilian interest willing to participate in a joint private/Government venture and/or who have the necessary available capital at reasonable cost. In many respects, it 1/ Alcoa (USA), Alcan (Canada), Alumetal (Italy), Alusuisse (Switzerland), Kaiser (USA), Pechiney (France), Reynolds (US), and VAW (Germany); Mitsui, Nippon Light Metal, Showa Denko and Sumitomo of Japan. 2/ Alcan, Alcoa, Kaiser, Mitsui, Nippon Light Metal, Pechiney, Reynolds, Sumitomo and Showa Denko. - 25 - would be easier to attract investors once the project is producing. This would mean, however, that a higher price per share might have to be paid to reflect adequately the value of the shares in a profitable operating enterprise. 4.05 It may be that before completion of the project or shortly after its start-up private Brazilian investors can be attracted to participate in Valesul's equity, so that private and Brazilian control could both be increased to over 50%. It has been agreed by CVRD that, in the event the objective of private and Brazilian control of the Company is not achieved by the time of physical completion of the plant facilities, CVRD will offer for sale to private Brazilian investors a third of its holding in excess of 49% of the capital stock of Valesul in each of the three 12-month periods following physical completion so that CVRD's holding is reduced to below 50%. Any shares remaining unsold from these offers will be re-offered during the next sale. If any of these sales are not made, CVRD shall, in consultation with the Bank, seek the advice of an expert third party to determine the most appropriate methods, terms and conditions for the sales. In the meantime, voting shares will be divided approximately as follows: CVRD 61%, 1/ Billiton 35%, and Reynolds 4%. The shareholders have agreed not to dispose of any of their shares without the prior approval of the Bank. B. The Sponsors 1. Companhia Vale do Rio Doce (CVRD) 4.06 The primary sponsor, CVRD, is mainly engaged in the exploration, mining, transport and export of iron ore, although it also has subsidiaries and associated companies involved in fertilizers and in forest industries, including pulp and paper. The Valesul project will be the third CVRD-spon- sored project with Bank Group participation, the first being the Trombetas bauxite project with US$15 million IFC participation made in 1977 (para. 2.14), and the second, the US$294 million Valefertil fertilizer project, 2/ with a Bank loan of US$82 million also extended in 1977. The Government is increas- ingly using CVRD's financial and managerial resources as a base for the State's role in a number of key, basic industrial projects. 4.07 CVRD's gross revenues increased dramatically from US$524 million in 1974 to approximately US$821 million in 1977. About 70% of this growth, until 1975, was due to increasing prices of iron ore and 30% to larger sales volume. CVRD accounts for about 70% of total Brazilian iron ore exports. Iron ore sales volume fell by 10% in 1977 compared to 1976. At the end of 1977, the long-term debt/equity ratio (28:72) was satisfactory; the current ratio was 1.1. In 1978, despite increases in the production (49 million 1/ Includes 0.7% participation of the Development Bank of Rio de Janeiro. 2/ IBRD Loan No. 1441-BR of April 29, 1977 with Appraisal Report No. 1452-BR dated April 7, 1977. Project execution is proceeding satisfactorily within original cost estimates and only a minor delay. Having played a key role in getting the project under way, CVRD has recently sold its participation, with Bank approval. - 26 - tons) and export (42 million tons) of iron ore, CVRD's performance was signi- ficantly lower, owing to generally lower iron ore prices which still prevail in the international market. Its financial performance for recent years is summarized below: Summary of CVRD's Financial Performance, 1974-1978 (US$ Millions) 1974 1975 1976 1977 1978 Iron ore sales in millions 48.4 50.1 50.5 45.7 51.4 of tons Sales 524 749 864 778 734 Net profit 163 198 214 82 n.a. Net profit as % of sales 31 26 24 10 n.a. Net profit as % of equity 24 21 20 8 n.a. Cash generation 186 280 314 209 n.a. 4.08 During 1973-77, CVRD's capital investments averaged US$288 million annually and are expected to increase substantially during the next five years. CVRD's investment program for 1978-82 might require financing commitments of about US$2-3 billion equivalent, including sdme part of US$3-5 billion total financing requirements for the Carajas iron ore project in the northeast, a share of the US$2.7 billion requirements for the ALBRAS and ALUNORTE aluminum/ alumina projects (para. 2.11), and US$89.2 million for its equity in the Valesul aluminum project, plus normal replacements and improvements. This program is expected to be financed with domestic and foreign loans, with new capital subscriptions and Government funds and with possibly up to 50% from internally generated resources. Possible Bank financing is also being dis- cussed for the Carajas project which has been postponed and is still at the project preparation stage. 4.09 To meet its broader responsibilities in areas other than iron ore, CVRD's organizational structure was reorganized in March 1977. Its Adminis- trative Council has nine members, including the President who is appointed by the President of Brazil. The other eight members are elected by the Ordinary General Assembly. Functioning below this Council is the Board of Directors, also presided over by the President, and which consists of six members elected by the Administrative Council. For operating purposes, the company has been structured into ten divisions, operating under CVRD's President. Although CVRD functions under the Ministry of Mines, it is organized and operated as a private entity. The members of its Board and of its Administrative Council are selected from the private and the State sector. 2. Shell/Billiton 4.10 Billiton International Metals is a service company coordinating the development and operation of a group of companies within the Royal Dutch/Shell Group (UK/Netherlands). The Billiton group companies are engaged in exploration, mining, metallurgy and trading of non-ferrous metals and their by-products. It has wholly owned companies in Surinam (bauxite) and in Thailand (tin). In addition, Billiton has interests in: the MANISIVIK lead/zinc project in Canada (11.25%); the Cuajone copper project in Peru - 27 - (11.5%); the Caballo Blanco Co., Ltd., a zinc/tin mining company in Bolivia (12.5%); the Trombetas bauxite project in Brazil (5%) and several metallur- gical plants located in Holland and in France. Its exploration activities are presently located in Australia, South Africa, Indonesia, South America and Canada. Billiton does not publish separate financial reports as these are consolidated into Shell's financial results. The present turnover of the Billiton companies is approximately US$1 billion. Shell Brasil (Petro- leo) S.A., which will be the Shell group company holding 35% of Valesul's shares, is well established in the production and marketing of Shell's petroleum and chemical products in Brazil. It is a financially sound company, with annual revenues (1978) of about US$2.5 billion, cash generation of about US$50 million, assets of US$480 million, a low long term debt to equity ratio of 3:97, and a current ratio of 1.3. 3. Reynolds Metals Company/Reynolds International, Inc. 4.11 Reynolds Metals Company (US), of which Reynolds International, Inc. (RII) is a wholly owned subsidiary, is a major worldwide producer and manufac- turer of aluminum products (1977 production of primary aluminum: approximately one million short tons). In recent years, RII has successfully participated in aluminum reduction projects in Iran, Germany and Venezuela. By the end of 1977, it was engaged in the startup of production in Venezuela from expansion of the Alcasa smelter, and in the construction of the Venalum smelter, which started production during 1978. Reynolds Metals' recent performance is summarized as follows: Summary of Reynolds Metals Company Financial Performance, 1974-1977 (US$ Millions) 1974 1975 1976 1977 Production of primary aluminum ('000 tons) 1,201 821 983 1,003 Revenues 2,048 1,730 2,132 2,392 Net profit 114 60 75 86 Net profit as % of revenues 5.6 3.5 3.5 3.6 Net profit as % of equity 14.4 7.2 8.5 8.7 Cash generation 191 132 146 160 Reynolds International, which is responsible for Reynolds' overseas activities and will hold the Reynolds 4% participation in Valesul as well as provide technical services, had revenues of US$599 million and net profits of US$12 million in 1977. Its US$6 million investment in Valesul's equity will be offset by the technology fee due to it under its technology transfer agreement with CVRD. C. Organization and Management 4.12 Valesul's organizational structure is presented in Annex 4. The Company's Administrative Council will be comprised of five members and re- spective alternates, elected by the Ordinary General Assembly, in which each shareholder or group of shareholders will have the right to appoint members according to their respective shareholding and as defined in the shareholders' agreement negotiated in late 1978 and early 1979 by the major - 28 - shareholders. Valesul will also have a Fiscal Council composed of at least three members, appointed by the shareholders. The Executive Committee of Valesul will be composed of five members: the President and four other Directors elected by the Administrative Council. 4.13 The President of Valesul is responsible to the Administrative Council for all Valesul's business and activities, including planning, opera- tions, finance, accounting, marketing and public relations. Four other Directors report to the President, with following functions: (i) Administra- tive Director: responsible for personnel and legal services; (ii) Control Director: responsible for accounting and management information; (iii) Financial Director: responsible for financial planning and securing finance; and (iv) Technical Director: responsible during project execution for organiz- ing and coordinating project engineering, construction and erection and procurement, during which period he will be assisted by a firm of project management and engineering consultants (para. 6.02). The Technical Director will also plan the future operation and maintenance of the smelter complex and later be responsible for carrying out these functions. A former Reynolds employee, well experienced in aluminum smelter projects, has been appointed to the position. 4.14 Valesul's shareholders plan to establish, in addition to the Fiscal Council mentioned above, three committees to monitor and advise on the execu- tion and operation of the project: one for engineering, procurement and con- struction, one for operating and one for finance. D. Financial Situation 4.15 As of October 31, 1978, Valesul had a subscribed capital of US$12.3 million and total assets of US$15.0 million. Preparation expenses were fi- nanced with a loan from CVRD. This loan was transformed into equity in February 1978. V. THE PROJECT A. Project Scope and Objectives 1. Basic Objectives 5.01 The project has been designed by Valesul and Reynolds. It will use the Reynolds pre-baked anode technology to produce approximately 86,500 TPY of primary aluminum in a final product mix envisaged as approximately 35% extru- sion billets, 35% rolling slabs and 30% in 50-lb. ingots, with perhaps some liquid metal for sale over the fence. Casting equipment will be sufficiently flexible to handle variations from this mix; but, as part of the market study to be done by the company (para. 3.27), a more precise determination of the likely production mix will be made. Initial production is expected to start in the third quarter of 1981, and full capacity to be reached during early 1982. - 29 - 5.02 The technology is basically the same as that used for many years by all the major international aluminum producers. Since early 1974, Reynolds has used its own version of this technology in its plant in Hamburg, Germany, and in two other projects in Venezuela: the Alcasa plant expansion (from 54,000 TPY to 124,000 TPY), which started production at the end of 1977, and the 310,000-TPY Venalum smelter, which started production during 1978. Following completion of the present project, the plant can easily be expanded to about 170,000 TPY with a relatively low investment to take advantage of better economies of scale. 5.03 The final feasibility study, prepared by Valesul with assistance from Reynolds, was completed in December 1977. The basic conditions set for the Valesul project were that the most modern aluminum-reduction technology should be used to build a relatively small plant to supply the domestic market and to be located close to consumer centers. This plant was to be built within the shortest time possible to start substituting imports, and to serve as a training center for larger aluminum products to be developed later in the Amazon region. Another condition for the project was that it should be profitable enough to attract foreign and local investors to share in the ownership. The selection of technology and foreign private investment to be used for Valesul was made by inviting proposals from international aluminum companies (para. 4.02). 2. Plant Location 5.04 At CVRD's request, extensive studies were carried out by Montreal Engenharia (Brazil) to determine the most appropriate location to establish the Valesul plant, given the objectives described above. For this purpose, the coastal strip between Bahia and Sao Paulo was carefully examined. It was determined that the State of Rio de Janeiro was the best area, mainly because of its available power and port facilities as well as for the proximity of large quantities of available, skilled and semi-skilled manpower. Another important factor in chosing this general area was the closeness to large, existing aluminum-consumption centers in both Rio and Sao Paulo. Subsequent detailed studies carried out within the State pinpointed available land designated for industrial development close to Santa Cruz. The site is approximately 60 km southwest of Rio, and 10 km northeast of the Sepetiba port project and is located near main highways, a railroad, major trans- mission lines, and a power station. Finally, the site is satisfactory from a construction point of view and needed only relatively minor upgrading. It was formerly owned by the Rio de Janeiro State Housing Development Company (Companhia Estadual de Habitacao de Rio de Janeiro-CEHAB), which has exchanged it through subscription of Valesul shares by Banco de Desenvolvimiento do Estado do Rio de Janeiro, BD-RIO (about US$1.0 million equivalent). - 30 - 3. Project Description (a) Plant Components 5.05 The aluminum reduction process is based on the electrolysis of alumina at approximately 950 C, in which oxygen is generated and must be re- duced using consumable carbon anodes. The main project components needed to produce primary aluminum are: a carbon plant to provide anodes, a rectifying substation to supply direct current, a potline of electrolytic cells where the reduction process takes place and a cast house in which liquid aluminum from the potline is cast into the selected aluminum products. Service and support facilities include storage and material-handling components, fume-control units and maintenance equipment. The project components are described and discussed below. The material flow diagram and the plant layout are shown in Annexes 5-1 and 5-2, respectively. (b) Raw Material Handling Facilities at the Plantsite 5.06 Alumina will enter the plantsite by truck, and possibly by rail later. It will be unloaded into a hopper and lifting system that will dis- charge into a silo. Petroleum coke, liquid pitch and other raw materials will be unloaded from trucks into storage tanks. (c) The Carbon Plant 5.07 The purpose of this facility is to produce anodes as well as carbon paste needed to repair worn cathodes. It is composed of four sections, as follows: (i) Green Plant. This section, known also as the "green mill," will produce green, unbaked anode blocks. Petroleum coke will be ground, blended, combined with liquid coaltar pitch and formed on vibrating tables into green anodes. Although all equipment could operate continuously, the design criteria of 18 tons per hour of anodes is based on operating only 12 shifts per week, because Reynolds wants to provide the same margin of safety which it uses normally in its other oper- ations. This is a critical part of the plant and will be procured on a turnkey basis, to be financed out of the Bank loan. (ii) Baking Furnace. In this section, the green anodes will be baked into blocks, weighing 870 kg each, in a continuous bake oven with oil burners. (iii) Rodding Shop. This section will be used to install steel yokes and aluminum connector rods into prebaked anode blocks. It will also reprocess spent anodes from the reduction cells, to recover the carbon, rods, yokes and cast iron used in connecting the rod to the block. - 31 - (iv) Cathode Paste Shop. This section uses part of the green plant facilities as well as its own to prepare about 28 tons per week of carbon paste to replace worn cathodes. It will form part of the turnkey contract for the green plant. The cathodes of the electrolytic cells have a life of three to four years. This results in normal repairs of one or two cathodes per week, with repair peaks of up to five cathodes per week. Reynolds' design for the Valesul plant provides that this work will take place in a cathode repair shop. This is a desirable method, with lower costs and less risks than more conventional in-line repair procedures. 5.08 The design criteria concerning utilization of the above-mentioned units are conservative, especially in the case of the green plant and the rodding shop. The oversizing of these units is considerable, and these two shops could handle two potlines without any additional equipment if they were operated on an about three shifts-per-day basis rather than two shifts as envisaged. On the basis of its experience, Reynolds has consistently applied this conservative criteria throughout its various plants to eliminate operat- ing risks and to provide a margin of safety, particularly during startup. It results, however, in higher costs which might add up to 5% to the total cost of the project. This additional investment can be regarded as well justified, as it very economically enables the subsequent expansion of the plant to a more profitable capacity. (d) The Potline 5.09 A series of 216 identical, electrolytic cells constitute the "pot- line" wherein alumina is "reduced" by high-amperage, direct current into molten aluminum. The cells are controlled by a computer, and are positioned side by side in two parallel potrooms of slightly more than 700 meters in length. The main-process operating parameters essentially reflect results obtained by Reynolds in its recent Hamburg plant, as adjusted to Valesul's lower capacity. These parameters are shown below: Valesul: Projected Process Operating Parameters Rated Production 86,500 TPY Line Voltage 920 volts Cells in Operation 216 Volts Per Cell 4.3 volts Production Per Cell 1.1 tons/day Power Consumption, D.C. 14.6 kwh/kg Amperage 155,000 Amperes Power Consumption, A.C. 15.5 kwh/kg Electric Current Efficiency 88% Cathode Life 3-4 years 5.10 Amperage, current efficiency and voltage levels are vitally impor- tant factors, as they determine the production capacity of each electrolytic cell. It is expected that once the plant is operating normally electrical current levels could progressively be increased, on an experimental basis, - 32 - possibly to 157,500 amperes in a first stage, and later further to a level to be determined on the basis of operating results, thus increasing the produc- tivity of each electrolytic cell. Achievement of such an amperage level could increase output from the plant by as much as 10% above the level assumed as the base case. 5.11 Projected current efficiency for Valesul is higher than the Hamburg plant's 87% because the latter was adversely affected by extensive phosphorous contamination, which originated from processing impure alumina with a high phosphorous content. Such difficulties will be avoided in Valesul by more stringent specification and control of alumina supplies. The operating parameters assumed are well within the reach of a modern, computer-controlled and reasonably well managed plant. (e) The Cast House 5.12 The cast house will include furnaces, casting units and related saws, cranes and support equipment. This facility will easily handle the expected average Brazilian product mix of 35% rolling slabs, 35% extrusion billets, and 30% remelt ingots, or substantial variations therefrom. (f) The Rectifying Substation 5.13 This facility consists of a switchyard, a rectifying station with six rectifier-transformer units rated at 35,000 amperes and 1,000 volts, to convert the 138,000-volt alternating current power from the transmission lines to provide direct current voltage for the operation of the electrolytic cells. This facility also includes a conventional 13.8 kilovolt plant supply system for service equipment and utilities. B. Raw Materials 5.14 Summarized below are the projected rates of consumption of raw materials for the Valesul plant at full capacity (86,500 TPY) when operating with a current of 155,000 amperes: Valesul: Projected Plant Consumption of Raw Materials at Full Production Consumption Per Ton of Material Unit Hot Metal Per year Alumina ton 1.92 166,000 Cryolite ton 0.015 1,297 Aluminum Fluoride ton 0.015 1,297 Petroleum Coke ton 0.3785 32,740 Coaltar Pitch ton 0.1165 10,080 Fuel Kcal 2.8 million 240 million - 33 - 1 Alumina 5.15 Alumina is the major raw material for the plant and its consumption will reach approximately 166,000 TPY at full capacity. Valesul is projected eventually to obtain alumina from CVRD'-s planned ALUNORTE project in the Amazon region or from an alumina plant under consideration at CVRD's Trombetas bauxite project. But since it is unlikely that alumina could be produced at ALUNORTE or Trombetas much before 1985 (para. 2.12), Valesul needs at least four years of interim alumina supply. Suitable contracts for the supply of alumina from refineries in Guyana and Surinam have been signed. In view of Brazil's substantial resources for the production of alumina and aluminum (bauxite and hydro-power), and to ensure the continuing import-substitution benefits of the project, the shareholders have agreed that Valesul will, following the initial alumina supply contracts, purchase all further alumina on an arms-length, commercially competitive, basis. Any importation of alumina will, of course, continue to be subject to Government import policies. 2. Petroleum Coke and Coaltar Pitch 5.16 These are the other two main raw materials, with consumptions of about 33,000 TPY and 10,000 TPY, respectively. Petroleum coke will be sup- plied by PETROCOQUE from a calcining plant located in Cubatao, Sao Paulo. Coaltar pitch will be obtained from either of the three large State-owned steel plants, CSN near Rio de Janeiro, COSIPA near Sao Paulo or USIMINAS near Belo Horizonte. The final supplier will be selected after pitch samples have been produced and tested. Other less significant raw materials are cryolite, aluminum fluoride, fluorspar, anthracite coal, cathode pitch, cast iron, soda ash and alloys. Although no firm commitments have been secured yet, there should be no serious difficulties in obtaining adequate supplies of these materials, most of which are readily available from Brazilian producers. C. Infrastructure 1. Power Supply 5.17 The Valesul substation will receive alternating current from both of two new 138-kilovolt line extensions connecting to a LIGHT-owned 1/ substation, which will be located at the plantsite. The two 4-km extensions will be on separate towers as a security measure to guard against the very serious consequences of a sudden, prolonged power outage, that, were it to last for more than one hour, could result in the freezing of the molten aluminum in the potlines, which are run continuously. The line extensions will be connected to one of the three existing 138-kilovolt transmission, double-circuit lines owned and operated by FURNAS, 2/ between the Jacarepagua 1/ LIGHT is the power distribution company with which Valesul has contracted its power. 2/ FURNAS, a subsidiary of ELETROBRAS, is the power-generating company which will supply power to Valesul via the distribution company (LIGHT), which recently also became an ELETROBRAS subsidy. - 34 - substation (25 km east of the plantsite) and the Santa Cruz 360-MW thermal generating plant substation (9 km west of the plantsite). Both substations are connected to the large 18,000-MW power grid of the southeast of Brazil. 5.18 Valesul's power demand of 160 MW is less than 1% of that of the southeast power grid capacity, and the Santa Cruz generating station provides a very satisfactory backup in case of a failure of the Jacarepagua line. Nevertheless, in view of the vital importance of a continuous power supply, ELETROBRAS has agreed to ensure that any of the Government agencies respon- sible for supplying power to Valesul will take all possible action to avoid supply interruptions that could lead to freezing up of the potlines. An analysis of past records of power outages in the Rio area indicates that, provided appropriate physical and contractual protective measures are taken, the chances of a significant interruption at the plant would be negligible. The power supply contract with Rio Light S.A. has been reviewed by the Bank, and its recommendations included. Power tariffs are discussed in para. 8.06. 2. Port 5.19 Raw material unloading facilities (primarily for alumina) will be located in the Port of Sepetiba about 17 km from the plantsite. Discussion between the Bank, Valesul, Docas de Rio and PORTOBRAS concluded that it would be possible to obtain facilities at Sepetiba on time and without interferring with the coal-unloading facilities presently under construction there. This is a much better alternative than the originally proposed port site at the Port of Rio about 60 km from the plantsite. The Sepetiba location is more advantageous because it (i) involves a shorter, less-expensive haulage to the plant; (ii) can handle larger vessels; and (iii) avoids the movement of trucks through the congested port and build-up area of Rio. Also, unloading capacity can be increased for possible later expansion of the smelter without excessive costs. According to present plans, alumina will be transported to the plant in rented trucks. PORTOBRAS has agreed to take all actions to ensure that the infrastructure for the installation of Valesul's unloading facilities will be completed on time. 3. Road 5.20 The plantsite is connected to a main highway to Sao Paulo through an 800-meter dirt road. Another main highway connecting Rio with Santos is located at a distance of 2,000 meters. Paving of the access road to the plant will be undertaken by the Municipality of Rio at a cost of about US$100,000. 4. Water 5.21 Valesul's overall consumption of industrial and potable water will be approximately 2,000 m3 per day. Potable water will be supplied from a water main which will also supply the town of Santa Cruz and be installed by the State of Rio water and sewage company (Compania Estadual de Aguas e Esgotos-CEDAE) by early 1979. Industrial water, mainly for construction and plant cooling, will be supplied from wells on the site. Water availability is satisfactory and has already been confirmed. - 35 - 5. Housing 5.22 The location of the plant, close to available, skilled and semi- skilled manpower in Rio, Santa Cruz and other nearby townships, has eliminated the need to build housing facilities as part of the project. D. Ecology 5.23 Although detailed pollution control regulations for an aluminum smelter in Brazil are not yet in existence, Valesul has recognized the need to exercise strict control over all aspects of environmental pollution, to avoid potential adverse effects that could stem from the proximity of the plant to highly populated areas, and intends to apply similar standards to those used by Reynolds for its Hamburg plant. The main sources of pollution from plants of this type are fluoride fumes and dust from the potline and bake oven fumes containing carbon monoxide, dust fluorides and tars. All the fumes from each completely hooded potline cell will be collected and ducted to fume- control units, where the gases will be reacted with the alumina feed to remove the fluorides and then recycled. Fluoride particles will then be over 99% removed from the air stream by bag-house filters before being exhausted through a stack of about 40 m height, of which the design, when completed, will be reviewed by the Bank. From this stack, a total of about 47 to 143 tons per year of fluorides will enter the atmosphere at the 86,000- TPY production level. This amount of fluoride emissions is within the best levels used by the aluminum industry. The bag-house solid products will be recycled back to the cell via the alumina feed. Bake-oven fume control will be done by precipitators, scrubbers or combustion, which will reduce dust, tar and fluoride emissions to acceptable levels. The potline and bake-oven control equipment will provide excellent levels of environmental control, among the best in the world. Alumina dust will not escape into the atmos- phere, as it will be unloaded and transported using equipment provided with vacuum protection. Valesul has agreed that the project will be designed, executed and operated with due regard to all environmental factors in a manner satisfactory to the Bank. E. Employment and Training 5.24 The project will provide direct employment for about 806 people, most of whom will be skilled or semi-skilled. Initial staff for the project execution period have been recruited mainly from CVRD and existing Brazilian aluminum companies. Training plans for the technical staff have been prepared and contracted with Reynolds. The general schedules for these are satisfac- tory. These plans will make use of training material prepared by Reynolds for the Hamburg (Germany) and Venalum (Venezuela) plants. In total, about 720 employees will be trained, of which about 660 (totalling 3,700 man-months) will be trained in Brazil, and 60 (totalling 300 man-months) will be sent abroad to facilities in the US, Germany and Venezuela. The cost of this program will be approximately US$3.2 million, of which about 30% will be allocated to overseas training. - 36 - VI. PROJECT IMPLEMENTATION A. Project Management and Organization 6.01 Valesul has put together a team of engineers with considerable operating experience in the aluminum industry gained mainly with private foreign-controlled companies operating in Brazil (Alcan and Alcominas). This team forms the nucleus of the staff that will implement and operate Valesul. At present, their responsibilities are basically divided into project prepara- tion and execution and preparing for operation of the plant. This team is well equipped to carry out the owner's representative duties in the management of the project, the more so as it will be assisted by five permanent Reynolds engineers, with good experience in implementing aluminum reduction projects, and by other Reynolds personnel to be requested for specific assignments, as required. The group, under a Technical Director, appointed from Reynolds' staff, reports directly to Valesul's President. Reynolds is supplying the basic engineering, including specifications for the key plant equipment components and assistance with the development of the project costs and schedule. 6.02 To assist it with project execution, Valesul contracted the ser- vices of Companhia Internacional de Engenharia (CIE) in December 1977 to do the local detailed engineering, construction supervision and local procure- ment. CIE was formed during 1977 by the merging of the Brazilian subsidiary of Morrison Knudsen (US) with Montreal Engenharia, a local engineering company. While the merger partners have extensive experience in construction and engineering in Brazil, CIE is lacking in experience in certain key areas of execution in large international projects and has no experience in construct- ing aluminum smelters. Therefore, CIE has subcontracted foreign assistance from Kaiser Engineers (US) to reinforce its staff in project cost control, scheduling and foreign procurement. For this purpose, CIE and Valesul evaluated proposals from a number of foreign firms with recent experience in the implementation of aluminum projects, and which were acceptable to the Bank. The foreign exchange cost of this assistance, which is being carried out through a subcontract between CIE and Kaiser is estimated at US$2.3 million. Average costs per man-month for foreign consulting assistance will be about US$9,980 in Brazil, and about US$7,200 outside of Brazil. Kaiser started work during the second quarter of 1978. 6.03 The Valesul project team is essentially using the Reynolds tech- nical group to assist it as an owner's representative and supplier of techno- logy and basic engineering. In this arrangement, CIE is responsible to Valesul for detailed local engineering, construction supervision, foreign and local procurement, cost control and scheduling. The staff of Valesul, Reynolds, CIE and Kaiser have been working as an integrated team for over six months now, and the arrangement is working out very well, with the Brazilian engineers undoubtedly benefiting from the transfer of know-how and experience. Valesul has agreed to continue to employ suitable engineer- ing and project management consultants until project completion. - 37 - 6.04 Construction, civil works and erection for the plant, as well as the installation of the equipment (apart from the turnkey green mill, para. 5.07) will be competitively tendered to Brazilian contractors. The easy access to the site, the ready availability of labor and certain excess capacity in the Brazilian construction industry should enable good competition and maintenance of schedules. B. Implementation Schedule 6.05 The Company has received authorization from the Government to proceed with the project and Reynolds, CIE and Kaiser are already working on engineer- ing, planning and procurement. Full bid packages prepared by Reynolds have been made available to Valesul and the Company is expected to receive the first international competitive bids for time-critical components by March 1979. Initial, long lead-time contracts, scheduled to be awarded in July 1979 are: the green mill, the electrical switchyard and the baking furnace. Field construction has begun with site preparation and some foundation work already complete. A project implementation schedule is shown in Annex 6. 6.06 According to this schedule, baked anode production will commence in December 1981, the first pots will be started in July 1981, and the start- up will be completed by December 1981, with full production achieved by early 1982. Initial pot room production would be based on imported anodes. Full capacity operation should be achieved fairly quickly after start-up of the final pots, as is normal in such plants. 6.07 Reynolds, on the basis of its recent experience in Venezuela, feels that the revised schedule, though tight, is achievable, provided the key components mentioned above can be contracted on schedule with delivery times conforming to the overall schedule. With the combined efforts of Valesul staff, CIE, Reynolds and the foreign project management consultants, the schedule is expected to be achieved. VII. CAPITAL COST, FINANCING PLAN AND PROCUREMENT A. Capital Cost 7.01 Total financing required for the project is estimated at US$370.1 million equivalent, of which US$185.6 million is in foreign exchange, as summarized below (Annex 7-1): - 38 - VALESUL: Summary of Capital Cost Estimates Cr$ Million/ US Million Cr Mlio- _ US Milo, /b Local Foreign Total Local Foreign-Total % Land 19.6 - 19.6 1.0 - 1.0 0.8 Equipment (including freight and spares) 868.1 1,608.5 2,476.6 44.2 81.9 126.1 34.4 Civil Works, Erection and Installation 785.6 361.4 1,147.0 40.0 18.4 58.4 31.2 Engineering, Technology Project Management 443.9 253.4 697.3 22.6 12.9 35.5 19.6 Total Fixed Assets 2,117.2 2,223.3 4,340.5 107.8 113.2 221.0 86.0 Preoperating Expenses 353.6 - 353.6 18.0 - 18.0 14.0 Total Base Cost Estimate (BCE) 2,470.8 2,223.3 4,694.1 125.8 113.2 239.0 100.0 Physical Contingencies /c 198.4 200.3 398.7 10.1 10.2 20.3 Price Escalation /d 390.8 351.6 742.4 19.9 17.9 37.8 Total Installed Cost 3,060.0 2,775.2 5,835.2 155.8 141.3 297.1 Working Capital 384.9 406.5 791.4 19.6 20.7 40.3 Interest During Construc- tion 178.7 463.5 642.2 9.1 23.6 32.7 Total Financing Required 3,623.6 3645.2 7,268.8 184.5 185.6 370.1 /a The costs expressed in Cr$ have been calculated from the US$ costs using an exchange rate of Cr$19.64 = US$1.00 and are therefore only notional, as changes in the exchange rate are expected (para. 7.05). /b Including indirect foreign exchange of about US$37.0 million. /c 10% on base cost; no physical contingency on fixed technology fee or land. /d Price escalation on civil works 12% p.a.; other items 7% for 1978, 7.5% for 1979, 7% p.a. for 1980 and thereafter. 7.02 The equipment costs have been derived from estimates prepared in October 1977 by Valesul with the assistance of Reynolds. Original base-cost estimates were in terms of 1977 prices, based on quotes and budget estimates obtained from suppliers mainly in the first half of the year. The capital cost estimate was revised in February 1978 by Reynolds and again in November 1978 at the Bank's request, based on similar Reynolds projects (VENALUM and Alcasa in Venezuela) still being executed in 1977/78 and a feasibility study prepared by Reynolds during 1977 for a similar project in Mexico. The revision by Reynolds benefited from the fact that design and equipment of Valesul is essentially the same as in the Venezuelan projects. Reynolds staff have been - 39 - in regular contact with the major suppliers so that the cost estimate reflects late 1978 actual payments or information, as well as exchange rate variations through November 1978. Reynolds also checked construction and engineering costs based on their Venezuelan experience. The civil works cost has been estimated by Valesul based on similar civil construction in Brazil. The unit costs used are based on recent civil construction costs for various CVRD projects and have been checked with data obtained in other Bank projects in Brazil. The construction quantities are comparable to other aluminum reduc- tion facilities. The piling, however, is more uncertain as to the quantities needed. A conservative estimate close to the maximum likely requirement has been used and found reasonable by Reynolds staff. The cost of technology and engineering is based on contracts already signed in 1977/78 with Reynolds, CIE and Kaiser Engineering, respectively. Initial construction contracts already signed, some of which are completed or well advanced (site grading, foundations) indicate that the estimates are somewhat conservative. 7.03 The project qualifies for 100% exemption from import duties on equipment, so the cost estimate includes no provision for duties. 7.04 The project cost estimates, when compared to those for other recently completed aluminum smelters, indicate that certain equipment items and civil works costs have increased significantly in recent years. Valesul's higher cost reflects recent changes in the exchange rate of the US$ vis-a-vis the currencies of countries which could provide significant portions of equipment, e.g., Japan and Germany. Also, the fact that Valesul is a greenfield plant and close to the minimum economic size for aluminum smelters makes its invest- ment cost per ton higher than for larger smelters or expansions to existing plants. Furthermore, Brazilian equipment is perhaps 30% more expensive than foreign equipment at the present exchange rate, although this would add less than 5% to the overall fixed asset costs since local equipment represents only an estimated 15% of total fixed assets. Also, the US$6.0 million Reynolds technology fee is charged totally to the project but has a broader value because the technology may be used in other projects. Taking into account these factors, Valesul's estimate is realistic. 7.05 Price escalation for equipment is calculated on the basis of pro- jected price increases in US dollars of 7% per annum for 1978, 7.5% for 1979 and 7% per annum thereafter in the major equipment supplying countries. No price escalation is applicable to the technology fee or land. International US dollar price increases have also been used for locally supplied equipment, goods and services on the assumption that differences in the domestic and the international inflation rates will be accounted for by adjustments in the cruzeiro exchange rate. This assumption is based on the current Government policy which is expected to continue. On civil works, however, escalation rates of 12% per year in US dollar terms for 1978-81 have been assumed, based on experience in the recent past that the cost of civil works in Brazil will rise faster than the general price level. The above cost estimate, including the provisions for physical contingencies (ample at 10%, given that basic plant engineering is virtually complete and detailed engineering well advanced) and for price escalation is considered adequate. - 40 - 7.06 The initial working capital requirement, estimated at US$40.3 mil- lion (Annex 7-2), is based on the achievement of full operation three months after completion of start-up. Interest during construction is calculated on the basis of US$222 million of debt (para. 7.07). B. Financing Plan 7.07 The financing plan for the project is as follows: VALESUL: Proposed Financing Plan US$ Million % Share Capital 148 40.0 Loans: Local Loans (FINAME) 34 9.2 Commercial Banks 90 24.3 World Bank 98 26.5 Total Loans 222 60.0 Total Financing 370 100.0 7.08 In exchange for the land, the Development Bank of the State of Rio de Janeiro (BD-Rio) has received US$1.0 million equivalent of preferred shares, which it is expected will be converted into common shares. Any such preferred shares would receive a 6% minimum dividend which, however, could not be paid out of capital or be cumulative. All share subscriptions in future will be in common shares. 7.09 CVRD was originally willing to provide all of the equity funds for the project. However, in order to achieve the simultaneous private and Brazilian control of Valesul consistent with Government policy, CVRD has negotiated with Shell/Billiton and Reynolds the placement of substantial portions of Valesul's shares (para. 4.04). The composition of Valesul's shareholders will be approximately as follows: VALESUL: Expected Shareholder Composition US$ Million % CVRD 89.2 60.3 BD-Rio 1.0 0.7 Total Brazilian Shareholders 90.2 61.0 Reynolds 6.0 4.0 Billiton 51.8 35.0 Total Foreign Private Shareholders 57.8 39.0 Total Equity 148.0 100.0 - 41 - 7.10 The schedule of equity payments will be made so that the long term debt to equity ratio will not exceed 70:30 at the end of each fiscal year during project execution and 60:40 on project completion and thereafter. 7.11 FINAME would finance through the Banco de Desenvolvimento do Estado do Rio de Janeiro 80% of most of the local equipment (i.e., 80% financing of US$43 million of eligible local equipment, out of total estimated US$69 mil- lion for local equipment and materials). FINAME's normal terms would be an 8-year maturity, including 3 years' grace. In view of the restricted cash flow situation in the initial years, FINAME has agreed to extend these to 10 years, including 3 years' grace. 7.12 An important aspect of the Bank Group's involvement will be to mobilize foreign commercial bank funds on terms better than would be possible without co-financing. CVRD has a firm offer from a US bank to lend US$90 mil- lion for the project, on a co-financing basis with the Bank, at 1-1/8% above LIBOR, and for 10 years, including a 5-year grace period. These funds will finance part of the local equipment costs, civil works and erection, engi- neering, working capital and interest during construction. The signing of this loan will be a condition of effectiveness of the Bank loan. 7.13 A Bank loan of US$98 million is proposed for 15 years, including 3 years' grace at the standard interest rate plus a fee to the Government to bring the total interest rate to Valesul to 10% per year in US$ terms. The Bank loan will be made to Valesul, which will bear the foreign exchange risk of other currencies against the US dollar, except for some offsetting of this by a reduction in the fee paid to the Government so that the cost of the loan would be kept at 10% per annum in US dollar terms over the life of the loan. Should the foreign exchange cost be such that the US$ equivalent cost of the loan would be equal to or greater than 10% per annum, no fee would be payable to the Government. As described further in para. 7.19, the loan will finance ICB equipment packages, equipment to be procured by international shopping, the CIE-Kaiser engineering contract and about half of the interest charges on the loan itself. 7.14 CVRD, Shell and Reynolds have agreed that they will not dispose of any of their shares without the prior consent of the Bank (except for CVRD reduction below 50%; see para. 4.05). Furthermore, the Shareholders' Agree- ment between IBRD, CVRD, Shell and Reynolds stipulates that, should a financing gap and/or cost overrun occur, CVRD, Shell and Reynolds will ensure that the necessary funds to complete the project are promptly provided in proportion to the shareholders' respective holdings on terms acceptable to the Bank. It has been agreed that until the Compliance Date of the project, unless the Bank shall agree otherwise, no debt will be contracted that would result in the Company's total outstanding long term debt exceeding US$222 million equivalent except for an additional US$20 million of debt, which, if needed for cost overrun financing, could be contracted provided it had at least a ten-year maturity with five years grace. For purposes of this covenant, Project Completion as per the Compliance Date will be defined as (i) completion of physical construction of the plant and associated facilities; (ii) maintenance - 42 - of an average of 90% of production capacity over a continuous six month period; (iii) achievement of a 1.3:1 current ratio; and (iv) a demonstrated ability to service all long-term debt during the six month period preceding the Project Completion. It has been further agreed that any of the share- holders or the Bank may at any time request a review of the estimated cost to complete the project, and, should this estimate exceed US$403 million, the shareholders will provide a plan for financing the overrun which is acceptable to the Bank. The foregoing covenants are proposed in light of the projected restrictive debt service situation for several years following completion of the plant. The Government has agreed to cause CVRD to perform punctually its obligations under the Shareholders' Agreement. 7.15 Through its involvement, the Bank is encouraging substantial foreign private and commercial bank participation in the financing of the project; this will greatly ease the demand on public Brazilian funds, while still enabling a strong public sector sponsor to play a leading role in the project. C. Procurement 7.16 Equipment, materials and the initial set of spare parts, valued at US$159 million for the project, have been divided into the following procure- ment categories: (i) items to be bid only among Brazilian suppliers, with an estimated ex-factory value of US$69 million, most of which will be 80% financed with FINAME loans, and the balance through commercial banks and equity funds, and (ii) items to be purchased using Bank's guidelines, with an estimated CIF value of US$90 million, of which about US$86 million will be procured through international competitive bidding (ICB) and the balance through international shopping for items not exceeding US$250,000 in value. An amount of US$1.0 million is allocated for retroactive financing of con- sulting services for project management (para. 6.02). 7.17 Brazilian manufacturers are expected to supply about 40% of the equipment to be procured by ICB. This arrangement means that, with an ICB/local reserved equipment split of about 57:43, a 40% participation by Brazilian suppliers in ICB equipment will give a foreign/local split of about 34:66. The equipment lists have been developed taking careful account of those items which are critical for the sound technical operation of the plant and/or in terms of delivery times, with those items reserved for local pro- curement being generally less technically specialized and less critical on delivery. The equipment lists have been approved by CACEX, the trade arm of the Central Bank. Local suppliers will be allowed to participate in interna- tional competitive bidding with a 15% (or the import duty rate, if lower) preference margin. Finally, the potential suppliers of critical equipment not financed by the Bank will also require prior Bank approval, i.e., pot room furnace and gas treatment systems for anode baking plant and pot rooms. 7.18 As mentioned in para. 6.04, construction, civil works and erection for the plant will be competitively bid among Brazilian contractors. - 43 - D. Allocation and Disbursement of Bank Loan 7.19 The Bank loan will finance goods and services as shown in the table below: .Allocation of Bank Loan Amount of the % of Expenditures Category Loan Allocated to be Financed (US$ million) Equipment 90.0 /a 100% of foreign expenditures or 100% of ex-factory cost Consultants' services 3.0 100% of foreign expenditures Interest during construction 5.0 Amounts due Total 98.0 /a Includes estimated US$4 million for foreign expenditures for imported items costing less than US$250,000 each, to be pur- chased through international shopping; also includes contin- gencies of US$10 million, which in Schedule 1 of the Loan Agreement are separately shown in an unallocated category. 7.20 It is expected that about 80% of the Bank loan will be disbursed against foreign exchange expenditures. The loan is expected to be fully disbursed by June 30, 1982 (Annex 7-5). Any funds remaining undisbursed at that time will be cancelled. VIII. FINANCIAL ANALYSIS A. Revenue and Operating Cost Estimate 8.01 Due to the difficulties in estimating future inflation rates in Brazil, the financial projections are expressed in current US dollars instead of cruzeiros, assuming an annual inflation rate in US-dollar terms of 7% in 1978, 6.5% in 1979 and 6.0% thereafter. This approach assumes that differences between domestic and international inflation are taken care of by appropriate exchange rate adjustments, which has generally been the case in the past and which is expected to continue in the long run. - 44 - 8.02 Commercial production is expected to begin in mid-1981, with the first pots being put on power in July 1981. Since the last pots will be started in late 1981, the plant will not reach full production until early 1982. The average electrical current efficiency during the startup period is estimated to be 85%, increasing to 88% thereafter. This will result in a gradual reduction of unit costs (Annex 8-1). The product mix at full pro- duction is estimated to be 70% ingots/30% slabs and billets progressively changing to reach 30% ingots, 35% slabs and 35% billets by 1985. 8.03 It has been assumed that the 1981 ingot price in Brazil would be 64 cents/pound in 1978 US dollars, and that adjustments would be made for inflation (para. 3.37). However, it has been also assumed that operating costs would increase at 1% more per annum than general inflation in order to reflect the time lag between cost increases and the approval of price adjust- ments by CIP, to reflect the alumina supply contract formulae under which alumina prices (which account for more than 30% of production costs) would increase slightly faster than the international metal price (para. 8.05), and to allow for possible real increases in power tariffs (para. 8.06). 8.04 Valesul's production cost breakdown per pound of aluminum metal, at 86,500 TPY production, is summarized below (Annex 8-1): VALESUL: Production Cost Estimate Per Unit of Output at Full Production (1978 US$) Cents per Pound of Aluminum % Alumina 16.2 29.2 Other Raw Material 5.8 10.4 Power 10.8 19.4 Miscellaneous 4.8 8.6 Subtotal - Variable Costs 37.6 67.6 Depreciation 12.5 22.5 Labor 2.6 4.7 Maintenance and Other Fixed Costs 2.9 5.2 Subtotal - Fixed Costs 18.0 32.4 Total (Excluding Financial Charges and Income Tax) 55.6 100.0 8.05 The most important cost items are alumina, accounting for 38% of production cost excluding depreciation and financial charges, and electric energy, equal to 25%. Valesul has negotiated two four to seven-year (seven years optional) contracts of alumina supply beginning in 1981 (para. 5.15). - 45 - The two contracts are with Billiton Aluminum B.V. of Surinam and Bauxite Industry Development Company, Limited (BIDCO) of Guyana. The alumina price in both contracts is expressed as a percentage of "ALCAN's World List Price." While the BIDCO contract is based on a flat 12.75% of the metal price less US$20 per ton, the Billiton contract specifies the percentages increasing over time so that in relation to the international metal price the cost of alumina would rise from 12.9% (1979) to 14.9% (1985). The CIF alumina price of US$188 per ton which was used in the financial projections reflects the arithmetic average of the two contracts. 8.06 Power tariffs in Brazil have been adjusted in January 1978 by an average 38% in cruzeiro terms over January 1977, resulting in a January 1978 rate in US-dollar terms of 15.44 mills per kwh for aluminum plants. This is the rate used in the above table. The increase of power tariffs is equal to the official inflation rate for 1977. The power cost in January 1977 for a high load factor user such as Valesul would have been 14 mills per kwh in US-dollar terms. Since power tariffs remained constant in cruzeiro terms during the remainder of 1977, the cost of electricity in December 1977 was 27% lower in current US dollars due to the devaluation of the cruzeiro. On the average, electricity costs to aluminum plants in 1977 were about 12 mills in current US-dollar terms. Since power tariffs have been adjusted in the past only once per year, the average power cost has been lower than the January rate in US dollar terms. Such a trend is expected to continue for the next few years, but in the longer term the cost of generating capacity will likely result in increases in real tariffs, which are taken into account by using the January rate as the average for the year in the projections. Labor represents 6% of production cost excluding depreciation. B. Financial Projections 8.07 Valesul's summarized financial results after plant startup are as follows (Annexes 8-2 through 8-7): - 46 - VALESUL: Summary of Financial Projections (US$ Million) 1981 1982 1983 1984 1985 1986 Production (tons) 19,494 85,668 86,500 86,500 86,500 86,500 Sales (tons) 15,781 85,668 86,500 86,500 86,500 86,500 Sales 27.9 162.1 175.5 188.3 201.6 213.7 Gross Profit 4.2 53.6 59.7 61.4 66.5 69.8 Operating Profit (14.0) 16.6 22.4 23.8 32.2 36.7 Interest & Financial Charges - 22.4 22.0 20.1 16.7 13.4 Income Tax - - - - 6.9 Net Profit After Tax (14.4) (5.7) 0.4 3.7 15.4 16.4 - as % of Sales (50.4) (3.5) 0.2 2.0 7.7 7.7 - as % of Assets (4.3) (1.7) 0.1 1.2 5.2 5.8 - as % of Equity (11.6) (4.5) 0.3 2.8 10.4 10.0 Cash Generation Before Interest But After Tax 3.1 50.3 56.1 57.5 62.3 58.4 Accumulated Profits (14.0) (19.8) (19.4) (15.7) (0.3) 16.2 Long-term Debt/Equity Ratio 62:38 61:39 58:42 53:47 44:56 34:66 Current Ratio 3.0 3.9 3.3 2.9 3.3 3.6 Debt Service Coverage - 1.6 1.6 1.4 1.3 1.3 8.08 Based on the important assumption that Brazilian aluminum price levels will be approximately 5% above international prices (para. 3.37), financial forecasts indicate that Valesul would have a very tight debt-service coverage during its early years, as production build-up coincides with the period of heaviest debt service. Over the past months, discussions between Valesul and CVRD and the Bank and other prospective lenders has resulted in some easing of this restricted situation. As already noted (para. 7.12), the commercial bank loans will be for ten years, including five years' grace. FINAME has extended its terms beyond the proposed eight-year period, including three years' grace to a ten-year maturity, including three years' grace (para. 7.11). These terms have been assumed in the financial projections. 8.09 The projections indicate that it may not be possible to pay divi- dends until about five years after plant startup. Even though the company may accumulate some cash, it is expected that its accumulated losses from the production build-up period, while giving it some tax relief, will prevent its paying dividends until about 1987. 8.10 The financial projections indicate that the company's revenues would not cover its operating expenses (including depreciation) until 1984, the second year of full production. In 1983, the first year of full production, Valesul would be able to finance its cash requirements out of its resources - 47 - with a capacity utilization above 71%. In 1985, the year of maximum debt service, the cash break-even point would be 83%. Thereafter, the financial situation would progressively improve, with diminishing repayments and interest on the debt financing. C. Financial Rate of Return 8.11 The current US-dollar cost/benefit streams for the calculation of the financial rate of return have been deflated at 7.0% p.a. for 1978, 6.5% p.a. for 1979, and at 6% p.a. thereafter. The results are summarized below (Annex 8-8): VALESUL: Sensitivity Tests on Financial Rate of Return (Before Tax) (in %) Base Case (before income tax) 10.8 Capital Costs up 10% 9.4 Capital Costs up 10%, Production down 10% 7.7 Operating Costs up 10% 6.8 Selling Prices up 10% 15.8 Selling Prices down 10% 4.7 Production down 10% 9.1 Production up 10% 12.5 Base Case (after income tax) 8.7 8.12 The resulting returns are somewhat low at 10.8% before and 8.7% after income tax. The rate of return is most sensitive to changes in the sales price and least sensitive to changes in the capital cost. In view of the pricing outlook and covenant (paras. 3.33-3.37), the technical and managerial competence of the project participants and the reasonably conserva- tive nature of the operating and cost assumptions and estimates, the downside risk is considered to be low, with there being a reasonable probability of some upside potential (para. 3.37). The project presents an attractive oppor- tunity to the investors in spite of the somewhat low financial return, given the possibility of even higher prices (based on an increasing proportion of more expensive new capacity in the sector), the opportunity for further profits from alumina supply and downstream fabricating, and the higher returns which would result from expansion of the plant. D. Financial Covenants 8.13 Valesul and its shareholders have agreed to the following financial covenants, to be applicable at all times after project completion: (i) to maintain a long-term debt/equity ratio not exceeding 60:40, with short-term debt in excess of US$3 million to be counted as long-term debt in calculating the debt-to-equity ratio; (ii) to maintain a current ratio of at least 1.1; (iii) to limit its dividend distribution or any other cash distribution, or its financial commitments or prepayment of any debt if such action would cause its current ratio to fall below 1.3; (iv) not to contract any debt if, on the basis of financial projections prepared by Valesul and acceptable to the Bank, its projected debt-service coverage would be less than 1.5 and its debt equity - 48 - ratio higher than 60:40 including the debt to be contracted; (v) not to create subsidiaries, grant or guarantee loans to other companies or make investments in other companies without prior Bank approval; (vi) not to sell or assign any voting shares held by CVRD or each of the principal foreign shareholders without the Bank's consent; .and (vii) to have its annual accounts audited by independent auditors acceptable to the Bank, and submit these to the Bank within three months after the end of the fiscal year. E. Major Risks 8.14 Valesul will face some financial risks in that the prices of all its products--ingots, slabs and billets--are subject to Government policies and regulations, and thus outside Valesul's control. Since Valesul's finan- cial performance will depend on these prices, assurance has been obtained from the Government that it will take all actions required to enable the Company to earn a reasonable return on its investments under efficient operations (para. 3.37). 8.15 Although CVRD has extensive iron ore experience, Valesul will be its first aluminum reduction plant. The project is not expected to face major management-related operational risks, however, since Valesul's technical and administrative staff has considerable operating experience in the aluminum industry. Moreover, the involvement of Shell/Billiton and Reynolds in the project and the implementation of a suitable training program are expected to improve the prospects for successful plant operation considerably. 8.16 Ecological and environmental risks are considered to be adequately covered by the measures to be taken and the proposed covenant in this respect (para. 5.23). 8.17 The risks related to project management seem to be minimal given the Reynolds, CIE and Kaiser support. The involvement of Reynolds, with its considerable experience in a large number of successful aluminum projects, helps ensure that risks associated with project management will be minimized. 8.18 A common risk in the aluminum industry is the reliability of power supply. The physical and contractual measures being taken (para. 5.17) are judged to be such that the risks in this regard are being minimized as far as realistically possible. 8.19 Valesul's entry to the market presents some risks (para. 3.39), but the growing demand and demand/supply gap, coupled with its location close to markets, should enable it to evolve sound strategies to reduce this risk, which strategies will form part of the marketing plan to be presented to the Bank (para. 3.39). - 49 - IX. ECONOMIC ANALYSIS 9.01 With its huge bauxite reserves and enormous hydropower potential, Brazil is particularly well endowed for the development of an aluminum indus- try. Nevertheless, Brazil's three primary aluminum producers have not been able to grow fast enough in order to satisfy the country's increasing demand. With between 30 and 40% of aluminum supply being imported in the past, the increasing volume of the market has exerted growing pressure on the balance of trade. The prospect of continued high aluminum imports in an environment of considerable balance-of-payments constraints and the desire to increase the Brazilian participation in industrial development led the Government to take an active role in stimulating the future development of the industry. A. Economic Costs and Benefits 9.02 For the economic analysis of the project, which will essentially substitute imports with domestic supplies, the economic ex-factory prices of the Valesul products have been estimated on the basis of the delivered cost of imports CIF Rio de Janeiro. For 1981 and thereafter, the international ingot price (FOB New York) has been estimated at 61 cents/pound in 1978 US$ (para. 3.20). The cost of freight, insurance and port handling (excluding taxes) is about 16% of the FOB value. Additionally, since 70% of Valesul's output will consist of slabs and billets which sell at a 12% price premium over ingots on average, a weighted average 8.4% adjustment has been applied to the international ingot price. 9.03 In the economic analysis, inputs have been taken at their financial values, except for power, because there are indications that the financial power cost (15.44 mills/kwh) does not represent the economic cost, i.e., the marginal cost of power from additional capacity. Also, Valesul as an alumi- num producer would receive a virtual subsidy on the power tariff due to its substantial exemption from subscription of ELETROBRAS bonds. The marginal cost of power has been estimated by Regional Energy Projects Staff at about 23 mills versus the 15.44 mills cost used in the financial analysis. B. Foreign Exchange Benefits 9.04 At full production, the project's output will be about 86,500 tons per year, substituting for an estimated import value of about US$145 million (in constant 1978 US dollars), using financial prices. The direct foreign exchange savings of the project, net of imported raw materials, is estimated at about US$120 million per year in constant terms before principal and interest payments on foreign loans. Net of foreign debt service, the project would still generate annual foreign exchange savings of approximately US$75 million in the years with the heaviest debt service. Valesul will thus have a con- tinuing and increasingly favorable impact on Brazil's balance of payments. Even with the Valesul project and other new projects and expansions expected, Brazil is projected to be a net importer of aluminum at least through the 1980's. - 50 - C. Economic Rate of Return 9.05 For the economic analysis, four adjustments have been made to the financial costs and benefits (Annex 9): (i) a power price of 23 mills (para. 9.03); (ii) shadow pricing of foreign exchange costs and benefits by 30% to reflect foreign trade distortions caused by import tariffs, export taxes and subsidies, as well as other forms of import restrictions and export incentives; (iii) the exclusion of all transfer payments and taxes; and (iv) Valesul's output has been valued at projected international aluminum prices (para. 9.02). The economic rate of return is satisfactory at about 20%. The economic sensitivity analysis shows the following: VALESUL: Sensitivity Tests on Economic Rate of Return (in %) Base Case 20.4 Capital Cost Up 10% 18.4 Capital Cost Up 10%, Production Down 10% 16.3 Operating Cost Up 10% 17.1 Revenue Down 10% 14.7 Power Cost 30 Mills 17.5 Base Case (without shadow pricing foreign exchange) 12.3 D. Plant Location 9.06 Although the Government's overall development strategy is to encourage more investment away from the southeastern part of the country, the decision for the site in the Santa Cruz area is fully justifiable. The site is in an area designated for industrial development in which a number of other industrial projects are located and planned, such as steel plants (Companhia Siderurgica Nacional's future No. 2 plant and Companhia Siderur- gica de Guanabara S.A. (COSIGUA), which has been partly financed by three IFC investments totalling US$75.5 million), 1/ and a nuclear power plant. To help reduce the congestion of the port of Rio de Janeiro, a new port is under construction at Sepetiba Bay, some 17 km from Valesul's site. The area is more than 50 km southwest of the center of Rio de Janeiro and well served by road and rail. The Santa Cruz region has had very little economic activity outside limited agricultural activity. The project therefore would have a beneficial employment impact in an area outside metropolitan Rio de Janeiro, particularly considering the prospect for the future downstream development of more labor-intensive fabricating facilities nearby. Furthermore, about 90% of Brazil's primary aluminum consumption is in the southeastern part of the country, and this proportion is expected to change little over the life of the plant. Ample power supplies are available nearby (the plant will consume less than 1% of the present total demand in the southeastern grid system), required raw materials will have easy access by water, workers for plant construction and operation are easily obtainable nearby, and investment in infrastructure will be relatively small. 1/ IFC/R 72-73, IFC/R 74-13 and IFC/R 76-67. - 51 - E. Employment Effects 9.07 The project will directly generate about 845 permanent jobs. Employment directly generated during construction is estimated at a total of about 5,000 man years. Additional jobs will be provided in the engineering and equipment industries. Moreover, permanent employment will be created indirectly through upstream and downstream linkages in raw material supply and fabricating industries. Training benefits will accrue from the executive level on down, particularly important in view of the planned Amazon projects. F. Other Benefits 9.08 The non-integrated primary aluminum consumers in Brazil have indi- cated that they strongly welcome the establishment of a new aluminum producer. These consumers have so far been dependent only on two sources of supply: high-cost imports and Alcominas, the only non-integrated producer at present. The independent fabricating industry--with limited access to metal in the past--is concerned about the possibility that Alcominas might expand into fabrication. This would result in the total absorption of Brazilian primary aluminum production by the integrated aluminum companies. In this environ- ment, the project will improve the tight supply situation in a part of the market presently dependent on one producer ana on imports and with the risk of relying in the future on imports only. The increased availability of metal is likely to increase capacity utilization and profitability of the consumers and would be an important stimulus to the whole industry. 9.09 The project would also provide the introduction to Brazil of the aluminum reduction technology of Reynolds, the third largest international aluminum company (after Alcoa and Alcan). Majority ownership will be Brazil- ian, however, thus improving the basis for Brazilian leadership in the devel- opment of the huge aluminum potential in the north of the country. X. AGREEMENTS 10.01 The following major agreements and assurances have been obtained: (a) From the Government that it will: (i) take all pricing actions to enable Valesul's achieving a reasonable financial performance (paras 3.37 and 8.14); (ii) cause CVRD to perform punctually its obligations under the Shareholders' Agreement-(para 7.14); (b) From CVRD, Billiton and Reynolds that they will: (i) assist Valesul to carry out a detailed market study and develop marketing plans by December 31, 1979 (paras 3.27 and 3.39); - 52 - (ii) take appropriate steps to achieve private and Brazilian control of Valesul (para 4.05); (iii) not dispose of voting shares in Valesul without Bank approval (paras 4.05 and 8.13); (iv) agree to Valesul's retaining freedom to purchase supplies of alumina on a commercially competitive arms-length basis (para 5.15); (v) provide funds on suitable terms to complete the project and preserve sound financial ratios; limit total amount of Valesul debt (para 7.14); and (c) From Valesul that it will: (i) carry out a detailed market study and develop marketing plans by December 31, 1979 (paras 3.27 and 3.39); (ii) ensure that the project is implemented and operated with due regard to environmental factors (para 5.23); (iii) observe certain financial covenants including limita- tion of debt (paras 7.14 and 8.13); and (iv) submit documentation on potential suppliers of critical equipment not financed by the Bank for prior Bank approval (para 7.17). (d) From ELETROBRAS that all actions will be taken to avoid power supply interruptions (para 5.18); (e) From PORTOBRAS that infrastructure for port unloading facili- ties will be completed on time (para 5.19). 10.02 The following are conditions of loan effectiveness: (a) registration of Valesul's by-laws (para 4.03); (b) effectiveness of the commercial bank loan contract (para 7.13); and (c) effectiveness of the Shareholders Agreement (para 7.14). 10.03 Given the above agreements, the project provides a sound basis for a Bank loan to Valesul of US$98 million equivalent for a period of 15 years, including 3 years' grace. Industrial Projects Department February 1979 -53- ANNEX 3 BRAZIL VALESUL ALUMINUM PROJECT PROJECTED BRAZILIAN PRIMARY ALUMINUM DEMAND/SUPPLY 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 (Preliminary) Demand 313 314 348 385 443 508 583 669 768 882 1,012 1,162 1,334 1,531 Production ALCAN 59 60 78 88 88 103 118 133 148 148 148 148 148 148 ALCOMINAS 59 60 70 90 90 90 90 90 90 90 90 90 90 90 CBA 49 80 80 80 100 120 120 120 120 120 120 120 120 120 Subtotal Existing Producers 167 200 228 258 278 313 328 343 358 358 358 358 358 358 VALESUL - - - - 15 86 86 86 86 86 86 86 86 86 ALBRAS - - - - - - - 40 90 144 204 270 324 324 Secondary Aluminum 34 31 35 38 44 51 58 67 77 88 88 88 88 88 Supply 201 231 263 296 337 450 472 536 611 676 736 802 856 856 Export (Import) (112) (83) (85) (89) (106) (58) (111) (133) (157) (206) (276) (360) (478) (675) ALBRAS Export - - - - - - - 20 45 72 102 135 162 162 Industrial Projects Department February 1979 - 54 - ANNEX 4 BRAZI L VALESUL ALUMINUM PROJECT PROJECTED ORGANIZATION STRUCTURE GENERAL ASSEMB LY 11 ADMINISTRATIVE COU ICIL FISCAL couri FINANCE COMMITTEE _I___________G___ |OPERATING G ____COMMITTEE_l ENGINEERING, PROCUREMENT AND CONSTRUCTION COMMITTEE PRESIDENT 1 COMMERCIAL MANAGERIAL ADVISOR PLANNING ADVISOR _ JURIDICAL _ ADVISOR AUDITING L TECHNICAL ADVISOR ADMINISTRATIVF CONTROL INANCIAL TECHNICAL DIRECTOR DIRECTOR DIRECTOR DIRECTOR Industrial Projects Department February 1979 World Bank - 20048 - 55 - ANNEX 5-1 BRAZI L VALESUL ALUMINUM PROJECT REDUCTION PLANT FLOWSHEET PET COKE KCAL ANODE 378.5 KG 135,000 PITCH 378.5 KG. 135.00 1 16.5KG. ELECTROLYTE: CRYOLITE 15 KG COMMERCIAL ALUMINA AL FLOURIDE 15 KG POWER SUPPLY 1,920 KG. SPECIAL ADDITIVES 15,530 ACKWH I -~~ 670 GREEN ANODES ACKWH 750 KG GENERAL PLANT USE [RECEIVE - UNLOAD-STORE-TRANSPORT TO CELL 14,860ACKWH RECTIFIER STATION 98% EFFICIENCY 14,563 DCKWH 57WBAKED AND ._RODCDED ANODES PACKING COKE 36 KG.* VOLATILE 35 KG. ANDBUT , _ 5 ~~240 KG. TRANSPORT TO CELL 700 KG. ,|ELECTROLYTIC |R EDUCTION CEL L| l P KCAL a TAP TO CRUCIBLE 2,093,000 | 1,000 KG. | | + , | ~~~~ANALYSE 1. ooo ALLOY ADDITION | }CAST HOUSE |K G | 22 KG. 22 KG. Industrial Projects Department WVorld Bank - 18704 February 1979 BRAZIL VALESUL ALunVIiNuivI PRIjJEC T PLANT LAYOUT - - = _ _ ATfItADO 00 LIME IlOAD EWAGE~~~~~~~~ - | ° 5[ 1 ~~~~~~~~~~~~~ ~ ~~~~~~TRIUCK U^t 0OrFFICE A | _ l r _ r~~~~~ ~~ ~~~~~~~~~~~~~~~~~~~~OFFICE \ P ARK o~ ~ ~ ~~~~~~HS 1le c. PARKX,0:H1 | c _F)ET^EJ|) ' W 5/\\ e&\___| 0 ____ __ > < lk t ; X rERNWASH/ LIGHT CCOltE WARD * *,J b L OIUM T A R SWITCH _________ _ CFUI. TREA YARdustria Projecs artmePLANTC POTebruary STORE IdENE PERSONNEL EC0TOOWER LU ~~~~~~~~~~~HO SE, U CAST~~~~~~~~~ HOUE "TAL z SERiVICE 0 L EAINAND Ak,TERNATIVF COKE SYOf FUEL OIL STOR. World Bank - 18705 Industrial Projects Department February 1979 - 57 - ANNEX 6 BRAZI L VALESUL ALUMINUM PROJECT IMPLEMENTATION SCHEDULE 1979 1980 1981 1982 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 '4 Earth Moving _ _ Civil Construction _ -= = _ Baking Furnace _EEIE T r ~~~C V T Green Mill - C = = = Rodding Shop - - _ +11 Potrooms * I E - - - - - - Cast House T - - - _ - - Rectifiers & Switchyard _ C _ - Port Unloading & Storage m - V _ Funse Controls D . . - Process Control _ C - _ _ - _ Laboratory A - Compressors _ _ - -V_ Pot Repair A-- - - Plant Production *p Mail Tender Documents V Start of botivery C Start of Civil Works V Bid Closing A Start of InstalLation D Start of Development of Software A, Placement of Orders O Physical Coaptettion T Start Operating Tests Industrial Projects Department * Startup F Full Production February 1979 World Bank - 20047 - 58 - ANNEX 7-1 BRAZIL - VALESUL ALUMINUM PROJECT Detailed Capital Costs (US$ million)- Equipment and Materials (including freight and spares) Erection, Construction Total Local Foreign Total Local Foreign Total Local Foreign/- Total Land _- - - - - 1.0 - 1.0 Facilities 01-03 09-12 ) Utilities 6.6 0.7 7.: 11.2 - 11.2 17.8 0.7 18.5 15-19 14 Laboratory 0.1 0.9 1.0 0.6 - 0.6 0.7 0.9 1.6 20 Cast House 7.3 3.4 10.7 4.9 0.7 5.6 12.2 4.1 16.3 22,27,28 Green Mill, Cathode Paste, Coke Storage 0.7 15.0 15.7 2.6 0.9 3.5 3.3 15.9 19.2 23 Carbon Baking 1.8 9.7 11.5 4.3 0.5 4.8 6.1 10.2 16.3 24 Anode Rodding 2.4 2.9 5.3 3.1 0.1 3.2 5.5 3.0 8.5 25 Dock Unloading and Storage 3.2 3.7 6.9 2.4 0.6 3.0 5.6 4.3 9.9 26 Plant Alumina Storage 2.3 - 2."l 1.0 - 1.0 3.3 - 3.3 29,30 Pot Reconditicning and Maintenance 2.0 0.2 2.2 2.4 - 2.4 4.4 0.2 4.6 31, 32 Warehouse and Electrolyte Storage 0.3 - 0. 1.4 - 1.4 1.7 - 1.7 40, 41 Rectifiers ancl Switchyard 0.1 8.3 8.4 0.9 0.2 1.1 1.0 8.5 9.5 47, 51 Fume Treatmen1: and Process Control 10.3 1.1 11.4 1.9 - 1.9 12.2 1.1 13.3 50 Pot Room 20.8 22.0 42.3 18.7 0.3 19.0 39.5 22.3 61.8 Subtotal Facilities 57.9 67.9 125.8 55.4 3.3 58.7 113.3 71.2 184.5 Engineering and Project Management 22.6 6.9 29.5 Technology Fee - 6.0 6.0 Total Fixed Assets 136.9 84.1 221.0 Preoperating Expenses 18.0 - 18.0 Base Cost Estimate 154.9 84.1 239.0 Physical Contingency 12.9 7.4 20.3 Price Escalation 25.3 12.5 37.8 Total Installed Cost 193.1 104.0 297.1 Working Capital 19.6 20.7 40.3 Interest During Construction 9.1 23.6 32.7 TOTAL FINANCING REQUIRED 221.8 148.5 370.1 /1 Excluding indirect foreign costs. Industrial Projects Department February 1979 - 59 - ANNEX 7-2 BRAZIL: VALESUL ALUMINUM PROJECT INITIAL WORKING CAPITAL REQUIREMENTS (US$'000) A. Operating Cash 1,000 B. Ead Product Stock 5,025 C. Raw Materials and Products Under Preparation - Aluminum 2,103 - Alumina 11,049 - Cryolite 681 - Fluoride 412 - Pet-coke 2,931 - Pitch 422 - Soda Ash 1 - Alloys 1,014 - Fuel 181 - Cathodes 466 - Stores and Miscellaneous 1,630 D. Capitalized Raw Materials 4,903 E. Receivables 13,849 F. Payables - Electric Energy (993) - Payroll (634) - Technical Assistance (294) - Domestic Raw Materials (1,736) G. Discounting of 50% of Receivables (6,924) H. Compulsory Deposit for Imported Raw Materials 5,214 40,300 Assumptions: A. Roughly 5 days of industrial production cost. B. 15 days of output (3,534 tons x 1,422 $/ton). C. Technical assumptions outlined in feasibility study of December 1977, available in the Project File (section 4.4.3 pages 4/20 - 4/24). D. (a) First anodes of each pot = 4,000 anodes US$2,640,064 (b) Cryolite filling for the pots = 2,462 tons US$2,262,704 E. 30 days of output at sales price US$4,902,768 F. - Electric energy 15 days - Payroll 15 days - Technical assistance 30 days - Domestic raw materials 30 days. I-.. Cn cryolite and fluoride imports - cryolite imported in 1981: 5,679 tons US$4,171,538 - fluoride imported in 1981: 1,258 tons =US$1,042,517 US$5,214,055 Industrial Projects Department February 1979 - 60 - ANNEX 7-3 BRAZIL VALESUL ALUMINUM PROJECT CATEGORY ALLOCATION OF IBRD LOAN Amount of Loan % of Allocated Expenditures Category (US$ Equivalent) to be Financed (1) Equipment 80,000,000 (a) Imported 100% of foreign expenditures (b) Locally manufactured 100% of ex-factory cost (2) Consultants' Services 3,000,000 100% of foreign expenditures (3) Interest and other charges 5,000,000 Amounts due on the Loan accrued on or before April 30, 1981 (4) Unallocated 10,000,000 TOTAL 98,000,000 Industrial Projects Department February 1979 - 61 - ANNEX 7-4 Page 1 of 2 BRAZIL VALESUL ALUMINUM PROJECT LIST OF EQUIPMENT TO BE FINANCED OUT OF THE PROCEEDS OF THE LOAN A. Equipment to be Procured through Approximate Value International Competitive Bidding (US$'000) Compressors--Facility No.18 497 Air compressors Cast House--Facility No.20 3,331 Billet saw Dross cooling system Casting machine Horizontal casting unit Degassing filters Green Mill--Facility No.22 15,878 Complete anode fabricating plant, including structural steel Carbon Baking--Facility No.23 10,839 Complete furnace with refractories Anode roller conveyor Two bake furnace cranes Carbon Rodding--Facility No.24 2,775 Induction furnace Butt stripping machine Stub press Overhead conveyors Bath removal equipment Dock Unloading and Storage--Facility No.25 3,895 Pneumatic unloaders Rectifiers and Substations--Facilities Nos. 40 and 41 9,046 Rectifiers and substations - 62 - ANNEX 7-4 Page 2 of 2 BRAZIL VALESUL ALUMINUM PROJECT LIST OF EQUIPMENT TO BE FINANCED OUT OF THE PROCEEDS OF THE LOAN (Continued) Equipment to be Procured through Approximate Value International Competitive Bidding (cont'd.) (US$'f00) Potroom--Facility No.50 21,342 Control panels Flexibles Busbar Welding wire Busbar diagonal saw Cathode blocks Jacking system Aluminum fume hoods Anode steel yokes Aluminum stem assemblies Anode change machine Process Control--Facility No.51 1,055 Process control equipment Interface and cables SUB-TOTAL 68,658 B. Equipment to be Procured by International Shopping 3,242 /1 TOTAL BASE COST ESTIMATE-/ 71,900 PHYSICAL CONTINGENCY 7,190 PRICE CONTINGENCY 10,910 TOTAL 90,000 /1 Including foreign erection and installation costs, spares and freight. Industrial Projects Department February 1979 - 63 - ANNEX 7-5 BRAZIL VALESUL ALUMINUM PROJECT DISBURSEMENT SCHEDULE OF IBRD LOAN Calendar Year Quarter Disbursed Cumulative Disbursement (US$ Million) US$ Million Z 1979 III 2.1 2.1 2.1 IV 6.4 8.5 8.7 1980 I 10.8 19.3 19.7 II 15.1 34.4 35.1 III 16.3 50.7 51.7 IV 15.5 66.2 67.6 1981 I 9.3 75.5 77.0 1I 6.4 81.9 83.6 III 4.6 86.5 88.3 IV 3.4 89.9 91.7 1982 I 4.2 94.1 96.0 II 3.9 98.0 100.0 Industrial Projects Department February 1979 - 64 - ANNEX 8-1 BRAZIL VALESUL ALUMINUM PROJECT Breakdown of Production Costs per ton-/ US$/t of Aluminum 1988 on % ITEMS 1981 ITEMS___________________ 2nd Half 1982 1983 1984 1985 1986 1987 US$/t ct/lb of total RAW MATERIALS Alumina 333 342 346 349 349 349 349 349 15.8 37.2 Cryolite 106 30 12 12 12 12 12 12 0.6 1.3 Fluoride 13 13 13 13 13 13 13 13 0.6 1.4 Soda Ash 1 - - - - - - - - _ Other Additives 19 5 5 5 5 5 5 5 0.2 0.5 Petroleum Coke 79 83 83 83 83 83 83 83 3.8 8.8 Anode Pitch 14 14 14 14 14 14 14 14 0.6 1.5 SUB TOTAL 565 487 473 476 476 476 476 476 21.6 50.7 ELECTRICAL ENERGY 248 238 238 238 238 238 238 238 10.8 25.3 FUEL Bake Furnace 7 7 7 7 7 7 7 7 0.3 0.7 Cast House 14 14 14 14 14 14 14 14 0.6 1.5 OTHER MATERIALS Maintenance 56 26 26 26 29 39 39 39 1.8 4.1 Potlining (fixed) - 2 7 33 28 24 24 24 1.1 2.6 Alloys 52 52 52 52 52 52 52 52 2.4 5/5 Packing Coke 8 8 8 8 8 8 8 8 0.4 0.9 MAN POWER Hourly 56 25 25 25 25 25 25 25 1.1 2.7 Salaried 69 32 32 32 32 32 32 32 1.5 3.4 RII 57 18 14 8 5 5 2 -_ SUB TOTAL 182 75 71 65 62 62 59 57 2.6 6.1 Miscellaneous 51 24 24 24 24 24 24 24 1.0 2.6 OPERATING CASH COST 1,183 931 920 943 938 944 941 939 42.6 100.0 /1 In constant 1978 US Dollars, without depreciation and financial charges. Industrial Projects Department February 1979 - 65 - BRAZ[l - Vu1I...ol Abau%Io Prool nt ANNEX 8-2 Pxoclet.d PrdcinCosts Page 1of 1 LIIM$ joilimol t9/7 [978 199I [888 I81 mu,1 iJR (8 3 1:49 944. [997 ("21 '9 99i 9, l99' 19Y9 998 42881'89M[( 88(44,4 81 ION [81 (UN I~~~~~~~~~~~~~~~~~~~~~4,k 0 14,47. 1 [,,.7.4 [.4 J 4,lOl I - - - - 9~ ., II1 0 1111~l 8148[I (I44(-2 u888n4 I MI i uH,, ('4j 'A8,44, 21M.[,2 IS Y''( II, AL4I MINIM [8114. 1F PF9881' 9 .1/ .9' .9 I/4 I I > , '9 A8L 9 149 24 9 4,'F,4 8/( (4/ '4'' .84/9 7/I,'.u'i' 8/6', 7/, V.9,,,,4 /,I,ii ,('I /1. 4,'I (IFNFMAI E;4F4F142F4, U"8 r8/ - 88,434, 182, 1.1 ''.4 I u.,' I IA ,'9 I I I ,' , A[2' J.9, .. ,:. ''' (4 ", (..4 I. I4 '/4 [.-( /4, I OR[II4 1 ) I'.(.('9 - 92/ 479 -66- AN011 8-3 BRAZIL Valemi. A]w$emn flmlmct Page 1 ml 1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. g. 997? 1 979 1979 1 999 1991 19982 1793 19914 99', 399A 999 199RIY9 1 990 1991 1 997 1999 1 999 370170 9790997 - 1~~~~~~~~~~~~~~~~~~~ ~~~~~~~~~~~~~~~~~~~~~7 9'2 192,906 1 70 49 1913 '31 '9I 91 '19 7 2. l-. 294 1. ! 254 4,13 e09 990 295.9' 9913. -3'l .1 3499,93 ", 7 1 C . 4 1 1S 7f L21, 93 1A5 I 1 14 . 91 0-1 94 9' 1 6 '1. 73,,,9 .. .994 399,94 212 54 2'?7 4", 7,43 .314 319102 IRCEIT 4,5 3.64 9 79 91 13 1.70 A~( 7.67'9,39 07 A I3,09 94,39 97,1, 960 9 919179 197 0ESI - 22. 39 92~0 0.II Il 7 :.3, 99 6 4 392.2r DI RI M1 331313 991 '423' '3' 0. '9 (1 79 49 0791,903 70771NS1 S 2 2.. 7 '. r5 ' ' 49 7-3 4.134. NET 1913031 91F903 799 -9-3-314 04 1'3,5 CA 3, 1 '3 0i254 51.6 4,99 18 34 99M 11 I 1 9E7 9933393 A 0I09 70T10. 41 19,41 30 4 2 30,0, Y 61 450 59 14 4 107091 99793419N31 1903I - 314,43 11 9/93 339,40' 11 `593 1 7 1 '7, 3019 . 392 4 91 399 " 31 '91 1 90I9 094 91:7 NC 197 1 197/S03.-33 R70, --(12 ; 2 5i1r - 341,43 'I V 791 13 17,309 133971 97U~SRILFP 730 : '7*;T 33P709 331793 33J 9RI 771F 797 (2/17>19 - 67 - 192 19/9 -19/9- 990O_ 1918 909~ 1. 1Q99 100' 1 '. I) 9909 19919 1 99.1 1_01 19'I0 1,APITAL FXF99N911TUR01-----1----- F510AN 4.961 1 2,.69 ,3U.,1' 1769 64.2 ~ 1 F1000 6069- A9. 100 "9 '"0 '1,9 3.1 4,11 4.32 9.09 4, 99 9.3' 1 INT, 009161. 9001,1519, - - .40 90,4 1 ,0 919-TOTAI 4,0 12,69 4,062 10/1129 11.I0' .9 - "3.2 4.11t 4,1AI 4,611 490 9 /1 A F," N109 4. 61 10,2 9.1 291 2,1 ' 1I9.1' 2'1, 10'Ii 2'I' 0 9 201 0.9 221. '1 0,' '0, 191, 9119960G 99999ONST.0R',4 9',11,9 1'.310 1". '93217 32.2 7 1i.0 11.0 2,4 '/9 97'O 1 99909S FoOOD 9991210 4,90 127.29 907. 91 22!,2115 100,1 9092~ 995 41'9' -.1 19.'12 9.1 .9 . 999 B."12.1' 2,9, 32,1" 19,1 D91`11'17MT1119 ANY, A9011791109N 090011-2- 21- 9 0- ----- - --- - - --1 '.--- 909-TOTAL - - J7.' 12,10 091 94.10 110.111 I19,2 I7- a 2,1 22916.0 2~9 9.9 224 ',1 NET1 F0099 900010 4,00 1 '.29 57.-I ;22".19 299.99 ,'909 4 1419 "I1 '4 101`. J`"/1 4" 1. 9 100.214 9.1 63,110 4 9.99 49.69O 40, 11 7.? IN00U1'RTOL p9n25CT9 IlEPA99T69r 395991I 59R2FARF1i -- 02/1 3/70 68 - 31401 8-5 1977 1978_ 1979.__1980___1981 19978 19973 994 95 p1.997 1969 19119 1990 199 1919 9 997 1 994 C2999 GENERATION9 NEI RI NI:1IE0AFTERO1A1 (I- 14,04191 15,I741 .219 11 247' 9,A4:9 25.61 30. 07 39.//19 I 45' SO 9 4 14 D1EPRECIATOI N 9A01F1. -1 7 11 6 57 11,5 CA.15 .17.95 79o.1 0.9:11 23.35 23,35 187 .9 INTEREST -- - ~~~~~~~~~~~~~~~~~~~~~~~~~~~-------.7 9,1 973 [./ 9.99 9411 4,o 1.:7.9 OUITOTAL - - - 57,99 13.47 97:17--- -----23161242 DECRFASE IN WnRK1141i CAPTIAL ~ ~~~~~~ ~~~~~~~~~~~~~~58.915 90.03 59.947 4" 90 4 7 9.5 99 9 749 C691PI TAPUND'S EQU(tiIT I- 121.19 969 7 44.H 9 .. . I I LOANS TOI -R - 9.48 .17. .8 29. - -.~ 0o 11011. 2 4.14 2'' 1 9 2RF1-112 ['09490 - -- 7.77 "0 10 9,1 -- -- -.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ ------ 11l31- I0TAL 4 .01J '12 .911 34.75 140( 3 679/.131 19 9 ----- TOTAL SOURCES 4,91 17.99 17,92, 197 29 IF' 5 39 01 93~ !iAUA 17 47 9>39 S,9 59.9 91 A0,113 99. 87 9" 9 /l " 93 9147 PLANT 4,961 17,998 35F,7721 '; 117,41 94.9 77.9 - .- IDC2 - 549 9,964 12.9 A - 1116- TOITAL~ 461 1:2,911 49,2 197,29 P1I I7 72.7 .--.… 031 PREEIIlI2 SHARES - - - --4.44 910 9.U0 1'5.U0 j i 09 20899.69.05......- .. ... ......4 4 6.0 9( . 00 ,' U9 12.00 19.990 7U.110 5011-TOTALV E 8.680 1 1112.0 3,11 1909 747 89 99 INTEREST 11191 - -9- .(I R> .1 14 9 DR. ~ MOU :4 09 ,4 1.70 3.41 0 47 .49 - oTHER 1014£ - OURf,-TOTAL 22- - .. - 77.11 17,77 17' I,7 9.99 6 91 4,7 7 13, 43 .91 ORRO - -. 09-R.174,99 7 9,1I7 G1,17 81 7 91 11 ,747 (10. I61. - - - 999 0 170~1 I179 11,07 R 17 60 .997 El 7 . FINAME t - - - 1,1101'.0001 09 5.00 9,9 OTHER LOCAL -17.79 - --- RUrO-TOTAL - 17.29 - 9.09 17 17 "' 11~7 70.97 30.197 39 07 1.9 1.7 94 ,71,740 TOTAL APPLICATIO1NS ---------------4.91 12.68 57,91.167.29 117.0:ll7 64, 77 77: 94 45:1 0 7 45(1.85-- 3.4Y 3.7.994- 4- .40 4 19 4.9 171 494 4CCUMILILATE1I 1ASH 90RK01 .1.953 ,1 68 8 " 1" 72,4 611.49 7410,71 .1. 1,0 19,9" 1,703 4 - - - 3.13 71,93 40 O~~~~~~~~ 1" 41 9.7,69 74.41 00 I ' 89 /2 103.00 17U.30 139 9" 146.99 157,79 171.016t)` 1(300 1,.30 36.9 DEB1T 86491120 COVE.RAGE - - - --1..60 [ . 9 1,.39 1.31 1 .37 14140 279,1.8 l,9 9I2I2OJIJLATED' L -T DEBlT 4,41 17,29 12,04 117.:41 2,19.77 779.301 7191413 '.1978 770,39 9'39.1749A 7 16 r7CCUNI]LATED REP9T6ENI -. - ~~~~~ ~~~~~~ ~~~~~~~~~~~~17.29 17.29 17.29 24,711 99, ' , 961 9' 97,1 1735923.8 23?3 23.f 239.7 "3398971 7.9 297 IIEBY OU10THNR1NI 4,91 17.29 ~~~~~~~~~~~~~~ ~~~~~~~~~34.75t 135,17. 20747713,90 19983 1 77.79 149.79 01 102 R51 14.53 9 11511 792.726 7 21 5 '04 719~ 127.71 4.04 RZEPORT f'1FlPlARER, - 02/17/79 BIlAZIL - VeetlAeI.aPrjc Projected Balanc Shee84 CURN9FNI (,';11 T9 (1514' (((~:4(411(, .' 444 ('' 4 , L.444 'I' i,50. (114N1 .4194 44', Co(4494 9.14,cm (2 . ' ) 4 '. . .,. '',' ' ' ' . ' .1 '] 9,' ',9 '94 9', 4'. (4411994(.4/H (94.9 ,9 (44 ..' / . ( ' ' . .. -. .4'.?'' 7' I 4,4 4'' .4' 9 99 SUP-TIATPI ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ 4 9 1 ' *4,4 ~ ,( ~ 1.. ~ 9'4 '9 .9..4 1E4X44D 91(s 9 4Is(<9 ('9 '... 4.4 .,' '' .. , 9 (.42.,1 949 '' ' 1 1 4 01 -111 r411(1. ((F(I4144 (11(44 r 411k I l 144491499 ' - . "'4 49' 4 9 4. 4~~~~~~~~~~~~~~~~~~~~~ V ',94 9..9l IA >9 7.4, '.9,' 9.41' 9441~~~~~~~~~~~~~~~~~~~~~~~~ 4.9444,199441994' 9111 ' 4/,?'. 4,9'. (~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ . ''' ~~~~~~'' '0 "."/ 17.44 44,1" 9, " 9,4/ 9,4/ 4,4.4~~~~~~~~~~~~~~~~~----- - -- 94 OTL' ;:' ,9 '(/ '. ' 1 ,' ,9 9444,. ,,4 ''9' 99 (.9 ., (9 F99 (9944. L 14(49. 19444 4.14l 499 I 4,' 9,9 4 9 , (' 9 9 " 1 ' " 49 42 291. :1141' 4,9 9 4 4, 4 9 44~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~2L 14 999411EB (EX- _49 .49 .38 .19 .124 .4" .1I4J4I.1/ R9 H " 9 91.019 ladueTYil PrejnoteDopeeme (Ipet LrPae 1 02/13/79, 14, A4 ~1 Il.0 11 , J 0.J 8.14,.i - 70 - ANNEX 8-7 Page 1 of 2 BRAZIL VALESUL ALUMINUM PROJECT ASSUMPTIONS UNDERLYING FINANCIAL PROJECTIONS A. Inflation Accounting 1. Brazil has been forced to cope with considerable rates of inflation over the past two decades. In 1964 it promulgated a system of "monetary corrections and flexible exchange rates" to obtain better control over rising inflation rates. The "Brazilian Model" worked satisfactorily until the oil crisis provoked a sudden push of imported inflation in 1974 which let infla- tion rates rise up to a level of about 40% p.a. 2. To avoid unnecessary distortions as a result of an uncertain development of Brazil's inflation and to facilitate comparisons with other similar projects, it was decided to express all financial projections in current US Dollars. Assuming that the policy of the Government taken in the past of adjusting the foreign exchange value of the Cruzeiro according to the difference between domestic and international inflation rates will con- tinue, the following inflation rates were applied in the financial analysis: International Year Price Inflation (%) 1978 7.0 1979 6.5 1980 and beyond 6.0 3. Since the formulation of the monetary correction system in 1964, a series of laws and decrees were introduced regulating the use of the monetary correction factors in the financial statements of companies. The regulations--especially for income tax purposes--change from time to time. For the purpose of the financial projections, the latest accounting rules were applied, with the difference that instead of the domestic "monetary correction factor" the international inflation rate as "indexing factor" was used. 4. According to Brazil's accounting principles, fixed assets, as well as local long-term loans, are subject to monetary adj-ustments and are indexed respectively. The difference between the revaluation of fixed assets and of the local long-term loans is added to equity to restore the balance between assets and liabilities. Since the financial projections are expressed in current US Dollars, there is no need to consider adjustments reflecting increases of principal repayments for foreign loans due to changes in the exchange rate between the cruzeiro and the US Dollar. B. Production Build-up 5. It is assumed that the first pots would be put on power in July 1981 and that full production would be reached by early 1982, resulting in the following production build-up: - 71 - ANNEX 8-7 Page 2 of 2 BRAZIL--Valesul Aluminum Project: Annual Output (tons) Year Output 1981 19,494 1982 85,668 1983 86,500 C. Revenues 6. In Brazil, aluminum ingot prices are controlled by the Governmett. In January 1979, the Brazilian ingot price per pound (ex-factory) was 59 cents com- pared to ALCAN's World List Price (FOB N.Y.) of 56 cents at the same time. The international price is expected to rise in real terms to 61 cents/lb in constant 1978 US Dollars by 1981. For the purposes of the financial projections, it was assumed that the Brazilian price in 1981 and beyond would be 64 cents/lb in constant 1978 US Dollars. The price of slabs and billets was assumed to be at a 12% premium over that of ingots, as has been the case for several years. D. Operating Cost 7. The operating cost per ton is projected to decrease over time until it stabilizes 6 years after startup. The higher production cost per ton in the first years is mainly due to a high consumption of cryplite after startup. Thereafter, production cost drops from US$1,183 to US$920 per ton in 1983. By 1984 expenses are expected to increase by US$26 per ton because of the need for pot relining. A detailed projection of production cost per ton is given in Annex 8-1. 8. Depreciation and amortization have been computed using the straight- line method. The following depreciation and amortization rates have been applied: Item Years Rates (%) Interest during construction 5 20 Civil construction 25 4 Equipment, engineering 10 10 Vehicles 4 25 Pre-operating expenses 5 20 E. Financing Terms 9. The financial projections are based on the following financing terms: BRAZIL--Valesul Aluminum Project: Assumed Loan Terms Lender Grace Period Repayment Annual Interest Rate (%, IBRD 3 years 12 years 7% + 3% Guarantee Fee Commercial Banks 5 years 5 years 13% in 1979, 12% in 198C 11% from 1981 onwards FINAME 3 years 7 years 12% Industrial Projects Department February 1979 - 72 - ANNEX 8-8 BRAZIL VALESUL ALUMINUM PROJECT FINANCIAL RATE OF RETURN--COST AND BENEFIT STREAMSla (US$ million in real 1978 terms) Sales Operating General Capital Year Revenues Costs Expenses Costs 1979 - - - 32.98 1980 - - - 139.02 1981 23.17 19.89 0.68 78.63 1982 127.21 26.05 1.70 25.73 1983 128.96 86.06 1.72 - 1984 130.54 88.98 1.74 - 1985 131.88 89.36 1.75 - 1986 131.88 89.79 1.77 - 1987 131.88 89.42 1.78 - 1988 131.88 90.03 1.80 - 1989 131.88 90.89 1.82 - 1990 131.88 91.74 1.84 - 1991 131.88 92.59 1.85 - 1992 131.88 93.46 1.87 - 1993 131.88 94.33 1.89 - 1994 131.88 95.21 1.91 - 1995 131.88 96.10 1.92 - 1996 131.88 97.00 1.94 _ 1997 131.88 97.90 1.96 - 1998 131.88 98.82 1.98 - /a Financial Rate of Return Base Case - 10.8%. Industrial Projects Department February 1979 - 73 - ANNEX 9 Page 1 of 2 BRAZIL VALESUL ALUMINUM PROJECT ECONOMIC RATE OF RETURN A. Assumptions for Economic Prices and Costs The economic rate of return has been calculated on the basis of the financial rate of return in real 1978 terms with the following modi- fications: (a) Foreign exchange costs and benefits were shadow priced by 30% to reflect foreign trade distortions (para. 9.05); (b) Sales revenues and operating costs were modified to take into account the following assumptions: Assumptions Affecting Sales Revenues and Operating Costs (US$) Economic Prices/Costs Before and After Shadow Pricing Financial of Foreign Exchange Price/Cost Before After Price per pound Aluminum Ingot 0.64 0.71 /a 0.92 Direct Costs per ton of Aluminum (Annex 8-1) Alumina 349 349 454 Cryolite, Fluoride 25 25 33 Other Raw Materials 102 102 102 Electric Energy 238 356 /b 356 Fuel 21 21 27 Other Materials 123 123 123 Manpower 57 57 57 Miscellaneous 24 24 24 Total Direct Costs 939 1,057 1,176 la A 16% CIF cost was added to the US$0.61 FOB New York price fore- casted in para. 3.20. /b Economic power price of 23 mills/kwh was substituted for the financial price of 15.44 mills/kwh. (c) The social tax and the 30% tax on Reynolds' technical assistance fee were eliminated from the cost streams. - 74 - ANNEX 9 Page 2 of Z B. Economic Benefit and Cost Streams /a Economic Benefit and Cost Streams- (US$ million in real 1978 terms) Sales Operating General Capital Year Revenues Costs Expenses Costs 1979 - - - 37.70 1980 - - - 158.90 1981 33.27 24.59 0.68 90.15 1982 182.67 106.07 1.70 29.50 1983 185.19 106.07 1.72 - 1984 187.46 109.70 1.74 - 1985 189.38 110.16 1.75 - 1986 189.38 110.94 1.77 - 1987 189.38 110.71 1.78 - 1988 189.38 111.48 1.80 - 1989 189.38 112.55 1.82 - 1990 189.38 113.62 1.84 - 1991 189.38 114.68 1.85 - 1992 189.38 115.77 1.87 - 1993 189.38 116.86 1.89 - 1994 189.38 117.96 1.91 - 1995 189.38 119.08 1.92 - 1996 1,89.38 120.20 1.94 - 1997 189.38 121.33 1.96 - 1998 189.38 122.48 1.98 - /a Economic Rate of Return Base Case = 20.4%. 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