iURN TO REPORTS - R E S T R I C T E E . Report No. TO-144; FILE COPY This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT APPRAISAL OF THE COMPANIA CARBONIFERA E INDUSTRIAL DE LOTA COAL MINE MODERNIZATION PROJECT CHILE July 9, 1957 Department of Technical Operations FILE COPY CURRENCY EQUIVALENTS $1 650 pesos Pesos I million $1,538.46 All tons are metric tons The Company's fiscal year ends Decmeber 31. TABLE 0O CONTEMES Summary and Conclusions I. Introduction Paras. 1 - 2 iI. The Company History and Present Cperations " 3 - 6 Special Risks 7 Ownership and Management 8 - 9 Labor 10 Associated ActiAities 11 Earnings Record and Financial Position 12 - 18 III. The Project General 19 Cost Reserves 20 Planned Development and Construction 21 -25 Work Completed to Date 26 Engineering and Construction Management 27 Operating Management 28 Construction Schedule n 29 Estimated Cost in Foreign Exchange and Local Currency " 30 -36 Labor Requirements 37 -38 Supervision at the Face 39 IV. The Market 40 -46 V. Economic Justification 47 -9 VI. Financing Plan and Financial Projections. 50 -58 Financing Plan Paras. 50 - 51 Financial Projections " 52 - 58 VII Proposed Protective Financial Arrangements Para 59 Annex 1 Map of Central and Northern Chile Annex 2-A Summary Balance Sheets, 1951 - 1956 Annex 2-B Summary Profit and Loss Statements, 1951 - 1956 Annex 2-C Sources and Allocation of Funds, 1952 - 1956 Annex 3 Schedule of Development Drivages Annex 4 The Market for Coal Annex 5 Costs and Earnings Projections, 1957 - 1968 Annex 6 Cash Flow Projections, 1957 - 1968 APPRAISAL OF CON4PA]qIA CARBONIFERA E INDUSTr.,IAL DuE LOTA COAL MINE MODERNIZATION AI1 EXPANSION PROJECT CHILE SUMMARY AND CONCIUTSIONS A, The Compania Carbonifera e Industrial de Lota, which owns and operates the largest coal mine in Chile (see map, Annex 1), has asked the Bank for a loan to meet the foreign exchange cost of an investment program designed to complete the modernization and expansion of its mine. The Chilean Government would guarantee the proposed loan, and the Corporacion de Fomento (CORFO) would be a co-borrower. B. The project involves the development of a new shaft mine, and the modernisation of the haulage and surface installations. The present working faces'are very scattered; in future they will be much more concentrated, thus reducing the complexity and cost of underground transport. The project has been investigated on behalf of the Bank by Powell Duffryn Technical Services,Ltd., consultants. C. The nroject is soundly coneeived from an engineering roint of view. Its main effect should be to reduce costs of nroduction. It should also rbsult in some increase in annual output capacity (from the present level of about 1,000,000 tons to about 1,100,000 tons). Output could eventually be increased further by about 25% if conditions justified it. The proved reserves are adequate to support the planned rate of output until 1970, by which time further reserves, at present in the "?indicated"t category, will have been proved. D. The Company is well managed, but its technical staff needs strengthening and some reorganization. labor relations are good, and the supply of labor is adequate. However, there is need of more supervisors (foremen, etc.) underground. E. The Company has no long term debt, and its current position is satisfactory. The company's earning nower has shown a tendency to decline during the last few years, partly because of rising costs due to inflation which were not nromptly matched by increases in Government controlled prices. Depreciation allowances have not always been adequate. Since selling prices were freed from control in July 1956, there has been an improvement in the profit margin on coal sales. F. To carry out its investment program, the company will have to spend about $14 million equivalent between now and the end of 1962. Of this total, about $6 million equivalent would be needed in local currency and about $8 million equivalent in foreign exchange. With interest during construction, the total foreign exchange requirement will be $9.6 million equivalent. II G. The market should be able to absorb Lotats increased output (as well as that of the other Chilean coal mines) without prices falling to an unremu- nerative level. It is the policy of the Government to ensure a market for the planned output of the industry. H. The project is Justified from an economic point of view because of the foreign exchange savings on imnorted fuels, the prevention of unemploy- ment which would result from declining production and ultimate closing of the mine, and the guarantee of a strategic minimum supply of fuel from domestic resources. These advantages outweigh the economic cost of having to afford the industry some degree of protection against the competition of imported fuel oil. I. The company proposes to borrow the amount of foreign exchange required for the nroject ($9.6 million equivalent, including interest during construction)from the Bank. It ulans to meet most of its local currency requirements from funds generated by its operations. The balance, presently estimated at about $2.8 million equivalent, it expects to borrow from CORFO. J. Since local currency expenditures may exceed the estimates because of continued inflation, the proposed loan from C0RF0 would not be limited to a specified amount, but would cover any amount by which the Comrany's financial resources fall short of its needs for the project. K. Conservative forecasts show that the Company's financial situation at the end of 1962 would be satisfactory, with a ratio of long-term debt to equity of 46:54. Total debt service would be covered at least 2.7 times in the following years. Even if sales in 1963 fell 20% below the assumed level debt service would be covered about twice over. L. The oroject is a suitable basis for a Bank loan of $9.6 million equivalent (including interest during construction). A term of 15 years (including a 51- years grace period) would be appropriate. M. If a Bank loan is made, the contractual arrangements should include appropriate limitations on he company's freedom to incur additional debt and to pay cash dividends (see para. below). The company should also undertake to strengthen its technical and supervisory Eaff,to carry out adequate mine development work, and to follow realistic depreciation and depletion policies. N. It should be a condition of effectiveness of a Bank loan that satis- factory arrangements have been made with CORFO for local currency financing. APPRAISAL OF THE COMPANIA CARBONIFIERA B INDUSTRPAL DE IOTA MODERNIZATION PROJECT I. INTRODUCTION 1. The Bank was first approached in 1949 about financing the Lota Company project for the concentration, expansion, and modernization of its coal mine, and this project was investigated for the Bank in 1950 and 1952 by J.W. Woomer and Associates of Wheeling, W,Va. The consultant's report was favorable, but further consideration of the project was suspended in 1952 pending settlement of certain matters between the Chilean Government and the Bank. When, in 1953, these other questions had been settled, Chile's financial position had deteriorated. It was not until June 15, 1956 that the Bank could inform the Chilean Government that it was prepared to resume lend- ing operations in Chile, and in this connection would be willing to reconsider the Lota coal project. 2. In June 1956, the Bank engaged the British firm of Powell Duffryn Technical Services Limited for a reappraisal of the Lota project from a technical and financial noint of view. This report which was submitted in November 1956 forms the basis for much of the following analysis. II. THE COMPANY History and Present Operations 3. The original Lota Company was formed in 1852. There have been several reorganisations; the present company (Compania Carbonifera e Industrial de Iota) dates from 1933. During the past 105 years several mines were oper- ated; at present all activities are concentrated at one drift (inclined shaft) mine and three vertical shaft mines at Lota, on the Bay of Arauco, about 300 miles south of Valparaiso (See Annex 1, Map of Central Chile). 4. One of these mines (Piques Carlos Cousino) is a new mine which was started in 1936 with the sinking of two shafts to a depth of 530 metres and the driving of two main galleries of about 5.5 km each. This initial con- struction was halted in 1942, and further development was postponed due to lack of funds. In 1949, the company approached the Bank with a view to financing certain equipment for this mine, including hoisting and haulage equipment. 5. Rather than financing only a portion of the company's investment program, the Bank suggested that the company should submit an integrated program of development and investment for their total coal mining operations. Such a program was prepared making the Piques Carlos Cousino the nucleus of the company's mining operations by connecting it with the other two shaft mines. In connection with this concentration of output, haulage and coal preparation facilities would be modernized. The completion of this general scheme forms the basis for the company's present loan application. - 2 - 6. During the last six years, the company's output has been remarkably steady at about one million tons per year (approximately 3,600 tons per work- day). The labor force at May 31, 1957 totalled about 8,000 workers in the mines and other departments plus about 610 salaried employees. Of the workers, about 5,500 are employed underground and on the surface of the mine (excluding workshops, preparation plant, administration, etc.). These figures refer to the total number of workers under contract; actually about 1,000 of the above 5,500 workers were absent due to illness, accidents, leave, etc., and were drawing only welfare allowances but nn regular pay. The output per man-shift underground is about 0.74 tons. The present haulage arrangements from the very scattered workings as well as the surface handling arrangements are complicated and largely outmoded, which has an adverse effect upon produc- tivity. The Chiflon Carlos drift mine has its own small screening rlant. The coal from the other mines is screened at a central screening plant near Piques Carlos Cousino. Part of the undersize (less than 3/4") "slack" coal (about 500 tons per day out of 1,500 tons) is washed in a Baum jig with a maximum capacity of about 650 tons per day. All these washed slacks are sold to the Chilean Steel Company. About 16,000 tons per year of the unwashed slacks are used to produce electric power in the companyl s own 20-year-old station. Although the cost is high, this is justified by the zossibility of covering peak requirements, for which there is a substantial surcharge when pur- chased power is used. At the present moment, this power station also serves as an outlet for some of the existing surplus of unwashed slacks. Approximately 25% of the coal is dispatched by rail and the remaining 75% by sea. Most of the latter is transported by Compania Naviera Arauco, an associatbd company. There is substantial downgrading of the screened coal from breakage in the handling between screening plant, storage bunkers and freight cars or vessel. Snecial Risks 7. Because of the dispersion of the workings, ventilation is difficult, and since 1941 there have been three major explosions (1947, 1950, and 1951). On the other hand, the seams are not liable to spontaneous combustion. According to the consultantts report, there is an excessive number of silicosis and anthracosis cases, a problem which could increase in severity in the future because of the proposed concentration of workings. Following the con- sultantts recommendations, the company's safety department has already intro- duced several measures to keep the dust problem under control. There was considerable damage to surface installations in the 1939 earthquake, but new buildings would appear to be built to reasonable safety standards in this respect. Ownership and Management 8. The ownership of the company is widely distributed. As of December 31, 1956, only slightly above one million of the company's 7.5 million shares 2/ This compares with an output per man-shift varying from 1.55 to 1.8 tons in the United Kingdom and the European Coal and Steel Community (except for Belgium where the figure is only 1.15 tons due to particularly difficult mining conditions).(January, 1957 figures.) - 3 - were owned by persons holding more than 50,000 shares each. The company's shares are quoted at the Santiago and Valparaiso stock exchanges. They were recently quoted at about 180 pesos as compared with a par value of 200 iesos. 9. Lota's management is competent and progressive. Nevertheless, there is an urgent need for an additional senior man to assist the present Chief Mining Engineer, and for the establishment of a separate Planning Department under a competent senior engineer. In addition to these two positions, the consultants recommend the hiring of additional engineers to ease the load on top management. Labor 10. The supply of labor is adequate. Strikes occur occasionally, parti- cularly at the time of the annual wage negotiations, but the latest one in 1954 which lasted 18 days was the longest in recent years. Lota's management is alive to the im-nortance of good labor relations. Only about one-fifth of the workers are paid by piece rates, a much smaller proportion than at Schwager, due partly to the complicated and extensive haulage required for the four separate mines. Associated Activities 11. Until recently, Lota also operated the Concepcion - Curanilahue railroad, a fleet of coal vessels, a refractory brick plant, and certain forest and agricultural activities. The railroad was ceded to the Chilean Government in 1956. The other activities had previously been organized as independent companies, and the shares distributed to Lotals shareholders except for small portions retained by the company. Earnings Record and Financial Position 12. Financial data for the Iota company as of December 31, 1956 are given below. More detailed balance sheets, and earnings and cash-flow state- ments may be-found in Annexes 2A, 2B, and 2C. Summary Balance Sheet as of December 31, 1956 (million pesos) Assets Liabilities and Equity Current Assets 2,912 Liabilities (mainly current) 1,869 Bonds, Shares, and Sundry Assets 686 Various Provisions 634 Revaluation Reserves 1,921 Fiked Assets 3,220 Capital and Earned Surplus 2,020 Minus depreciation 373 2,842 Total Assets 6.445 Total Liabilities & Equity 6.445 - 4 - 13. The persistent inflation in Chile makes it particularly difficult to appraise the companyts recent earnings record and financial position, and the following analysis can only nrovide an approximate picture. 14. The fixed assets of the company have been revalued several times to bring them into line with current replacement costs; the most recent revalua- tion was made as of December 31, 1955. In view of the depreciation of the peso since that time, an up-to-date value of fixed assets would be about twice the current book value. About 60% of the revaluation reserves arise from the revaluation of fixed assets. The remainder corresponds to price increases for bonds and shares and for inventories, which are both valued in the balance sheet at about current market values. 15. Recent trends in production and profits are shown below. Profits are expressed both in the original pesos and in sterling-- the latter to facili- tate a comparison over time as well as a comparison with the Schwager Company, whose accounts are kept in sterling. The principles followed for inventory valuation have not been very consistent. (See Remarks under Annex 2 A). Nevertheless, over the period as a whole, book gains on inventories other than coal are probably urnmdportant, and book gains on coal inventories relatively moderate. Output of Coal and Profits after Income Taxes Profits after Income Taxes t 000 Million % of L Sterling Output pesos equity I Equiv. (t00o Tons) 1951 1,007 98 (10.5) __ 1952 1,083 125 9.3 439 1953 1,008 142 7.5 409 1954 974 172 (8.0) 376 1955 1,004 217 6.3 310 1956 96o 282 (6.1) 251 / Percentages within brackets are misleadingly high since in those years there was no revaluation of fixed assets in snite of very substantial inflation. / Approximation arrived at by taking the average of the sterling rate at the beginning and the rate at the end of each year. 16. The profits for 1956 were adversely affected by substantial operating losses on the Concepcion - Curanilahue railroad and by book losses in connection with the transfer of this railroad to the Chilean Government (altogether 243 million pesos). On the other hand, depreciation allowances based on December 31, 1955 prices (103 million 0esos) were only approximately one-half of the amounts required according to replacement values. Profits after taxes and after depreciation according to replacement values but before extraordinary losses were about L370,000 equivalent in 1956 compared with 1310,000 equivalent in 1955. 17. In order to obtain an approximate idea of changes in the companyts real earning power, allowing both for changes in the value of the currency and for differences in the annual allowances for depreciation and in pre-profit reservations, a special cash-flow statement was prepared (Annex 2 C). This shows the following picture. (The bracketed figure for 1956 shows profits before the loss on the transfer of the railroad.) Profits before Depreciation. Pre-nrofit Allocations to Reserves and Taxes (in thousand Lsterling equivalent) 1952 1,042 1953 842 1954 678 1955 781 1956 427 (634) 18. There has evidently been a fairly consistent though moderate decline in the company's earning -ower in recent years. The 1956 adjusted net profits after taxes of 1370 million represent only 5.7% of the equity revalued in accordance with the replacement value of net fixed assets. This is not very satisfactory, but a substantial improvement should result from the recent removal of price controls on coal. The company s depreciation policy and methods of inventory valuation, although generally aiming at the full replacement of existing assets in an inflationary economy, have not been consistently ap-olied towards this end. It would be sound financial policy for the company to pro- vide in future adequate allowances in these respects before calculating the profits available for distribution to shareholders. III. THE PROJECT General 19. The Lota project involves essentially the concentration of operations to the new Piques Carlos Cousino mine and the simultaneous improvement and reconstruction of coal haulage installations, preparation plant, and storage and loading facilities. Development work would be pushed vigorously to provide new work areas in the so-called ttnew mine", where most of the companyts reserves of coal are located. Coal Reserves 20. The coal bearing horizon contains nine seems of coal, but not all of these are of workable thickness. In the lota mines only seams 2, 3, 4, and 5 have been worked. The new mine reserves are all located in the number 5 seam, Estimated reserves of workable coal for the old and the new mine in millions of tons are as follows: Old Mine New Mine Total Proved 3.9 10.9 14.8 Indicated -- 6.2 6.2 Inferred -- 94.5 94.5 Proved reserves are sufficient to last until 1970 on the assumption that full mroduction at 4,000 tons per day is reached in 1964. However, there is no doubt that by that time some of the presently indicated and inferred reserves will have been proved. Planned Development and Construction 21. The present output is obtained mainly from the old mine which has an estimated capacity of about 3,600 tons per day (1.01 million tons per year assuming 280 work days). The company has, however, made the conservative assumption that, in 1957 and 1958, only about 850 and 875 thousand tons respectively could be marketed. From 1959 on, the rate of output would be determined by physical rather than market factors. As the old mine reserves are worked out, extraction from the new districts would be stepped up, and there would be a gradual increase in output to 4,000 tons per day by 1964 from the better faces in these districts. In 1960, the new preparation plant and the increased efficiency of handling and haulage facilities should result in a substantial reduction in costs. At the same time, the company should be able to obtain higher average sales prices, because of reduced breakage and of improved quality of coal due to more efficient preparation. (In the finan- cial forecasts it has been assumed conservatively, however, that the rreparation plant will not be in normal operation until 1961.) 22. The shafts and main haulage roadways at Piquez Carlos Cousino through which it is proposed to bring the future output to the surface are already in existence. Underground concentration will begin as soon as the necessary connecting roadways from the old mine to the new shafts have been comnleted. These connections have already been started and will be completed in 1957/60. This degree of concentration is independent of any expansion of output but it would bring about a considerable reduction in cost by reducing the number of haulage workers. 23. Besides connecting roadways it is necessary to undertake considerable development work. To complete this scheme, over a five year period beginning in 1957, 51 kilometres of development and connecting drivage (rock tunnelling) must be worked. 24. Other underground and surface construction includes equipping of the new shaft with up to date hoisting and decking facilities, electrification of hoisting equipment of one of the old shafts, coal preparation plant, stocking facilities, machine shop, engineers' offices, safety department and lamp room, foremen's building and baths. 25. Endesa will provide about 75% of Lota's Dower requirements estimated at 44 million Kwh Der year. The rest, as in the past, will be supplied from the companyts own small thermal station. Work completed to date 26. A considerable amount of work has already been done towards the completion of the new installations including the sinking of the two shafts to the 500 metre level. Since 1952, one of the shafts has been equipped with modern hoisting machinery and decking facilities. A fan with a capacity of 300,000 cu. ft. per minute has been installed and a turbo-compressor is now being installed. A quantity of underground machinery including conveyors and mine cars has been acquired. The total cost of all this equipment installed since 1952 has been about U.S. $3.2 million equivalent. Additional orders have been xolaced for equipment on a medium-term credit basis, and at the end of March 1957 about U.S. $620,000 was still owed on this account. Another 200 million pesos have been spent for new buildings. All these investments have been financed from the company's own resources, without recourse to outside borrowing. Engineering and Construction Management 27. No planning department exists at Lota and all the planning, engineering and construction supervision for the new installations scheme has so far been carried out by the operating staff of the company. The company has agreed, however, to set up a new department responsible for planaing and development. Operating Management 28. Lotals operating staff is well qualified. In order to relieve the Chief Mining Engineer of some of the burden of daily supervision of the mine, the company will hire a qualified engineer, to whom this responsibility can be delegated. The duties of the operating staff will also be lightened by the establishment of the new rlanning department. Construction Schedule 29. According to the construction schedule, all the equipment for rock work should be delivered by the end of 1960, by which time the coal preparation plant should be completed. All the equipment for use at the coal faces should be delivered by the end of 1961, and the other installations should be finished by the end of 1962. The last deliveries of the imported equipment for which the company is seeking financial assistance from the Bank, should take place during the first half of 1962. Estimated .ost in Foreign Exchange and Local Currency 30. The cost estimates for the various items of imported equipment are based, in many instances, on recent quotations from manufacturers, in other - 8 - cases from older quotations brought up to date by what the consultants con- sidered to be suitable increments, and in one or two cases are the results of the best estimate made by the consultants from their experience of similar installations elsewhere. 31. The total future capital requirements, both in foreign and local currency, for equipment and construction work for the projected new installa- tions are set out below: Foreign ITEM Exchange Local Total (million U.S.$ equivalent) Winding, Ventilation and Compressors 1.27 0.76 2.03 Coal Preparation Plant and Conveyors 1.33 0o34 1.67 Workshops, surface traffic buildings and sidings o.62 2.89 3.51 Underground haulage and electrical equipment, incline and staple shafts, trunk conveyors 2.01 0.36 2.37 Coal face equipment 1.22 0.04 1.26 Rock development work and equipment 0.53 1.46 1.99 Accounting equipment, trucks and vehicles for moving personnel 0.45 -o 0.45 Contingencies o.68 -- o.68 Interest duzing construction 1.49 o.42 1.91 Total 6.28 15.88 32. The estimate for each item of imoorted equipment includes an allowance fcr possible price advances of 5% per year, as recommended by the consultants and also an allowance for spare parts which averages about 4%. The allowances for spares are not higher, because the company's repair shops will be able to manufacture many items, so that there will be no need to hold large stocks of spares. The contingencies item for foreign exchange costs represents an allowance of 10% on all items plus an additional 10% on the coal preparation plant. The total amount of contingencies included in the foreign exchange estimates is about $1,550,000. 33. The local cost estimates have been calculated on a conservative basis, using 1957 orices for labor and materials and adding to each item an allowance of 17%, which is the present best estimate of the increase in local prices likely to take place in 1958. The estimate for rock development work contains a very substantial contingencies allowance. - 9 - 34. It is recognised that the inflationary trends of recent years may continue during the construction period, but it is not practical to make any estimate of the amount by which the local currency investment costs may exceed the estimates on this account. The local currency financing arrange- ments (described in Chapter VI below) provide an assurance that the comnany will have at its disposal sufficient local currency resources to complete the project. 35. Subject to the above comment on the local currency elements, the cost estimates are reasonable. 36. Equi-ment and services proposed to be financed by the Bank loan will be rrocured, as far as practicable, on the basis of international competition. labor Requirements 37. When the new installations are completed, the numbpr of men required to be at work underground and on the surface of the mine (excluding workshops, preparation plant, administration, etc.), will have decreased from the nresent figure of approximately 4,600 to 3,350 and the output per man shift (underground and at the head of the shaft), should increase from 0.67 tons to 1.13 tons. In pnarticular, the output per haulage worker would be increased from the present figure of 2.5 to about 6.7 tons per shift. 38. In general, the average rate of reduction of the labor force should be no more than the normal reduction on account of retirements, etc., but careful plans would need to be made for 1961 and 1962 since in this two-year period the reduction in labor requirements might exceed this normal rate. Supervision at the Face 39. The ratio of workmen to supervisors at Lota is approximately 50:1 and this figure is completely inadequate by European (19 in the U.K.), and American standards. This indicates the need for additional supervisory personnel at the lower level to improve production and quality of work. IV. THE MARKET 40. A market analysis has been undertaken jointly by the Schwager and Lota companies according to specifications suggested by the Bank. This ana- lysis which is summarized in Annex 4 falls into two parts: a study of coal-oil competition and a detailed analysis of the demand for coal by sectors 1956-1964. - 10 - 41. Assuming -present imnort duties and taxes for fuel oil and diesel oil, the estimated future prices for coal and oil are shown to be almost exactly the same on a coal equivalent basis. This is assuming (a) an equivalent of 1.7 tons of screened coal per ton fuel oil and (b) a decline to the pre-Suez level both of fuel oil quotations f.o.b. Aruba . and of ocean freights Aruba-Chile. Both these assumptions are conservative. 42. The detailed analysis, by sectors, shows demand for coal growing rather slowly from the present level of 2,050,000 tons by 210,000 tons through 1960 and an additional 459,000 tons through 1964. Reflecting, in part, the very conservative production forecasts by both Lota and Schwager and the expected temporary decline in the production by small -nroducers (some of the mines will be closed), the total production of coal is shown to be lower than actual demand during 1957-59 and only slightly higher in 1960. According to the data presented by the companies, the combined Chilean output would again fall short of demand in 1961-62. Only in 1963, as the new Schwager mine goes into nearly full nroduction, would there be a slight temporary surplus of about 100,000 tons which would fall to negligible proportions in 1964 and subsequent years. 43. The following comments may be made regarding these forecasts by the companies: (a) The conclusion that there will be no appreciable surplus in 1957-1960 is accepted. (b) A more cautious appraisal of total demand 1961-1966 suggests that it may fall short by 150-200,000 tons per year of the company estimates. In 1961-62, this would be due mainly to faster railroad electrification; in 1963_66 mainly to n slower increase in require- ments for thermal power. (c) It would be more conservative to assume a production by small mines of 600,000 tons of coal from 1961 on rather than 525,000 tons, as assumed by the companies. Detailed reasons for these comments are given in Annex 4. They suggest possible surpluses of coal of the following orders of magnitude: 1961 250,000 tons 1962 100,000 tons 1963 400,000 tons 1964-1966 300,000 tons declining towards 250,000 tons 44. The figure for 1963 corresponds to about 15 per cent of the estimated total demand in that year. There are good prospects for eliminating or at least reducing this surplus through sales of coal to Argentina (Including sales of coking coal) and/or through additional sales to thermal power stations, 1/ The Netherlands West Indies basing point for prices of oil products. - 11 - if a new nower station is established on the mine fields to serve the Concepcion market. Nevertheless, it is better not to include these possi- bilities in a conservative appraisal of the future market. 45. (Deleted) 46. No consideration has been given above to the special measures that the Chilean Government may introduce (over and above the existing protection against fuel oil) to stimulate consumption of coal or otherwise aid the industry. According to a letter from the Ministry of Mines to the Corporacion de Fomento, dated April 2, 1957, it is a main preoccupation of the Chilean Government to secure a market for the planned output of the domestic coal mining industry. In order to achieve this end, the Government will, if necessary, take special measures to stimulate coal consumption and lower coal production costs, and also to coordinate the consumption of various types of fuels. V. kOIONOMIC JUSTIFICATION 47. Although coal was shown to be commercially competitive with fuel oil, it should be noted that import duties and taxes constitute about one- third of the price of fuel oil as compared with only a negligible portion for coal. In view of this substantial protection, the question of the economic justification for the project becomes very pertinent. 48. In the appraisal of the market, very conservative assumptions were made regarding the future world price level for oil, and attention was focussed on the part of the market where coal is in the least favorable competitive position, where sales of fuel oil are made to large consumers at no mark-up over the so-called quoted r,rice c.i.f. Chilean pnort. In appraising the project from the general economic point of view the following criteria would seem more appropriate in comparing Chilean coal with the major rival fuel, imported oil: (a) The comparison need not be based on such a pessimistic assumption concerning oil prices as is appropriate for a cautious market appraisal on which financial forecasts are based. If oil prices were to remain at about their present level, they would be about 3,000 pesos per ton higher than the prices assumed in the market study. - 12 - (b) In the same way, the most likely price for coal would reflect somewhat lower costs than those assumed for the purposes of the financial forecasts. Furthermore, even on the basis of those costs, there may be some scope for lowering the assumed prices, particularly in the late 1960's. (c) In some sectors of the market, coal is fully competitive with oil without tariff protection (e.g. coking coal for the steel industry) and in other areas coal would not need the full amount of the oresent customs and tax protection. 49. On these more favorable assumptions the average protection needed by coal would be only about 10%. This degree of protection would be more than justified by various benefits to be derived from continued coal production, namely: (a) savings in foreign exchange (roughly $70 million equivalent per year which compares with total Chilean imnorts 1955 of $399 million equivalent); (b) prevention of substantial unemployment which would occur if the mines were to close down. The mobility of labor in the Chilean coal industry is probably low due to the local concentration of the industry and the ftirly specialized type of employment. (c) the guarantee of a strategic minimum suprly of fuels. Domestic coal at the present moment accounts for about one-quarter of the total Chilean energy consumption. VI. FINANCING PLAN AND FINANCIAL PROJECTIONS Financing Plan 50. The comnany proposes to borrow $9.6 million equivalent (6.24 million pesos) from the Bank to finance foreign exchange expenditures for the project 1957-1962. The Corporacion de Fomento (CORFO) has agreed to finance that portion of the domestic currency requirements which Lota will not be able to finance out of its own resources, presently estimated at 1.83 billion pesos. According to the financial projections, the company itself would generate about 10.0 billion pesos ove rthe period 1957-1962 in depreciation allowances and net profits, most of which would be reinvested. The availability and the proposed uses of funds during the period 1957-1962 are estimated as follows: - 13 - Sources of Funds Billion Pesos $Million Equivalent Depreciation and denletion 4,209 6,475 Allocation to insurance fund 210 323 Net profits before interest 5,201 8,002 Company generation of funds 9,620 14,8o0 IBED loan 6,240 9,600 CORFO loan 1,829 2,814 17,689 27,214 Uses of Funds Billion Pesos $Million Equivalent Project Investment 10,319 15,875 Other Investments 2,299 3,537 Increase net working capital 1,835 2,823 Debt Service 903 1,389 Dividends 826 1,271 t"Additional Assetst" 1,507 2,318 17,689 27,214 ii] "Additional Assets" represents the accumulated excess of the company's sources of funds over its requirements during the neriod (as shown in Annex 6). 51. It has been assumed for ,yurioses of calculation that the IBRD loan would be for 15 years, including a five-year grace period, and would carry interest at 5-5/8%. Interest during the grace period would be capitalized, but commitment changes would be paid out of current earnings. The CORFO loan would be for 13p years with a 3k year grace period and an assumed maximum interest rate of 6%; interest would be capitalized during the grace period. The shorter grace period for the CORFO loan is justified by the expected cash generation. Financial Projections 52. Financial projections (Annexes 5 and 6) are based upon the following major assumptions: - 14 - (a) Lotats sales of coal will increase from 850,000 tons in 1957 to 1.08 million tons in 1962 and 1.12 million tons in 1964 and future years. These projections are justified by market prospects. Apart from the market, the major present limitation on Iotals potential output is the availability of proven reserves. When suffieient additional reserves are proven, it would take only very limited investments to raise Iota's output to 5,000 tons per day as compared with the presently contemplated maximum of 4,000 tons. (b) The projections reflect present prices for coal and an exchange rate of 650 pesos per U.S.$. It is assumed that any cost increases due to further depreciation of the Chilean currency (whether in the form of higher costs for imported equipment or increases in wages and other domestic cost elements) will be pased on in the form of higher prices. (c) Projected production costs, verified by the Bank's consultants in July 1956 have been updated. They are now based upon the actual costs during the last quarter of 1956 adjusted for a 30.16% increase in wage rates and a 35A expected increase in material prices as well as for estimated increases in prices for electric power and in indirect costs. Allowance has also been made for the cost of additional engineers and foremen. Finally, provision has been made for additional depreciation based upon current replacement costs and for future wage increases (not compensated by price increases) of 0.75% per year. Since substantial portions of the new project will come into operation ia the course of the construction period, and depreciation on each item begins as it is taken into operation, there is a rapid increase in depreciation allowances throughout the construction period. (d) 1957 sales returns have been reduced by 93 pesos per ton cor- responding to aprice concession to railroads and gas companies. This is a special contribution by the coal companies to the Government1s anti-inflation program, and these concessions will bewithdrawn from 1958 on. (e) Although the new coal preparation plant is scheduled to be operating from 1960 on, it has been assumed conservatively that the corresponding gains through lower production costs and a higher average sales price will only occur from 1961 on. (f) The total cost of development drivages in the period 1957-1961 will be about 3,300 million pesos, of which about 2,025 million will be charged to cost of -roduction and 1,275 million will be capitalised. From 1962 on, all development work will be charged to cost. These cost assumptions are very pessimistic, being based on a rate of advance of only 800 metres per year, whereas a rate of 1,200 metres is probable and a rate of 1,500 metres possible. - 15 - 53. The following additional assum2tions have been made for the cash flow forecasts: (a) Interest (but not commitment charge) on the proposed Bank loan and interest on the CORFO loan would be capitalised during the respective grace periods. (b) Investments for renlacement and modernization outside the project investment will correspond to one-half of the annual depreciation and depletion allowances during the period 1957-1966. After that time, it is assumed that the full annual depreciation and depletion allowances would be used for replacements and modernization. In addition, the company will reserve 5 per cent of their net nrofits for workers and employees' housing. This sum is included in the project investment (local expenditure) for the years 1957-1961. (c) Dividends during the construction period will be limite6 to 20 per cent of earnings after taxes and will rise in 1962 and future years to 750 million pesos, corresponding to about 50 per cent of earnings after profit participation by workers and manage- ment and taxes and about 7 per cent on a realistic valuation of the company's equity at the end of 1962. 54. The above nrojects show an increase in Lota's annual net earnings after taxes from an estimated low of 275 million pesos for 1958 to 742 million pesos in 1959 as production picks up and to 1,230 million pesos in 1961, as the benefits from the new preparation plant start accruing. From 1962 on, the profits would vary roughly between 1,400 and 1,700 million pesos per year. Using a figure of 1,500 million pesos and relating this to a revalued equity as of the end of 1962 of 10.75 billion pesos, this would correspond to a return of about 14 per cent, which is very satisfactory. 55. The debt service coverage on the combinedIBRD and CORFO debts would be acceptable for this type of industry, varying between 2.7 and 2.9 over the years 1963-1968. The cover would not be jeopardised even if output and sales fell considerably below the estimated levels. A 20% fall in sales would still provide the company with sufficient funds to cover its debt service requirements about 2.0 times in 1963 (as compared with the estimated cover of 2.7 times). 56. The company's latest balance sheet as of December 31, 1956 and pro forma balance sheet as of the end of the construction period December 31, 1962 are shown below. In the 1962 balance sheet, amortization payments falling due in the year 1963 are treated as current liabilities, and have consequently been deducted from the long-term debt. (Figures in million pesos) - 16 - Dec. 31, 1956 Dec. 31, 1962 Dec. 31, 1968 ASSETS Current Assets 2,912 6,118 6,312 "Additional Assets"l 1,507 3,381 Sundry Assets (non-current) 686 686 686 Fixed Assets 3,220 15,838 20,536 less Depreciation and Depletion -J73 -4,582 -10,943 Net Fixed Assets 2,847 11,256 9,523 Total Assets 6.445 19,567 19,872 LIABILITIES AITD EQUITY Current Liabilities 1,869 3,887 4,272 Long-term debt, IBRD _- 5,510 1,901 CORFO -- 1,391 244 Various Provisions 634 844 1,262 Capital, Reserves, and Surplus L942 7235 12,193 Total Liabilities and Equity 6,445 19,567 19,872 RATIOS Net Current Assets to Sales 17.8% 17.8% 17.8% Debt to Equity __ 44:56 14:86 57. In calculating the ratio of net current assets to sales, the whole debt service payments for the year 1963 (i.e. not on1y the amortization quotas included under current liabilities in the above pro forma balance sheet) have been regarded as current liabilities. 58. The above pro forma balance sheet as of the end of December 1962 shows a sound financial position with respect to both liquidity and capital structure. Since the fixed assets were undervalued at the end of 1956, the debt-equity ratio at the end of 1962 would actually be better than that shown above. - 17 - VII. PROPOSED PROTECTIVE FINANCIAL AR.AYGEMENITS 59. If a Bank loan is made for this project, the contractual arrangements should include undertakings by the company: (a) to limit cash dividends during the construction period to say 20% of net earnings (after taxes and profit participations by workers and management) accumulated since December 31, 1956. The obj˘ct of this limitation is to ensure that most of the earnings are reinvested during the construction period. (b) to refrain from paying cash dividends which would unduly reduce the net working capital, which needs to be the equivalent of about one-sixth of annual sales. (c) not to incur additional long-term debt (aDart from debt incurred to meet the expenses of the project) if as a result the total amount of long-term debt would exceed the equity. (d) not to incur short-term debt except in the ordinary course of business for working capital purposes, or by way of interim financing to be repaid out of the proceeds of the Ban-k loan or the loan to be obtained from CORFO. Iquiqueu ) r TocopIlla S Antofogasto / C VolIenorJ T.1 LoSreno ! Coqimb, -.o BUENOS AIRES Volparotso \SANTIAGO MAP OF NORTHERN Son an,on,ol N AND 2 / xJ oS CENTRAL CHILE |ICO ^ ! SHOWING LOCATION OF gIc mS. GOLFO DE ARAUCO AREA HbOOn polo / f Concepci Chilln SCHWAGER gs t Go/foe de 9 AroC i f Temuco MAIN ROADS MAIN RAILROADS ld ) Z U \~~~~~~~SOUTH AMERICA) Corrol w 0 on trot MonEt AREA Aniofi6 w \ g COVERED sr m4p 0 100 200 500 400KM JUNE 1957 IBRD-342 Annex 2 A Comnpania Carbonifera e Industrial de Iota Su=mmry Balance Sheets. 1951 - 1956 (million pesos) Fiscal Years Ended Dec. 31 1921 1952 1954 1 1956 End of year exchange rate 230 340 355 560 840 1510 (pesos per r sterling) ASSETS Cash 13 47 16 48 105 67 Receivables (net) 154 242 336 456 635 1164 Inventories 5A 138 ~29 168 Total Current Assets 351 602 706 892 1372 2912 Bonds and Shares, held by company 19 124 100 369 742 512 nt n n ,deposited under guarantee agreement 47 62 135 91 305 173 Transitory Assets 6 1 _1 1 fl Total Sundry Assets 72 187 235 473 1048 686 Mining Property 346 566 559 559 1090 1090 Buildings,Plant,Equipment,etc. 332 318 337 390 900 1202 Railroad, Vessels, etc. 215 255 294 231 458 8 Workers,Housing & Welfare Facilities - 202 238 232 566 635 Farms and Forests -- 44 48 48 112 112 Work under Construction 18 46 191 266 11L 173 Gross Value of Fixed Assets 912 1431 1667 1726 3240 3220 less Depreciation allowed by tax laws - 247 - 149 - 205 - 244 - 216 - 312 Additional Depreciation - 5 - 28 - 28 -JL3 - 61 -___ Net Fixed Assets 659 1253 1434 1439 2963 2847 Total Assets 1082 2042 2375 2804 5383 6445 LIABILITIES AND EQUITY Current Liabilities 49 50 102 166 256 1025 Other Liabilities ?2 90 "A A" Total Liabilities 150 309 365 507 702 1869 Various Reserves (or Provisions) 90 179 271 327 531 634 Share Capital 369 369 1200 1200 1320 1500 Revaluation Reserve for Inventories -- - -- -- -- 212 Revaluation Reserves for Fixed Assets 183 828 154 205 1495 1201 Reserves for Fluctuations in Security Values 34 41 149 212 871 508 Other Reserves and Accufulated Profit 256 36 236 25 464 520 Total Equity 842 1554 1739 1965 4121 39413 Total Liabilities and Equity 1082 2042 2375 2804 5383 6445 General Remark: The above headings have been suzmarized and rearranged in accordance with Bank practice. The classification, by major groups of assets, however, agrees with the published balance sheets. Accounts are audited by Price Waterhouse & Peat Co. Footnotes to certain items: Buildinas. Plant, Equinment, etc.: The 1951 figure includes workeral housing and welfare facilities. Farms and Forests: Not separately stated in 1951. Inventories: Lota values its inventories for coal (345 million pesos at the end of 1956) according to the "First in First out" method. There have been repeated changes in the methods of valuation for other inventories (700 million pesos at the end of 1956). In 1951-1953 and throughout most of 1954, materials from these inventories were charged to operations according to the average cost of acquisition. In 1955, the company started applying a variant of the "Last in First out" (LIFO) method, charging materials to operations according to the "last cost at sight." The application of this method in a period of run-away inflation resulted in substantial credit balances on these inventory accounts. To compensate for thia more than desired write-down, the company decided to value its final inventories as of December 1955 at December 1953 prices. The final 1956 inventories were revalued at current prices and the difference be- tween current values and previous book values was credited to a special reserve for revaluation of inven- tories. Although the valuation procedures used would appear unnecessarily complicated, In the end they prob- ably came close to minimising book gains or losses on inventories other than coal. For coal, the use of FIFO in 1955 and 1956 apparently resulted in book gains on existing stocks of about 50 and 100 million pesos respectively. Other Liabilities: In fact, these are also of a current nature. Annex 2 B Compania Carbonifera e Industrial de Iota Summarr Profit and Loss Statement. 1951 - 1956 (million pesos) Fiscal Years Ended Dec. 31 1951 1952 1 1L End-of-year exchange rate 230 340 355 560 840 1510 (pesos per t sterling) INCONE Sales of coal 995 1126 1596 2348 3910 5846 Income from Ceramics plant,shipping,ete. 89 54 - -- - - Interest 12 22 41 44 105 222 Extraordinary revenue 11 - 8 L0 _ 55 1107 1202 1645 2432 4046 6123 EXPENDITURE Wages and Salaries,Materials & Supplies 688 591 952 1327 2274 3405 Social Security & Welfare Payments 182 265 327 524 951 1464 Depreciation of Fixed Assets allowed by tax authorities 47 60 58 62 84 103 additional 5 23 - 20 42 - Write-down of invest.,secur.,receiv. 11 10 13 27 42 9 Write-down of coal stocks - - -- - -- 82 Sundry charges 38 56 76 120 231 272 Extraordinary expenditure -- - - 47 -- 243 Interest 5 13 19 38 80 123 Income & Real Estate Taxes 33 60 58 94 124 140 Net Profits 98 125 142 172 217282 1107 1202 1645 2432 4046 6123 Ave. Equity and "Provisions" (932) 1353 1892 2154 3437 4628 Profits after Income Taxes/Ave Equity and Provisions (10.5)% 9.3% 7.5% (8.0)% 6.3% (6.1)% Footnotes to certain items Extraordinary expenditure: The figure for 1954 represents loss on sale of vessels to new subsidiary; the 1956 figure is composed of loss on operations of Concepcion - Curanilahue railroad (152) and on the sale of this railroad to the Government (75) plus certain related expenses (16). Write-down or coal stocks and Inventory Valuation: See footnote under balance sheet. Ratio of Profits to Equity: Percentages within brackets are misleadingly high since in those years there was no revaluation of assets in spite of substantial inflation. Depreciation Allowanc4a: The differences between the figures in Annex 2A and those in thie Annex are explained in the footnote to Annex 2C. Annex 2 C Cocpania Carbonifera e Industrial de Lota Sourceo and Allocation of Funds Fiscal Years Ended December 31 1952 193 1954 1955 1956 1252 1953 15 1955 1956 in million pesos in thousand f-sterling squivalent End-of-year exchange rate (pesos per Z) 340 355 560 840 1510 340 355 560 840 1510 SOURCM Depreciation allowances 83 58 82 126 103 291 167 179 180 88 Reservations before net profits 89 92 56 204 104 312 265 123 291 88 Net Profits after Taxes s12 142 172 217 295 432 409 376 310 251 Total Sources 297 292 310 547 502 1042 841 781 427 ALLOCATION Plant and Equiprent 32 225 36 260 356 112 648 79 371 303 Loss on Donation of Railroad -- - - - 75 -- - - -64 Sundry Assets 108 -60 134 -42 1 379 -173 293 -60 1 Increase in Net Working Capital 92 48 44 285 161 323 138 96 407 137 Dividends 6_5 79 96 44 59 228 228 210 63 50 Total Allocation 297 292 310 547 502 1042 841 678 781 427 Footnotes Conversion into Sterling: This conversion has been made at the average of the market rate at the beginning and the rate at the end of the Special Cmoent Regarding 1956: But for the extraordinary losses on the donation of the Concepcion - Curanilahue railroad and on the operation of this railroad, the gross profits (- total sources in the above table) would have been higher by t 207,000. Plant and Ecluipment. Sundry Assets, Net Working Capital: Changes in the revaluation reserves for fixed assets, securities, and inventories have been excluded from the "Sources." The above figures therefore do not include revaluation gains (except possibly, to a minor extent, in inventories). Net Protits after Taxes in 1956: The figure shown here corresponds to the figure shown in the profit_and-logs statement (282 million pesos) plus profits from the sale of certain assets (13 mllion pesos) credited directly to a special reserve. Plant and Ikuinaent and Depreciatlon Allowances: The totals shown above are higher than the net increases in the Fized Assets and Depreciation accounts shown In the balance sheets In Annex 2A. The differences represent the gross value of assets retired during the year and the accumulated depreciation on these assets. ILOTA MINE Annex 3 Schedule of Develonment Drivages (in metres) Section in sq. metres 17 12.5 11 Starnle Shaft Total Year 1957 5,940 5,960 -- -- 11,900 1958 5,620 6,200 - 120 11, 940 1959 2,700 6,ooo 1,446 -- 10,140 1960 2,760 5,740 3,080 -- 11,580 1961 720 4,320 680 -- 5,720 1957-1961 17,740 21,220 5,200 120 51,280 Annex 4 The Market for Coal The General Energy Picture 1. In 1952, coal accounted for somewhat less than 30% of the total Chilean energy consumption (excluding gasoline). Firewood and black oils were resnonsible for about 25% each, and hydro-power supiolied the balance of 20%. 2. Apparent consumption of coal rose from 2.2 million tons in 1950 to a high of 2.6 million tons in 1952 and has since declined steadily to about 2,1 million tons in 1956 (prelininary estimate). Imports have averaged about 0.2 million tons during the last four years, representing mainly imr-orts of coking coal by the Chiloan Steel Company. Lota and Schwager over th4 same neriod supplied 74-77% of the Chilean output; the balance was provided by several small mines. The stagnation in coal output is explained by the lack of ecoromic expansion and, to a lesser extent, by loss of markets to oil. 3. Chile is very rich in hydro-nower resources, wthich have thus far been only partially developed. Long-range plans aim towards an even supply of hydro-Ebwer throughout normal years, taking advantage of the different seasonal flows at Oifferent latitudes and the large potential storage capa- city of highland lakes. In these schemes, thermal power will nlay only a very limited role. 4. The consumption of blackr oils (fuel oil and gas/diesel oil) was statiorary in the period 1947-1953. Very heavy taxes and import duties (together they represent over 50% on the c.i.f. value) are levied on these fuels. These were comnensated to some extent by preferential exchange rates (now abolished) which are said to have been responsible, at least in part, for the increase in fuel oil consumption from 850 thousand tons in 1953 to 970 thousand tons in 1955 and in gas/diesel oil consumption from 160 to 230 thousand tons. Two-thirds of the fuel oil is used by mining companies (mainly copper and nitrate mines), and the remainder mainly for general distribution in Central Chile. According to the market study maae by the coal companies, and from information supplied by Empresa Nacional de Petrolio, consumption of fuel oil (primarily for genpral distribution ) would rise from 970 thousand tons in 1955 to 1.4 - 1.6 million tons in 1965. 5. Of great potential importance is the recent development of crude oil and refinery nrodurtion in Chile. The production of crude in the Magallanes fields rose from 400,000 cu.m. in 1955 to 60o,000 cu.m. annual rate in August-October 1956. Most of this crude is shipped to the new refinery at Concon near Santiago with a reported capacity of 850,000 tons of refined produrts per year, of which about 100,000 tons would be gas/diesel oil and 250,000 tons fuel oil. The planned increase in the capacity of this refinery would further increase the potential supply of fuel oil to about 580,000 tons. Another nossible source of fuel for Chile is natural gas from the Bolivian fields which, according to a recent project, would be piped to the copper mines in Northern Chile. - 2 - 6. The initial effect of increased Chilean rroduction of crude and of supnlies of 3olivian gas would be to displace imported crudes rather than to displace coal. Since only 25% of the refinery yield would be fuel oil, it would take about 3.9 million tons (4.4 million cu.m.) of Chilean crude to suprly even the present consumDtion of fuel oil. This does not take into account nossible limitations in refining capacity. In conclusion, although such spectacular increases in Chilean production of crude and refined products cannot be entirely ruled out, these possibilities are not so imminent as to justify their consideration in the forecasts for the future coal market. The competition between coal. and imnorted oil, on the other hand, is of great importance. Competition Coal-Oil 7. Coal and oil are in competition for virtually every segment of the fuel market: power stations, industries, households. The following figures summarize the competitive position of the two fuels at the present moment at San Antonio (representative for coastal locations) and Santiago, the largest inland market. TABLE 4 A Comparison of Coal and Oil Prices (pesos per ton oil equivalent)V Delivered Delivered Quoted Cost Cost Price Ex Mine San Antonio Santiago Santiago Price for screened coal 18,?85 23,763 25,177 28,184 Price for slack 17,800 23,266 25,276 28,158 Estimated prices for fuel oil#6 Full "normal" price J 27,900 31,120 Net "normal" rrice, including sales tax 4' 23,710 27,270 1 In agreement with the companies, the following equivalents were used: 1 ton of fuel oil = 1.7 tons of screened coal or 2.0 tons slack This takes into account differences in thermal values as well as the greater convenience of fuel oil. / As explained in the text, the "normal" price has been estimated after suit- able deductions for the recent inflationary increases in oil nrices and ocean freights, The "full" normal price corresponds to the quoted price, including distributive mn-rk-up and sales tax. The net nromal price excludes the distributive mark-up, and because of this exclusion the sales tax is also lowered. 8. It is assumed that the price for fuel oil c.i.f. Chilean port in September 1956 represented a normal market level. The current market price is higher for two reasons: (a) an increase in the basis quotation f.o.b. Aruba, Netherlands West Indies (b) a substantial increase in the freight allowance Aruba-Valparaiso. The increase in the Aruba quotation is mainly a reflection of higher crude values resulting' from the Suez crisis; while the increase in tanker rates reflects the abnormal shortage of tanker space. A conservative assumption is that both the f.o.b. quotation and the freight allowance will recede to the rre-Suez level. A further decline in the Aruba quotation below the -re-Suez level is not likely. 9. The coal companies have no information on the rebates, if any, below the full price secured by major oil consumers. According to infor- mation received by the Bank, the Chilean State railroads pay only the net or nosted nrice for diesel oil, and experience from the United States suggests that the same may be true for the consumption of fuel oil by large utilities or industrial concerns. It is conceivable, however, that, in some important areas of competition between oil and coal, the oil companies in Chile would not be willing to forego the whole of their mark-up over the posted price. The comparison with coal on the basis of net prices plus sales tax for oil, therefore, rests upon the most unfavorable assumption for coal. On this conservative basis, coal would be somewhat less exnensive than fuel oil at the nort of San Antonio but would be slightly more expensive at Santiago. This continued close ccrpetition with oil should be kept in mind in the following review of the market nrospects, by sectors. The outlook for demand, by sectors 9. The following table shows the present and the estimated future consumption, by sectors, according to a market study prepared jointly by the two companies: TABLE 4 B 1956 1958 1960 1962 1964 Actual Mines own consumption 11 150 150 150 150 150 Railroads 522 507 22 40 389 Chilena Electricidad 81 218 227 462 574 Gas de Santiago 167 139 100 80 80 Other gas companies 47 48 48 21 22 CAP 325 335 335 450 570 Cement industry 214 204 240 260 261 Mining industry 45 45 95 95 95 Other indul try 259 313 333 357 376 Shipping 141 112 85 83 50 Other 100 114 126 __i 153 2,051 2,051 2.185 2,261 2537 2,720 " "Mines consumption"' includes consumption by Araveo and Coronel shipping companies, which consurntion is therefore excluded from shipping. - 4 - TABLE 4 B (continued) Actual or Estimated Production Lota 960 873 1,042 1,080 1,109 Schwager 724 650 723 812 1,120 Small Mines 500 662 496 645 491 2,184 2,185 2,261 2,537 2,720 Deduct: Increase instocks (-133) = Consumption 2,051 / For 1958-196.4 the figures shown for small mines represent the difference between the estimated total consumption and the estimated production by Lota and Schwager as shown in their financial forecasts. 10. The following comments may be made regarding these estimates: Railroads. The exmected decline in consumption is attributed to the elec- trification of the Santiagc-Chillan section estimated to take place between 1958 and 1960. According to the Bank's railroad consultant, this electrifi- cation would, within the course of roughly one year (say, the year 1961), reduce coal consumption by about 220,000 tons (based upon information supplied by the Chilean State Railways April 24, 1957). The companies, relying also upon information supplied by the State Railways, have estimated that the re- duction in coal consumption attributable to electrification (plus some addi- tional dieselization 1964-1966) would be about 47,000 tons in 1961 and would rise gradually to about 220,000 tons in 1966. The reasoning behind these different assumrptions will have to be clarified. Ultimately, the State Railways would hope to electrify the branch lines to San Antonio and Concepcion and also the southward extension of the nain line (to Temuco and Puerto Montt). No time schedule has been fixed, anI the Bankls consultant regards it as unlikely, for financial reasons, that this scheme would be initiated over the next ten years. The same is true for dieselization of sections which are not to be electrified since the transfer of steam loco- motives from electriLied lines is likely to postpone the date that diesel- ization can be considered. No redundant locomotives could be transferred to the Northern Section, however, since this section operates on a different gauge. Complete dieselization of this section (not presently contemnlated) would mean the further loss of a market for about 4k,000 tons of coal. Chilena Blectricidad. This is a subsidiary of American & Foreign Power which owns about 164,000 kw of generating capacity in the Valparaiso-Santiago region, and distributes about 75 % of the total energy sold in that region. The Valparaiso-Santiago region accounts for about 75% of the total consumption in the areas to be included in the Interconnected Endesa system. (Endesa is the Government corporation responsible for overall planning and development of Chilean rower resources.) According to plans subnitted by Endesa in M5y 1956, consumption and output of power were expected to grow in the following manner over the next decade (million kwh): TABL, 4 C 1956 1958 12 S 1962 1265 Total consumption 2,069 2,660 3,484 4,o68 4,997 Hydro-production (firm power only) 1,974 2,380 3,799 4,183 4,352 Required thermal productioni 95 280 176 129 645 Available thermal power 285 329 356 429 647 of which 3rd region (Valparaiso-Santiago) 270 270 330 410 630 3rd region from new stations - - 16o 240 420 The thermal production shown is that portion which cannot be replaced by hydro-power. In 1960 and 1962 there would be an excess of hydro-power. 4 . According to the original plans, new thermal capacity would be commissioned in 1960, 1961 and 1965. Since then the plans have been revised. TwO 50,000 kw thermal units equipned for dual firing (coal or oil) have been ordered, and would start operating in the Valparaiso-Santiago region in 1961. Moreover, instead of supplying the balance which could not be provided by hydro-power, these new thermal units would operate as base-load plants. This would represent a total generation of 6oo million kwh (based upon 8 months) from 1961 on, assuming the old thermal plants were put on a stand-by basis. Using a factor of 0.7 kg of slack per kwh, this would mean a total coal consumption of 420,000 tons per year. This agrees reasonably well with the coal consumption shown in the table under para.9. According to tentative plans, Endesa would install an additional 150,000 kw of thermal power by 1966. The estimated total coal consumption is given as 565,000 tons corresponding to about 800 million kwh which suggests that this additional capacity would be used mainly for peak loads. >2 In conclusion, present Endesa plans indicate a reasonably assured outlet for about 420,000 tons of coal for thermal power from 1961 on. Any increases above this level are at this moment highly speculative since they would depend upon the role assigned to thermal power (whether base-load or peak-load), and where base-load use is contemplated, upon the relative advantages by 1965 of conventional steam power as compared with hydro-power or atomic power. According to the information received, the new -50,000 kw unit would use oil or coal depending upon the relative cost nf the two competing fuels at any one moment. In view of uncertainties regarding the future coal-oil price relationship, thermal power generation cannot be counted as an assured market for coal. Nevertheless, in view of the present Government policy of favoring - 6 - Chilean coal, it has been assured that the companies can plan for minimum annual sales to power stations amounting to 420,000 tons. Cia Acero del Pacifico. At the present moment, this steel mill is using a 65/35 blend of Chilean and imported United States coal, corresponding to a consumption of Chilean coal of about 330,000 tons of which Schwager and lota each sup ly about one-half. Based upon an estimated 73 per cent increase in CAPts coke require- ments by 1964 and an unchanged proportion of Chilean and imported coal, CAP's consumption of Chilean coal would increase to 570,000 tons. The price for imrorted coal was $17.40 c.i.f. in January 1956 and $18.80 in Jamary 1957 corresponding to Ch. pesos 11,310 - 12,220 per ton. This compares with the present price for washed slacks of 9,945 pesos rer ton ex mine Schwager or Lota. Since Chilean coal is competitive with imported coal, the companies should be able to reach the above sales target, assuming that the expected increase in steel-mill operations will be achieved. Gas Oomnanies. The estimated decrease in coal consumption is due to the fact that both the Santiago and the Valparaiso gas companies expect to receive refinery gas from the Concon oil refinery. Other consumers. On balance, an increase of about 120,000 tons is expected between 1956 and 1960 and a further 71,000 tons between 1960 and 1965. There would be substantial increases for sugar factories, metal smelters, cement plants, and breweries, while there would be a substantial decline for shipping companies. This forecast appears optimistic in some respects (continied use of 50,000 tons of coal by shipping companies, consumption of another 50,000 tons by a new smelter at Papudo, a further 55,000 tons by new beet sugar factories, increased consumption by PaPeles y Cartones). On the other hand, some as yet unforeseen industrial expansion will undoubtedly take place between now and 1965. 11. In the past the two companies have had certain difficulties in disposing of their slack coal (coal under 3/4t1 size, representing about 40 per cent of the total output). Thus, the stocks of slack at the mines increased from 26,000 tons on December 31, 1955 to 123,000 tons as of April 10,1957. Both companies at present have facilities for washing some of their slacks but these washing plants are outmoded, and only limited quantities are actually washed. Both the Iota and the Schwager proj4cts include new coal preparation plants, and in the new plants all the coal would be washed except fines under 1/811 as compared with the present cut-off points of 3/411 - l's. These fines would either be burned in the companiest own thermal plants or mixed back with the slack for sale to certain customers, e,g. cement plants. The lower cut-off point for the cleaning and the in- creased possibilities of mixing the small fines with cleaned slack are expected to do away with the special marketing problem for slack. The new Schwager coal preparation plant would be in operation from January 1, 1960 on, while the Iota plant would start January 1, 1960 at the latest. -7- One special problem concerns the sale of metallurgical coal to CAP, which can only use coal with a maximum sulphur content of 1.2 - 1.4 per cent. While this presents no problem for Lota, only about 30 per cent of the present Schwager output meets this standard. This is only slightly in excess of the quantities Schwager would hope to sell to CAP by 1964. While the risk for insufficient availabilities of such coal cannot be entirely ruled out, analyses of coal from the seams struck on the other side of the Linderos fault in Schwager suggest that, in fact, the proportion of low- sulphur coal will be substantially higher in the future. Output by Small Mines 13. The market for Schwager and Lota also depends upon the output that may be expected from the small coal mines. over the period 1948-1956, fifteen small mines operated during one period or another. Eight of these mines never produced more than 5,000 tons per year; six of these have been closed since 1953 and the remaining two ceased operations this year. The development of small mine production since 1948 may be seen from the following summary (th. tons): TA3LE 4 D 1248 1950 22f2 1954 1956 Colico Sur 40.9 59.5 98.9 109.8 128.5 Pilpilco 40.0 70.9 84.9 95.3 106.2 Victoria 5.9 41.3 47.0 56.o 55.4 Plegaria 128.0 - - 27.3 60.1 Catamutun (lignite mine) - - - - 27.1 El Chilco 3.9 11.5 25.4 22.7 4.4 Lirquen (lignite mine) 138.0 126.5 152.7 132.4 113.1 Other 12.2 2.6 1.6 7.8 5.0 369.1 312.3 41o.5 4.513 499.8 24. The above mines are all located in the Concepcion and Arauco area. The first three mines are partly owned by Corfo. All except Lirquen sell a major portion of their output to the railroads. Only Victoria and Lirquen have facilities for shipping their coal by sea. There has been a fairly steady increase in their output in recent years. On the basis of these past trends, Lota and Schwager estimate that the small mines might produce as much as 750,000 tons by 1965. In early May 1957, however, there were indications that two of these mines may be permanently closed; the Victoria mine which is being operated at a substantial lose and the Plegaria mine where safety conditions are said to be unsatisfactory. Although no final decision has been reached, it now appears likely that the 1958 output from the small mines would not be much above 400,000 tons, and that 600,ooo tons would be an absolute maximum for 1962 which might result e.g. from the planned expansion at Colico Sur to 200,000 tons (1960) plus various minor increases from other mines. According to the most recent forecast made by the Mines Department, with which Iota and Schwager concur, it is, in fact, unlikely that production would exceed 525,000 tons. Conclusion 15. In conclusion, although the market forecast prepared by the companies is based upon generally conservative assumptions, it is subject to considerable uncertainties,in the following respects: (1) consumption by railroads, in particular 1961 and 1962 (2) consumption by power stations from 1963 on (3) output by small mines from 1963 on. An idea of the possible reductions in the sales by the two companies as a result of these factors is shown in Table 4 E, This table suggests possible surpluses of coal of the following orders of magnitude: 1961 250,000 tons 1962 100,000 tons 1963 400,000 tons 1964-1966 300,000 tons declining towards 250,000 tons 16. The figure for 1963 corresponds to about 15 per cent of the estimated total demand in that year. There are good prospects for eliminating or at least reducing this surplus through sales of coal to Argentina (including sales of coking coal) and/or through additional sales of thermal power, if Endesa agrees to establish a new -nower station on the minefields. Nevertheless, it is better not to include these possibilities in a conservative appraisal of the future market. TABUE 4 1 IAtinated consumption and supl_les of coal and DQssible surDluses. 1956-1966 (thousand metric tons) l96 i2 19S8 I295 1960 1961 1962 1962 1964 1965 1966 Estimated Consumption 2,051 2,055 2,183 2,224 2,260 2,332 2,536 2,585 2,719 2,729 .2,732 Estimated SuDolies (Original Compam' Estimates) Lota 960 851 873 1,026 1,042 1,053 1,081 1,081 1,120 1,120 1,120 Schwager 724 650 650 712 723 747 812 1,085 1,120 1,120 1,120 Small mines (500) 510 390 465 525 525 525 525 525 525 525 Increase in stocks (-133) -- -- -- - -- -- -- -- -- -- Deficit (+) or surplus (-) -4 208 21 - 30 7 118 -106 -46 -36 -33 Total Supplies 2.051 2.055 2.183 2!2 2.260 2.332 2.536 2.S8S 2.719 2.Z29 2.732 Revised Estimate of Possible Surpluses Surplus (A-), as above -44 -208 -21 30 -7 -118 106 46 36 33 Reduced demand by railroads -- -- -- - 173 115 53 38 18 47 Reduced demand by power stations -- - -- -- -- 42 154 154 154 154 Possible additional output by small mines - - 75 7 5 75 75 Total Surplus -44 -208 -21 30 241 114 388 13 285 262 Comufnoia farbonifera a Industrial de 1Iota Costs and ]mrninRs ProJections. 1957 - 1968 Jiscal Years hdod Dec. '11 1252 19S8 1 12 1964 196 6k 12t2 92 Output of law coal th. tong 851 873 1026 1042 1053 1081 1081 1120 1120 11p0 1120 1120 Kips Consumption & Washing losses th. tons _M , 9l 114 Juzz i32 M1 -)h2 _1k _13 -ik 1U Sales of Coal th. tons 750 780 912 915 914 944 944 979 979 979 979 979 DOrset minin. Coots poses per ton rav coal Waoes a Salaries 3411 3387 3015 2817 2631 2220 2236 2196 2211 2Z27 2242 2258 Other 201 172 1910 1910 190S 19S. 1I0 1O5 1905 Total Direct Costs 5329 5478 4932 4679 4582 4130 4146 4101 4116 4132 4147 4163 Indirect N-nin, Costs Was & Salaries 495 486 416 412 412 404 407 400 403 406 409 412 Depreciation & Depletion 282 506 649 817 936 967 972 948 948 948 948 948 Provisions for Inture Development -- -- - -- -- 133 133 133 133 133 133 133 Other -1j51 1282 1Z58 4" f91 118 1162 114j 5 1145 1j Total Indirect Costs 2Z82 2451 2347 2487 Z591 2703 2696 2643 2642 2632 2635 2638 Total mining Costs pesos per ton raw coal 7611 7929 7279 7166 7173 6833 6842 674 6758 6764 6782 6801 total minim Costs pesos per ton coal sold 8636 8874 8189 8161 8264 7825 7835 7715 7731 7738 7759 7781 Washing & Sales Expense pesos per ton coal sold 695 695 699 700 401 390 380 380 380 380 380 380 Income tax (18.1%) pesos per ton coal sold 105 78 168 262 297 358 329 361 365 371 375 379 Workers' and hxecutives' Participation pesos per ton coal sold 50 37 182 216 225 240 235 242 244 246 249 250 Coshitsent Charges and Bond Interest pesos per ton coal sold 29 45 29 16 124 292 446 391 350 308 262 215 SPecial Service Obares to CO RO peos per ton coal sold - I- -S .. .S 6 0 O 7 Total Cost pesos per ton coal sold 9515 9729 9267 9355 9311 -910 9230 9094 9076 9049 9031 9012 Average Selling Price pesos per ton coal sold 29 10081 10081 1OC81 10657 10726 102 10726 10726 12 1072 10726 let Profit after Taxes pC5o5 per ton coal sold 473 352 814 726 1346 1618 1496 1632 1650 1675 1695 1714 total Net Profit million pesos 355 275 742 664 1230 1527 1412 1598 1615 1640 1659 1678 Not Profit before Bond Interest aillion pebos (1347) (1818) (1858) (1989) (1965) (1948) (1921) (1893) Aimex 6 ComPoaia Carbonifer e Industrial de Iots Cash Plow Pro1ections. 1497 - 1968 (millions of Pesos) 1957- Poe1a Years kda.e Dec .1 125 5 12 Q 1 12t11 22Z 12 1261 1264 12§i 1Z 2 Depreciation and Depletion 240 442 666 830 986 1045 4209 105. 1062 1062 1062 1062 1062 Allocation for development oharged to cost 335 453 443 488 310 436 2465 436 436 436 436 436 436 Allocation for accident insurance charged to costli 15 23 31 39 47 55 210 63 71 71 71 71 71 Net Profits before boni interest, after taxes jj .zj 742 664 j 11181 520i iA5 12E2 i 12t- 4 21 ai C°opan°'s onn generation of funds 945 1193 1882 2021 2690 3354 12085 3408 3558 3534 3517 3490 3462 IBlD loan 1094 1091 1301 1609 679 466 6240 - -- - -- -- -- 00CB0 lon 785 640 300 1C4 _ -- 10Z1 - _ total Sources 2824 2924 3483 3734 3369 3820 20154 W8 355B 534 3517 3490 3462 AIJ.OCAT-IOT OF POND Project Investeent 1799 2132 2419 2385 949 635 10319 - -- - -- -- Other Investsente 335 221 333 415 483 512 2299 605 613 613 613 1127 1127 Mine Developsente I 335 453 443 488 310 436 2465 436 436 436 436 436 436 Increase in let Working Capital 297 60 230 80 100 10683/ 1835 - 70 -- -- -- -- Interest IBPD loan -- -- -- -- -- 176 176 331 303 273 242 208 173 Interest ORO loan -- -- -- -- 107 99 206 90 80 70 60 49 37 Amortization LBRD loan -- -- -- -- -- 237 237 493 522 551 582 616 651 Amortization COSPO loan -- -- 1- -- 138 146 284 154 164 174 185 196 207 Dividends 58 58 58 116 232 304 826 900 900 900 900 900 900 CONDO Partictoation in Profits -- -- -- -- -- -- -- ._ . TO axB1 .. Total Allocation 2824 2924 3683 3484 2319 2545 18647 3009 3088 3017 3028 3532 3531 Set Generation of Ponds, specified year 250 1050 207 -- 399 470 517 489 - 42 - 69 *et Generation of Ponds. cumlative 250 1300 1507 -- 1906 2376 2893 3382 3340 3271 Debt Service Coverag e 2.72 2.86 2.84 2.82 2.81 2.76 ! Thi - covers insurance obligations which woald aries in case the sine were to be permanently closed. Sice current payment. on account of accidents are included in operating costs. these allocations represent a source of funds without a corresponding cash outflow. Z/ Includes only development expenditure charged to cost totaling 2029 million pesos 1957-19t1. That portion of sine development which is capitalized (1278 million pesos 1957- 1961) is included in the project In-vstment. 5] This increase correspond. to the need for wrking capital to cover one year's debt service on the IBRD and CORO loans. / Times debt service covered by net profits before bond interest and before depreciation and depletion.