N ~~~103SuS Joint UNDP/World Bank Energy Sector Management Assistance Programme Instituto Nacional de Energía-ECUADOR Ecuador's Energy Situation: Analysis of Current Problems, Short-term and Medium-term Policy Guidelines and Repercussions on the Economy" Washington, April 1991 This document has restred disirbution and may be used by recipients only in the performance of the¡r official duties. Its contents may not otherwise be disclosed wi~hout UNDP or World Bank authorization. ECUADOR'S ENERGY SITUATION: ANALYSIS OF CURIENT PROBLEMS, SHORT-TERM AND MEDIUM-TERM POLICY GUIDELINES AND REPERCUSSIONS ON THE ECONOMY This is the English version of the report issued in Spanish in Quito in July 1988. This study was financed by the World Bank, the United Nations Development Program and the Government of Italy. FOREWORD This study, requested by the Ministry of Energy and Mines and coordinated by thoe National Energy Institute, was prepared by a group of Ecuadorian and international consultat wh-> wae advised by sovezal World Bank missions. During the timo this document was prepared, Mr. Jaime Yumiseva was Executive Director of the National Energy Institute. Appreciation is extended to h9m, for the assístance provided by the Institute, and to Mr. Patricio Romero J., Director of Energy Planning of the Instiute, who coordinated the study. TIbe members of the Ecuadorian consulting team were Messrs. Luis Bacigalupo, Maro Davalos, Wilson Pastor (petroleum subsector), Marcelo Jaramillo (electricity subsector), Carlos Quevedo (alternate sources and energy conservation subsector) and Carlos Izurieta (macroeconomics). Ibe Ecuadorian consultanta were assisted by: Messrs. Luis Andrada (energy economist), Joao N. Baptsta (electricity specialist), Franco Brunelli, Marlo Rastelli (electricity tariffs), Hernan Campero (macroeconomics), Kenneth Hornby (petroleum specialist), Claus Rose (gas specialist), David ScL.xdt (specialist in energy economics), and William Simmons (petroleum specialist). Additional assistance was provided by officials of Ecadorian energy institutions, including: INE: Messrs. Byron Granda, Francisco Lopez, Julio Teran and Juan Zak; CEPE: Messrs. Julio Cardenas and Benigno Trjillo; National Hydrocarbons Directorate: Mr. Julio Aldaz; INECEL: Mes=rs. Edgar Almeida, Bolivar Lucio and Ruben Suarez. Mr. Michel Del Buono, Senior Economist, World Bank Industry and Energy Department, led the World Bank advisory missions that included staff members Messrs. Jaime Porto Carreiro and Jeffrey Mullaney. Special thanks are given to the secretarial pool: Mmes. Maria Susana Aguirre, Maria Antonieta Flores and Irene Ricci. The English version of the study was typed by Ms. Olga Camacho and edited by Ms. Maria Cerritelli. AlUSrRACr Despite the drastic decline in world oil prices, Ecuador's economy continues o be strongly dependent on oil production and exporta. It la estimated tbat a 10% increase ín oil exporta- brought on elther by increased production or reduction in domestic coasumption-wouid result la an increase of approximately 1% in Gross Domestic Product in the sborterm. A number of problema face Ecuador's energy sector: limited reserve potea of hydrocabons; heavy subsidy of energy prices; and financial and legal constraints witbin wbich CEPE and INECEL are forced to operate. With a reserves-to-production ratio of less than ten years, Ecuador must inteaslfy ita owv exploration efforts and maintain foreign investments in order that ¡ia hydrocarbons subsector might contribute to the national economy into the 21st century. Tle domestic price of crude oil continues to lag behiad replacement costs (-30%), and represents only 50% of economic costa. Transiated into retail prices of refined products, this causes huge governrent subsidies and losses to the public sector, wnd to CEPE in particular. CEPE's investment program, currently emphasizing transportation and refining activities which present no critical problems, should give priority to er.ploration and production. Ibis step is necessary not only because of the general state of Ecuador s reserves, but also because of the high economic returns attainable through these upstream activities. CEPE's present finances, which show a budget deficit estmated at 40% for the five-year period 1988-1992, are in difficulty as they neither permit recory of operating costs nor provide incendves for expansion of activities. CEPE's financl deadiock can only be solved by a structual reform of current oil revenues distribution. CEPE, like any other company, should be able to cover ita costa and obtain a reasonable profit to self-finance some share of its investmenta. Ihe legal status of both CEPE and INECEL, as entities dependent on the central organa of government, should be modified to allow for the financial and operational autonomy of private companies. A critical problem affecting the electricity subsector is the financial difficulty currently experienced by INECEL and by electricity distribution companles. Ihis difficulty la a consequence of low revenues caused by tariffs which are 40% below production costs, and of reductions in government capital contributions to the subsector. Ibis situation has caused yearly losses since 1982 with accumulation of arrears and inability to meet debt service. The following measures are recommended to solve these problema: rationalization of electricity tariffs, recapitalization of the subsector and drastic reduction in investments based on a retbinking of coverage expansion and reliabiity of service. In addidon, solutions are needed for teciniall problema (energy losses in the distribution systems, sedimentation in the Amaluza reservoir); legal problema (atructure of subsector agencies, lack of defialtion of EMELEC's situation, etc.); ad adminltraoiv problema. By way of illustration, the study provides an analysis of the impact which several of tie recommended measures would have on the subsector. In particular, the study examines the economic repercusslona of meaures such as new tariffs-which would permit cost recovery in Ihe short mn and partially contribute to investment (20%-30%) in the medium terrm-and reduction of energy losses and of government capital contributions to subsector enterprises. q» ACRONYMS IDB Interamerican Development Bank IBRD International Bank for Reconstruction and Development CEPE Ecuadorian State Petroleum Corporation CONADE National Council for Development CSE Superior Council of Energy DNH National Hydrocarbons Directorate E. E. Electriclty Distribution Company EMELEC Electricity Company of Ecuador (a private firn) INE National Energy Institute INECEL Ecuadorian Electrification Institute MEM Ministry of Energy and Mines OLADE Latin American Energy Organization GBG General Budget of the Govermment OPEC Organization of Petroleum Exporting Countries GDP Gross Domestic Product SNI National Interconnected System ABBREVIATIONS API American Petroleum Institute b Barrel BPD Barreis Per Day LPG Liquid Petroleum Gas GW Gigawatt GWh Gigawatt-hour Kgoo Kilogram of Oil Equivalent Km Kilometer kv Kilovolt kWh Kilowatt-hour kW Kilowatt (1000 watts) MBCD Ibousand Barreis Per Calendar Day MBPD Tlhousand Barreis Per Day MMB Million Barreis MMCF Milion Cubic Feet MMCFD Million Cubic Feet Day MW megawatt S sucres toe tona of oil equivalent AGR Annual Growth Rate GAV Gross Aggregate Value W Watt CURRENCY EQUIVALBNT (198) Exchange rate used in this study: US$1 = 300 Sucres FNERGY CONVERSION FACTORS Petroleum Crude Oil 139 toe = 1,000 b LPG 114 toe = 1,000 b Gasoline 122 toe = 1.000 b Kerosene and Jet Fuel 133 toe = 1,000 b Diesd Fuel 139 toe = 1,000 b Fuel Oil 153 toe = 1,000 b Firewood 300 toe = 1,000 b Charcoai 650 we = 1,000 b Bagasse 209 toe = 1,000 b E vIº1Wcy 86 toe/GWh TABILE OF CONTENTS EXECUT¡VE SUMMARY ......................................... i-xxii I. ENERGY IN THE ECUADORIAN ECONOMY Energy and the Economic Structr the Country ..................... 1 Economic Development in the Fe ' Sector ......................... 1 Influence on the Public Seor .................... 3 Description of the Energy Sector .................... 4 Energy Resources ............................. 4 Evolution of the Structure of Energy Consumption ............... 4 Institutional Aspecta of Energy Policy Management ............. .5 INE ................................................. 6 CEPE .............................6 INECEL ................................................ 7 Technical Aspects of the Hydrocarbons Sector ................ 7 Reserves ................................................ 7 Production .............................. 8 Natural Gas ....................... ....................... 10 Refining ..0........................ l Distribution Systems ............................ 11 Demand for Refined Products............................. 11 Domestic Prices. .......................................... 11 Technical Aspects of the Electricity Subsector .......... .. ............ 12 Generation ....................... ....................... 12 Transmission and Distribution ....... ........ .. ................. 12 Losses and Consumption ................... ................... 13 Financial Aspects of the Hydrocarbons and Electricity Subsectors .......... .. 15 Role of Conservation and Aternate Sources of Energy ....... .. .......... 17 Energy Conservation .................... .................... 17 Alternate Sources of Energy ................................... 18 Energy Scenarios ..................... ..................... 18 II. ANALYSIS OF THE ENERGY SECTOR PROBLEMS .................. 21 Introduction .............................................. 21 Hydrocarbons ............................................ 21 The Drop in World Oil Prices and in Real Domestic Prices of Hydrocarbons ......................................... 21 Reserves, Output, Domestic Demand and Exportable Surplus ............... 23 Reserves ................................................ 23 - ¡j - OilOutput .............................................. 24 CEPE's Financial Difficulties ................................... 25 CEPE's Financial Future if the Present System of Allocating Oil Revenues ls Maintained .......................... 28 Analysis of Prob¡ems in CEPE's Investment Program .................... 29 Exploration ............. 30 Exploration Investments by Oil Companlea .......................... 30 Production ............................................... 30 Processing: Refining and Use of Gas .............................. 31 Gas Plants ..... 32 Other Industrial Projects ...................................... 32 Transport and Storage ...... . ................................ 33 LPG Transport and/or Storage Projects, Under Consideration or Implementation ........................................ 33 Other Transport and Storage Projects Under Consideration ................ 33 CEPE: Institutional Aspects .................................... 34 Electricity . .............................................. 35 General Introduction to the Subsector .............................. 35 Electricity Tariffs. ......................................... 36 Objectives ............................................... 36 Tariff Evolution ........................................... 36 Household Tariffs. ......................................... 37 Conclusions .............................................. 39 Financial Situation .......................................... 40 Subsector Evolution. ........................................ 40 Oil Revenues ............................................. 41 Debts . ............................................... 41 Bad Debts. .............................................. 42 Source and Use of Funds ...................................... 43 Planned Expansion ......................................... 43 Demand Projections ......................................... 43 Power Generation Program .................................... 44 Investment . ............................................. 45 Tariff Adjustments .. ...................................... 46 Technical Problems ......................................... 48 Sedimentadion of the Amaluza Reservoir (Paute) ....................... 48 Feasibility Studies of Hydroelectric Projects ......................... 48 Power Losses ............................................ 48 Operation of the Interconnected System ............................ 49 Institutional and Legal Problems ................................. 51 Planning Problems ......................................... 51 Legal Framework .......................................... 52 Public Relations Problems. .................................... 52 Problems in Energy Conservation and in New and Renewable Sources of Energy ................................ 53 Energy Shortages in Rural Areas ................................ 53 Electricity in Rural Areas ..................................... 53 In-House Cemfort in Rural Households ............................ 54 Obstacles to the Development of New and Renewable Sources of Energy ................................. 54 Households .............................................. 54 Industry . . . ............... 54 Transport ..... 55 Deforestation and Ecelogical Deterioration .......................... 55 System of Sector Institutions ................................... 55 Management, Supervision and Coordination of the Sector as a Whole ........ .. 55 Institutional Situation of INE and Subsector A.............56 mII. OPTIONS FOR THE SOLUTION OF ENERGY SECTOR PROBLEMS ..57 Introduction ..57 Hydrocarbons ..57 Measures for the Subsector ..57 Domestic Prives of Refined Products ..57 Technical Aspects ..57 Financial Aspects of CEPE ..58 Recommendations for CEPE's Five-Year Investment Program . .58 Institutional Aspects... 59 Domestic Prive System ..60 Cost of Crude ..61 Fuel Prices: Historical, Replacement, and Economic Costs . .63 Alternauves for Refined Product Price Levels ..64 Average Level of Refined Product Prirs ..64 Hydrocarbons Law (Low Option) ..65 Opportunity Cost Option (High Option) ..65 Replacement Cost Option (Recommended Option for the Short-Term). .65 Refined Products Price Structure ..66 Program for the Immediate Adjustment of Refined Products Prices . .68 Proposats for a Financial Solution for CEPE ..69 Establishing Investment Priorities for CEPE. .69 Exploration ..70 Production ..70 Oil Refining ..71 Industrial Projects in Association with Other Companies. .72 Transport and Storage ..72 Alternate Financial Solutions for CEPE by Means of Allocation of Oil Revenues ..73 Elimination of Exchange Rate Ceiings. .75 Cost Recovery If Current Revenue Allocation la Maintained . .75 Cost Recovery Plus Percentage of Oil Revenue ..76 Cost Recovery Plus Percentage of Profit of Refined Products. .76 Recommendatons. .77 Measures Related to Institutional d Legal Aspects ..77 Organizational Restnucturing ........ ........................... 77 Judicial and Financial Reforms .................................. 77 Supervision of Opdrators (Oil Companies) ........................... 78 Electric Power ............................................ 79 Measures for the Electricity Subsector ......................... . 79 Expansion Plan ........................................... 79 Institutdonaland Legal Aspects .................. .... 80 Expansion Plan ................... 80 Investment Reduction .80 Generation .81 Transmission .82 Distribution (Excluding EMELEC) .82 Other Investment Studies .82 Other Assumptions .83 Investment Schedule .83 Tariffs .84 Re iíction of Distribution Losses .85 Capitalization of the Subsector. 86 Stncture of the Subsector .86 Insuitutional and Legal Aspecta: Charjes in INECEL'a Legal Framework .86 INECEL: Internal Organization and Public Relations Aspects .87 Energy Conservation Measures and Alternate Sources .87 Policy Measures .88 Specific Measures for Energy Conservation. 88 In the Industrial Sector .88 In the Transport Sector. 89 In the Household Sector .89 Specific Measures for Alternate Sources of Energy .89 Solar Energy .89 Mini-Hydroelectric Plants .90 Geothermal: Completion of Feasibiity Studies .90 iomas. .90 IV. IMPACT OF PROPOSED MEASURES ON TRE ECONOMY .91 Impact on Economic Indicators .93 Impact of Increased Crude Exports .93 Impact of Reduced Electricity Demand ............................. 93 Impact of lnflation ......................................... 94 Effect of the Reestimation of Reserves and Price Changes on Petroleum Production, Domestic Consumption and Exports ....... ........ 96 Low Scenario (Pessinistic) ........ .......................... 96 MiddleScenario (Expected) ........ ........................... 96 High Scenario (Optimistic) ................. 96 Evaluation of the Three Scenarios. ............... ................ 97 Refined Product Demand and Exportable Petroleum Surplus ...... .. ........ 97 .V- Higb Denand. ............................................. 98 Low Dem~ .................................................... 98 Petmolun Export Prices ...................................... 99 Growth of GDP ........................................... 100 Trade Balance ................................................... 101 Impact of Institutiornal, Legal and Price Measures on Sector Enterprise Pirknces, General Budget of Government, Other Public nstitudons ........................... 101 Hydrocarbons ........... . . 101 Price of Refined Products at Replacement Cost (Recommended Option). ........ 102 Change in Relative Prico Structure ............................... 102 Reform of Oi Renue DLstributon System .......................... 102 Invesanent Ratioa on ................ 103 Impact of Recommended Measures on the Eleccity Subsector .............. 104 Tariff Adjustments ......................................... 104 Reduction of Losses, Reduction of Investment, Renegotiation of Debt, Elimination (or Revision) of Exchange Rate Cellinga . .................. 104 TABLES Tule 1: Average Prices of Refined Products in the Recommended, High and Low Alteives in 1987 USSB. xiii Table 2: Structure of Prices of Refined Products .xiii Table 3: CEPE: Investment Programs for 1988-1992 .xvi Table 4: lnvestment Prog s (1988-1992) ......... .................. xx Table 5: Impact of Fuel Price Increases on Production Costs ................xxi Table 6: Impact of Eectricity Tariff Increases on Productn Costa .... ........ xxvii Table 7: Scenarios of Production and Remaining Reserves ................. xxviii Table 8: Petroleum Production, Consumption and Export Projectiona . xxix Table 9: Scenarios br Exports and International Oil Prices .xxix Table 10: Impact of Alternative Price Policies on Distribution of Oil Revenue .xxxi Table 11: CEPE: Investment Program 1988-1991 .xxxii Table 1.1: Structure of Real GDP, 1982, 1986, and 1987. 1 Table 1.2: Relative Prices of Energy in Housebold and Industry Sectors Year 1987 ... 5 Table 1.3: Distribution of Average Daily Production. 9 Table 1.4: Structure of Generation Capacity (anuary 1988) .12 Table 1.5: Summary of Basic Data of Electric Subsector Peak Demand for Power (MW) Generation and Sales (GWh) .13 Table 1.6: Electricity Subsector Market Structure in 1986 .14 Table 1.7: Number of Users - Distribution by Sector and Company .14 Tabla 1.8 INECEL'S Oil Revenues National Electrification Fund (FNE) .16 Table 1.9: Hydrocarbons Subsector Scenarios for Export Prices Current US Dollars per Barrel. 20 Table2.1: BudgetarylncomeStructure .26 Table 2.2: Structure of Budgetary Expenditures .26 vi - Table 2.3: CEPE: Budgetary Income and Expenditures 1988-92 ............... 27 Table 2.4: Sensitivty of CEPE'S Budget Deflcit to 10% Increases in Four Major Variables 28 Table 2.5: CEPE: Investment Program ............................... 29 Table 2.6: Refinery Balances ..................................... 31 Table 2.7: Projected Gas Production ................................ 32 Table 2.8: Tariff Evolution ...................................... 37 Table 2.9: Household Consumption of Electricity Distribution of Users as a Percentage of the Total Nwnber ofHousehold Users ..... 38 Table 2.10: Household Consumption of Electricity Distribution of Household Consumption as a Percentage of Total Household Consumption ................. 38 Table 2.11: Average Price per kWh for Household Use ..................... 39 Table 2.12: The Electricíty Subsector ................................ 41 Table 2.13: Evolution of OU Revenues Transferred to 1NECEL .41 Table 2.14: The Electricity Subsector Long-Term Debt/Net Worth .42 Table 2.15: The Electricity Subsector Ung-Term DebtlNet Worth .42 Table 2.16: Electricity Subsector. 1984-1987 Statements of Source and Use of Funds ... 43 Table 2.17: Master Electrification Plan. Power Supply and Demand Projections .44 Table 2.18: Electricity Subsector. Power Capacity and Power Generation of the Paute and Daule-Peripa Projects .44 Table 2.19: INECEL: Data on the Pr ' A,B,C, Mazar and Sopladora Projects 45 Táble 2.20: Master Electrification ir .388-1996 Investment Program .46 Table 2.21: Master Electrification Plan 1988-1996 .47 Table 2.22: Average Annual Tariffs ................................. 47 Table 2.23: Major Thermal Power Plants Basic Operating Data in 1987 .... ....... S0 Table 2.24: The Electricity Subsector ................................ 51 Table 3.1: Raw Material Costs Under Different Concepts of Current Costs .... .... 61 Table 3.2: Unit Costs of Replacement in 1987 Dollars ..................... 62 Table 3.3: Average Prices of Refined Products .......................... 63 Table 3.4: Structure of Costs, Taxes, and Profita of a Gallon of iRefined Products Under the Hydrocarbons Law in 1988 ........................ 64 Table 3.5: Average Prices of Refined Products According to the Three Alternatives ... 66 Table 3.6: Price Structure ....................................... 66 Table 3.7: Refined Product Prices ....... ................67 Table 3.8: Relative Prices of Refined Products with the Recommunded Pricing Option. 68 Table 3.9: Real Increase in Refined Product Prices ....................... 69 Table 3.10: CEPE: Recomnmended Investment Progr . ..................... 73 Table 3.11: CEPE'S Financial Situation with Minimum Investment Program .... .... 74 Table 3.12: CEPE: Financial Alternatives for the 1988-1992 Period .75 Table 3.13: INECEL: Master Plan and Alternate Plan Required Peak Power and Generation Projections .................................. 81 Table 3.14: Alternate Expansion Plan ................................ 83 Table 3.15: Alternate Expansion Plan ................................ 84 Table 4.1: Structure of Domestic Consumption and Final Energy Demand .... .... 94 Table 4.2: Impact of Fuel Price Increases on Production Costs ................ 95 Table 4.3: Impact cf Electricity Tariff Increases on Production Costs .... ........ 95 Table 4.4: Scenarios for Production and Remaining Reserves ................. 97 Table 4.5: Projections of Petro!um Production, Consumption and Exports .98 - vii - Table 4.6: Projections of Petroleum Production, Consumption, and Exports ........ 99 Table 4.7: Scenarios for Exports and International Oil Prices ................. 100 Table 4.8: Trade Balance ....................................... 101 Table 4.9: Impact of Alternative Price Policies on Distribution of Oil Revenue .... .. 103 Table 4.10: CEPE: Investment Program 1988-1992 ........................ 104 Table 4.11: Electricity Subsector ................................... 105 EXECUTIVE SUIMARY Enery in the Economic Structure of the Country Economic Development and the Energy Sector 1. Since August 1972, when Ecuador first exported oil, revenue from oil marketing has emerged as the main source of financing of the economy. This resource has mnde possible coundess investments which have radically changed Ecuador into a country quite different from what it was 16 years ago, particularly with regards to energy infrastructure, communications, transport, housing, beiaith and education. 2. Over thc past 25 years Ecuador's GDP has grown at the rate of approximatly 6.7%. This growth, however, has been almost exclusively associated with oil sector productivity sector due to the stagnation of other economic activities resulting from exchange and monetary policies which have kept the sucre overvalued and the real interest rate negative for almost ten yoars. Since the drop in oil prices in 1985, Ecuador has ceased to grow. As a result, and due also to a change in foreign exchange policy, the agricultural, forestry and fishing sectors have increased their combined participation in GDP from 14.97% in 1982 to 17.7% in 1987. 3. Average annual growth rates of the petroleum (9.22%) and electricity (7.13%) subsectors over the period 1977-1986, which are higher than the growth rate of the entire GDP (3.37%), show the importance of the energy sector in the economy. Tbe substantial growth of the petroleum and electricity subsectors is due to considerable increases in CEPE and INECEL investments, resulting in a significant expansion of oil and hydroolectric infrastructures in recent years. Ibus, for example, in 1983 the Gross Value Added of oil increased by 27.2% and that of electricity by 14.9%. Ibis coincided with the beginning of oil production in the Libertador fiold and of the Pauto project, while global GDP fell by 2.8%. Il 1984, growth rates were 9.2% and 28.8% for oil and electricity, as against 4.2% for GDP. 4. In examining Ecuador's domw,tic demand for energy, two factors should be noted: the global and the sectoral energy content per GDP. Records show higher consumption levels than elsewhere in Latin America, a logical result of price policies since 1972. Based on 1986 data, the energy content of GDP is calculated at approximately 400 Kgoe per thousand US dollars of GDP, whie the average ln Latin America for the same year was 290 Kgoe per thousand US dollars of GDP. S. ¡be influence of the energy sector on the economy, based on the current economic structure (1986 intersectoral relations), shows that an increase of 10% in oil exports would result in an increase of 1.1% ín GDP, whie a decrease of 10% in the domestic demand for refined products, due to domestic price hikes or otder energy conservation measures, would causo a decrease of only 0.1% in GDP. For each 10% decroase in domestic fuel consumption, therefore, there is a net increase of 0.5% in GDP. According to the samo analysis, a 10% decrease in electricity consumption would effect a deireaso ln GDP of only 0.01% and would result in savings of little over 0.02% in foreign exchange; however, it would channl significant additional resources to the electricity subsector. Petroleum and Public Finances 6. Ecuador's public finances have, since the 1970s, depended heavily upon petroleum revenue and external financing. Efforts to diversify taxation outside the energy sector have proved ineffective. Public consumption and low-return investments haye increased while private consumption has been encouraged by an irrational, widespread subsidy policy financed by a growing external debt. Public expenditure grew at a real annual rate of 10% between 1973 and 1982, because of foreign loans which multiplied the external debt 13 times. 7. If we consider that a reduction e§US$1 per barrel in the price of crude means a decrease of approximately 1% in GDP-and that during the current year oil prices have fallen to US$13/barrel from the budgeted price of US$17-then we can expect that grovth of GDP will be reduced by approximately 4% during the current year. Furthermore, as reduction in oil prices causes an almost equal decline in public revenue, we can assume that the government deficit wil increase to almost 9% of GDP as against the 5% budgeted at the beginning of the year. 8. Oil exports accounted for 74% of total exports in 1983 and fell to 40% in 1987, as a result of the decline in worid oil prices and the inteiruption of production caused by the earthquake of March 1987. On the other hand, non-petroleum exports, especially shrimp and seafood (which have expanded mostly as a result of changes in foreign exchange policies since 1981) have increased participation in total exports from 14% in 1981 to 27% in 1987. finergy Resorces 9. Ecuador abounds in energy resources. Hydroelectric resources represent a gross potential of about 93 GW, of which approximately 900 MW are utilized. Ecuador has proven oil reserves of approximately 1100 million barrels (151 million TOE), which at current rate of production would be sufficient for approximately 9.6 years of production. The approaching maturity of main fields and the growth of domestic consumption due to excessively subsidized prices have contributed to a declining trend in Ecuador's annual production. Ecuador looks set, therefore, to become a net importer by the year 2002-based on the moderately optimistic scenario of new reserve discoveries-or by the year 2007 using the optimistic scenario. Proven reserves of dry natural gas are estimated at 160,000 MMCF in the Gulf of Guayaquil and at 270,000 MMCF in associated form in teic Oriente oil fields. Mineral coal reserves, which have not yet been developed, are estimated at 15 million TOE. Furdhermore, there are substantial non-conventional resources such as biomass, geothermal and solar energy. Evolution of the Structure of Energy Consumption 10. Final energy consumption in 1986 was 5.1 million TOE, with an average annual growdh rate of 4% (1980-1986). Tibs figure, which may be considered high, is due in part to the low domestic prices of refined products and electricity. - fil - 11. Energy demand in the period 1974-1986 has becen met mainly by hydrocarbons (an average of 93% of final consumption). Tbe most striking change in the structure of consumption of hydrocarbons is the increase in participation of LPG: this rose from 1% of total demand in 1984, to almost E% in 1986. Ecuador's annual per capita consumption of 230 barrels ranks substantially higher than the average of Latin American countries at a similar level of development (150 barrels per inhabitant per annum). Electric energy production per inhabitant in 1987 was 540 I;Whlyear, lower than the mean of Latin America (700-800 kWh per inhabitant per year). However, electricity consumption per houschold user in 1987 was 1600 kWh per year, reaching levels comparable only to those of European countries such as Spain and Austria, despite a price disadvantage in relation to hydrocarbons. The cost of LPG and domestic kerosene expressed in terms of useful energy in the household sector for cooking is four times lower than that of electricity and six times lower than that of fi¡ewood. In the industrial sector, and as motive power, electricity expressed in useful terms costs twice as much as diesel used as fuel. 12. Transport leads all sectors in energy consumption, with growth at 19% per year, accounting for 41% of total consumption in 1986 as compared to 16% in 1974. Average consumption by the transport sector in Latin America was 25% of total energy consumption, with a declining tendency over the medium-term. This means that lo Ecuador there is high, indiscriminate, and low-priority energy consumption. The commercial and public sectors absorbed 31% of the '986 demand, followed by industry (18%). Agriculture, fishing and others accounted for the remaining 10%. Institutional ASDects of Energy Policy Management 13. The Higher Council of Energy (CSE) coordinates energy policies with the development of the country's other sectors. Its main funoctions are: to establish national energy policies and submit them for approval to the President of the Republic; to approve and control development of the Master Energy Plan prepared by the National Energy Institute; and to regulate energy sector activities. The Executive Director of the National Energy Instituto acts as advisor without vote. To this date the Council has not been operative. 14. The Ministry of Energy and Mines (MEM) is responsible for establishing and supervising energy policies. The National Energy Institute (INE) advises the MEM on energy policies and coordinates sector planning. Planning, implementation and control of operations in the main subsectors have becen entrusted to the two main sector enterprises, namely CEPE for hydrocarbons and INECEL for electric power. LNEL 15. The National Enegy Institute (INE) was created in September 1978 as an agency under the MEM. It comprises a Technical Council, which resembles a Board of Directors, an Execudve Directorate vnd a Technical-Administrativw Office. INE is responsible for preparing the Master Energy - lv - Plan as well as short-, medium- and long-erm programs, and for considering energy efficiency aM any environmental impacts that might arise in their execution. INE promotes, moreover, esearch on development, demonstration and transfer o, technology of new, renewable ad non-conventlonal sources of energy. As advisor in the management of the energy sector, INE coordinated the preparation of this study. 16. TIe State Petroleum Corporation (CEPE) was created in June 1972 as an agency under the MEM. In addition to producing, refiming, transporting and marketing oil, CEPE is a member of the CEPE-TEXACO Consortium, with 62.5% of shares, of the CEPE-CITY Association, and of the ANGLO and REPETROL Refineries. It is also a minority shareholder of Austrogas, an LPG distribution company, and of the steel firm ECUASIDER. CEPE is Ecuador`s most important company, with estimated sales of $1,400 million in 1988 and a workforce numbering 4,200 employees, of which 12% are managemtent and professional personnel. WINECEL 17. iTe Ecuadorian Electrification Institute (INECEL) was created in 1961 as the official organization in charge of the country's electrification. INECEL, responsible for the generation, tansmission and distribution of electric energy, has established 17 electricity distribution companies, and is the major stockholder in each. The Empresa Electrica del Ecuador (EMELEC) does notbelong to tbis group: it is a private company, owned by foreign capital and serving the city of Guayaquil. In 1986, INECEL employees numbered 2,500, of which 37.5% were executive and technical personnel. TIe electricity distribution comranles, excluding EMELEC, numbered 6,700 employees. Technical Aspects of tie Hydrocarbons Subsector Reserves 18. Petroleum reserves are estimated quantities of oil expected to be commercially recoverable under existing technical and economic conditions. These estimates should be revised as production proceeds and as more geological and/or engineering information becomes available, or as changes occur in the economic conditions of evaluation. Tle relative degree of uncertainty may be exprased by classifying reserve as proven or unproven. Certainty of recovering unproven reserves is lower, so they may be further classified as probable or possible, to denote the progressive degree of uncertainty. 19. Proven reserves remaining in the fielda currently under production are estmated at 1083 mUlion barrels, to which 71.4 million must be added, from fields as yet undeveloped. Probable reserves . y - (with a lesser degree of certainty than proven ones) are 647 MMB. With theso resources, Ecuador couid continue exporting oil until the end of the century. By then, it will havo consumed approximately 1150 million additional barreis of its reserves. 20. The substantial increase in world oil prices and a temporary abwudance of forelgn currency in Ecuador in the 1970s led to diminished exploratory activity and a subsequent decrease in reserves. 21. Official reserve figures began to be increased noticeably in 1984. Two mala factora affected this increase: changes in the recovery factor of deposis and, to a lesser degreo, discovery or incorporation of new fields. Thus, from 882 MMB in 1983, reserves figures were shown as 1126 MMB in 1985, 1219 MMB in 1986 and 1557 MMB ín 1987. 22. Accuracy of the reserves figure 1557 MMB is questionable: there ls insufficient technical evidence to infer that the water injection process near the aquifer - which maintains pressure in the Sacha and Shushufirdi-Aguarico fields - is generating additional secondary reserves. Discoverles over the past 15 years, wik the exception of tuo, Libertador field, have been rather small, (fields with reserves of approximately 10-50 MMB), and in recent years, discoveries have been mainly of medium density crudes (15-25 API). 23. Proven natural gas reserves are located in the Gulf of Guayaquil and in the Oriente region. In the former, proven reserves of dry natural gas in the Amistad field are estimated at 160,000 MMCF, a volume which at present does not guarantee the field's commercial value. The associated gas produced in the Oriente, with reserves estimated at 270,000 MMCF, will run out at the same time as petroleum. Geographic dispersion of the fields, together with the high cost of extraction, accounts for the failure to utilize all of the associated gas. Producdon 24. Ecuador's petroleum activities dateoto 1911 with discovery of the Ancon No. 1 well inthe Santa Elena Peninsula on the Pacific Coast. A new oil era began with petroleum exports ',rom Balao, Esmeraldas in 1972. In the following decade, production was maintained, with minor fluctuatons, at approximately 175-210 MBPD. In the wake of the drop in international oil prices, an expansionist production policy was implementea as compensation for die decrease in export revenue. T[hus, production reached 278 MBPD in 1985 and 291 MBPD in 1986. 25. Of Ecuador's total production, 99.68% comes from the Amazon region. la tdis reglon, the CEPE-TEXACO Consortium produces 78.31% of total production, CEPE produces 19.73% and CEPE-CITY 1.96%. - vi - 26. Of the 439 wells drilled to date in the Amazon region, 295 are under production. Of these welts, 67% use artificial lift: pneumatic, hydraulic and electric; the others use natural water pressure. The other 144 wells have been abandoned, closed down due to lack of pressure or mechanical problems, or transformed into water injector wells. In the Santa Elena Peninsula, only 560 of the more than 1800 wells drilled are operative, producing 1000 barrels of petroleum a day. Given the 1083 million barreis of remaining proven reserves still in the fields under production, and the average production for 1988 of 310 MBPD, the country's present reserves-to-production ratio is 9.6 years. Refining 27. Ecuador has five refineries with a total operating capacity of 137 MBCD. Tbe new Amazonas refinery and the one already in existence in Lago Agrio are «toppingo units which operate at full capacity (joint production of 10 MBCD to supply their areas of influence). Recent modernization of the Esmeraldas refinery, which has conversion units, has increased its processing level to 85 MBCD. In the Santa Elena Peninsula there are two refineries with 'topping" units (ANGLO and REPETROL) with capacities of 34 MBCD and 8 MBCD, respectively. Distribution Svsem 28. The Transecuadorian Pipeline transports the crude produced in the Oriente to the Pacific Coast Terminal in Balao, near the Esmeraldas refinery. The pipeline is 500 km long, with a nominal transport capacity of 320 MBPD. There is also a connection with die Colombian pipeline, Puerto Asis- Tumaco, which makes the transport of an additional 50 MBPD possible. This capacity could be expanded to 70 MBPD at little additional cost, if this should prove neceasary. If die optimistic exploration/production scenario is considered, however, maximum expected level of production could reach 347 MBPD, which is lower than the pipelines' current transportation capacity. 29. LPG from the Shushufindi extraction plant and surplus gasoline from the Amazonas refinery are sent to Quito through a pipeline of 6.7 MBPD capacity. Refined products from the Esmeraldas refinery are transported to Quito through a clean product pipeline with a capacity of 56 MBPD, to Ambato through another pipeline of 14.4 MBPD capacity, to the Guayaquil area by sea, and to die northern part of the country by tank trucks. Refined products from the Anglo and Repetrol refineries are transported to the soudi of the country and to Guayaquil by tankers and tank trucks. A portion of die products for Guayaquil is unloaded in Tres Bocas and pumped to Pascuales dirough a 108 MBPD pipeline. 30. There are 16 tanker ships, with a total capacity of 300,000 tons, which are chartered for the export of crude and fuel oil and for coastwise shipping of oil and refined products. - vil - 31. Present storage capacity is 1.6 MMB, distributed among lane main tenninis, plus an additional 2.8 MMB in the refineries. However, there la insufficient LPG atorage, barely 8 days' supply at the El Salitral terminal and at the botting planta ( 14 days' when the atorage of the refinerles ls included). Technical As~ecta of the Electriciy Sector Generation 32. Nominal installed power at the beginning of 1988 was 1764 MW, of which 1100 correspond to the National Interconnected System (SNI) and the remainder to regional companies. Of the firm power of 1444 MW, 52% comes from hydroelectric power planta. Transmission losses reduce that power to 1320 MW, which was the amount avaltable in 1987 in the main SNI subst&iioas to cover maximum peak demand of 1020 MW. It is feasible to rehabilitate a good part of the existing thermal capacity in the regional electric companles. Transmission and Distribution 33. At ¡he end of 1988, the transmission system in service will still haye a radial configuration. The system has a total 1734 km of high tension transmission lines (615 km of 230 kV and 11 19 km of 138 kV). The sub-transmission and distribution network has a total of 3300 km, the greater part at 69 kV. The 17 distribution companies and a cooperative operate the sub-transmission and distribution systems servicing a total of 1,181,000 users (as of December 1987). These companies, together with INECEL, are implementing a Rural Electrification Program to serve 38,000 new users. Because of current very low tariffs, the program, in the short/medium term, will result in an inerease in financial losses, for both INECEL and the companies. Losses and Consumption 34. Energy losses in the distribution systems are rather high, with an average of 18% in Quito and Guayaquil. Some companies have registered losses of up to 32%. ibis is evidence of technical problems in installations, illegal consumption, and inefficient mechanisms for metering and billing. Electricity consumption is mostly for household use (40%), followed by industrial use (33%). Distribution by company is asymmetric, with industrial consumption being greater in the Guayaquil area (EMELEC). EMELEC accounts for almost 40% of total sales and, in conjunction with the Quito Electric Company, for 65%. The remaining 35% is shared by the other 16 companles. Of total users, on December 1987, 85% were households and 1.4% were industries. EMELEC and the Quito Electric Company, together, have 42% of total customers. Ibe volume of sales and the number of customers of - viii - the remalnlog 16 companles are limited and do not justify the existence of so many different companies. Reduction la their number could improve efficiency, service quallty, and, in addition, perbaps reduce costs. Financial Aspects of the Hydrocarbons and EIectrciy Subsectors 35. CEPE and INECEL are totally financially dependent on the goveroment. Oil revenue ia admted by the government through an allocation system that leaves the Corporation with fewer funda than proper management requires. Ibis situation leads to excessive dependence on government transfe, which are essentially unpredictable stopgaps. Pressure has reached such levela that it hindera development of CEPE and subsequently of the oil industry es a whole, since CEPE cannot honor its financial obligations to third parties, and in particular to operating companles (such as TEXACO and CITY) aod service contractors. 36. l¡e present situation stems from 1979, when legal measures curtaillng revenues were established together with a fiscal policy drastically reducing CEPE's share of oil revenues. In 1983, with the advent of an exchange rate ceiing of 44 sucres to the dollar for oil exports, CEPE's share of revenue was frozen. Concurrently, purchase of foreign currency for CEPE's expenditures was made at tie considerably higher official exchange rate (now 250-275 sucres to the dollar). In 1984, CEPE's revenues from sale of fuels in the domestic market were frozeo, and in 1985 a new ceiling was set for the dollar exchange rate for oil exports from the Northeast (66.5 sucres per dollar). Finally, in 1986 any new revenues that CEPE might haye obtained from new production or discoveries were blocked. 37. CEPE's financial situation grew critical in 1988 when, for the first time in the company's history, the operational deficit reached almost 43% of the approved budget (using an exchange rate of 300 sucres/dollar io 1988). CEPE's fioancial situation over the five-year period ls expected to be u_nanageable: if the investments programmed in CEPE's five-year plan and the current oil revenue allocation system are maintained, the accumulated deficit will be approximately $1800 million. 38. 'bese legal measures have rendered unprofitable CEPE's four main activities: the export of oil from tde CEPE-TEXACO Consortium, of petroleum from tde Northeast, of fuel oil and tde sale of refined products in tde domestic market. Only two margidal activities- sale of lubricants and traosport through the Transecuadorian Pipeline- remain free of currency restrictions and price freeze. 39. Increase io oil exports from the Northeast partially counteracted, until 1985, the impact of tdese measures. Increase in costs and depreciation of the sucre beglnmog in 1986, served, however, to exacerbate tde situation. 40. Through tde 1973 creation of the National Electrification Fund (FNE), which served as local counterpart in granting foreign loans for the large investments made io the last 15 years, INECEL's fionecial resources inoreased because of oil. In the past four years, however, FNE revenues havo . ix - dml!nished considerably duo to the drop in international oil prices and the fixed sucre/dollar oxchango rato at 66.5 for oil royalties of the subsector. la 1983 INECEL r( ¡ved US$171.2 milhion; in 1987 it rwcolved only US$20.8 mUaion. 41. luIs decrease in revenue has been exacerbated by other government measures such as elimination of customs duty exemptions, increase in fuel costs, sucre devaluations and, since June 1988, freesing of the monthly electriclty tariff increase. Ibe government has failed to compensate for the reduction in oUi tranfera by a real increase in tariffs. Since 1982, tariffs in constant money have bcen eroded as a result of factors unrelated to the subsector, such as inflation, rate of exchango and political ínterference in fixed tariffs. lbis deterioration la much more noticeable if tarifas are atated in US$ equivaleacy. In these terms, tariffs dropped fromn USS.12 centa per kWh in 1980 to US3.83 ceuta in 1987. l'be highest tariff charged was US6.52 cents per kWh in 1981. It ls evident that all this contributes significantly to the deficit of the electricity subsector. Role o Conservation and Alternate Sources of Ener Exic Co nser vat ion 42. There is ample potential for energy conservation in the various consumer mectors as well as in the energy supply system. 1 he industrial sector, after traosportation, emerges as the mali consumer of commercial energy, with 17% (1986) of final consumption. Non-metallic mineral industries consume tde greatest amount of energy: cement (44% of the commercial energy consumed by thedindustrial sector), followed by the food industry, including sugar and beverages (26% of total commercial energy). Energy audits made by INE in the main energy-consuming industries, extrapolated to the entire sector, show substantial energy saving potential. 43. Ihe transport sector, the main consumer of final energy (41%), uses only oil products and has go-d potential for saving energy through: (a) improvement of vehicle efficiency; (b) increase in utilization factor; (c) optimization of size of vehicle; and (d) promotion of more economical vehicles. 44. Ibe household sector, which consumes 33% of total energy, shows energy saving poteatial. In urban arcas, the main steps to take could be: improvement in the efficiency of locally-made . x - equipment, taking into consideration the limitations of national industry, and the substitution of electriclty by solar energy, when this becomes economically justifiable. 45. In rural areas, firewood is the main source of energy for cooking. Traditional stoves are inefflcient and create a high demand for flrewood, which supply Is inadequate in the central provinces and in Loja. Ibis situation contributes to problems of deforestation and soil erosíon. Programs for dissemination of efficient stoves, reforestation and promotion of alternative fuelis, such as biogas and domestic kerosene, could address the energy problem facing some of the country's rural arcas, and could contribute to environmental protection. Alterate Sources of Energy 46. Development and dissemination of alternate sources of energy and their technologies could affect an improvement in energy supply conditions. Since 1980, INE has instituted a broad program for development of alternate sources of energy and for research, adaptation and demonstration of new technologies. 47. SmalI hydroelectric power plants operating with Ecuadorian equipment may prove an economlc alternative for providing electricity to those consumers who live at a distance from the main distribution system. Solar water heating is now a mature technology in the country and has already given rise to established commercial activity. 48. Passive solar energy offers great potential for savings in air conditioning systems. Photovoltaic systems for applications in remote areas which require little energy could be an alternative. Other sources, such as biomass, wind and geothermal energy could play an important role if the prices of conventional sources approached their economic costs. 49. The excessively subsidized prices of conventional energy make alternate sources of energy and energy conservation economically unattractive to consumers. Moreover, these subsidized prices do not encourage self-generation or co-generation by producers, which could result in significantly lower costs and, consequently, reduce investmnents required of the government. Energyv Scenarios 50. To analyze probable trends of future economic growth, it has been assumed tiat oil exports are the explanatory variable in the behavior of CDP, both in the short- and in the mediumn-term. Consequently, two basic scenarios have been designed which take into account the average production projections, a single refining structure and two estimates, by CEPE and by INE, of domestic demand fbr hydrocarbons. A high hypothesis and a low hypothesis of evolution have bcen used for international oil prices to establish the impact of oil exports on GDP growth. -xi - S5. Production projections and their behavior over time are estimated according te three scenarlos: the pessimistic (in which maxímum production of 295 MBPD would be reached in 1988 and later decline); the optimistic (in which the level of production would reach 347 MBPD in 1994); and the medium or expected scenarlo (in which a peak production of 312 MBPD would be reached in 1989). 'Tis last production profile, used to calculate the impact on GDP, reflects the most probable reserve estimate at December 31, 1987 of 1 100 million barrels, to which 568 million barrela could be added as a result of exploration to be carried out between 1988 and 1993 by 13 international companles. 52. As to refining, it is assumed that installed refuning capacity will remain the same as that of 1987. Prices of hydrocarbons determine domestic demand and volume of exports. Decreased consumption due to higher prices (with prices rising between 100% and 250%) of refined products on the domestic market is expected to increase the exportable surplus of hydrocarbons. This surplus is included in the exportable amounts under the INE hypothesis, whose estimate of demand is better than CEPE's. 53. There are two scenarlos for international oil prices: the first is based on World Bank estimates forecasting an average annual growth rate of 8.6% for the 1988-1995 period and 7.6% (in current dollars) between 1988 and the year 2000. The second ls a more optimlistic scenario in which price increases are projected one year ahead. Real prices are relatively stable in both acenari, without any pronounced increase in the medium-term. Alternate Measures and Proposais to Resolve Problems in the Energy Sector 54. This part of the Executive Summary describes alternate measures and proposals for the solution of energy sector problems. Chapter 11 offers an analysis of Ecuador's energy sector problems. Alternatives and proposals are presented in Chapter mfi, and a brief evaluation of the impact of. the measures and proposals is discussed in Chapter IV. This section will introduce in the following order: Hydrocarbons, Electricity, Conservation and Alternate Sources, and Institutions. Domestic Prices of Refined Products 55. Prices of refined products must be readjusted by considering the cost of replacement of crude oil instead of the historical cost; depreciation and amortization should be charged against revalued assets for the various stages of production (transporting, refining, and distributing the refined products) together with a real profit margin on investment at each stage of production. It is recommended that an immediate study be made of CEPE's accounting and financia¡ systems in order to revalue the corporation's assets. - xUl - 56. Refined producta require a new price strucí,.re, wherein the price of diesel fuel approaches bam of premTum gasoline and the price of liquid petroleum gas (LPG) approaches the averago price. Ib. price of domestic kerosene should be lower than the prico of LPG to encourage its consumptlon In rural areas (rather than the more cosdy LPG). Avera&e Price Level of Refined Products 57. Uniesa the Hydrocarbons Law ls amended, Ita limitationa cannot curreny be avoided. On the other hand, domestic pricing policy should tend towards prices that .eflect the (Internal) cost of replacement, and eventually economic costs (worid prices). HykoQ¡arbons Law Option (Low Option) 58. ibis option assumes that, according to the Hydrocarbons Law, prices will be readjusted to historic costs and maintained in real terms. Under this assumption, during 1988 the average price should increase 115% by June 1988 (125 sucres a gallon). tXportunity Cost Otion (High Option) 59. Ibis policy is based on international crude oil prices and on the losa constituted by selling crude oil at domestic historic cost. The average price of refined products, according to this option, would be 212 sucres a gallon, by Juno 1988 - almost four times the present price (58 sucres a gallon). Gradual adjustment of prices to this level (or concept) wouid allow Ecuador to adapt to its future as oil importer, predicted for the end of the 1990s. Setting prices of refined products according to this option would require amendment of the Hydrocarbons Law. R acanent Cost OQpion (Recommended Short-Term Option) 60. Tbis option takes into consideration the cost of gradually renewing present reserves in accordance with the cost of exploration, development and production of newly discovered deposit. According to CEPE's exploration policy, the most representativo replacement cost is expected to be that of the central easterm region. The average price of refined products with this replacement cost would be 170 sucres a gallon ín 1988 - almost 200% higher tIan current prices. To set prices of refined products according to this policy wouid not require an amendment of the present Hydrocarbons Law but rather a re-¡nt.rpretatlon which wouid consider the need for replacing those reserves that are consumed. Ibis study recommends this optfon. The following table shows the prices according to the three options. - xiii - Table l AVERAGE PRICES OF REFINED PRCDUCTS ll THE RECaIEWrED, HIGH ANO LOW ALTERNATIVES IN 1498T US$UB 1988 1989 1990 1991 1992 Low Optlon 8.1 17.0 16.63 15.0 14.7 High Option 8.1 28.7 26.9 27.1 28.3 R.co..Optton 8.1 23.0 22.5 21.5 21.3 pl BesS truBe of Refined oucts 61. As indicated in Chapter U, the price stmcture of refined products in Ecuador suffers from two significant distortdons: the first conceras diesel fuel, and the second LPG. lhie strcture proposed is not as wide as the current atructure, particularly with regards to gasoline and distillates. Wis would reduce the subsidy for diesel fuel and, to a lesser degree, the subsidy for LPG as well. ite relative price of superlextra gasoline woutd permit greater consumption of super gasoline. lbe relative decrease in the price of extra gasoline would be compensated by the price of diesel fuel. Domestlc kcrosene and LPG prices wouid remain competitive, and use of fuel oil k~tead of diesel No.1 would contnue to be encouraged. ITis stmcture is merely indicative. If the prices were actaly applied, it couid be modulated and graduaply adapted. Tie following table describes current and proposed price structures. Table No. 2 STRUCTURE OF PRICES OF REFINED PRODUCTS ............... ................................. CURRENT PROPOS .............................................. Suer Gasoltne 190 150 Extra Gasoline 155 130 Diesel 1 95 115 Dlesel 2 95 115 Residual 60 60 Domtfc Kerosene 52 SO LPG 56 100 Average Price 100 100 ,............................................ 62. la order to actually fix the prices of refined products it is proposed that by mid 1988 the level of the Hydrocarbons Law be reached (125 current sucres a gallon), L.e., an increase of 115% over the current price-and tdat tdis price be kept stable in real terms. Beginning in 1989, the trend should be towards replacement cost in & -" terms, which would imply that increase for tdat year-in real terms- shouid be 30%. Prices would afterwards be adjusted to offset infiation. Tbis means that in 1987 sucres, the average price of a gallon of refined product shouid go up from SI.39 (in April 1988) to SI.84, L.e., 115% la real terms. If this decision ls postponed, increase in the last quarter of 1988 should be 140%, duo to inflation. - xtv - TeGhnical Aspc~ 63. To ensure reliable figures for proven reserves and production projectiona, it would be advisable to form an inter-institutional group of impartial specialista to carry out the simulation and follow-up of the bebavior of deposits in the different oil fields. Computer facilities available in Ecuador would be used but, for the initial stage, computer programs and technical advice would be bired. 64. Special emphasis should be given to extraction of medium density oils of 15 to 25 API degreas, taking advantage of the presence of lighter crudes, since this ls probably the only way of extracting and tranaporting these crudes. Study and evaluation of heavy crudes (8 to 15 API) should be continued in the fields of Pungarayacu, Oglan, etc., because of ti,e importance of their reserves. 65. Production rates of the consortium's old fields require updating, as some of the official production rates have not been modified since 1978 and are not adjusted to current deposit conditions. 66. Exploration in the Amistad fieId and in other offshore areas should be left to foreign investora because of the high risk involved. 67. 'be rehabilitation project for the Santa Elena Peninsula fielda should be re-evaluated in light of present economic conditions. CEpE's Financial Aspecta 68. The present oil revenues distribution system shou'd undergo some changes, in order that CEPE may recover costs in each activity as well as a percentage ot global oil revenue (between 5% and 10%). 'he latter would enable CEPE to generate reasonable self-financing of the minimum investmenta programmed. Since these reforms may take some time-possibly a year of analysis and legal change-it is proposed for the sale of refined products on the internal market tdat CEPE immediately recover its costs plus a percentage (20%) of profits, which at present end up in the Government budget. To tdis end, it would suffice to regulate Article 73 of the Hydrocarbons Law through an Executive Decree. Recommendations for CEPE's Five-Year Investment Plan (a) reinforcement of team responsible for coordinating the investment budget in the planning department, in order that it may determine which projects are economically feasible and establish investment priorities; @b) expansion of geophysical investments: CEPE would thereby have sufficient exploratory objectives to implement drilling of at least five wells a year; . xv - (c) modification of CEPE's exploratory program, inereasing exploratory wells from 14 to 23 so as to gradually replace foreign companies' exploratory program beginning in 1990; (d) modification of CEPE's production program, to include development of fields ín the central eastern region, such as Capiron (N-E), Tivacuno, Curaray and Primavera; (e) study of expansion of the Peninsula refineries towards the closing of the five-year period, in order to find the most economical option for meeting demand for refined products; (f) preparation of comparative technical and economic studies on size, location and type of gas plant as well as determination of the best use for the Libertador ficld gas; (g) limitation of CEPE's investments in other industrial companies, leaving this to the private sector. (h) to date no studies are necessary for the expansion of the Transecuadorian Pipeline; (i) ali investments proposed by CEPE for pipelines should be economically evaluated and assigned priorities relative to all other CEPE projects; ",) bottling projects for LPG and lubricating oils should be financed by private companies and removed from CEPE's Investment Program; and (k) study of present storage capacity for refined products (especially LPG) in each one of the terminals and their zone of influence to determine capacity. CEPE Investment Priorities 69. In brief, CEPE's investment program should be substantially reduced and reoriented toward upstream activities such as exploration and production. CEPE's investment program, according to the Five-Year Plan, updated to June 1988, contemplates an investment of US$1102 million for the 1988-1992 period, of which 64% is for processing and transport projects, which should have low priority. This study proposes a US$647 million program for the five-year period, of which 23% is for processing and transport. Exploration and developmentlproduction activities are emphasized. Theproposed program is summarizd inhe following table. - xvi - Table No. 3 CEPE: INVEST£NIT PROGR^AS FOR 1988-1992 (in mliltan of 1987 doblera) ..................................................... 1988 1989 1990 1991 1992 Total ..................... ....................................... Present 177 235 288 290 112 1102 Proposed 154 139 122 110 122 647 ..................................................... Difference -23 -96 -166 -180 +10 -455 70. Tbis reduction in the investment program is of crucial importance. CEPE will otherwise continue to show a substantial deficit which cannot be covered tbrough the alternative finaclial solutiona proposed for CEPE (see preceding paragraph and Chapter mI, paras. 3.53-3.69). 71. Congress should pass a new law granting CEPE financíal and oporational autonomy. It should also invest CEPE with the power to create affiliates and subsidiaries (some of which could involve private national andlor foreign capital) under the control of the National Directorate of Hydrocarbons, for techilcal aspects, and of the Superintendency of Companies, for financial aspects. lb. same law should incorporate the above-mentioned financial rationale. 72. lhe Hydrocarbons Law should also: (a) introduce, explicitly, the concept of replacement cost of a barrel of petroleum as Ihe com of production and allow the gradual application, by the govermnent, of the economic cost as the national economy evolves from a petroleum exporter to a petroleum importer; (b) change the rnak-eup of the Advisory Commission of Petroleum Policy in order tbat it becomes the Energy Policy Advisory Commission and includes INE; (c) include new provisions in the Hydrocarbons Law regarding exploration and production of free natural gas, particularly with respect to ita selling price on the domestc market and the relative price of natural gas and its substitutes such as fuel oil; d) establish priorities in allocating oil revenues so diat CEPE may first recover its costs in each phase and a percentago of the profit, to finance the expansion of its activides, befor. profit is distributed among other recipients; and - xvii- (e) invest CEPE wtth responsib¡'ity for operations of the CEPE-TEXACO Consortium, the Transecuadorian Pipeline, the field jointly managed with CITY and the ANGLO and REPETROL refineries. CEPE should prepare and set up appropriate organization and management systems. Electricity 73. The problems facing the electric energy subsector resemble those facíng the hydrocarbons subsector in that they are of a financial, planning, institutional and legal nature. "xansion Pan 74. The following is a summary of the measu.es recommended for the Electricity Subsector. Reduction of investments, as follows: (a) deferment of the Paute Mazar Project-instead, a thermal steam plant of 125 MW for 1996 or 1997 should be considered; *b) revision of the Demand Projection; (c) rescheduling of works in progress; (d) implementation of essential programmed works: Daule-Peripa, dredging, transmission, atudies; (e) reduction of investments in other activities; (f) setting an adequate tariff level that will permit covering costs in the short-term and contribute to investment in the medium-term; and (g) increasing the tariff for block sales by 100% and the tariff to the final user by 40%. Ihese tariffs should be maintained at their real value by periodic increases in lino with inflation. 75. Energy losses suffered by electricity companies should be reduced from 17% to 15% in 1989-1990 and subsequently to 12%-13% in 1992-1993. - xviii - 76. Subsector Capitalization: It is essential that the government make annual contributions of capital to INECEL in accordance with investment needs. The exchange rate ceiling of SI.66.501US$ for oil royalties should be eliminated under a legal reform of the distribution of oil revenues. 77. Structuring of the Subsector: EMELEC should be integrated into the subsector in accordance with the law and the specific contract to avoid bad debt problems and optimize energy generation. 78. The number of distributor companles should be reduced to a total of nine. Institutional and Legal Aspects 79. INECSL's legal framework should be changed. INECEL should be converted into a public enterprise under the control of the Superintendency of Companies so as to: (a) limit the influence of the Board of Directors on internal management; (b) revise the make-up of the Board of Directors; (c) re-establish control over electricity companies; (d) establish uniform and more balanced labor relations; (e) improve internal coordination inside INECEL and between INECEL and the other companies; and (f) implement a public relations program. Reduction of Investments 80. The Master Electrification Plan requires thorough updating, in line with present and future financial conditions, through the study of alternatives which would drastically reduce investments, especially in the short/medium term. Possible options could be the reduction of area serviced, establishment of service priorities and reasonable reduction in the degree of service reliability. 81. An alternate expansion program has been considered which would include the following measures. - xix- Demand (a) downward revision of demand projections; (b) re-scheduling of generation projects in progress (Paute C) within the teum of the contracts; (c) construction and start-up in 1993 of Daule Peripa (samne as in the Master Plan); (d) implementation of the first dredging phase (deep dredging) in the Amaluza reservoir (same as in the Master Plan) and a study of final alternate solutdons for the sedimentation problem; (e) deferment of implementation of the Mazar project; (f) rehabilitation, between 1989 and 1993, of part of the thermal generation capacity of the distributing companies. This wIl allow deferment of the start-up of new important plants for at least a year; (g) consideration of the construction of a steam plant (125 MW) for sta-up in 1996, followed by a hydroelectric project (eventually San Francisco) in 1998; Qh) continuation of the Master Plan transmission projects, although it would seem advisable to make technical studies to postpone the Paute-Pascuales-Prosperina line (US$25 million at June 1987 prices); (i) limitation of INECEL distribution investments to 60% of the Master Plan figure; fJ) assignment to distributing companies of a maximum of US$20 million per year (this includes the cost of rehabilitating thermal generation capacity); (k) completion of rural electrification works for which there is financing; and (1) continuation of feasibility studies that have financing. The most important ones are San Francisco, Sopladora, Coca-Codo Sinclair and Chespi (which does not have financing yet). (a) utiization of a 10% discount rate instead of the 8% used in the Master Plan; and - xx - (b) utilization of more realistic fuel costs (present ones are too high and bias the Ieast cost path towards hydroplants). 82. The following paragraphs describe in greater detail two of the main recommendatlons for the electric subsector, namely, the investment program and the tariffpolicy. A more extensive discussion of the other proposais is found in Chapter III. Investmnent Prog[am 83. INECEL's investment program is based on an optimistic view of future demand and on availabiity of a petroleum surplus. Without harming the electricity subsector, which is one of the country's best public services, programmed investments could be substantially reduced in the next five years, as sbown in the following table. Table No. 4 INECEL: INVESTNENT PROGRUIS (1988-1992? (in mittions of 1987 doIlara) .. ..... ...................... ...................................... .. .. . 1988 1989 1990 1991 1992 TOTAL ..................... .......;....... ....... .......... Pre ent 230 186 189 183 185 973 Proposed 157 179 92 54 75 557 . ......................................... ........... Diff. -73 n 7 -97 -129 -110 -416 .......................................... ............ Note: The 1 nvestmmnt progra was modíffed up to 1997. Further reductions are posalbie (see Chapter III, paras, 3.85-3.88). 84. Tariffs must be set at leveis that will cover service costs in the short-term and contribute to investment in the medium-term. Measures shou¡d include mechanisms that prevent futuro deterioration of tariffs resulting from inflation. They should consider a structure that differentiates according to level of tension, hour of day and period of the year. Net positive internal generation of funds shouid be sought in the short-term. TIbis could be achieved gradually, with annual increases, in real terms, over a prlod of years, or quickly, through substantial increases from time to time. An ad hoc tariff analysis determined overail average costs for block sales and sales to final users. In 1988 sucres, these were 7.5 S/kWh and 12.8 S/lkWh, respectively. Estimates based on legal provisions in force until Juno 1988 show that this year distributing compan`es will pay an average of 3.8 S/kWh for block purchases, and final tusers will pay an average of 9.15 S/kWh. 85. It wouid prove convenient, moreover, to increase concomittently elecitc¡ty tariffs and the prices for refined products. Tie first increase should alm to cover service costs, plus depreciatdon and financial charges. Ibis means an increase of 100% for block sales and an increasa of 40% for sales to tho final user. Assumlng that tariffs are increased in August/September 1988, tho averago new tariff - xxi - shouid be approximately 7.5 S/kWh for block sales and 13 S/lkWh for final user. TIese tariffa cold be maintained in real terms for a year, after which there would be a new adjustment. After the seoond increase, tariffs should be moderately inereased in real terms until they contribute 20-30% of the investments constrained in Expansion Plan. 86. The increases, which should be made simultaneously for block sales and final user, could serve to introduce the concept of a more adequate tariff structure, in line with the expected results of th11 Worid Bank financed study of Long Run Marginal Costs (LRMC): (a) increases should differentiate by level of tension, and (b) block tariffs should be the same for all distributing companies. Conservation and Alternate Sources of Energy 87. Although reduction of subsidies for conventional energy and continuation of development activities by INE will help promote conservation and the use of alternate sources of energy, these steps must be complemented by the following measures: (a) gradual improvement of energy sector efficiency to decrease demand for operation as weil as investment resources; b) diversification of energy sources and technologies to achieve greater harmony between energy supply and demand requirements; (c) inclusion of environmental protection as a factor in selecting energy projects and as an objective of sector management; (d) updating of energy sector legislation and organization to permit, when warranted, utilization of decentralized energy sources and construction and operation of small energy systems (below 500 kW), including cogeneration, by the private sector; and (e) establishment of expeditious financing mechanisms (through credit institutioDs) for investments in conservation and alternate sources of energy. -xxii- Specific Measures for the Promotion of Energy Conservation 88. Industrial Secto (a) Continue program for promotion of energy conservation through energy audits, traíning, technical assistance to the industrial sector, etc., which INE has been carrying out since 1981. (b) Promote optimum use of procesa heat In industry through cogeneration. Prepare pertinent legal reforms and ensure that they are enacted. (c) Study feasibility of substituting non-commercial fuels (bagasse, industrial wastes, etc.) and geothermal fluid for oil products, taking into consideration environment protection. 119. Transnort Sector (a) Update legal provisions to improve efficiency and utiization of existing vehicles, reorganize urban traffic and make a detailed study of fuel consumption in maritime transportation, which has exceedingly high consumption leveis. 90. Houschold Set (a) The urban household sector shows potential for reducing electricity consumption through efficient use of appliances, controlling time of use, and resorting to alternative energy sources. (b) It is possible to improve the efficiency of locally produced lamps, ventilators, air conditioners. refrigerators, stoves and heaters. Specific Measures for Promotion of Alternate Sources of Energy 91. Solar Energy (a) Use of solar systems, whenever economical, for heating water in projects sponsored or implemented by the public sector. (b) Consideration of photovoltaic systems for communications (IETEL) and health (IEOS) installations in remote areas. - xxiii - (c) Preparation of design manuals for using passive solar energy (INE). (d) Periodic training of construction professionals in the use of passive solar energy, and provision of advisory services to entities in charge of urban development for the use of passive solar energy. 92. Smali Hydroelectric Plants (a) Schedule implementation of small plants already identified as users of national technology (INECEL-INE) after their evaluation, and acquire a better understanding of the potential of smali hydroelectric plants. 93. Geom al Energy (a) Complete feasibility studies already underway, i.e., the low-enthalpy project in Los Chillos Valley (INE), the binational high-entbalpy project (with Colombia), fiurther study of geothermal potential. 94. Iiºmass (a) Coordinate (INE-Ministry of Agriculture) a program of incentives for forestry plantations in Chimborazo, Cotopaxi, Tungurahua, Bolivar and Loja (Provinces with the greatest fuelwood deficits). (b) Promote training in forestry administration. (c) Identify projects which both produce energy and help the environment, such as treatment of sewerage water, processing of wastes from slaughterhouses and other industries, treatment of solid waste for heat generation, etc. Impact of Proposed Measures on the Economy 95. This section analyzes the impact of proposed measures on the main economie lndicators, such as GDP, Balance of Payments, Public Finances and the level of domestic prices. Effects of the proposed measures, especially of prices and institutional changes (such as distribution of oil revenues) on sector enterprises and on tdc Government Budget have been estimated and discuased in Chapter I. x ¡xiv - 96. lIe following is a summary of the maln conclusions reached concerning tho impact of proposed measures. (i) Conslderlag the optimistic hypothesis of an increase ln nonoleum exports, a reduction in uon-productive consumption and a substantial growth ln investment ratio, it has been determained that growth of GDP for the four scenarios will fluctuate between 3.8% and 2.1% over the period 1988-1995. OnIy the first two would prevent a 8b0w lmpoverishment of the population, since Ecuador's annual population growtd mate in coming years 18 estimated at more thai 2.6%. (ii) ReadJustment of prices of refined producta as well as changes il their atucture wouid tend to increase exportable petroleum surpluses due to lower consumption, decreased smuggling and greater lnvestments, made possible by additional revenues. In view of the importance of petroleum exports, reduced domestic consumption of oil products should be encouraged, and a fund shouid be created for investments in energy conservation. (iii) Increase in fuel prices would have a lower intlationary impact than is generally believed. Econometrically, the impact should not be greater than 3.6% fbr a 100% lncrease. Tie real figure could be slightly higher because of psychological and speculative factors. This could be attenuated at the consumer level dtrough monetary measures aid proper controls. Because of its lower penetration of productive sectors and family budgets, the increase la electricity tariffs would have a lower inflationary effect. Incidence of electric energy as a production input, even in branches which use electricity intensively, such as the cement industry, does not exceed 3% of total production costs. Even though an increase ln electricity tariffs does not have the same economic effects as an increase in the prices of refined products, it would slow future demand and would therefore reduce lnvestment and foreign currency requirements as well as chainel additional financial resources to the utilities. (iv) Current inflation levels and trends require immediate price revisions at the suggested levels and maintainance of these in real terms. A later revision or at lower levels wouid be affected by inflation and would require subsequent drastic increases to offset this effect, at much higher economic and social costs. (v) Volume of oil exports would diminish between 1988 and 1995 due to depletion of reserves, technical restrictions of production and increase in domestic demand. For the high scenario, the decrease would be at an annual average rata of 6.6%; for the low acenario, the decrease would be 9.8% a year. (vi) Ihis situation makes it essential to rationalize CEPE's investments, giving priority to exploration and field development which yield immediate returns. This would make It - xxv - possible to increase exportable petroleum surpluses in the short^terr. High-r¡sk investment should be undertaken by foreiga companies. (vii) Given the two hypotheses of international prices, projections of crude exporta (and equivalent) at current dollar prices show rates which range from 2.6% for the high scenarlo to -2.0% for the low scenauio. Using an aveage annual inflation of 3.5% for the dollar, it can be seen that in all scenarlos there is a real decrease in the value of petroleumn exports. (viii) Revenue prospects from hydrocarbons exports, which are rather disheartening, requiro that non-petuolum exports be encouraged to compensate for future decrease of exportable crude balances, which will tend to disappear by the end of the nineties. (ix) For the above-mentioned scenarios, the size of the Trade Balance wil be similar to that of recent years, with a slight growth in current dollars but a decrease in real terms. Consequently, it is necessary to attract foreign capital. (x) Deficit in the Public Sector Budget, as weli as in CEPE and INECEL, can be dimined through raising prices of refined products and electricity tarffs, as weil as revising investmnents and the priority attached to them. (xi) Tle strong impact of the exchange rate on economic activity, on CEPE and INECEL flinances, on Public Sector Budget, on Balance of Payments, etc., requires careful handling of the foreign exchange policy. Imact of the Increase nl Crude Exºorts Under the present economic structure (1986 intersectoral relations), an increase of 10% in petroleum exporta represents an incrcase of 1. 1% in GDP and in the Value Added of the economy. On the other hand, a 10% decrease in domestic demand for refined products due to a price increase, or some other energy conservation measure, produces decreased economic activity which results in a reduction of 0.1% in GDP. Consequently, for cach 10% increase in fuel exports (which couid be achieved through eliminating contraband and lowering domestic consumption by 10%, which could result from 100% to 150% price increases) a net GDP increase of approximately 1% ls obtained. Impact of Reduction in Electricity Demand 98. Reduction in electricity consumption by 10% would cause a small decline (0.01%) and a slightly higher savings of foreign exchange (0.02%). However, it shouid be borne in mind that substantial indirect savinga of foreign currency would result from a decrease in futuro demand for . xxvi - electricity because of reduced construction programs, which have a large imported component. Additionally, this would help channel substantial financial resources into the electricity subsector, reducing INECEL's deficit considerably and, therefore, the need for government subsidies (and the growth of the monetary supply). The foregoing demonstrates the convenience of taking measures to conserve electricity, such as setting tariffs to discourage waste. Impact on Inflation 99. Based on production and final consumption structures, estimates havo been made of the impact of the increase in prices of refined products and electryciq tariffs on inflation at gross production and final consumer leveis. Approximate opportunity costs of refined products are 250% higLer than present market prices. The following table shows the increase in production costs by sectors for increases of 100% and 250% in current prices. Greatest impact, as shown, apart from on the sector's own consumption (as in petroleum refining), is in the electricity (thermal generation) aund transport (gasoline and diesel) sectors. Table No. 5 IMPACT OF FUEL PRICE INCREASES ON PRODUCTION COSTS (PERCENTAGES) SECTORS 1002 INCREASE 250X INCREASE AgrículturaL-Livestock 0.8 2.0 Petroleum and Gas 0.1 0.2 Refintng 24.56 61.2 Ntning 1.8 4.6 Food Industry 0.5 1.2 Netatworking 0.7 1.7 Nanufacturing Industry 0.5 1.3 Etectrictty 17.64 44.0 Construction 0.7 1.9 Transportatton 10.n 26.8 Services 0.5 1.2 Productton ¡nflatton: 3.6 9.0 - Ftnat Consumption Inflatton: 3.1 7.8 SauCce: Work Group and ¡NE. 100. Likewise, the rise in production costs and in final consumption prices in the electricity subsector is shown on Table No. 6. As indicated, the greatest impact is on the Mining and Services sectors. This impact, however, is minor in general. - xxvii - Table No. 6 INPACT OF ELECTRICITY TARIFF INCREASES ON PRODUCTION COSTS (PERCENTACES) SECTORS 100X INCREASE 250X INCREASE Agrtcultural-LIvestock 0.10 0.20 Pevroltem awd Gas 0.10 0.21 Refinlng 0.04 0.08 mining 1.17 2= Food Industry 0.49 0.99 NetalworkIng 0.52 1.03 N anu facturing Industry 0.37 0.74 Electricity 10.31 20.61 Construction 0.17 0.35 Transportation 0.03 0.06 Services 1.12 2.23 - Pro~ction ¡nflatíon 0.80 1.40 - Final Consumption Inflation 0.60 0.70 Source: Work Group and ¡NE. Effect of Reestimation of Reserves and of Price Changes on Petroleum Production. Domestic Consumntiún and Exports 101. While official estimates show a reserves-to-production ratio of almost 14 years, based on daily production of 310,000 barrels, estimations of this study show 9.5 years, L.e., the duration of reserves is shorter by 4.5 years. 102. To analyze the effect of this re-estimation, three scenarios for discovery of reserves have been studied: low, medium (the expected case) and optimistic. A description of the scenarios follows. - xxviii - Table No. 7 SCENARIOS OF PRODUCTION AMD RENAININO RESERVES YEARS LOW SCE=MARZO EDIUN SCENARIO NIGN ICEUARIO PROD. R.RES PROD. R.RES. PROD. R.RES. (NEPD) (NO) (KM)SPD ( HTEN 1988 1989 1990 1991 1992 1995 Total Proódction 113 114 111 106 106 86 Rf f'ery Throqhputs 37 38 40 41 42 46 Cn.deI ports Equiv. 2 1 0 0 0 2 Crud Exporta EquIv. 9 8 9 10 11 15 TotaL Ooa tc Conr~ftlon 38 39 40 41 43 47 Crud.E¡xports 75 75 71 65 62 39 Total CrudoEports 84 83 80 75 73 55 Sorceo: CEPE nd Work Group Estmates. 105. Petroleum and refined product exports for 1995 are equivalent to 65% of estimaed exports for 1988, which implies that between 1988 and 1992, exportable surpluses would be reduced by 29 million barrels. Average annual reduction in the exportable surpluses is 5.8%. Petroleum Exoo Priºee 106. lhe economic impact of higher world oil prices has been esdmad on the basila of the intersectoral relationships and aggregate demand structure (Input-Output Matrix) of 1986. Two international price hypotheses have been used to estimate oil exports, as shown in the foiowing table. Tebe No. 9 SCEUNRIOS FOR EXPORTS AND INTERNATIONL OIL PRICES EXPORTS PRICE (millIan of barreta) £current dotarar mer barral VEARS HIGH LOW HICH LOO 1988 84 74 14 14 1989 83 73 15 14 1990 80 69 17 15 1991 75 63 19 17 1992 73 59 21 19 1993 92 58 24 21 1994 63 49 25 24 1995 55 41 27 25 &oure: Work Croup. . xxx - 107. la order to measure the impact of oil export projections on GDP, it was necessary to make two assumptions: (1) Projections for non-petroleum exports (traditional and new) were made based on historical trends and on the need to compensate in part for volume and price declines in oil exports. (2) It was assumed that their value would increase at an average annual rate of 4.6% in current dollars. 108. Basad on the input-output matrix of 1986 and the above-mentioned export and oil price scenarios, estimated growth rates for GDP over the 1988-1995 period are shown below. Probable export volume l8 the high estimate, and thus the most probable growth rates are 3.8% and 3.3%. GDP GROWTH RATE (1975 price) EXPORWf/PRICE ANNUAL GROWTH RATE (%1 High High 3.8 High Low 3.3 Low High 2.5 Low Low 2.1 ine Trade Balance 109. The Trade Balance will be similar to that of recent years, with a slight growth in current dollan but a decrease in real terms. Cumulative annual growth rate of the Trade Balance varies between 3.1% for the high-high and 1.87% for the low-low scenarios. Impact of Institutional, Legal and Price Measures on Finances of Sector Enterprises. Government Budget and Otber Institutions Hydrocarbons 110. Chapter II makes reference to the fact that CEPE's projected financial situation under the Five-Year Plan-ssuming there will be no change in its revenue, expenditures or investments-will show an accumulated deficit of US$1900 million for the period 1988-1992. In view of this unmanageable situation, the following is an evaluation of the results of the different measures proposed in Chapter m to improve the Corporation's financial situation and to correct economic distortions caused by present price structure, distribution of petroleum revenue and investment program. - xxxi - Price of Refined Products at Reolacement Cost (Recommended Option) 111. A change in prices of refined products to match replacement costs would result In additional revenues of US$6.3/BI on average, compared to the Hydrocarbons Law price (Low option). This wouid mean additional government annual revenue of around US$250-296 million, based on INE and CEPE domestic consumption projections. The alternative based on International o¡i prices (bigh option) wouid generate approximately twice as much additional revenue as the recommended option. Reform of the Oil Revenue Distribution System 112. With regard to the impact of different alternatives on oUi revenue distribution, it can be noted that adjustment in the price of refined products (to match replacement costa) implies an increase of US$1974 milion for the General Budget and US$104 million for CEPE, whereas the other recipients would continue to receive their same allotment. The immediate, short-term alternative implies variations only in General Budget and CEPE revenues, totaling US$1967 million. Contrary to general belief, in- depth restructuring of the oil revenue distribution system would imply redistributing revenue among only two recipients: the General Budget and CEPE. Different alternatives and their effect on revenue of the GDB, CEPE, the Armed Forces and other recipients are shown in the following table. Table No. 10 ¡MPACT OF ALTERNATIVE PRICE POLICIES ON DISTRIEUTION OF OIL REVENUS (Period 1988-1992) (MIllions of 1987 USS) ALTERNATIVE GBG CEPE ARNED CON- INP OTNER INECEL TOTAL FORCES PANIES Base Case No Fuel PrIce Adjustment 3668 541 823 759 278 194 52 6315 Base Case Fuel Price Adjustment 5642 645 823 759 278 194 52 8395 Eliminatfan of Exch. Rate Cel lnga 3208 1931 969 759 278 857 343 8395 Recovery Costo + 5X Petroteum Rey. 4827 1725 802 759 278 251 52 8395 Recovery Cost, Sale Ref. Prods. +202 Prof. 4675 1613 823 759 278 194 52 8395 Source: Work Group. Investment Rationalization 113. Rationalization of the investment program for the period 1988-1992, in accordance with the proposal made in this study, implies a reduction of US$455 million (1987 dollars) in investmenta. CEPE's financlal deficit for that period would consequently be reduced from US$1790 milion to 1340 milhion, which would be a positive complement to other proposed measures. As Table No. 11 shows, the proposed rationalization of investments would lead to greater exploratory and production activity. - xxxii - Table No. 11 CEPE: INVESTNENT PROGR~N 1988-1991 (Milion of 1987 US Doliere) CEPE PLAN PROPOSAL DIFFERENCE Exploretton 81 114.4 + 30.4 Productian 259 340.1 + 81.1 Procem,Ing 411 45.3 -365.7 Tranmport & StorgP 296 101.6 -194.4 Narketlnm & Other services 55 48.8 - 6.2 TOTAL 1102 647.2 -454.8 Source: CEPE and Work Group. Impact of Recommended Measures on Electricity Subsector 114. As mentioned before, under the Master Electrification Plan, which calís for mondiy tariff increasea (2% for block sales and 3% for final users), the estimated deficit for 1988-1992 li US$734 million at June 1987 prices, with disbursements of US$414 million of external credit. Given these facts and the country's economic situation, an analysls of the economic impact of the measures suggested in tbis study follows. Tariff Adi"~nt 115. Increases of 100% have been recommended for block sales and 40% increases for sales to final consumer. A real increase (that is, higher than the rato of inflation) of 1% per month could be an altenate option. Reduction of Losses. Reduction of Investments. Renegotiation of Debt. and Elimination (Qr Revisionl of Exchange Rate Ceilings 116. Financial rehabilitation proposed through these measures aims to ma~e animal deficita disappear after 1991 and cover the accumulated deflcit by the year 1993, when there would be a positive balance. It should be noted that these results are mnerely theoretical and that a more important reordering of thd entire sector, such as the reorganization of the oil revenue distribution system, would render certala measures obsolete (for example, the elimination of exchange rate ceihngs). It ls asso probable that in five years INECEL will no longer receive any petroleum funds. 'le only effect of thdse measures outslde the electrlcity subsector would be that, to the extent that the subsector covers its costs, government subsidies would be reduced. CHAP ¡ ENERGY IN THE ECUADORIAN ECONOMY Energy and the Economic Structure of the Country Economic Development and the Energy Sector 1.1 Ecuador began exporting oil in August 1972. Revenue from oil marketing has emerged as the main source of financing of the economy, making possible numerous investment¡ that have radically altered the country. These investments havo affected, in particular, energy infastructure, communications, transport, housing, health, and education. 1.2 Over the past 25 years, the Gross Domestic Product of Ecuador has grown at a rate of 6.7%, comparable to the growth rate of the GDP of Brazil over the same period. Ibis growth has been almost exclusively associated with productivity of the petroleum sector, however, because exchange and monetary policies haye kept the sucre overvalued and the real interest rate negative for almost ten years. Ibese two fcors baye prevented diversification in economic activities. Witd the drop in oil prices in late 1985, Ecuador has been growing at a rate slightiy higher than its population growth rato, due to the contribution of other economic activities such as fishing (especially shrimp), agricultural and livestock production and, to a lesser degree, mmning. ibe relative importance of the oi sector has decreased in die past year, while the agricultural, forestry, and fishing sectors show a slightly upward trend, as shown in Table No. 1.1. Tablae o. 1.1. STRUCTURE OF REAL CDP, 1982, 1986, MD 1987 (Total percentages) ºl 1982 1986 1987 fgriculture wd Llvestoc 12.5 12.2 14.0 Forestry and Fishfng 2.4 3.1 3.7 NIntng 0.3 0.7 0.8 Petrolte and Reftning 9.7 14.2 6.9 Nanufacturine 19.1 16.6 17.6 Servlces S.O 53.2 57.0 TOTAL 100.0 100.0 100.0 e/ Based on 1975 sucres. Source: Natfonal Energy Instttute, World Bank. 1.3 The most dynamic sectors in Ecuador's economy are: services, the food industry, petroleum and gas, manufacturing, agriculture and livestock, and construction. Average annual growth rate for the petroleum sector during the decade 1977-1986 was (9.22%) and for the electricity subsector (7.13%). ibat both rates wero higher than the rato of thd entire GDP (3.37%) proves the importanco of the energy uctor in the economy. -2 - 1.4 High growth in the oil and electricity subsectors is explained by the substantial increase in investments made in recent years-by the Ecuadorian State Petroleum Corporation (CEPE) and by the Ecuadorian Electrification Institute (INECEL)-in petroleum and hydroelectric infrastructure. Petroleum income has been a determining factor in achiwving these results. Contrast between the growth rate of these subsectors and the average growth rate of the economy is renarkable. Thus in 1983 the Gross Value Added of oil increased by 27.2% and the GVA of electricity by 14.9%. These figures coincide with the beginning of oil production in the Libertador ficed and the Paute project. In contrast, global GDP dropped 2.8%. In 1984, growth rates were 9.2% and 28.8%, respectively, versus 4.2% for GDP. 1.5 During the 1970s and early 1980s, oil ranked as Ecuador's most imnportant export product. Oil exports increased from 0.4% of total exports in 1970 to 48% in 1973 and to almost 60% in 1982. Fuel oil exports accounted for an additional 5.2% in recent years. With the fall of worid oil prices, exports of crude dropped to 44.9% of total exports in 1986. Only shrimp and fish exports, besides oil, increased their share of total exports between 1970 and 1986. In 1986, shrimp exporta worth almost US$400 million made up approximately 17% of total exports. 1.6 Slow-down in economic activity over the past few years (in 1987 there was negative growth of 5.2%), refiects the impact of the drop in international oil prices and of thd earthquake of March 1987, which caused suspension of oil exports for several montis. Tbis situation also affected per capita GDP, which felU from US$1,668 in 1981 to US$960 in 1987 in current terms, i.e., to figures below the pre-1978 level. 1.7 During the period 1986-1987, the non-petroleum economy barely grew at the rate of population, and growth of some sectors was even below population growth-such as export agriculture, which in 1986 increased to 1.1 % and in 1987 decreased by 10.3%. The behavior of the industrial sector shows minor increases or growth for the years 1983, 1984 and 1986. 1.8 With regard to domestic demand for energy, global ener2y content of GDP, and energy content of GDP by sectors, available energy consumption figures ind!cate an energy intensity greater than elsewhere ii Latin America, a logical result of price policies since 1972. Based on 1986 data, energy content of GDP is calculated at approximately 400 kgoe per thousand US dollars of GDP, one of the highest leveis of energy intensity in Latin America, where the mean for the same year was 290 kgoe per thousand US dollars of GDP. The transportation sector is the largest consumer, with 41% of final total consumption (see para. 1.20). 1.9 In recent years, consumption of goods and services has increased sharply in Ecuador`s economy, as a share of the Aggregate Final Demand: its share has grown from 63.8% in 1980 to 67.6% in 1987, contrasting with the pronounced decrease in Gross Capital Formation, which dropped from 20.3% in 1980 to 14.4% of GDP in 1987. 1.10 The influence of the energy sector on the economy, based on the current economic structure (intersectoral relationships of 1986), means that an increase of 10% in oil exports would result - 3 - in an increase of 1. 1 % in GDP, while a decrease of 10% in domestie demand for refined products, due to domestic price hikes and other energy conservation measures, would cause a decrease of only 0.1 % in GDP. Por each 10% decrease in domestic fuel consumption, therefore, there is a net increase of 0.5% in GDP. 1.11 According to the same analysis, although a 10% decrease in electricity consumption would mean a decrease in GDP of only 0.01% and would result in savings of little over 0.02% in foreign currency, it would channel significant additional resources to the electricity subsector. Intluence on the Public Sector 1.12 Ecuador's public finances have, since the 1970s, depended heavily upon petroleum revenues and external financing. Efforts to diversify taxation outside the energy sector have diminished as inflation rises and price policies lag behind. Public consumption and low-return investments have increased, and private consumption has been encouraged by an irrational subsidy policy, financed by a growing external debt. 1.13 In real terms, govemnent expenditures have increased at an annual rate of 10% between 1973 and 1982, whie foreign loans were used to cover the public deficit, thereby multiplying the external debt by 13. Oil exports, which were practically nil in 1970, reached 74% of total exports in 1983. When oil prices dropped and exports were suspended because of the earthquake in March 1987, the proportion dropped to 40%. Non-petroleum exports (which greatly flourished as a result of changes in foreign exchange policy since 1981) have been sustained in the past three years by shrimp and seaf~od exports, which increased their share of the total from 14% in 1981 to 27% in 1987. 1.14 If we consider that a reduction of US$1 per barrel in the price of crude means a decrease of approximately 1% in GDP and that during the current year oil prices have fallen to US$13/barrel from the budgeted price of US$17, then we can conclude that the growth of GDP will be reduced by approximately 4% during the current year. Furthermore, as reduction in oil prices affects mainly fiscal revenues, the government deficit will increase to almost 9% of GDP, as against the 5% budgeted at the beginning of the year. 1.15 The persistence of the public deficit reflects the excessive growth of this sector. The following factors contribute to this excessive growth: high level of public employment, worrisome inabiity to control spending, subsidy policy that is wasteful of resources, deficits in the operations of govermnent enterprises, and low non-petroleum tax collections. .4- Description of tie Energy Sfg¿ Energy Resources 1.16 Ecuador has abundant energy resources. Hydtoelectric resources represent a gross potential of approximately 93 GW, of which almost 20 GW are technically and economically usable (50 million TOE per year). Potential currently used ¡a approximato1y 900 MW, L.e., lass than 5% of usable energy resources. The country atill has proven reserves la petroleum resources of approximately 1,100 million barrels (151 million TOE). At current rate of production, these would suffice for approxlmately 9.6 years of production. With the declinlng trend in anoual production raulting from the ma~i fielda reaching maturity and from lncreasing internal consumption as a consequence of excesslvely subsidized pricea, it is expected that Ecuador will become a net importer by about 2002 under the moderately optimistic scenario that new reserves wlhl be discovered, or by the year 2007 using the optimistic scenario. Proven reserves of dry natural gas aro estimated at 160,000 MMCF in the Gulf of Guayaquil, and at 270,000 MMCF in the oil fields of the Oriente as a whole. Mineral coal reserves, as yet undeveloped, are estimated at 15 miltion TOE. In additdon, there are substantial non-conventional resaources such as biomass, geothernal and solar energy. Evolution of the Structure of Energy Consumptloí 1.17 Demand for commercial energy in the perlod 1974-1986 has beon substanially covered by hydrocarbons (an average of 93% of final consumption). la fact, in 1977, hydrocarbons met 94% of demand. In 1986 dhis feUl to 92% because of greater supply of electric energy. In the composidon of hydrocarbons consumption, the increase in the share of LPW is worth noting: from 1% of the total demand in 1984, it reached almost 6% in 1986, with a per capita consumption of 230 kg, noticeably higher than the mean for Latín American countries at a similar level of economic development (150 kg per inhabitant). 1.18 Electric energy production per inhabitant in 1987 was 540 Whlyear, lower thai the mean consumption in Latin America (700-800 kWh per lnhabitant per year). But electricity consumpdon per customer was 1,600 kWh per year, which la comparable to consumptton levels of European countries such as Spain and Austria. It is stUI expanding (8.1% annual growth per year in tde period 1965-1987), despite higher relative prices than hydrocarbons (in potendally interchangeable uses). For example, as can be sean in the following table, the cost of LPG and domestic kerosene, expressed as useful energy for cooking, la four times lower than the cost of electric energy and aix times lower than firewood (especially because of the latter's low efficiency). In the industrial sector, on the other hand, and as motive power, electric energy exprassed in useful terms costa twice as much as diesel used as fuel. labte No. 1.2. RELATIVE PRICE8 OF ENERGY IN HOUSENOLD AL INDUSTRY SECTORS TEAR 1987 COSI USEFUL LEVEL OF ENERGY EULATIVE (1987 USO/TVO) COST (1) HOUSEHOL0 SECTOR (2) -Electrictty 477 3.60 -Dooestlc keroene 133 1.02 -L. P. 0. 131 1.00 -Fireood 821 6.20 INDUSTRIAL SECTOR (3) -Electricety 477 1.86 DIesol 1256 1.00 (1) Bese: LPG In Household Sector; diesel ln Industriel Sector. (2) Used for cooking. (3> Motive power. 3OUrCe: INE-Lmtin Aerican Energy Orgni tion *nd Wortd 8 n Studv of Energy Sector. 1.19 Final energy consumption in 1986 was S. 1 million TOE, with a mean annual growth rate of 4% (1980-1986). Tbis figure, which may be considered high, was duo in part to significant modernizadon of the economy and to low domestdc prices for petroleum products and electricity. 1.20 Transport ¡eads all sectors in energy consumpdon, wíth 41% of total consumption in 1986, up from only 16% in 1974, and growing at a rate of 19%, encouraged by indiscriminate subsidies on the price of hydrocarbons. Ut is interesting to note that Latin American average consumpton for the transport sector is 25% total consumption with a declining tendency over the medium-term. Ibe commercial and public sectors absorb 31% of ihe 1986 demand, followed by industry with 18%, while agriculture, fishing, and others add up to the remaining 10%. Institional Aspects of nergXy Policy Management 1.21 A Higher Council of Energy (CSE Consejo Superior de Energia) was established to coordinate energy policies with the development of the country's other economic sectors. Ibe Council's chief functions are: to establish national energy policies and submit them to the President of the Repuhlic; to approve and control the development of the Master Energy Plan prepared by the National Energy Institute; and to regulate energy sector activities. Ibe Executive Director of the National Energy Instituto acts u advisor without vote. blis Council has not, to date, been operative. -6 - 1.22 The Ministry of Energy and Mines (MEM) ia responsible for the implementation and supervision of energy policles. The National Energy Institute (INE) ls in charge of formulating national energy policy and coordinating and orienting sector nianagement. Planning, implementation, and monitoring and operations in the main subsectors haye been entrusted to the two main sector enterprises: the Ecuadorian State Petroleum Corporation (CEPE) and the Ecuadorian Electrification Institute (INECEL). 1.23 INE was created in September 1978 as an agency undor the MEM. It comprises a Technical Council, an Executive Directorate, and a Technical-Administrative Office. TIe Technical Council, similar to a Board of Directors, has nine representatives from different government institutions and is presided by the MEM U¡¡derseocretary. Its main function is to establish IN_'s basis, guidelines, and strategles. 1.24 INE, as the planning, advisory, evaluating, and coordinating agency of the energy sector, is responsible for the preparation of the Master Energy Plan. It is also responsible for short, medium, and long range programs, to address such issues as the possibility of rationalizing energy consumption, fuel savings, and the conservation of the ecological balance. In addition, INE promotes research relating to the development, demonstration and transfer of technology of new, renewable and non-conventional sources of energy. Organizationally, it is composed of the Exocutive Directorate and the Directorates of Energy Planning and Development and of Financial Management. It has a staff of 59, of which 50% are higher level technicians. 1.25 As part of overall planning and coordination of the E-nergy Sector, INE chairs the Committee responsible for projecting Energy Demand. This committeo was created by a Ministerial Agreement, and its purpose is to establish and update the most probable path of national energy demand. It is formed by representatives from CEPE, INECEL, the National Development Council, and the MEM. As advisor in the management of the energy sector, INE also coordinated the preparation of this study. 1.26 The State Petroleum Corporation (CEPE) was established in June 1972 as an entity under the MEM. CEPE's Board of Directors is chaired by the Minister of Energy and Mines; other members include the President of CONADE, the Chief of Staff of the Armed Forces, the Minister of Finances, and the Minister of Industry. CEPE's administrative organiation ls made up of the Office of the General Manager, the Office of the Operations Manager (Production and Refining), the Offíce of the Marketing and Transportation Manager, and the Office of ohe Financial Manager. -7 - 1.27 In conjunction with its activities li the production, refining, transportation, and marketing of hydrocarbons, CEPE la a majority stockholder in the CEPE-TEXACO Consortdum with 62.5% participation, the largest stockholder in the CEPE-CITY Association. It la also a minority abareholder in the ANCGLO and REPRETROL Refinerles, wtth 12.50% part'pation, as we1l as in Austrogas (LPG distribution) and in Empresa Siderurgica Ecuasider (steel). CEPE la Ecuador's most Important company, with sales estimated at US$1,400 million in 1988 and with 4,200 employees, of which 12% are management and professional personnel. INECEL 1.28 The Ecuadorian Electrification Institute, INECEL, was created in 1961 to take charge of Ecuador's electrification. INECEL, which la responsible for the generation, transmission, and distribution of electric energy, set up 17 electric power distribution companles organized as stock companies and is a majority shareholder in each. The Ecuadorian Electric Company (EMELEC) ¡s not among these companies: it is a private company, with foreign capital, serving the Guayaquil market. INECEL is responsible for the generation and transmission of energy through the National Interconnected System (SNI). The Board of INECEL is composed of the Minister of Energy and Mines, who presides; the Minister of Finance and Public Credit; the Minister of Industry, Commerce, Integration, and Fishing; the President of CONADE; the Chief of Staff of the Armed Forces; a representative of the regional electricity companies; a representative of the Instkute of Electrical Engineers; and a representative of the workers of the electricity companies. In 1986 INECEL had 2,546 employees, of which 37.5% were executive and technical personnel, and the electricity companies had 6,748 employecs (excluding EMELEC). Tecbnical Aspects of the Hydrocarbons Subsector Reserves 1.29 Reserves represent the estimated oil volume that could be commercially recovered at a given moment under existing technical and economic conditions. These estimates should be revised as production begins and as more geological and/or engineering information bocomes available or as changes occur in the economic conditions of the evaluation. 1.30 Relative degree of uncertainty may be expressed by classifying reserves as proven or unproven. Unproven reserves have a lower protabiity of being recovered and may be further classified as probable or possible to denote the progressive degree of uncertainty. -8- 1.31 Proven reserves re_alnng ln the fields curently under production are estimated at 1,083 million bas. There are an additional 71.4 mUlion barrela from fidda as yet undeveloped. Probable reserves (with a lower degree of ceranty than the proven ones) are 647 MMB. 1.32 With these resources, Ecuador could continue exporting petroleum until the end of this cennry. By then it wUl havo extracted approximately 1,150 million addidonal barrets from ita present reserves. 1.33 Substantial lincrease In internadonal oil prices and a temporary abundance of foreign currency in Ecador during the 1970s led tu diminished exploratory activity aid a subsequent decrease in reserves. 1.34 After 1984 official reserves were increased gradually and notlceably, mainiy because of changes in the recovery factor of the deposits and, to a lesser degree, because of the discovery or incorporadon of new fields. TIus, from 882 MMB in 1983, official reserves were increased to 1,126 MMB in 1985; to 1,219 MMB in 1986; and to 1,557 MMB in 1987. 1.35 Ihere ls insufficient technical evidence to infer that the water lnjection procesa near the aquifer - which maintaina pressure ín the Sacha and Shushufindi-Aguarico fields - is generating addidional aecmndary reserves, since thes deposits are subject to strong natural hvdrosc presaure. Proof of this ¡a the great repressurization that these fields underwent during the months after dio 1987 eardiquake, when both productirn and water injection were stopped. 1.36 Furthermore, except in the case of the Libertador fleid, discoverles in the past 15 years have been rather small (fleads with reserves of 10-50 MMB), and especially of medium gravity crudes (15-25API). 1.37 Proven natural gas reserves are located in the Gulf of Guayaquil and in the Oriente region. la the former, the geological and tectonic complexity of the ares l the reason for the uncertainty and diversity of reserve estimates. A study made in April 1988 by the INE-CEPE-NHD Inter-institutional Commission, sponsored by the European Economic Community, estimated proven dry naural gas reserves at the Amistad field at 160,000 MMCF, a volume which at present does not guarantee the field's commercal value. 1.38 It is expected that associated gas reserves in the Oriente, estmated at 270,000 MMCF, will mun out at the same time as oil reserves. Geographic dispersion of the fields and high cost of production and gathering account for the failure to exploit all the associated gas. Pfoduction 1.39 Ecuador's petroleum activities date to 1911 wl the di.covey of Ancon No. 1 Well i1 the Santa Elena Peninsula on the Pacific Coast. During almost half a century it was a net exporter of -9 - petroleum, producing moro than 100 million barrs by Ihe time it entered a new oil era with petroleum exports through Balao, Esmeraldas, in 1972. 1.40 In the eosuing decade, production was malntained, wíth mlaor flucions, at approximateiy 175-210 MBPD. With the incorporation of tie CEPE fieida la ine Norematera Amazon region, production increased to 236 MBPD la 1983 and to 255 MBPD ín 1984. As a result of the fal in itenational prices, an expanslonist production policy was put lato effect as a mecnsm to compensate for decreased export revenues. lbus, production reached 278 MBPD in 1985 and 291 MBPD in 1986. 1.41 Following the March 1987 ar~hquake, pumping was suspended for several months due to the destruction of more than 11 km of the Transecuadorian Pipeline. Production tiat year dropped 40% to an average of 174 MBPFD, but if the exports by proxy of 14.5 million barea made by Venezuela and Nigeria are takea into account, the decline in production was only 26% compared to 1986. Average daily production from January to April, 1988, has been 307 MBPD. 1.42 While in 1972-1973 production cane from diree fields of the Texaco-Gulf consortium (Lago Agrio, Shushufindi, and Sacha), current production comes from 23 fields, of which 22 are in the Amazon Region; 12 belong to the CEPE-TEXACO consortium; 7 belong to CEPE and 3 belong to the CEPE-CITY asociation. The other ficld ¡a located in the Sata Elena Penisula. It belonga to CEPE and includes the Ancon area subfields. 1.43 Of the country's total production, 99.68% comes from the Amazon Region. In this region, the CEPE-TEXACO consortium produces 78.31%; CEPE, 19.73%; and CEPE-CITY, 1.96%, as shown in the following table. TebL o. 1.3. DISTRIBTIOIN OF AVERAGE DAILY PR0IUC1IU C' ry-Apri , 1988, MPS) DAILY IATI^L F ¡ E L D PRCOCTION CONTRIBUTI0N (2) Shushufindt-Agurico 110,990 36.23 Sache 66,961 21.86 others 61.972 20.22 Satotel CEPE-TEXACO 239,923 78.31 ........... ....................,.,,................ Libertador 41.257 13.47 Others 19.176 6.26 SMtotel CEPE 60,U4 19.73 S"totel CITY 6.009 1.96 ................................ '6.................9"...... Suhtotel Oriente 306.365 99.68 ................... ............................................................ PeninsuLa 990 0.32 ........................................................... Totrl 307,355 100.00 ......... t.............................. .................. - 10- 1.44 Of the 439 wells drilied in the Amazon Region to date, 295 aro currently producing. Of these, 67% produce by means of artificial lifting using pneumatic, hydraulic, and electric, and the rest produce by natural flow. TIe other 144 welis have been abandoned, cdosed down because of lack of flow or mechanical problems, or transformed into water injection welis. In the Santa Elena Peninsula, only 560 of over 1,800 wells drilled since the beginning of the century are currently in operation, producing 1,000 barrels of oil per day. 1.45 A great part of Ecuador's oil production continues to come from the Sacha and Shushufindi-Aguarico fields, which account for 74% o¡ die CEPE-TEXACO consortium production, which in turn accounts for 78.3% of national output. 1.46 Given the 1,083 million barrels of proven reserves still in the fields which are being exploited and the average production for 1988 of 310,000 b/d, the ratio between the country's reserves and production is only 9.6 years. NaturalQli 1.47 Since oil fields in the Orient are dispersed and some show very low gas/petroleum ratios, only the production of associated gas in the Shushufindi-Aguarico and Libertador fields could bo economically feasible. Expectod production of associated gas from those fielda in 1988 is 53 MMCFD, decreasing to 38 MMCFD in 1995 and to 15 MMCFD in the year 2005. 1.48 The LPG extraction plant at Shushufindi is operating at 65% capacity (that is, 15 MMCFD) because of insufficient collection, but with an increase in compressing capacity, it could process 25 MMCFD by the beginning of next year. At fulU producUion, the plant could produce 3,600 BPD of LPG and 1,200 EPD of natural gasoline, besides 14 MMCFD of dry gas (part of which is being used at the present time for generation of electricity and reinjection). Refining 1.49 Ecuador has five refineries, with a total capacity of 137 MBCD. lhe new Amazonas Refinery and the one already in existence in Lago Agrio are "topping" units which operate at full capacity (oint production of 10 MBCD to supply their area of influence). Recent modernization of the Esmeraldas Refinery, which has conversion units, has raised its processing capacity to 85 MBCD. Ln the Santa Elena Peninsula there are two refineries with "topping" units (ANGLO and REPETROL) with capacities of 34 MBCD and 8 MBCD, respectively. - 11 - Distributionl Systems 1.50 The Transecuadorian Pipeline transports the crude produced in the Oriente to the Pacific Coast Terminal in Balao, near the Esmeraldas Refinery. The pipeline 1a 500 km long and has a nominal transport capacity of 320 MBPD. There is also a connection with the Colombian P!peline, Puerto Asis- Tumaco, which makes the transport of an additional 50 MBPD possible. 'luis capacity could, with a small investment, be expanded to 70 MBPD if necessary. However, lf the optimistic exploration/production scenario is considered, the maximum expected level of production could reach 347 MBPD, that is, a volume below the pipelines' present transport capacity. LPG from the Shushufindi extraction plant and surplus gasoline from the Amazon Refinery are sent to Quito through a pipeline of 6.7 MBPD capacity. Petroleum by-products from the Esmeraldas Refinery are sent to Quito through a pipeline for clean products with a 56 MBPD capacity; to Ambato ¡hrough another lino of 14.4 MBPD; to the Guayaquil area by sea and to ¡he north of the country by tank trucks. Refined products from the Anglo and Repetrol refineries are transported to the south of the country and to Guayaquil in tankers and tank trucks. One part of the products for Guayaquil is unloaded in Tres Bocas and pumped to Pascuales through a 108 MBPD pipeline. There are 16 tanker ships wi¡h a total capacity of 300,000 tons which are chartered for ¡he exporn of crudo and fuel oil and for coastwise shipping of oil and products. 1.51 Present storage capacity is 1.6 MMB, distributed among the nine main terminals, plus an additional 2.8 MMB in the refineries. However, there is currently a critical shortage of LPG atorage, barely 8-days' supply at the El Salitral terminal and at ¡he bottling plants (14 days' if atorage at the refineries is included). Demand for Refined Producta 1.52 Present demand for refined products is approximately 91 MBPD and requires a throughput of crude of approximately 108 MBPD. This produces a 14-MBPD fuel oil surplus which ¡s exported. The deficit in LPG production (4 MBPD) is imported through the El Salitral terminal in Guayaquil. Domestic Prices 1.53 Domestic prices for petroleum products in Ecuador are established by the Law of Hydrocarbons, which specifies that these must be adjusted to the historical costs of production, processing, and transport, plus a reasonable profit margin. Present interpretation of the Law has resulted in very low prices, relative both to international levesl (opportunity costs) and to domestic prices, because nominal products prices, readjusted very sporadically, have been rapidly eroded by inflation. Consequently, 1988 domestic prices for refined products are barely a third of world prices and, in absoluto termn, are lower ¡han they were in 1980. - 12 - 1.54 Tibis price pollcy has led to the development of a very active contraband trade ln refined producta. INE e s that 10% of domestlc sales of refined products (or approximately 10 MBD) are ilegally expoted to neighbor,ng countries where prices are substantially higher. Tecbnlcal Aspecta of the Electricity Subsector 1.55 Nominal Installed capacity at the beginning of 1988 was 1764 MW, of which 1 100 MW corresponded to the National Interconnected System and the remainder to regional companies. However, a more accurate figure would be 1444 MW of firm power because of the availabilty factor or other limitations of the installations. Of the firm power, 52% corresponds to hydroelectric power plants. Transmission losses reduce that power to 1320 MW, which was the available amount in the main substationa of the interconnected system to cover a maximum peak demand of 1020 MW in 1987. A summary of the atructure of generation capacity as of lanuary 1988 ls shown in Table No. 1.4. Table No. 1.4. STRUCTURE OF GENERATION CAPACITY (JANUARY 198B) MW VALUES AT GENERATION tYPE OF PLANT INECEL REGE'JNAL TOTAL 3) RELATION CasO. 1) 2) PUB.UTIL. IP/FP IP FP IP FP IP FP X NYDROELECTRIC 725 660 165 103 890 763 65.7 TNERNELECTRIC 375 353 499 328 874 681 77.9 . . .. . . .. . . . .. . . . . . .. . . . . . . . . . . . .. .. .. TOTAL 1100 1013 664 431 1764 1444 81.8 .................................................................... IP a Instatled poer FP a Fir po r Dincludes sama all hydro.lectric plants. 2)1ncludoc ENELEC. 3)The Oriente, Gal snd uNmcipaltty group are mt constdered. (IP a 22 IXW, FP a 1SN"W Sourec: INECEL, Internet Report, 1968. 1.56 It is aiso possible to rehabilitate an importantpart of the existing thermal capacity of the regional companles. T uammision and Di nnbuio 1.57 At the end of 1988 the transmission system in service will still have a radial configuration. Tbe sealing of the first ring of 230 kV, which has its three most important poles in the Paute power plant and in the loada of Quito and Guayaquil, la schoduled for 1989. lhb present coniguration la not very reliable and requires the functloning of thermal groups from Guayaquil becauso - 13 - of voltage problems. The system has a total of 1734 km. of hlgh tesioa tranunisson lines (615 km. of 230 kV and 111 9 of 138 kV). The submrason and distribution nework hbas a total of 3300 km., the grear part at 69 IV. 1.58 Ihe 17 d"str¡buting companies, together with a ¢coperative, operate the subanmilsson ad distribution systems, brínging servica to a total of 1,181,000 customers (as of December 198. Furthermore, these companies and INECEL are carrying out, wlth IDB tbnencing, a Rural Electrification Program, whlch will add 38,000 new customers by the end of 1989. la view of the preseat low tariffs, the program will result in additional financial losses for the companies ad INECEL. Losses and Consumtion 1.59 Energy losses la the distribution networks are rather high, wlth an average of 17% (registered in Quito and Guayaquil) and a high of 32% in some companies. Ihis la evidence not only of technical problems in the Installatios but also of ineffective mechanisma for metering and billing. Table No. 1.5 suows a summary of the development of the electric subsector. -lbe No. 1.5. S~RY OF BASIC DATA OF ELECTRIC ShCTOR PEAK DENAID FOR POUER <1W> NERATICN AID SAES (> IR 1970 1960 1984 1965 1966 1987 Pee 0mad (M) 193 673 798 667 940 1020 Ger. (GCh> 62 3101 4220 4547 4975 5345 Nyro. 372 S56 3207 3251 3976 4532 Iheril 450 2245 1013 1296 99? 813 Salos (MAi) 662 2615 3290 3540 3631 4211 Residentiel 270 1050 1332 1390 1508 1660 Casrcf . 102 362 514 547 607 662 Inatrial 210 930 1062 1193 1266 1360 Other, 60 253 382 410 450 530 con~ft on ou i (X) (G C ) (GWh) (X) TOTAL 1002 26.2 1490 38.9 1339 34.9 Nousehold 440 43.9 530 35.6 538 40.2 Comercial 146 14.6 248 16.6 213 15.9 Industriat 287 28.6 586 39.3 393 29.4 Other 129 12.9 126 8.5 195 14.5 ................................................................... Souree: (1) INECEL, Econ~micFInanctal Studies Unit, Bank of Hlstortc Dato of Electric Pouer Narket. 1.62 EMELEC accounts for almost 40% of total sales, and together witb the Quito Electric Company, 65%; the remaining 35% is shared by the other 16 companies. Tabte No. 1.7 NLMUER OF USERS DISTRIWUTION BY SECTLn AND COMPANY (Deceetar 31, 1987, figures) ]SECTOR E. E. QUITO ENELEC OTHER TOTAL COMPANIES Household 223,606 197,681 581.723 1,003,010 Coamerclal 34 283 29,076 86 685 150,044 Industrial 4,789 3.602 8,257 16,648 Offtctal Instiutions 2,293 1,059 7,215 10.567 other 1 1 829 831 ..................................................................... TOTAL 264,972 231,419 684,709 1,181,100 ..................................................................... souree: INECEL, DDC, Statistical Bulletin No. 22. 1.63 It is important to point out that of the total number of users, 85% are household and 1.4% are Industri. Together, EMELEC and the Quito Electricity Company haye 42% of the total number of usme. lTe volume of sales and the number of users of the remaining 16 companies are too low to justfy the existence of so many different companies; a reduction in their number could improve efficiency, servlce quality and, possibly, could reduce costs. - 15 - Financial Aspects of the Hydrocarbons and Electriciqy Subsectora 1.64 CEPE and INECEL are financially dependent on the government. Oil revenues are administered by the government through an allocation system that ¡caves the Corporation (CJPE) with fewer funds than proper management requires. This situation leads to excessive dependence on government transfers, which are essentially stopgapa. 1.65 The pressure has reached such levela that it not only hampers the development of the Corporation but also jeopardizes the development of the oDi industry as a whole, since CEPE cannot honor its financial obligations to third parties, particularly operating companies, such as Texaco and City, and service contractors. 1.66 Ibis situation results from legal measures which, since 1979, havo curtailed revenues by establishing a fiscal policy which drastically reduces CEPE's share of oil revenues. In 1983, with the establishment of ceilings in the sucre/dollar exchange rate, CEPE's sharo of those revenues was frozen, while the purchase of foreign currency for its expenditures was made at the considerably higher official exchange rate. In 1984 and 1985 these measures were again reinforced. In 1984 the frezing of CEPE's revenues from the sale of fuels was ratified, and in 1985 a new exchange rate ceiling was established. Finally, in 1986, any new revenues that CEPE might have obtained from new production or discoverles were blocked. 1.67 CEPE's financial situation between 1980 and 1983 showed a surplus, as not all budgeted funds were utilized (only 65% to 88% of budgeted expenditures). This situation rapidly worsened and by 1985 deficits began to appear. CEPE's financial situation grew critical in 1988, when for the first time in CEPE's history there was an operational deficit that reached almost 43% of the approved budget (using an exchange rate of 300 sucres/dollar in 1988). For the five-year period between 1988 and 1992, CEPE's financial situation is expected to become unmanageable: if the investments programmed in CEPE's five-year plan and the current system of oil revenue distribution are maintained, the accumulated deficit will be approximately $1,800 mDlion. 1.68 These legal measures have rendered CEPE's four main activities unprofitable: export of oil from the CEPE-TEXACO consortium, export of oi from the Northeast, export of fuel oil, and sale of refined products in the domestic market. Only two marginal activities, the sale of lubricants and transport through the Transecuadorian Pipeline, are not subject to currency restrictions or a price freeze. 1.69 Ibe lmpact of these measures until 1985 was partially offset by the ¡ncreas. in oil exports from the Northeast and by the occasional appropriations granted by the government as stopgapa. By 1986, however, the accumulated negative effects direatened CEPE's finances. 1.70 Since 1973, INECEL has received oil resources through the creation of the National Electrification Fund (FNE). Ibe FNE served as the local counterpart in granting foreiga loans for those -16- largo lnvestments that over the past I5 yeas hayo probably transformed thbs sector ito the country's best public service. 1.71 In the past four years, FNE revenues haye decreasod dratically bocause of tho country's economic crisis, the faUl in world oil prices and the establishment of exchange ceilings, as shown in the following table: Tbte No. 1.8 INECEL1S OIL REWULES MATIONAL ELECTRIFICATI0o FUND (exchng rate *t off Ictl celLIn9) chng rete) 1980 126.4 3161 126.4 1984 120.4 8004 106.3 1985 142.0 9442 97.8 1986 86.7 5767 46.7 1987 53.3 3543 20.8 1> fS9ure« *u¡ppl1A by INECEL (Curremnt ter..> 3 wrce: INECEL. 1.72 lbe decrease in revenues has boen exacerbated by other government economic maews, such as elimination of customs duty exemptions, increase in fuel oosts, devaluation of local currency, freezing of foreign exchange rate (at SI.66.50/US$1) for FNE's royalties and, sinco Juno 1988, temporary freezing of the monthly tariff increase. T¡he govermment has not compensatd the reduction in oil transfers with a real ¡nmrease in tariffs. Ibis move would hayo ensured the covering of costs and the creation of surpluses, thereby allowing for part of the expansion program to be self-f_manced. 1.73 Tariff have, in constant terms, boen eroded since 1982. Factors unrelated to the subsector, such as the inflation and foreign exchango rates, as well as politícal ínterferce in the setaug of the tariffs themselves, havo contributed to this erosion. The deterioration becomoes much moro moticeable when tariffs are sta~ed in their U.S. dollar equivalent, which is necded not only to cover the foreign currency component in projects already underway but, more importantly, for the servicing of the debt. ibus, the tariff dropped from S. 12 U.S.cents per kWh in 1980 to 3.83 U.S.cents in 1987. ibe highest value was reached in 1981: 6.52 U.S.cents per kWh. 1.74 la De emb 1r1977, the subsector, including the electricity companies (except EMELEC), owned total assets (revalued) of 524 bilion sucres with a net worth of 305 bilion sucres. The longten» llabilities, on tiat samo dato, wero 177 billion sucres, (at the exchange rato of SI.222 per US$1 at the cnd of thd year); i.e., almost 80W million dollars. Servicing of the foreign debt in this samo year was 94 million dollas, of which 78 million corresponded to INECEL. - 17 - Role of Conservation and Alternate Sources of Ea_ Eney Conlervation 1.75 There is ample potential for energy conservation ln tho vardous consumer sectors as well as in the energy supply system. Ibe industrial sector is, afRer transportation, tho main consumer of commercial energy, with 17% (1986) of final consumption. Non-metallic mineral industries consume the greatest amount of energy: cement (44% of the commercial energy of the industrial sector), followed by foodstuffs, including sugar and beverages (26% of commercial energy). Energy audits mado by INE in the main energy-consuming industries, extrapolated to the wholo sector, prove there i8 potential for substantial energy savings. 1.76 The transportation sector, the main consumer of final energy (41%), uses only petroleum products - land transport consumes 66%; sea, 23%; air, 7%; pipelines, 3%; and the railroads, 1%. The greatest potential savings ln the sector would ¡le first in theransportation of cargo through the improvement of the efficiency of the units and an increase in the utilization factor and in the size of the units; and, second, in light transportation through the improvement of vehiclo efficiency and size reductions. 1.77 It is possible to transport substantial quantities of eaergy and to improve the quality of service in public transport through an increase in engíne efficiency and in the size of the unita serving the main urban routes. 1.78 Maritime transport shows a growth in energy consumption between 1979 and 1984 of more than 200%, which seems excessivo. Furthermore, fual consumption per unit of transported cargo is far above international levels. Therefore, potential for saving does exist, and a detailed study of the situation is required. 1.79 'he household sector also shows potential for energy saving. In urban arcas, the main line of action could be to improve the efficiency of locally-made equipment, taldng into consideration the limitations of local industry. Also, consumers should be informed about using particular appliances during particular hours so as to lower the peak demand for electricity. Finally, when ecoonomically justifiable, electricity could be partially substituted by other sources, such as solar energy. 1.80 In rural arcas, firewood provides the mai source of onergy for cookling. Traditional stoves are inefficient, creating a demand for firewood that ls higher than it should be. Firewood, moreover, is in limited supply in the central provinces and in Loja. lhis situation contributes to the problems of deforestation and soil erosion. Programs for tho dissemination of efficient stoves, reforetation, and the promotion of alternative fuels, could help solvo the energy problem facing some of the country's rural arcas as well as contribute to the conservation of the environment. - 18- Alternate Sources of Ener=y 1.81 The development and dissemination of alternate sources of energy and their technologies could help improve energy supply conditions. Since 1980, INE has developed a broad educational program on alternate sources of energy and on research, adaptation and demonstration of new technologies. 1.82 Small hydroelectric power plants, with locally-made equipment, could probably serve as an economic alternative, especially in isolated rural arcas. Technology ls available for the low cost construction of turbines (up to 150 kW, can be expanded to 300 kW), switchboards, and control systems, which have already becen tested in operating installations. 1.83 Solar heating for water is a mature technology in Ecuador, and one already established as a commercial activity. Estimated current capacity for solar collectors production is 10,000 a year. Furthermore, passive solar energy offers lmportant savings potential in mechanical air conditioning systems. Photovoltaic systems, which use little energy, could be an alternative. Tle systems could be applied in arcas of social importance, such as health and communication in remote places. Once the prices of conventional sources are set at or nearer to their economic costs, other non-onventional sources, such as biomass, wind, and geothermal energy, could play minor specific roles. 1.84 The excessively subsidized prices of conventional energy make alternate sources of energy, as well as energy conservation, economically unattractive to consumera. The legal structure of the sector, through its institutional organization and allocation of large public resources, promotes centralized energy systems against decentralized ones. It also emphasizes the growth of energy supply, placing little emphasis on end-use efficiency, and does not encourage self-generation or co-generation by the producers, which could, at times, generate energy at lower costs. 1.85 In analyses of the probable trends of the future growth of the economy, petroleum exports are expected to constitute the explanatory variable of the behavlor of GDP, both in the short- and the medium-term. 1.86 To this effect, two basic scenarlos haye becen designed which take into consideration the following: the middle output projection which will be analyzed in detall in Chapter 4, a single refining structure to define refinery throughput and the exports of refined products; and two estimates, by CEPE and by INE, of domestic demand for hydrocarbons. The incorporation of the international oil price variable takes into account a high and a low hypothesis of the evolution of these prices to establish the lmpact of oil exports on GDP. - 19 - 1.87 Production projections and their behavior over time have been estimated according to three acenarios: pessimístic, In which maximum output (295 MBPD) would be reached this year (1988) and would later decline; optimistic, according to which output would reach 347 MBPD iD 1994; and the middle or expected one, with a peak output of 312 MBPD in 1989. This last profile, used to calculate the impact of oil output on GDP, reflects the most probable (expected) reserve estimate, 1,100 Imillion barreis as of December 31, 1987. An additlonal 568 MMB are expected to accrue from the exploratlon program which 13 international corporations are carrying out at a cost of about $400 mDlion between 1988 and 1993. 1.88 Assuming that the installed refining capacity remains at the level of 1987 throughout the five-year period of this analysis, the average refinery througbput for the acenarios has boen estimated at 118 MBD in 1988 and 125 MBD in 1992. 1.89 As to prices of hydrocarbons, which determine domestic demand and the value of exports, the following considerations have boen made. The demand projections, made by CEPE (March 1988) and by INE (May 1988), do not take into account the effect of elasticity (price or income) of demand. The reductions in consumption resulting from increasing the price of refined products in the domestic market, in a range of 100% to 250%, will add to the exportable hydrocarbons surpluses. Those additional surpluses seem to be included in INE's estimate of exportable amounts, wh,ch are higher tham CEPE's. 1.90 Two scenarios have boen considered for international oil prices: tde first is based on World Bank estimates forecasting an Average Annual Growth Rato of 8.6% for the period 1988-1995 and of 7.6% for tde period 1988-2000; the second, a more optimistic scenario with price increases a year in advance, shows average growth rates of 9.8% and 8.2%. As tde following table shows, the two scenarios imply relatively stable real prices during the five year-period (1988-1992) without any significant real growth in oil prices. -20- Tblo No. 1.9 NYDROCAUSOS 5USECTOR SCEINAROS FOR EXPORT PRICES CURRENT US DOLLARS PER URREL VEARS l¡lW ICERIO NION SCEUARIO 1988 14 14 1989 14 15 1990 15 1? 1991 17 19 1992 19 21 1993 21 24 1994 24 25 1995 25 27 1996 27 29 1997 29 30 1998 30 32 1999 32 34 2000 34 36 our¡ : Work GroWi, World Ban. -21- CHAPFE u ANALYSIS OF ENEltGY SECTOR PROIBLIEMS Introduction 2.1 TIe preceding chapter showed at length how energy sector problems can bayo a substantial impact on the economy as a whole. Tbis chapter wil provide a comprebensive discusion of tiose problems, although it may go beyond the boundarles of the sector and delve into macroeconomic issues. 2.2 The problems will be discussed in the following order: (a) Hydrocarbons (b) Electric Power (c) Conservation and Alternative Sources of Energy, and (d) Institutional Management of the Sector as a Whole Hydrocarbons *he DrOD in World Oil Prices and In Real Domestie Prices of Hydrcod 2.3 Tbe drop in oil prices in late 1985 created a multitude of problema for Ecuador. In the first place, the balance of payments suffered a tremendous setback, since the value of oil and refined product exports felí from US$1927 million in 1985 to US$982 million in 1986 and to US$817 million in 1987. Although prices recovered slightly in 1987, the earthquake that year intemrpted oil exports. TIese were partially off'set by Venezuelan and Nigerian oil loans (tbat are being repaid in 1988). 2.4 Declining world petroleum prices and the suspension of oil exports also had a substantial and negative impact on public revenues. 'he share of oil income in total public revenues dropped from 52.6% in 1985, to 41.5% in 1986 and to 31.7% in 1987. 2.5 4t the same time, the domestic price of refined products plummeted due to inflation and depreciation of the sucre. Current prices of refined products are substantially lower than international prices (33% of the CIF prico plus transport and distribution costa, in 1988). From 1981 to 1987 tbis ratio rose from 21% to 46% only because of declining international oil prices. 'Tis ls explained by the faa that, under the Hydrocarbons Law, refined product prices are based on historical costa, and -22 - therefore, domestic prices of crude are barely 50% of international prices. Moreover, the periodic readjustments required by inflatíionary conditions havo not been made. Although refined product prices were raised four times this decade, they remain low when compared to international prices and currently rank among the lowest in Latin America and in the world. 2.6 Thus, the weighted average price of refined products, in real termis, dropped by one third in 1988. It fell from 58 sucres/gallon in 1987 to 39 sucres/gallon in 1988, due to the 50 percent inflation (in 1987 sucres) estimated for those years. As a result of this unfavorable situation, domestic consumption is on the rise, while production remains at a level that cannot be significantly increased in the short-term (see Section A.3 for production, domestic consumption and export projections). 2.7 The average price of refined products in Ecuador (in 1987 dollars) has ranged from 10 to 12 dollars/barrtJ throughout the present decade. Given the lack of readjustments, by 1984 prices started to drop, falling to US$8.1 per barrel in 1988, the lowest level of the decade, except for 1980. 2.8 Prices of refined products, with the excepition of premium gasoline whicn reached its international price in April 1987, haye been subsidized sine0e 1980. During this period, the real price of LPG fell 53%, making LPG, once the country's most expensive product, its mostheavily subsidized one. Until mid-decade, the price of diesel fuel was below the average price of refined products and at present, it costs only 60% of the price of premium gasoline. Ibis causes a very serious distortion that will certainly grow, as this product faces supply problems in the short-term. The price of fuel oil has remained at 60% of the average price over the same period. 2.9 Current prices for refined products in Ecuador have caused substantial losses because of contraband trade (estimated by INE to be 10% of consumption, i.e., around 8000-10000 barrels per day). July prices for premium gasoline and diesel were a quarter of Colombian prices. Based on opportunity costs, and keeping the Hydrocarbons Law profit margins, the subsidy (including benefits foregone) for refined products in Ecuador is an estimated US$620 million in 1988. 2.10 Prices of refined products in Ecuador face a major constrait: the interpretation of the Hydrocarbons Law, according to which prices shall only cover historical costs inciuding a reasonable non-specified profit. Ibis makes it impossible to consider other cost concepts, such as: replacement costs, reserve depletion margins and opportunity costs. 2.11 According to econometric research work done for this study, it is estimated that a 10% increase in oil exports (due to lower domestic consumption and the elimination of contraband) could add anproximately 1 % to annual GDP. -23 - Reserves, Qutput. Domestic Demand and Exºortable Surplus 2.12 In June 1988, production of crude averaged 307 MBPD, while daily consumption (including contraband) totaled 107 thousand BPD, leaving an exportable surplus of approximately 200 BPD. Reserves 2.13 Ecuador's oil industry is based on a fragile reserve structure, given the present and future needs for this non-renewable resource. Proven reserves havy been failing from 1500 MMB in 1972, to 1023 MMB in 1979 and then to 882 MMB in 1983. But a modest though gradual ímprovement (1083 MMB) has beon observed over the 1984-1987 period, mainly due to the better-than-expected performance of two of the major Oriente fields, Shushufindi-Aguarico and Sacha. Proof of this is the repressurizing of the deposits, caused by the natural pressure of water while the wells were shut down in the wake of the March 1987 earthquale. At the same time, the reservelproduction ratio decreased from 55 years in 1972 to 15 years in 1979, to 11 years in 1983 and to 9.6 years in 1987. From 1972 to 1987 the Oriente fields produced 1186 MMB of oUi. Associated natural gas reserves are estimated at 270,000 MMPC. 2.14 Official proven reserve figures were substantially raised from 882 MMB in 1983 to 1557 MMB in 1987, alleging improved recovery in the two above-mentioned fields through water injection in the "U" and "T" sands of the Napo formation. Ibis explanation has no sound techaical basis, as it is difficult to conceive secondary recovery in deposits that are subject to an active natural hydrostatic push. 2.15 According to the National Directorate of Hydrocarbons (DNH), discovery of new fields in the 1972-1987 period yielded additional reserves of 378 MMB versus a cumulative production of 1186 MMB. This implies an apparent decline in the probability of major discoveries. Exploration costs, meanwhile, are climbing as deeper drilling la required in more distant areas, under less familiar geological conditions. 2.16 Replacement cost of a new barrel in the North Oriente s estimated at 7.5 US$Sbbl. It increases to 10.2 US$Sbbl in the Central Oriente and to 13.7 US$Ibbl in the South Oriente, as against a selling price of 12.7 US$Ibbl at the end of June 1988. 2.17 To make up for diminishing reserves, legal and tax reforms were implemented early in the decade to attract foreign companies. Starting in 1986 these corporations - under 13 Service Contracts - have launched an intensivo exploration effort, with a $400 million investment commitment that includes the completion of 20,000 km of seismic lines and 50 wildcat wells until 1992. Hydrocarbons have been found in 9 of the 12 welis drilled by these companies. Ibe DNH evaluates the discoveries at a modest 20 MMB of proven reserves and 115 MMB of probable reserves. It a evident that a good part of Eciador's ahort- and medium-term oil future, as well as CEPE's capacity to finance exploradton, will depend on the results of this exploration endeavor. - 24 - 2.18 Acoording to this work group's projectiona, Ecuador will extract nearly 1150 MMD by the year 2000. To replace these reserves would require Intensive exploration efforts in which inteional companles would be necessarily Involved (to supplement CEPE activities). This ls oll the more apparent when conslderíng that future discovery of new fields would need to triple the hitorical trend. Increasing lnvestments, moreover, mlast be made in field development and i opimizing oil extraction in order to recover probable reserves of the order of 670 MMB. 2.19 With regards to natural dry gas, the only discovery thus far is the Amistad Ficld, located southwest of Puna Island in the Gulf of Guayaquil. Tbe area's geological and tectonic complexity and the limited data available account for the uncertainty and the diversity of the reserve estimates. A recent study (April 88) prepared by an INE-CEPE-DNH Committee, sponsored by the European Economic Co_mmnlty, estimated proven reserves at 160 thousand MMCP. llhis volume is insufficient to ensure the commercial value of the field, which would require a minimum 365 thousand MMCF, that la, a daily production of 50 MMCFD over 20 years. 2.20 Should the necessary reserves exist, it is estimand (Cm a study conducted by SOFREGAZ) that there is a market in the industrial zone of Guayaquil for 38 MMCFD, 22 million of which would be used to replace oil in industry and 16 million for thermoelectric power. Thermal energy consumptlon would increase to 42 MMCFD in 1992 and to 48 MMCFD in the year 2000. liere would be odier potential markets in tde refineries of the Peninsula (4.7 MMCFD) and in industries of the Chanduy and Posorja areas (8-14 MMCFD). No consideration has been given to tie use of gas in industrial projects (fertilizers, steel and ¡ron industry). Ibese activities do not appear economic. In short, there is a sigLificant potential market for natural gas in Guayaquil and in the Santa Elena Peninsula. 2.21 Current oil output is 307,000 b/d and is approaching the highest historical levels and the Trana-Ecuadorian Pipeline's maximum operating capacity of 320 MBPD. Should any substantial discovery take place, output could be transported to Colombia through the pipeline branch, which has a current uperating capacity of 50 MBPD, and which could be inareased to 70 MBPD at little additional cost. ibe foregoing analysis suggests that there is no need to expand the capacity of the Trans-Ecuadorian Pipeline because the peak output expected in the optimistic scenarlo - 347 MBPD in 1994 - would be below the combined capacity of the Ecuadorian and Colombian pipelines. 2.22 Ecuador`s increasing oil output over recent years ls not commensurate with the limited number of discoveries of new reserves. A large part of the country's production continues to depend on the Sacha and Shushufindi ffieds, which have so far been responsible for 74% of the CEPE-TEXACO Consortlum, whích in tun, accounts for 78.3% of national production. -25 - 2.23 Unless substantial new reserves are discovered, Ecuador will soon reach its pel output leveis. It ls moat probable that output will continuo to decrease conslatently until the year 2000, when it wilI drop to 145 MBPD, dose to domestfc requirementa and leaving little to export. 2.24 According to CEPE's demand projectiona and considering this stdy's medium-range scenario for the discovery of new oil reserves, Ecuador wil become an oil importer around the year 2002. Considering the optimistic scenario, net imports would be needed around 2007. 2.25 Future output will come from increasingly distant and scattered fielda, with mounting investmnenta and operating costs. 'his prediction takes into account CEPE's bringing onstream the Coca, Payamino, Paralso, Tiguino and Pucuna fielda. CEPE's Financial Difficulties 2.26 From the very beginning, CEPE's activities haye been self-supporting. Funds derive from the company's entrepreneurial undertakings, from its sharea in producing companies such as TEXACO and CITY, and, since 1985, from increasing government allocations of proceeda from domestic sale of refined producta. By law such proceeda belong to the General Budget of the State. When in 1987 the pipeline suffered damages, CEPE received an $80 million capital contribution financed by a World Bank loan to the Ecuadorian Goveriment. In general, however, CEPE's financial resources originate, cither direcdy or indirecdy, from ita own business activities. 2.27 Table No.2. 1 depicta the structure of CEPE's budgeted income from 1988 to 1992, under the following assumptions: recommended output projection; demand as projected by CEPE; domestic and foreign inflation and monetary devaluations asmed by tbe World Bank within the framework of tde present study; international oil prices (downward trend); investments as under the Five-Year CEPE Plan; and adjustments in the prices of refined producta according to the Hydrocarbons Law. 2.28 Although crde oil sales to refinerles la the mnain income item, this ls a mere accounting entry, for the same amount is allocated to CEPE crude oil purchases for the refineries (Table No. 2.2). Proceeds from sales of refined products represent the most significant income item. TIey are followed by crudo oil and fuel-oil exports, income from pipeline transport services, and finally, income from shares iD other companies. Incomo from compensatory crude la quite significant in 1988, owing to repayment of the crude oil borrowed from Venezuela for the domestic market in 1987. It should be ioted that the domesdc price of the compensatory crude is tie only one received by CEPE in fuli, at the official controlled exchange rate of the Central Bank. From 1989 on, compensatory crude income wil decrease due to reduced imports of refined producta (which are pald with crude) and the compledon of the repaymcnt of the oil loan to Venezuela. -26- Table No. 2.1 WDGETARY INCOM STRUCTURE (In *lflfoes of 1987 dolia)s> 1988 1989 1990 1991 1992 Incoam frm aharts fn other ventures 2 1 1 1 0 Crudo nd Fuel-Oll Exports 55 S1 46 39 34 Tranmportatfon of Cruda 33 31 28 27 25 gatos of Refinad Products 107 89 77 70 66 Refinery Throughputs 188 201 209 218 229 Compensatlon 85 30 20 27 27 Other 10 0 0 0 0 TotaL Incase 479 403 380 382 381 Soure : CEPE Ftve-Year Plan. 2.29 With regards to expenditures, other tban the above-mentioned expenditure item urchase of its own crude for the refineries), the main item Is investments or capital expenditures, which in 1987 totaled 1100 mnllion dollars, according to CEPE. The second most important item is the purchase of crude from TEXACO and CITY for the domestic ¡narket, followed by ANGLO reftning tariffs, the purchase of refined produ¡cts from REPETROL and inputs for the Esmeraldas Refinery. Another significant item is CEPE oudlays in CEPE-TEXACO operations. On the whole, oil production operating and administrative costs are not very significant. Debt servicing for 1988 (based on existing outstanding debt) amounts to 10% of current expenditures. Table No. 2.2 STRUCTURE Of BWDCETARY EXPENIDITURES (in ulfLUos of 1987 dollers) 1988 1989 1990 1991 1992 CEPE In the Comortflu 55 52 49 47 44 PipeLina Operatcon 17 16 16 15 14 CEPE-Own Output 18 36 S0 48 63 Externally Markht1ng 5 5 5 5 4 AdufnistratIon 28 26 25 24 24 Crude Purchases fron CEPE 213 201 208 218 229 Crudo Purchases fro Cap. 62 61 62 66 74 Reffning 66 66 64 61 55 Lubricants 5 4 3 2 2 Total Operatfng Expenses 468 467 483 487 510 D.bt Servicing 51 66 67 63 55 Total Current ExpendItures 519 533 549 50 565 Capital Expenditures 176 234 287 290 112 TOTAL EXPENDITURES 695 767 836 840 677 u CEPE Ffve Year Plan and Vorkfng Group estimtes nd calculatfon. -27 - 2.30 Although It is likely that investment can be reduced (especially In processing and transport/storage, where substantial investments were recently made, and where domestic demand wil tend to drop because of rising domestic prices and declining economic activity), the financial situation is obviously untenable. The underlying reason is that three of CEPE's four major activities are running at a loss. CEPE incurs losses on domestic sales of refined products, since there can be no cost recovery, and in the export of crude and refined products (fuel-oil) due to the rate of exchange ceilings of 44 sucres/dollar on which ita income ls based. Its fourth activity, exports of crude ftom the North Oriente fields, showed a slight surplus this year but wll also tun into a deficit as of 1989. Furthermore, CEPE's external indebtedness for 1988 totala US$289 million while its íiternal debt la S/.3000 million. Ibe cumulative deficit for the 1988-1992 period amounta to 1900 mlllion dollara, that la, 46% of ita budget. Considering that the operational deficit (excluding investment) ls 19%, CEPE would be unable to service the debts already contracted. Tabte No. 2.3 CEPE: WDGETARY INCOSE AND EXPENDITURES 198-92 IN 1987 DOULARS 1988 1989 1990 1991 1992 Current ¡ncme 479 403 380 382 381 Current Expanditures 519 533 549 550 565 Current Deftictt 40 130 169 168 184 Investuents (1) 176 234 287 290 112 Total Deftctt <2) 216 364 456 458 296 (1> IncLudes US$186m itaon to nmdemize the Peninsula refinrrtes, uhich amaunt had been amitt.d. Expenses are broken dun es folto s: USS39 ftilton a year In 1989-1990; Us$98 mliton In 1991 *nd US$10 tilton In 1992. (2> For the year 1988, 50X of tnvestmnt has been finenced uith external loans that have redcced the deficit. Source: CEPE wd Worktng Group estimetes. 2.31 CEPE's financial situation ls due to falling income resulting from legislative measures begun in 1980 and adjusted in 1982 and 1985. These measures, in turn, reflect the overall decline in oil revenue caused by lower oil prices. 2.32 Key factors responsible for CEPE's financial woes are: first, non-recovery of costs in the different stages of processing due to legal provisions and exchange rate ceiings that freeze ita sucre income; and second, requirements whereby CEPE expenditures (70%) are made in dollars at the Central Bank's managedi market rate (250 sucresidollar in June 1988). 2.33 Assuming present allocation of oil revenues and an improvement in the fbur key variables affecting the Corporation's budgetary balance-(a) international oil prices; (b) price of refinad products for the domestic narket; (c) oil production; and (d) monetary devaluation-,CEPE's financial condition -28 - will not improve. In the case of the last two variables, indeed, budgetary imbalanco will worsen. As a resit, CEPE's economic position for the immediate future will grow more critical. The company must either sop all investments or change ita aystem of oil revenues distribution. CEPE's Financial Future if the Present System of Allocating Oil Revenues is Maintained 1/ 2.34 Table No. 2.4 provides a sensitivity analyss of CEPE's financial position for the five-year 1988-1992 period, considering variations in international oil prices, in refined product prices for tie domestic market, in oil output, and in exchange rates. TobLe No. 2.4 5ENSITIVITY OF CEPE'S BUDGET DEFICIT TO 102 INCREASES IN FOUR NAJOR VARIABLES Defiitt Decrea (-> PERCENTAUE VARIATION Incres (> AS AGAINST VARIABLE m SUCES THE CURRENt DEfICIT - Refinad p.oduct prices - 2735 2.6X - Olt output 2364 2.2X - Ixchanh Rete 9 9630 9.02 ¡orce: Work Grou. 2.35 The deficit is vinually insensitive to a 10% increas in international oil prices, due to CEPE's limited share in oil and fuel-oil export earnings. CEPE's income therefore remains constant, at some 50 million dollars a year. No improvement in CEPE's income can be expected from future inereases in international oil prices. 2.36 A 10% variation in domestic fuel prices, as indicated above, will not significantly alter CEPE's income, given its determinad fuel sales market share. Any fuel price inc«e or reduction would primarily affect the General Budget. 2.37 An expansion in oil output would generate a larger budget deficit, as unit cost of production in the new fields cannot be recovered due to the exchange rate ceiings. 2.38 Monetary devaluation represents the worst tbreat to CEPE's finances. ibis ls because CEPE computes sucre income at a constant exchange rate when company expenditures are effected at the 1/ Oil revenues as used in this paper mean the gross valuo of domestic and foreign sales of crudo and refined products. Oil rents, of course, refer to the economic surplus, which ls the difference between income and costs. -29- managed market rate. Continuing devaluations will prove the major reason for CEPE's financial failure in tie next few years lf the current system of oil revenue allocatdon 18 maintained. 2.39 CEPE has proved unable to recover Ita opeating costa, let alao generate resources for new lnvestments, because of the many legal measures affocting the allocation of oil reveaue, aM, too, bocana of dovelopmenta in the national econromy. Ita external debt total8 $289 million in 1988, but will reach $344 million in 1989 and $300 mnilion in 1990. By 1992, It wlll drop to 196 million, (excluding any additdonal borrowíng during the 1988-1992 five-year pericd). Analyuis of Problems in CEPE's Ivmestment Program 2.40 CEPE's investment program needs to be further prioritized. Each department submita its program separately, without takling lnto account dither CEPE's situation or the country's general economic situation. 'Mis is evidenced in CEPE's Five-Year Investment Program of lune 1988. 2.41 Recoet large-scale lnvestmenta havo bcen undertalen in processing (especially refining), and thus this area's requirements will not be a high priority ir, coming yeara. I¡is is especially true when consideriag diat demand could drop because of decreasing economic activity, and because of possibly substantl prico increases. In view of the reserve situation meneioned carlier, investment efforts should coneate on exploration and production. CEPE's investment program, however, places emphasis on processing and trasport projects, which together represent 64% of the total investments. Moreover, the processing investnent program containas a multitude of programs wi no establihed economic or social priorities. Given preseat economic troubles, this situation should be reviewed and corrected. Tabte No. 2.5 CEPE: INESTNENT PRAN Ctn *lilton of dololar) 1988 1989 1990 1991 1992 TOTAL Ei 10 76 133 158 34 411 Trport sad Storago 67 75 80 64 10 296 arkattng & Othar Servtcn 14 12 10 10 9 55 TOTAL 177 235 2m 290 112 1102 (e) Thbl 1nclud the USS186 miLtlon to modía*iz the PenínsuTl refin rien thot ure not covered in the tnvetmmnt progre, elthoug the works u*re includad. It e os ud thot the .westmemt scheóLe witl be u folloas: US$39 milItan por yeor In 1989 u*d 1990; US$98 milIton In 1991 ond US$10 militan In 1992. Murce: CEPE wd Vork Grou estfmats. - 30- 2.42 Exploration lnvestments shown in the CEPE Plan and those proposed in this study differ as follows: - Under CEPE's Plan, only 14 wildcat wells and 5000 km of seismic would be made, whereas this study's proposal calla for 23 wells and the same 5000 kilometers of selsmic. la CEPE's Plan, each we1l costs US$800,000, whereas in this proposal, the cost ¡a estimated at US$2 million, a figure more in line with recent experience. - lbe above changes in the Pive Year Investment Program result in a USS32.1 million lncrease in exploration investments. EXD ortion Investnnents bvOil Companies 2.43 Exploration investments by the service companies are greater than those established in the repective contracta. Higher seismic and drilling costa account for this. During the years 1985 thmugh 1988, thero was a 40% increase above committed investments. TIis additional percentage was applied to investemnts for the 1989-1992 period. Production 2.44 Production investments provided for in CEPE's Program and those proposed in this study differ as follows: - Under CEPE's Program, 16 fields would be developed, with the drilling of 70 wells, at a cost of US$660,000 per well. Artificial lift would be carried out in the Libertador, Bermejo Sur, Tetete-Tapi, and Cuyabeno-Sansahuari fields. - hle proposed investment program ¡caves out the development of 8 wells included by CEPE but íncorporates other fields: Capiron, Tivacuno, Curaray, and Primavera. In- vestment estimates are based on the amount of investment per barrel of Initial Peak Production (IBIPP), according to the models used by CEPE to asaesa investment in the North Oriente, South Oriente, and Central Oriente. These investments are roughly $3500/lBIPP in the North Oriente, $5500/IBIPP in the Central Oriente, and $8300/IBIPP in the South Oriente. Figures cover aU investments in drilling, in production and storage facilities, in opening roads and laying flow lines. - Nc provision has been made for investments in the probable substitution of the gas-lift system by other artificial lift systems whera the water cut in the wells increases. It la, however, appropriate to point out that the estimated amount for each wehl ls around -31 - $S00,OO0. lThe proposed production plan for the five-year period requires $S80.7 million more tlan CEPE's Program provides for. ProcessinL: Ref,niny and Use of Gas 2.45 These undertakings involve investments that are required to meet domestic de nand for refined produats. Forecasts are that the growth rate of demand for refined producta will be 3.64.7% a year throughout the 1988-1992 period according to INE and CEPE projections. According to the two demand projections, the refineries would have a fuel-oil production surplus for export and a LPG shortage that would have to be covered by imports. 2.46 Table No. 2.6 summarizes the refinery throughputs estimated by CEPE in order to satisfy the domestic demand for reffned products. It also includes the fuel-oil exportable surplus and the amount of LPG to be imported. Table No. 2.6 REFINERY BALANCES (in thousands of barrela per doy) 1988 1989 1990 1991 1992 Refinery Throughputs 108 112 117 121 125 Refined Product Production 105 110 115 119 123 Refinery ConsuWption 5 5 5 5 5 LPG Prod. (Oriente) 2 3 4 6 6 ExportabLe FueL-Oll 14 14 15 16 19 LPG Imorto 4 3 4 3 5 Source: CEPE demd projectiona for refined products. 2.47 Current demand for refined products includes approximately 10% of petroleum products that are illegally exported because of low domestic prices. This contraband could be totally eliminated with a more rational price policy. 2.48 Ecuador's total reflning capacity suffices to supply refined products, except for LPO, during the next 5-7 years (depending on the demand behavior). If product prices were increased and maintained at a more reasonable level (that is, at the level of replacement of used reserves or of international prices), superfluous consumption and contraband trade would be minimized, and installed capacity would cover from 7 to 9 years. Considering that three years are required to build or expand a refinery, the first year of investment would fall outside of the five-year period studied in this paper. 2.49 CEPE's Five-Year Investment Program allocates only US$6 million to modernizo the Peninsula refinerles, but US$192 million are required for conversion units in those refinerles. Ibis project would reduce fuel-oil exports by 35% starting in 1993 and produce LPG and gasoline. lie world -32- oUi supply sltuation in the short-term does not provide sufficient economic inctives for the construction of new refineries or for the expansion of high-converion facities, as compared with tih lmporation of producta. Gjas Planta 2.50 With regards to the associated gas ln the Oriente fidds, the WPO extraction plant in Shushufindi is operating only at 15 MMCFD (approximately 60% of ita gaa-processing capacity). It ls being expanded by the addition of three new compressors that will make k posalbie to atain the maximum capacity of 25 MMPCD. 2.51 CEPE is preparing an LPG extraction project with a 15 MMCFD capacity for tio Libertador Field at an estimated cost of US$31 milion. It is anticipated, however, that gas production in this field wil decline rather quickly, as shown in the following table. Consequently, the limited availability of gas suggests that the plant may be oversized and that its economic justification could be impaired. Alternatives suggested for consideration include the fractionation of the liquida extracted at the compression sites where gas is reinjected. Table No. 2.7 PROJECTED GAS PRCOUCT ION (in mUtlfno of cubie f..t por dq) 1989 1990 1991 1992 1995 2000 Lbertador FPeLd 12.9 12.9 12.9 11.8 9.2 6.1 5gurce: Work GroW Ekttmtes. Other Industrial Projects 2.52 CEPE, in its Five-Year Program, has budgeted US$172.8 million for investments wth other companies to manufacture special products (aromatica, solvents, basic olsa for lubricants/paraffin, methanol and ammonia-urea). Most of these investments (US$147.6 million), are for a lubricating oil plant. Whereas the solvent plant could provide good economkc returna, aromatics and methanol will probably give only marginal returna. Basic lubricating oils and the ammonia/urea planta are not economically sound projects, given the size of the planta and the international market prices for those producta. CEPE has budgeted US$5.6 million to study the need for an asphalt plant in the Amazonas Refinery and a fertilizer ammonialurea plant in the Oriente. lhere la no justification for a new plant, since the Esmeraldas Refinery has adequate asphalt capacity. Although gas ls available in the Oriente, a fertilizer plant should be located in the areas of greatest consumption. Ibere ls no jusdfication for a smal-lized ammonialurea plant in light of current and projected international prices for import of dhese producta. - 33 - Trasprt and Storage 2.53 Two major problems emerge in this area. Tbe first is the lack of LPG atorago capacity, especially in the southern region of the country, and particularly in GuayaquU. Tbe soond la that sveral projects are wow underway and will very probably hayo to reach completion, untea they can be discontinued without substantial losses (for example, lf matUríais andlor equipment already purchased for the Monteverde-Manta Products Pipeline can be used in other more profitable activities). LPG Transport and/or Storage ProJects. Under Consideration or Implementation (1) Expansion of the Tres Bocas Terminal and construction of the fuel-ol aud LPG tranfer lines for storage at El Salitral, with a subsequent fuel-oil ectension to the INECEL plant. This project includes two fuel-oil tanks. kt la considered necessary, since the beltway around Guayaquil will block access to the formerly used wharfs (US$3.1 mnillon). (ii) LPG storege expansion in the El Salitral Plant ($23.6 million). Current LPG storage faciities in Ecuador are insufficient, particularly in the Guayaquil area, which has a mere 5 days of reserves and could be left without supplies. Nearly 4 MBD of LPG are imported via Guayaquil, while an addidonal 2 MBD are brought from the Esmeraldas Refinery in tank trucks. An LPG tanker has been leased as floating storage. (iii) Supplementary works for LPG-bottling plants ($7.2 million). LPG distribution la a private business; for project iii, consideration could be given to limiting CEPFE activities to bulk sales. Other Transoort and Storage Proiects Under Consideration (i) Clean-products pipeline from Libertad-Monteverde-Manta and Monteverde-Pascuales. It includes a seaport terminal and storage facilities for clean products in Monteverde with nine new tanks ($44. 1 million). Bids for construction will be received in September, and it will be entirely financed by the Government of Argentina. (ii) Clean-products pipeline, Pascuales-Naranjal-Cuenca and Naranjal-Machala ($63.3 milion). (iii) New packaging plant for lubricating oils ($78.6 million). fiv) Expansion of Trans-Ecuadorian Pipeline ($2.7 million). Of these projects, some of which are at the planning/design stage or are now underway, none have been prioritized. lbe projects total almost $200 million, and it is obvious that many of them shouid be critically reassessed and postponed until the situation improves. -34- CEPE: Institutional Aspects 2.54 A large number of official organizations are active hi the energy sector: the MEM is the energy policy-making body; the INE is the planning and advisory agency; CEPE-INECEL has operational and administrativo responsibilities; and the National Directorate of Hydrocarbons is in charge of technical control and supervision of finances of the oil sector. A weak interface among the above organizations, however, impairs proper functioning of this institutional system. A number of factors contribute to this weak interface: the organizations, for a variety of reasons, fulfill their tasks only in part; they exceed, in practice, their areas of responsibility; or they suffer from an inate inabiity to discharge their duties; or finally, they are incapable of adapting because of historical inertia. 2.55 The DNH exceeds the limits of its responsibiities, for it not only controis and supervises the operators (including CEPE), but also exceeds its authority by intervening in the planning and execution of activities internal to CEPE, such as domestic marketing, and by intervening in the management of CEPE's partner companies (such as the CEPE-TEXACO Consortium and the service companies). 2.56 CEPE's inherent institutional inadequacies emerge from its inability to perform its functions efficiently, free of legal and financial obstacles. The Corporation Charter that established CEPE in 1972 conceived it as an institution dependent on the Central Government's administrative organization and system of control. It was not meant to be a corporation with its own autonomous administrative and operational management, governed by business standards and practices. The highest level of decision in CEPE (the Board), whose members represent the Ministry of Finance, Ministry of Defense, CONADE (National Development Council), Ministry of l.dustries and Ministry of Energy and Minos, represents almost all the interests of the State and also determines the major guidelines for management of the Corporation. The Board, however, intervenes in even the details of CEPE's operations. lhis should normally be the duty of the General Manager and of the Area Managers. Moreover, as CEPE iS burdened by rules governing the centralized public administration, under the Organic Law of Financial Administration and Control (LOA FYC), cumbersome administrative and control procedures prevent it from responding to the dynamics of die oil industry. Thus, decision-making is curtailed through fear of the General Comptroller's Office and ita audits. The Office's public-fund monitoring system is based on compliance with bureaucratic formalities typical of ministerial departments rather than on performance. 2.57 CEPE, moreover, was created without any internal economic, business-oriented procedure. CEPE's objectives are set forth in the Hydrocarbons Law and in its Corporate Charter as being exploration, production, transport, refuning and marketing of hydrocarbons. No mention is made of economic performance, which explains why CEPE's income bears no relation to its business performance. CEPE is allocated funds, irrespectivo of cost recovery needs or expansion of activities. It is considered as yet another party sharing in oil revenues, but not as the eLtity generating these revenues. 2.58 Finally, development of the oil industry has brought new institutional functions, which havo not boen assimilated by the existing system. CEPE's partnership with TEXACO, within the CEPE-TEXACO Consortium, should have brought about the establishment of a new enterprise beaded by a Managememt Committee to represent CEPE interests and to provide management standards for die operator, Texaco Petroleum Co. of Ecuador. But the juridical nature of the Consortium remain~ legally undefined (de facto corporation), and in practice, the operator implements its own administrative - 35 - procedures in the Corporation. The Trans-Ecuadorian Pipeline continues to be managed under the same rutes that applied when it was the exclusive property of Texaco and Gulf, although it is now wholly owned by CEPE. Service contractors operating for CEPE in exploration and production of hydrocarbons depend much more on the DNH than on CEPE, as would be the case if they operated wnder conceasion contracts. This results in the duplication of administrative and control tasks, which are often carried out in both CEPE and DNH, and add to the burden of the operators. 2.59 To conclude, since TEXACO's share in the CEPE-TEXACO Consortium will revert to the State in 1992, it is essential to change the current juridical, financial, and managerial status of CEPE so that it may take on the entire responsibility for the Consortium's oil operations. Electr-icity General Introduction to the Subsector 2.60 To recapitulate the main data on the electricity subsector, it should be noted that in 1987 the system showed a peak demand of 1020 MW and a consumption of 4211 GWh. To meat this demand, the system generated 5345 GWh, 85% of which were from hydroelectric and 15% from thermal generation. Total losses (trarsmissionldistribution) represented 21.2% of generated power. lhis represents a very sizeable loss, and the problem must be studied with a view to establish losa reduction programs. To meet consumption requirements, the system has a total installed capacity of 1764 MW, equivalent to a total firm power supply of 1444 MW, at generation, 763 MW of which are hydroelectric and 681 MW, are thermal. 2.61 Available data for the January-May 1988 period show a substantial decrease in the historical rate of growth of consumption of 8%, an annual average of only 3.5% (estimated). Peak demand over the same period was 983 MW, which could indicate a peak estimated demand of 1070 MW by December 1988. Firm capacity has a large reserve margin to cover current demand. By late December 1987, the system had 1,181,100 registered consumers, and electricity reached about 63.5% of the population. 2.62 A wide range of problems currently affect ¡ie electricity sa-úubsw.. e subseor's difficult economic and financial situation requires urgent short-term measures and the sihw:uit=us development of medium- and long-term recovery programs. lhe problems may be grouped as follows, in decreasing order of importance: (a) Very low tariff levels and an unbalanced tariff structure tiat fails to promote the rational and balanced use of energy. Insufficient government measures. (b) Worrisome financial situation of the subsector, and of INECEL in particular, with a worsening trend in the last few years. (c) Serious technlcal problems in the major hydroelectric power plant (Paute): uncertaynt regarding the costa and efficiency of the measures proposed; potential unknown tecbical -36- and cost implicatdons for other hydrom actrlc projecta wow under construction (Paute, phase C) or under study (Sopladora). (d) Excessively large expansion program (relative to anticipated demand). The program la badly underfinanced and requires revision. Difficulties il comparíng alteratives (to determine the Ieast-cost program) because of differences la the level of detall of power project studies. (e) Deficiencies i the organization, operation and managelnent of the subsector. Insufficient coordination between INECEL and other electricity companies. Inadequate legal framework. (f) Status of EMELEC not yet defined; no detailed studies on alternative solutions and on their impact on INECEL. Elfectricity Tariffs Obiectives 2.63 The tariff policy is probably the most sensitive issue facing the electricity subsector, directdy affecting its revenues and and its abiity to finance expansíon projects. An analysis of tariffs la Ecuador must be based on accounting criteria (i.e. average costs and revenue needs of the utilities) because there are no estimates of Long Run Marginal Costs (LRMC) on which to base tarifas. 2.64 lbe Basic Electrification Law determines thatINECEL's Board of Directors is responsible for approving the taiiffs to be applied by the distribution companles. lhese tariffs must cover direct operatng and maintenance costs and depreciation rates and ensure a reasonable profit. TariffRegulations stipulate the need for annual profits to permit an "adequat~ contribution to investment. lhies percentages are determined annually by INECEL's Board of Directora. 2.65 In practice, the Government has never designed a tariff policy consistent with these legal provisions and has restrained adjustments essential to the healtdy economic and financial development of the subsector. Thus, since at least 1980, tariffs have filed to cover even oprating costs, not to mention a contribudion to investment. Erosion of real tariffs grew worse with the suspension of the montbly 2% and 3% increases in July 1988. Iaff outixn 2.66 ihe major tariff policy measures are reflected in two increases: (a) starting la July 1983, a 2% cumulative monthly increase on bulk sales by INECEL to the companles and by the latter to users; and (b) atarting in October 1985, an additional 1% monthly cumulative increase on sales to final users. Tie following table shows tdat these increases have failed even in oifsetting inflation. Deterboration is even more sdgnificant il tberm of the US$ equivalent. Tbe largest decrease took place between 1982 and 1984, and was never recuperated. - 37 - Tebls No. 2.8 TARIFF EVOIUTICO (1) (Values In Current md Constant Curr ncy) YEARS 1980 1981 1982 1983 1984 1985 1966 1987 Average tou-tena. terftf Current om~y (S.Ikuh) 1.28 1.63 2.01 2.17 2.86 3.48 4.64 6.51 Constant Currency (1980) (S.IkWh) 1.28 1.40 1.47 1.08 1.09 1.02 1.07 1.20 Current USM (cIkYh) 5.10 6.52 6.01 4.98 3.80 3.61 3.75 3.83 Bulk Sales Teriff Current noney (S.IkUh) 0.63 0.91 0.97 1.14 1.45 1.S5 2.35 2.99 Constant oMny (1980 - S./kWh) 0.63 0.78 0.71 0.57 0.55 0.54 0.54 0.55 Current U1$ (clkWh) 2.52 3.64 2.94 2.61 1.93 1.92 1.90 1.76 1) Average Annual Values Fmurae: INECEL. 2.67 For consumers of low-tension electricity, tariffs went down from 6.52 USo/kWh la 1981 to 3.83 la 1987 (in current dollars). For bulik sales, tariffs fell continously since 1981, from 3.64 UScIkWh to 1.76 in 1987 (also in current dollars). 2.68 It is impossible to compare tariffs with their economic costs since no approximnat estiates of RMC are availdble. But in accounting terms, operating income never reached positive interral net generation of funds. An analysis made within the ftamework of the present study establisbes for 1988 an average tariff to the final consumer of about 12.8 S./lcWb and a tariff for block sales of about 7.5 S./kWh as the amounts required to cover annual opeating costa (including interest charges) without contributing to self-flnancing. l hese figures are much bigber than tdose expected to prevail inc current fiscal year. 2.69 llbe present tariff structure is too low as weIl as inappropriate. It classifies consumers according to their economic activities but ignores differences in tension leveis, time of day, and does not reflect the user's location on the load curve. It thus fails to send appropriate signais about the actal cost of electricity and penalizes (in relative terms) tdose consumer whose use-patterns are better for the system. Household Tarff 2.70 Households account for nearly 40% of total consumption and 85% of registered consumen. Specific annual consumption per houschold user (Cm 1987) was 1630 kWh. Ibis is a very bigh figure in light of tie country's level of development. lbis consumption is equal to that of Brazil or Portugal in 1987 and similar to tdat of Spain in 1984. Funthermore, specific consumption by company diffe considerably: 2670 kWh/customer/year for EMELEC, 2150 kWh/customerlyear for thd Quito Electric Company (E. E. Quito) and 1070 kWMlcustomerlyear In the remaining companies. Figures for -38 - Quito and Guayaquil are higher than the average figures for the household (residential) sector in Italy or Greece ;/, for example. The main reason for such high specific consumption in Guayaquil is probably the intensive use of air conditioning. But generally speaking, high consumption is encouraged by low tariffs and the rather uncontrolled use of electric power, plus possible inefficiencies in electrical appliances. Tbere are also the "socially-oriented" consumption quotas with frozen and excessively !ow tariffs which in many countries are limited to 30 -50 kWh per month, whíle in Ecuador th y range from 80 to 150 kWh. 2.71 Distribution of consumers by leveis of consumption in the case of the major companies (Quito and EMELEC) is different from the rest. These differences in load characteristics make for differences in profitabDity and argue in favor of the concentration of companies. Tables No. 2.9 and No. 2.10 show the distribution of household users by level of monthly consumpdon as a percentage of the total number of household users and as a percentage of total monthly household consumption. Table No. 2.9 NOUSENOLD CONSUKPTION OF ELECTRICITY DISTRIBUTION OF USERS AS A PERCENTAGE OF THE TOTAL NUMBER OF NOUSEHOLD USERS LEVELS OF CONSUIPTION (in KUhI.anth) Cua. Ctu. CoMPANY 0-20 21-50 51-80 81-120 121-150 151-300 301-500 500 0-80 0-150 (3) 10,28 1000 9,90 9,19 (R-3) C*) 10,28 (*> R-3 Tariffs only available in ENELEC <1252> <1047> (3766) Iet Incrn before pabnt of Interest (1497) (1378> 195 78 Interest charged to aperaioas (4053> (5394> (7215> (10538> let aperatíng poft/ltoss (6000> (6722> (7020> (9754) Soum: IMECEL QlRevenues 2.78 Government allocation of oil revenues has proved amnong the sector`s major sources of fwxds. Ihese funds have steadily decreased, not only because of the drop in oil prices and the suspension of production in 1987, but also because the exchange rate (at which Wroyalty dollars. are converted to sucres) has becen frozen at SI.66.50 since 1983, while the official is used for debt service and for payment of imported goods. Oil funds dropped from 6,165 million sucres in 1982 to 2,639 milhion sucres in 1987. 1I See Table 2.13. T-bIe No. 2.13 EVOLUTIOI OF OIL REVEMUES TRANSFERRED TO INECEL (In lltloan of sucres and uliLios of current dollars> 1980 1984 1985 1986 1987 Nlittlon of *royulty dolItera 126.4 120.4 142.0 86.7 53.3 Nl o1m of sucres 3161 .0 8004.0 9442.0 5767.0 3543.0 Nlilana of dollers (actual) 126.4 106.3 97.8 46.7 20.8 $ource INECEL. 2.79 Decreasíng oil revenues led to increased borrowing, accounting for the increase in the long-~erm debt of the subsector (INECEL+Companies) from 44 to 177 billion sucres over the 1984-1987 period. lo current dollara, and at the official year-end exchange rate, liabiities rose from 580 to 800 YI Differeot INECEL sources (Planning and Accounting) present different figures. lbe Accounlmg figures are used here. - 42 - million dollas over the 1984-1987 period. Nearly 80% of the total debt is INECEL's. Variationa in the debt ratio (iong-term debtlnet worth) over the four-year period were as follows: Table No. 2.14 THE ELECTRICITY SU8SECTOR LONG-TERN DEBT/NET WORTH tREVALUED ASSETS) YEAR 1984 1985 1986 1987 Debt rmtto 0.33 0.42 0.50 0.58 Swurce: INECEL. 2.80 Although the ratios are increasing, they are still low and below 1. Low ratios are due to the revaluation of assets, which in the 1984-1987 period represented between 70% and 80% of total assets. If increases at historical book values are computed on the basis of 1982 values, and using the assets, values obtained are much higher and increasing, as shown in Table No. 2.15. Tabte No. 2.15 THE ELECTRIC!TY SUBSECTOR L-NG-TERN DEBTINET UORTH (NON-REVALUED ASSETS) VEAR 1985 1986 1987 Incrertel change -n the debt ratio 2.3 4.3 6.9 Swurce: IdECEL 2.81 Tle servicing of the debt (interest plus amortization) has remained relatively constan ina current dollars (around 100 million dollars a year) but, of course, grew in current sucres, from 8,000 million in 1984 to 16,000 million in 1987 with the sucre's depreciation. In percentage terms, interest has increased at a faster pace than arnortizations. Bad Dsebts 2.82 Internally, bad debts (arrears due INECEL) amount to approximately 11,000 million sucres, of which EMELEC's are about 9,000 million sucres. This is quite alarming. EMELEC continues to pay for the encrgy it purchases from INECEL at the 1983 price (0.92 sucreslkWh), which is very low. - 43 - Source and Use of Funda 2.83 Finally, it is important to compare the source and use of funds over recent years, as shown in the following table. It shouid be noted that the internal generation of funds is always negative and that with few exceptions investment is entirely fnanced by borrowing. Table Ni. 2.16 ELECTRICITY SUBSECTOR. 1984-1987 STATENENTS OF SOURCE ANO USE OF FUIDS (in mlilton of current sucres> 1984 1985 1986 1987 Gros Internet generation 3644 4712 8036 11279 Ddbt service (*) (7976) (9279> (13150) (15889) Uet Internet generatton (4332) (4567) (5114> (4610) CapItal contributions 6112 7308 6060 2566 Loan d1sbursements 5533 4893 14204 16628 DIrect Investuento In works 3378 9074 13197 10531 Financotl Investmunts 2093 653 455 1577 D-rect Lo anslnvestmentsa() 164 54 108 158 (*) Internet nd amortlzatíon SºYrce: INECEL. 2.84 Tne foregoing is an analysis of the consolidated electricity subsector (excepting EMELEC). A similar analysis of INECEL alone would reveal an even worse situation due to the following factors: a) the most important direct investments and capital requirements are those of INECEL (hydroelectric facilities); b) the external debt is almost wholly INECEL's responsibiity; c) as a result, INECEL`s net internal generation of funds is even more negative than that of the consolidated subsector and requires a larger participation of external sources in investments. Planned Expansion Demand Projections 2.85 The government ls giving top priority to attaining 100% electricity coverage by bringing service to the remaining, mostly rural, 36.5% of the population. In late 1987, INECEL completed the 1987-2010 Master Electrification Plan for Ecuador. The demand forecast is based on what it considers the least favorable' scenarlo, with a 3.0% annual GDP growth per year. A 3% real growth per year in GDP would be considered a solid perforsmance under present conditions (see Table 2.17). - 44. Table llo. 2,17 NASTER ELECTRIFICATION PLAN. PFER SIPPLY AN DEIAND PROJECTIONS (1988-1997) YEAR 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Canswpt1on lii> 4431 465 4911 5170 5514 5802 6097 640 6692 6695 Groeth rate (C) 5.1 5.4 5.3 6.7 5.2 b.1 5.0 4.5 4.5 Power GCnratfon 1027 1067 1122 1175 1255 1310 1371 1434 1492 1553 Se: IIECEL, Mster Electrlficatlon Plan. 2.86 By using a different methodology, INE obtains lower projections: 4722 GWh in 1990, 5956 GWh in 1995, and 6436 GWh in 1997. The difference between projections for 1993 is approximately 355 GWh. Although demand estimates were changed in April 1988, new macroeconomic scenarios have not been considered. Moreover, the probable fall in GDP ia 1988 and the elasticity of consumption to a significant rate increase have yet to be taken into account. Power Generation Prog ra 2.87 lbhe Master Plan expects to meet demand until 1995, with existing generation capacity and two new hydroelectric projects: Paute, Phase C, now underwny, and Daule-Peripa.41 fle projects have the following characteristics: Table lo. 2.18 ELECTRICITY SU8SECTCR: PO~EN CIPACITY AND POMER GENERAT10N OF THE PAUTE AND DAUI.E-PERIPA PROJECTS Pouer Capactty t Project Installed Firs PrImry Mean Prfiry-l*an (mitlion doLLar.) Project In.t. Fim (dry yer> (uno> (2) Mzr 180 92 428 631 507 3pLador (A1) 400 336 1229 2442 338 Sopladora (11 400 336 1730 2442 338 Paute ABC(A) 1000 769 2270 5138 - Paute ABC(I> 1000 769 3260 5262 - <1) (AmOperation uwthout conBtructino Mzar; tl) operation integrated with Mazar. (2) Jamry 1987 dotteras S~e: INECEL. 2.90 Ibe Pauto-Mazar project ¡s located upstream of the Pauto-Molinos Project, Phases A,B,C. It is not very valuable by itself (primary energy equal to that of Daule Peripa, with greater installed capacity and much greater cost). Owing to its substantial regulatory capacity it does, however, provide lmportant benefits for finn power generadon of the downstream projects, such as Paute ABC and Sopladora. The project can also control part of the silt carried by the river towards the Amaluza reservoir (Paute) -a serious technical problem which remains unsolved. Mazar ia at the design stage, while the Sopladora project is at the prefeasibility stage. Project cost and the influence of sediments discharged from the upstream Amaluza reservoir have yet to be identified. lnvestinet 2.91 The INECEL lMaster Plan, which includes transmission, distribution, and other investmenta (excluding EMELEC), would give rise to the following investment program: -46 - Table No. 2.20 NASTER ELECTRIFICATION PLAN 1988-1996 INVESTNENT PRO~RAN lin milliona of June 1987 dollars) TOTAL YEAR 88 89 90 91 92 93 94 95 96 8U-92 Generatfon 66 63 82 95 100 95 110 115 138 406 Traamlsston 43 24 10 9 4 3 3 3 3 90 Dlstribution 83 53 56 44 49 48 49 49 48 285 other Invest. 29 37 26 17 15 5 4 10 4 124 ................. .................................................................. S"btotal 221 177 174 165 168 151 166 177 193 905 .................................. ........................................................... -.... lnterest on Construction 9 9 15 18 17 21 24 29 8 68 ........................................................................... TOTAL 230 186 189 183 185 172 190 206 201 973 -rsce: INECEL 2.92 The program has substantial investment requirements, particularly in the short-term. Tliese requirements fail to reflect the stagnation of demand, the sector's financial situation, and the government's abiity (as the National Electric Fund) to make capital contributions. Investments in the different items budgeted also appear unbalanced, for there is an excessive allotment to *distributionmand a very high percentage in 'other investments". Tariff Adjustments 2.93 Thte plan assumes that monthly tariff increases mendoned carlier (2% for bulk sales and 3% for final consumers) wil continue until 1990. It later reduces increases on sales to users to 10% a year and maintains 27% a year on bulk sales.5I Net internal generation is negative until 1991; the program lacks finaucing and has high annual deficits, as shown in Table No. 2.19. This makes its implementation unfeasible. 11 In actual fact, with the step increases assumed for the Plan, bulk sales tariffs would show negative growth rates (in real terms) in 1988 and 1989. - 47 - TobMe No. 2.21 MASTER ELECTRIFICATION PLAN 1988-1996 Source and Use of Funds (in mltlons of June 1987 dolIera) TOTAL VEAR 88 89 90 91 92 93 94 95 96 88-92 Total tnvest. 230 186 189 183 185 17n 190 206 201 973 Net Int. Gen. -94 -57 -22 -12 10 40 56 68 43 -175 Loans( 4> 122 79 n 74 67 60 69 73 90 414 Deficit 202 164 139 121 108 n 65 65 6a 734 (1) Dlsbursements on outstandIng loan~ or on ton under negottatIon. Source: INECEL, Master Electrification Plan. 2.94. The deficit for the 1988-1992 period runs to $734 milion (at June 1987 prices), although loan disbursements of 414 million dollars are assumed to talce place. Assuming the extreme case that the entire deficit were to be financed with tariff-based revenues, annual average tariffs required would be as folows: Table No. 2.22 AVERAGE ANNUAL TARIFFS c(n U.S. cents/kUh Jume 1987 currency) 1988 1989 1990 1991 1992 1993 1994 1995 1996 Naster PlanC1) 4.26 4.88 5.80 5.80 5.80 5.80 5.80 5.80 5.80 Defifct Cov.(2) cents/kWh 7.79 7.66 8.05 7.70 7.44 6.79 6.65 6.63 6.68 Sumres/kWh(3) 13.2 13.0 13.7 13.1 12.6 11.5 11.3 11.3 11.4 (1) Tariff chanes over tfme assumed In the Naster Plan (2) Tarlff required to completely cover the deficit (3) Conversion mt 170 SI. per dollar (June 1987 dollars> Source: INECEL and Work Group Estimates. 2.95. The above tariffs are the averages on bulk sales to EMELEC and to final users: tariffs for final users would be higher, reaching a maximum in 1990, and then drop, in real terms. At Juno 1988 prices, the average tariff for the final user would be nearly 20 SI.kWh. ThMe analysis shows the impossibiity of implementing the Plan and the need to find alternative plans, with lower investments, in the next few years. -48 - Technical EMffiema Simentation of the Amaluz Reservoir (Pautel 2.96 Sedimentation of the Amaluza Reservoir is a crucial technical problem, threaing phaes A, B and C of the Paute Hydroelectric Plant with a total Instled capacity of 1000 MW. lhe problem is aggravated by the postponement of the upstream Paute-Mazar project, since one of the obJectives of this project was to stop the river's carrying of solid. The financial burden implied by the constuction of such a project requires alternatives to the Mazar project. 2.97 Solution of the sedimentation problem of the Amaluza reservoir appears even more reote since the postponement of the Mazar project. Tle alternative sdetd comprises deep dredging, dredging upstream of the lower portion of the reservoir, and the possible raising of the water intake. A number of uncertainties still exist, since the two-stage dredging solution, both deep (still at the testing alage) and conventional (upstream, at 2 to 5 km from the dam) could havy high costa or, even worse, be inadequate and turn the Paute Plant into a run-of-the-river without any regulation capacity. 2.98 Precise estimates of the cost of the Amaluza dredging project are unaaable, but die figures provided thus far range b3tween US$2 and US$6 per cubic meter of silt. As the a~nual volume of dredging is estimated at nearly 3 million cubic metera, tais would entail a~mual dredging costa of $6 to $18 million. Estimated equipment costs for the first phase (deep dredging) are $12 million. Feasibility Studies of Hydroelectric Proiects 2.99 Another technical problem ís the inadeqiacy of studies on those hydroelectric projects considered for incorporation into the system ín the medium-term, such aa Sopladora, Chespi San Francisco, and even Coca-Codo-Sinclair itself. TIus far, and in the INECEL expaosion plan, they aro compared with Paute-Mazar, despite the lesser degree of information avallable on them. TIe feasibility studies of the Sopladora, San Francisco, and Coca projects are underway or about to start. INECEL has a $36-million IDB loan available for these studies, and they should be completad in two years late 1990). Disbursements on the above loan have been suspended sinuce October 1987. Poer ovess 2.100 In the last few years, power losses in the subtraosmission and distribution gdds have averaged 17%-18% of available power in the substations of the Nationra Interconnected System. Sharp loSa variations exist among the different companles, though statistica on some of them are not -49 - very reliable, as they show large-scale, inexplicable changes over two consecutive years. Tbis couid be accounted for by poor metering and computing fI However, while the Quito and Guayaquil load centers, which make up 65% of the overail market, incur losses of around 16%-17%, there are regional companies whose losses exceed 30%. This high level of power losses might be caused not only by aging distribution grids in population centers and by inappropriate subtransmisaion systems (overloaded), but also by unmetered users, by the poor or by fraud or theft. The better losa performance in Quito and Guayaquil, moreover, is due to substantial internal generation in medium-tension grida, which is instrumental in reducing overall losses. 2.101 Priority investments in the distribution networks (that contribute to losa reductiona) should be made in Guayaquil, since EMELEC has minimized ita investments to a minimum for several years, probably because its concession was to terminate in 1985. 71 The detailed identification of the studies and investments required for this system should include a definition of the future insttutional framework of the EMELEC area. 2.102 The distribution companles have no incentives to reduce losses, for the institutional arrangements in effect allow theni to pass on their own financial loases to INECEL without any consequences to themselves. Loss-reduct,on programs are badly needed, and these would surely improve the worst cases. lle results would reduce company demand on INECEL, and consequentiy, reduce total consumption and required generation. Operation of the Interconnected System 2.103 Operation of the generation system, including power generated by INECEL and that generated by the other companies is not being optimized. Ibis has resulted in the operation of inefficient thermal power plants, rather than of the most efficient ones; and occasionally, in the operation of thermal planta while water has spiled from hydroelectric plants. Their output is approximately 9.93 IWh/gallon- while the Quito Electric Company produces almost 14.9 kWh/gallon and INECEL nearly 13.3 kWh (excluding Esmeraldas). Table No. 2.21 compares output of the major dhermal plants in 198 -nd computes the plant factor, exclusive of availabiity. Whereas EMELEC attained a plant factor of dmost 21%, INECEL only achieved 15%, and the Quito Electric Company, which has the most efficient planta, barely reached 3.5%. One of the problems is that EMELEC's thermal plants are the most inefficient in the system. fi/ Losses are measured by the difference between the power purchased from INECEL (or internally generated) and the power sold to final consumers. No one can guarantee tdat this power ¡a measured within the same period as the power generated. 2/ Ibe EMELEC distribution network in Guayaquil, which la entirely aerial, poses serious safety problema for the 'opulation and wouid require complete overhauling in the short term. -50 - Table No. 2.23 M>.JOR THERMAL POCER PLANTS BASIC OPERATING DATA tu 1987 Company Avallabte EffIclency Gemratlon Plant cap.ctty CkWh/gal on) 1987 Factor ENELEC 171 9.93 312 20.8 E. E. Quito 55 14.92 17 3.5 INECEL excluding Esmeraldas 256 13.38 338 15.1 Esmeraldas 125 14.80 Source: INECEL. 2.104 Operation of the EMELEC power plants at a national level has been impossible to coordinate, as the company insists on operating them on its own. Voltage control in Guayaquil, which EMELEC regards as a real problem, could be achieved without power generation but with EMELEC units functioning as synchronous compensators. 2.105 It is not clear, moreover, wby the thermal steam Iplant in Esmeraldas, which began operating in 1982 with a working capacity of 125 MW, generated power only in 1982 and 1983 (with plant factors of 42% and 33%) and stopped operating from 1984 to 1987. lhe plant is modern and efficient, consu,tes residual fuel (which is cheaper than diesel), and is geographically located *oppositeu Paute, so thL. sa operation would both lower costs and increase system reliabiity. -Sl - Toble No. 2.24 THE ELECTRICITV SLISECTOR CONSOLIDATEO PROFIT AND LOSS STATENENTS 1983 1987 (<, mtilIona of current tucres) YEAR 1983 1984 1985 1986 1987 Powr Salas (GWh> 3288 3588 3830 4204 Operatfng In ome Power Sales 5817 7m98 10198 14947 22596 Other Income 119 156 211 283 414 y§s 75; j040 15230 D1Oi .... .... . ........ ..... .................. Operat tng Expend~tures Operattng Expenses 4091 4322 6263 7585 9868 Depreclation 1723 5061 5398 6598 9376 Total Operating expenditures 5814 §m8 1 14183 19-24 , ... .. .... ......... ... ....... ..... Net Operating Income 122 <1429) (1252) 1047 3766 Other non-operat ng Income (net) (278) (518) (126) (852) (2982) Net Income before Interest <156) (1947) (1378) (195) (784) Ffnanctal chorg«s (fnterest) <1335) (4422) (6325) (9081) (11328) Interest during construction 369 931 1866 790 Interest chorged to operation (M33) 153 c53%Z <7OM (<1531> .... ...... .... ...... ...... ......... ............ Net oparating profits or (losses) (1491) (6000) (6722) <7020) tif (1) INECEL and the Distributing Cospanies (excludíng ENELEC) Source: INECEL. Institutional and Lega Problems Plannino Pro~lxn 2.106 Planning in the electricity subsector lacks an appropriate linkage with sector development and with overall nationwide development. Despite the establishment of the National Energy Instituto and of the Higher Council of Energy, no coordinated programs haye been officially approved. Ibero is an evident lack of objectives as well as non-existent or insufficient coordination on methodologies. LNECEL planning has been isolated from the rest of tho energy sector. INECEL, however, has designed concrete plans for the medium- and long-term. At present, planning in -S2 - INECEL has lost importance, and the Master Electrification Plan has .t oven beoe officially approved. Power generation planning, moreover, ís not integrated with the planning of distribution and marketlng, nor is any control exercised over them. 2.107 Planning is very poor in some of the Alectzicity companies and non-eistent in others. High investments are scheduled and not implemented, given the absence of criteria as a basis to assess projects, identify priorities, and coordinate budgets under financial constrainta. Failure to receive ¡Icome, or merely management difficulties (for example delays in bidding and contracting), account for this poor planning. In the distribution area, only 39% of lnvestments materialized as budgeted in 1987. Nonetheleas, larger investments wTthout any funding have boa proposed for fu ure years. INECEL's lack of control and leadership over electrickty companies, even though it la generally their major shareholder, with often up to 95% of shares, is a crucial problem. INECEL's authority in investmnent decision-making, in allocation of resources, and in exacting payment (for power sales) la hindered by political intervention. 2.108 At an organizational level, there is no clear-cut separation of duties. Tlis ls particularly true between the Board and INECEL management. 'be Roard is an administrative body that often causes unnecesaary delays in decision making, bocause of the many topics for disacusion and time limitations. Political intervention is also often responsible for distortions in sectoral planning, giving priority to works that are of secondary importance. Because Board members represent interests other than those ot the electricity subsector, the Board does not support the subsector's autonomy in administrative and financial maners. L&L Framewo 2.109 'he legal framework of the electricity subsector is inadequate, not only because of contradictory legislation, but aIso because the laws by which it is governed fall within public sector legislation. Consequently, the centralist approach practiced by public sector legislation meana that decisions can only be taken at the highest leveis of the administration. Owing to the complexity of this legal system, there is uncertainty about whether or not the State will fulfill its commitments. 'bis forces contractors to take into account the risk factor, which results in higher costs. The inadequate legal framework ¡a exemplified by the obsolete Procurement Law or rather, by the lack of a public procurement law which couid take into account the notable size and characteristics of projects typical of the electricity subsector. Public Relations Probem 2.110 Due to ineffective public relations, the subsector suifers from a deteriorating image, both with the public and in political circíes. 'bus, information on labor issues and the need for tariff increases have wot boen adequately communicated. Users should be informed on the proper use of energy and how to savo it so as to diminish losses and improve the load curve. It would aIso be -53 - useful to undertake a public information campaign on he subsector's precarious financíal situaton, pointing out that hydropower (although water ls a free and renewable resource) requires enormous initial outlays and that benefits accrue over long periods of time. prolems in Energy Conservation and in New and Renewab!s Sources of Energy 2.111 Implementation of energy conservation measures and development of renewable energy sourcea, as an integral part of energy policies, could help solve some of the pressing problema of the sector, as will be discussed below. Energy Shortaees in Rural Areas 2.112 Fojd Cokn . Fuelwood and biomass are the main energy sources used for cooking in low-income households in rural arcas (68% of final energy). Most usera gather firewood free of charge. Given the uneven distribution of the resource and of the population, annual forest increment is not enough to meet firewood requirements in the central provinces of Chimborazo, Tungurahua, Cotopaxi, or in Bolivar or Loja. Rapid deforestation of these provinces has-ocurred together with a snortage of energy for cooking, particularly in the poorest households. 2.113 An economically viable alternative couid be the use of more efficient stoves (such as the one developed by INE together with GTZ, which increases efficiency by a factor of 2.2), and reforestation, as i currently being done under the TPlan Bosque' (Reforestation Program). Electricity in Rural Areas 2.114 Whereas in urban areas electricity is universally available, in rural arcas the service only covers 34% of households (1985). It would be possible to decentralize the electricity supply system by using the country's water resources (through mini-hydroelectric plants near demand points) and by using Ecuadoriani-made equipment. 'Te minihydro sometimes proves more economical than the extension of the grid. Photovoltaic energy could be an alternative for basic services which require little energy, such as communications and health, in the absence of other sources of energy. Its costs per unit of usefid energy are US$ 1. /lkWh in communications and twice that figure in health. -54 - In-House Comrfort in Rural Households 2.115 As shown by several INE projects, the use of passive solar energy both for cold climates and warm-humid climates makes for a significant improvement in home comfort. Tlis ¡a achieved without the use of conventional energy and with little inerease in construction costs. Obstacles to the Development of N.ew and Renewable Sources of EnerDy 2.116 Legal, institutional, and financial obstacles obstruct the development of new and renewable energy sources. These obstacles could hinder the use of locally available energy sources (water, biomass, solar, wind, geothermal, etc.) and the adaptation of supplies to final uses. Supported by the subsidized prices of conventional energy, the energy supply system has remained centralized and concentrated in its primary sources (hydrocarbons, biomass and hydroelectricity), and therefore, has become more vulnerable. Lack of options for the user of final energy has encouraged the use of energy forms whose quality exceeds requirements. This state of affairs is discussed below for each consumer sector. louselholds 2.117 The problems faced by rural households were discussed earlier. 'be urban household sector, for its part, is the largest electric power consumer, and consequently, its habits have a strong bearing on the load curve and on peak power demand. Studies undertaken by members of the Work Group suggest that the medium-income and high-income population groups tend to use electricity, because of its convenience, for heatirg purposes that would be better served by other, more efficient sources. Industr 2.118 Industry accounts for 17% (in 1986) of final energy consumption; its greater concentration and organizational methods facilitate energy conservation programs. INE's energy audita show a potential savings of the establishment of 13% at domestic market prices (in 1987). With the establishment of more realistic prices, energy conservation would become more profitable and would warrant special support by the government and INE. 2.119 Co-generation of electricity with residual process heat would be an option to improve tho officlent use of such heat in industry. Several industries In industrialized and devlloping countries - -5 - haye already achieved this. Such an aiternative would reauire legal and orgaizationa changes to provide tlexibility and incentives for investments. Ta[nsport 2.120 'Me transport sector ia the major consumer of oil products, and overland transport is the largest energy consumer in this sector (70%). Cargo carriers aro in the lead, followed by light transport and then by mass transport. Cargo transport has a greater specific savings potential (48%). Buses (urban 46%, rural 41%) can also save fuel by using diesel engines, by improving maintenance and the use factor (especially in cargo) and by putting Isrger-sized vehidces into service. As for light vebicdes, the 19% specific savings estimatad for the year 2000 would derive from greater efficiency and smaller-sized units. In maritime transport, consumption tripled from 1979 to 1984. 'Ibis could also point to illicit exports of fuel, so that substantial savings potential appears to exist in this area. Deforestation and Ecological Deterioration 2.121 Ecuador is undergoing a very serious deforestation; the "Reforestation Plan" estimates that 300,000 Ha/year are affected. Energy consumption would account for 11% of that figure, so that its responsibility at the national level is not great. In five provinces, as already mentionned, firewood consumption exceeds forest growth, thus bringirg about rapid deforestation. Ihis process causes erosion and soil degradation and requires an effective environmental protection policy, particularly in the more fragile zones. A major component of this policy should be an aggressive reforestation program (Plan Bosque), supplemented by widespread use of efficient stoves and fuel substitution in critical areas. System of Sector Institutions 2.122 This section will discuss the problems that arise in the management/supervision/coordination of the sector as a whole (the establishment of general policies, etc.). Management, Suyervision, and Coordination of the Sector as a Whole 2.123 As described above, the structute of the energy sector is acceptable in theory. But in practice it is inefficient, chiefly for the following reasons: the agencies responsible for establishing the sector's major policy guidelines (CSE and MEM) lack the time and resources to set clear medium- and long-term guidelines. They simply resolve short-term problems as they arise. INE should be primarily responsible for secor management, but this institution lacks the financial means and number of technical personnel required (or the required levels of remuneration) to fulfilí its duties under its -56 - Chaer. Aithough they hay. a good tecl'nical leve! and are relatively efficient businesswis, the autonomous entides, CEPE and INECEL, lack coordination and operate under significant legal constrais and excessive political interference (se. para. 2.125). IsLtutonal Situation of INE and Subsector 2.124 Under its Charter, IN's role is to act as the governing body of Energy Plaing and as technical support for the formulation of policies for approval by the Higher Council of Energy (CSE) and for implementation by the Ministry of Eneigy. Despite its legal mandate, INE has performed its role only in part. Two factors account for this: the absence of a real awareness of its ntegrating fuiction for global energy policy, and toe pr.dence of major executing agencies, which, because of their administrative and technical importance, impose the guidelines for oil and clectric power planning. Mention must also be made of the cnterest shown by both CEPE and INECEL in conducting their own activities. Ibis is why INE has been engaged in comprehensive and regional planning, with energy supply and demand studies, short-term trend analyses, energy balances, energy informaon systems, alternative energy sources, etc. INE's main contribution to sectoral coordination has beo the creation of the Committee of Deniand, whose objective is to harmonizo demand projections in the subsector. Coordination for the study and its execution has been one of INE's most important taska to date. 2.125 Although CEPE and INECEL are autonomous and decentralized institutions, this autonomy is more apparent than real, as political interference reaches down to tecical decision mading levels. INE, in conjunction with CEPE's and INECEL's boards of directors, should provide INECEL's bydrocabons and electricity policy orientations. lhe MEM, which appoints most board member. currently presides over both companies' boards of directors. -57 - CHAPBr m OPTIONS FOR THE SOLUTION OF ENERGY SECTOR PROBLEMS Induction 3.1 Ihis chapter analyzes alternate solutiona to those problems of the energy sector discussed in the preceding chapter. It follows the ame order: hydrocarbons, electricity, institutions, and conservation and alternative energy sources. Hydrocarbons Measures for the Subsector 3.2 Characteriatica of oil sector planning discourage a long-term approach: hence only short- term recommendations are provided below. Domestic Prices of Refined EMucta (i) An adjustment of prices of refined producta ¡a recommended, to be based on replacement corts of crude oil rather than On historical cost; on depreciations and amort ons, computed on the basis of the revalued asseta for the refining, transport, and distribution stages and a real "profit margin* for investment in each of those stages. To tdis end, an immediate review of CEPE accounting aud financial systems is also recommended, to establish the new value of its assets. Cdi) A new price structure ta recommanded for refined products: the price of diesel fuel should draw closer to the price of premium gasoline while LPO prices should draw dlose to the average for all refined products. Kerosene for household use should be cheaper than LPG in order to encourage its consumption in rural areas, via a retail sales scheme (5-gallon contalners). Tedudcal A (iii) Tu ensure reliable figures for proven reserves and production projections, it would be advisable to form an inter-institutional group of impartial experts which will make - 58 - simulations and monitor the performance of deposits in the different oil fields. Ibis would be dono with Ecuadoran computíng facilities, and, in the initial atage, with external techimcal assistance and software. (iv) Particular emphasis should be placed on the extraction of medium density crudes, with gravities between 15 anid 25 API, taking Pdvantage of die presence of lighter crudes, since this could be the only way to extrarí and transport these crudes. (Y) Study and evaluation of heavy crudes (8-15 API) in the Puigarayacu, Oglan, etc. fields must continue, given the importance of reserves. (vi) Certain official production rates in the Consortium fields havo not been modified since 1978. Tbey are not, therefore, in keeping with cunfent conditions of deposits and should be revised. (vii) Exploration in the Amistad ficld and in other off-shore areas should be left to foreign investors, given the high risk involved. (viii) Rehabiitation of the Santa Elena Peninsula fields should be reassessed in the light of current econíomic conditions. Financial Asnects of CEPE (ix) Reform of the current oil-revenue allotment system. This would enable CEPE to recover costs in each activity and have a percentage of the overail oil revenue (between 5 and 10<-). This wil enable CEPE to generato reasonablo self-financing for minimum planned investment. As analysis of, and legal changes for, these reforms may possibly take one year. It is proposed that, for the immediate futuro, CEFi3 recover its costs plus a percentage (20%) of profits on the clomestic sale of refined products, which are at present destined for the Government Budget. This requires only that the president of the Republic issue an Executive Decree regulating Articlo 73 of the Hydrocarbons Law. Recommnendations for CEPE's Five-Year Investment Pro&= (x) Reinforcement of mechanism coordinating the investment budget in the planning department, in order to evaluate the economic viability of projects and assign them priorities. -59 - (xi) Exparsion of lnvestment in geophysics, so that CEPE may have sufficient exploration objectives to drill at least five wells a year. (xii) Modification of CEPE's exploration program by increasing the number of wildcat wells from 14 to 23, so as to gradually offset the decline in the exploration programn of foreign oil companies, startlng in 1990. (xiii) Modification of CEPE's production program by adding the development of fields in the Central Oriente, such as: Capiron (N-E), Tivacuno, Curaray, and Primavera. (xiv) Study of the expansion of the Peninsula refineries at the close of the five-year period, as part of the search for the most economic alternative to meet refined product demand. (xv) Comparative technical-economic studies of the size, location, and type of gas plant and identification of the best use for the gas of the Libertador Field. (xvi) Limitation of CEPE's investments in other industrial companies, leaving such investments to the private sector. (xvii) It is not necessary, at present, to study the expansion of the Trana-Ecuadorian Pipeline. (xviii) Al investments proposed by CEPE for pipelines must be subjected to economic analysis and ranked in relation to all other CEPE projects. (xix) Projects for LPG bottling plants and lubricating oil packaging plants should be lef to private firms and removed from CEPE's investment progam. (xx) Analysis of current refined product (particularly LPG) storage capacity in eacb of the terminals and their areas of influence, to check wbether capacity is adequate. Institutional Aspects (xxi) Congress should enact a new Law for CEPE to provide it with financial and operational autonomy and the power to establish affiliated companies and subsidiaries. Tlis new CEPE would be under the ontrol of the National Directorate of Hydrocarbons in technical matters, and of the Superintendency of Companies in financial matters. This law should make provisiona for the financial reforms described above in Paragraph 3.2 ix. - 60 - (xxii) T.e Hydrocarbons Law shou1d be amended as follows: - It should expliciWy introduce the concept of replacement cost as a production cost and allow the Executive Branch to eventually apply economic or opportunity costa as bases for domestic price settig. Tbis la necessary because Ecuador's economy ls likely to go from oil-exporter to oil-importer within the next decade. - Tlbe Advisory Comm'1ep ona Petroleum Policies should become the Energy Policy Advisory Comrissfr d should Include the Planning Department of INM. - New articles should be included in the Hydrocarbns Law focusing on exploration and production of unassociated natural gas. These new provisions sbould address, in particular, its selling price on the domestic market and the economic equivalence between natural gas and substitutes, such as fuel oil. - Overall priority should be given to CEPE in allocation of oil revenues, so that it may recover its costs at cach stage in addition to a percentage of the profits to fnance the expansion of its activities. (xxiii) CEPE should be prepared to take on the operational responsibilities of the CEPE-TEXACO Consortium, the Trans-Ecuadorian Pipeline, the joint field with CITY, aud the ANGLO and REPETROL refíneries. To this end, it must prepare itself by strengthening its management and staff. Do~etc Price Systm 3.3 Esablishment of prices for refined products in Ecuador is based on historical costs alone, according to an uiterpretation of the Hydrocarbons Law which precludes coasideration of other factors such as replacement cost of each barrel consumed, allowance for depletion of existing reserves, or economic or opportunity costa. Ibis state of atfbira accounts for the rapid decline of real domestic prices, requires subsidies, lowers public revenues, leads to waste in the use of refined products and reduces exportable surpluses, all of which hurt the balance of payments and economic growth. 3.4 A change in price level and structure, and in determining corrt., would prove a key short-term remedy to the fall in real domestic prices of refined products as well as to the imbalances resuling from current cost interpretation. To this end, three alternative concepts of costa and a narrower price structure are proposed. A program for the immediate adjustment of refined product prices is also proposed. -61 - Cof ºiCrde 3.5 Assuming the recommended rate of productlon and the sewential com¡ng on strem of the flelds a eseablished therein, Table No. 3.1 shows that the bistorical CosI of crude oil in 1988 was USS6.8brrel. ITis figuro la 35% lower tan replacement cost (10.6 US$18), and 51% below economic cost (14 US$/B). As can be observed, the hislorical cost 1s far from refldcting investments dhe couitry must make to Incorporate a new reserve barel amd the benefits forgone by selling it at tiat cost on the domestic market Instead of at the intenational price. T.bte No. 3.1 RMW MATERIAL COSTS UIIDER DIFFERENT CCOCEPTS OF CURRENT COSTS (Us$/,) . ....... ........................................................................... ... .... . YEAR 1967 1988 1989 1990 1991 1992 1995 2000 ................................................................. HNstorícat Cost 7.7 6.8 7.2 7.3 7.5 8.0 8.6 10.0 ReptLcnt CoBt 10.2 10.6 10.9 11.3 11.7 12.1 13.4 16.0 Eclmc Cost 16.3 14.0 14.0 15.5 17.3 19.2 25.1 34.4 ........ ............... «.................... $mrce: Work Grmp Estlmtn. 3.6 lie following criteria haye boen considered for replacement cost calculations: - na the shortem (e~rly 90s), the Central Oriente will be the main reghin where new reserves wll be established if exploration eforta by foreign companles are successful. - Replacement cost reflects the incorporation of between 100 and 200 million barreis of reserves. - Cost of capital is 12%, while development and production investment per initial barrel of peak prod"ction ranges between $5,300 and $5,700. 3.7 Table No. 3.2 summarizes the replacement cost structure for the North, Central and South Oriente aroas of Ecuador's Amazon Region, updated to 1987. lbe barre' obsained by foreign company exploration and production ¡8 certainly more expensivo in the Central and South Oriente. However, king ¡ato account that exploration investment by CEPE would haye to be doubled or tripled, owing to exploraticn risks, the difference between the two (Oi Co versus CEPE) la not very significant. Insofar as the North Oriente ¡s concemed, the replacement cost is lower there, and this zone has beon reserved for CEPE. -62 - Ttble MO. 3.2 UWIT COSTS OF REPLACENENT IN 1987 DOLLARS (1987 DOLUMS PER BARREL) NOTH ORIENTE RESERVES EXPLOR. PROOUCT. OPER.C. TRANS. CEPE COMP. IBIPP COST OCLV ................................... .............................. 100 0.75 1.84 2.25 1.64 6.48 7.98 3331 125 0.65 1.81 2.17 1.65 6.27 7.82 3395 150 0.58 1.67 1.95 1.67 5.88 7.53 3380 175 0.57 1.63 1.85 1.68 5.73 7.42 3363 200 0.55 1.53 1.68 1.70 5.47 7.23 3344 .................................................................. CENTRAL ORIENTE ........................................................................... RESERVES EXPLOR. PRODUCT. OPER.C. TRANS. CEPE COMP. IBIPP COST OCLV me ....................................................................... 100 1.43 2.86 3.79 2.05 10.13 10.76 5325 12 1.26 2.76 3.70 2.07 9.79 10.57 5413 150 1.14 2.61 3.40 2.09 9.23 10.19 5495 175 1.08 2.48 3.13 2.11 8.81 9.90 5477 200 1.09 2.37 2.89 2.13 8.48 9.66 5361 ... ........ .................................................................. OTH ORIENTE RESERVES EXPLOR. PRCOUCT. OPER.C. TRAÑS. CEPE COMP. IBIPP COST CNLV .................................................... ..................... 100 2.14 5.34 5.11 3.25 h.Z4 13.82 8595 125 1.54 4.30 5.32 3.42 14.58 14.19 P637 150 1.38 4.02 4.91 3.48 13.78 13.68 8680 175 1.31 3.81 4.64 3.52 13.28 13.36 8662 200 1.31 3.65 4.50 3.55 13.01 13.18 85GC ......................................................................... gou£ce: CEPE and Workino Group Estimates. IBIPP: Investmet por barrel of tnttial Peak Productfon. 3.8 As can be observed, production costs per barrel range from $7 to $8 in the North Oriente, from $10 to $11 in the Central Oriente, and from $13 to $15 in the South Oriente. According to the analysis of reserve prospects, potential for new discoveries in the k-adorian Oriente would be limited to medium and small deposits. It is quite unlikely that giant deposits, such as Shushufindi and Sacha, will be discovered in the future. Therefore, the analysis of replacement costs is based on reserve discoveríes of 100 to 200 million barreis from small structures typical of the Central Oriente. 3.9 Economic costs are based on the low oil export- price growth assumed by the World Bank: an 11% annual growth rate from 1990 to 1994, and 6.5% from 1995 to 2000, in curent terms. -63 - Fuel Prices: Historical. Replacement. and Economlc Costs 3.10 Once the cost of crudo has been considered, the profit margin applied in the pricing of fuels (30%) under the Hydrocarbons Law has emerged as the determiving factor in setting the prlces of refined products. This margin is applied or not in response to fiscal interests or socli Lipact and l8 not a permanent element of a mandatory nature. Thus, it was not applied in the 1987 fiel price increae, although the methodology of 1984 was used (when a profit margin was applied). 3.11 Table No. 3.3 shows the series of average refined proauct prirs, takling into account historical costs, replacement costs and econúmic costa, wlth and without the 30% profit. Clearly, the lowest series is that of the Hydrocarbons Law, whlch is bereft of profit. lhe Hydrocarbons Law price with the 30% profit is similar to the replacement cost. The economic cost, however, exceeds the Hydrocarbons Law price, with and without profit. Economie costs are expected to drop slightly until 1990 and ti¡en to rise slowly, in real terms, until the year 2000. Prices according to the Hydrocarbons Law and replacement costs remain practically the same, in real terms, because only transpo efining, and distri' ition costs grow at the general rate of inflation, in current values. Althoughthe I - - .¡cal costs in the new fields are higher than those of the older fields, their Gutput is still relatively low (and does not yet influ.cie cost levels under the Hydrocarbons Law). Tibie No. 3.3 AVERAGE PRICES OF REFINED PRODUCTS (IN 1987 DOALARS/BARREL) CURRENT 1988 1989 1990 1991 1992 1995 2000 Prices under Nydrocarbons Lmw OX Prof. 8.12 11.73 11.23 10.31 10.22 9.99 9.68 12.13 Prf ces under Nydrocarbons Law 30X Prof. 16.97 16.26 15.02 14.74 18.08 14.29 17.15 Prices at Replace. Cost 02 Prof. 15.55 15.09 14.27 14.21 14.03 13.66 16.05 Prf ces it Replace. Cost 302 Prof. 23.02 22.47 21.47 21.28 21.26 19.95 22.60 PrIces «t Opportunity Cost 02 Prof. 19.12 18.00 18.05 18.93 19.80 22.56 26.64 Pricos at Opportunlty Cost 302 Prof. 28.66 26.89 27.11 28.27 29.95 33.7¿ 39.05 Source: World Cank ard Work Group Esttmates 3.12 Ihe floating element of 30% profit as an integral part of the makeup of fuel prices has the following drawbacks: in the first place, since it is based on historical costs, it does not reflect the profitabiity of revalued investments in the refining, transport, and distribution stages. In the second place, the 30% is applied at each stage to the c is of the raw material, plus the cost of that stage, as if the profit margins belonged to different companies. It would be logical to have prof1t margins a a percentago (at least equal to economy-wide cost of of capital) of the non-amortized investments at each -64- atago. However, we must also consider that a 30% margin can undervaluo the real retutn on ¡nvest given existing levols of inflation. 3.13 Tbo following table shows the cost, profit, ad tax atructuro that shouid be la effoct for 1988 according to the Hydrocarbons Law, íf prices wero establihed acoording to that Law. Teble No. 3.4. #TRUCTURE OF COSTS, TAXS, ANO PROFITS OF A GALLOS OF REFIMEO PRODUCTS UYDER THE HYEROCURBONS 4LV 10 198 ................................................................. U ./G.X ................................................................ 1. COSTS Rcu Materitl Cost 45.69 37.4 Refinint Cost 10.42 8.5 Iwoort Coste 4.16 3.4 Treneportation ed Storage Cot 9.36 7.6 .r.tIno Cost 6.55 5.4 " totel Costa 76.18 62.3 2. TAXES 11.00 9.0 SU>totil Coste . Texc 87.18 71.3 3. PROFITS 35.09 28.7 Reftntna 13.51 11.0 Ofstribution 21.58 17.7 TOTAL COSTS + TAXIS + PROFITS 122.27 100.0 Note:Other costa couLd legittmtely b *dded to thee: the depletion elloe nc.end en *eount destinad to csvar the cost of clemning up envirental pollution problet crested In ud cround currently xploItad oil fletds. 5gur£*: DUN nd Work Group cleuletiona. Alternatives for Refined Product Price Levels 3.14 To analyze the lmpact of the price of refined products on macroeconomic variables, the price series according to the Hydrocarbons Law and prices according to replacement cota and to economic costs with 30% profit margin structure were considered. Increas over present-day prices would be around 115%, 190% and 260%, respectively. Avaa Level of Refined Product Pies 3.15 Although constraints of the Hydrocarbons Law cannot be avolded (unless the law is amended), a pricing policy should be designed that will bring refined product prices closer to actual domestic replacement costa and to (iternational) economic costs. -65- Hydrocarbons Law _o on (LQW pion 3.16 This alternative assumes that, under the provisions of the Hydrocarbons Law, prices at historical costa will he readjusted and that their real value wlll be maintained. According to this proposal, in 1988 the average price should be inoreased by 1 15% as of June (125 SI.'G.). With respect to current prices, this alternativo would imply a 114% incroase in raw material costs, owing to monetary devaluation. By repaying the loana for the expansion of the Esmeraldas and the Amanas Refineries, this alternaive would increase refining costs by 128%. Tho cost of imports has boen reduced by 58%, owing to t'ie increase in domestic refining capacity. On the whole, costa plus taxes aro increased by 45%. As for the profits that were not considered in 1987, for 1988 they are estimated at 40% of costs plus taxes, due to the aggregation of the various stages, on whih a cumulative 30% is applied. Opportunity Cost Option (High Optionl 3.17 This policy is based on the international price of crude and on what Ecuador forgoes by selling the crude at domestic historical cost. Under this alten ative, the average price of refined producta, as of June 1988, would be 212 SI.IG., t . is, four times the current price (58 Sl.lGal). According to this proposal, the establishment of refin, ,roduct prices would pormit the economy to move gradually from oil exporter to oil importer by the late 1990s. 'he establishment cf refined product prices, under tiis alternativo, requires that the Hydrocarbons Law be amended. (I'is was also proposed in this paper. See paragraph 3.2, Inustitutional Aspects"). Rºe¡lacement Cst Option (Recommended Oplion for Ihe Short-Termú 3.18 This alternative takes into account the costs of gradual replacement of current reserves, in terms of the costs of exploring, developing, and producing the new flelds that have boen discovered. According to the exploration policy developed by CEPE, it is estimated dial the replacement cost in the Central Oriente zone is the most representative. With this replaceme~t cost, the average price of refined products would come to 170 Sl.lG. in 1988, i.e., nearly 200% higher than the current prices. 3.19 According to this policy, pricing of refined products would not require modification of the Hydrocarbons Law, but rather a reinterpretation that would take into account the need to replace reserves consumed. ITis is the option recommended by the Work Group. 3.20 Prices according to the three alternatives are shown in the following table: -66- Table No. 3.5 AVERAGE PRICES OF REFINED PRODUCTS ACCORDIMO tO THE THREE ALTERNATIVES - tu 1987 US$/5 .......................................................................... 1988 1989 1990 1991 1992 1995 2000 2005 ........................................................................... Low Altornativo 8.1 17.0 16.3 15.0 14.7 15.1 14.3 17.1 Ntgh Atternative 8.1 28.7 26.9 27.1 28.3 30.0 33.7 39.1 Rec. Alternative 8.1 23.0 22.5 21.5 21.3 21.3 20.0 22.6 Source: Wortd Bank and Work Group Estimutes Refined Products Price Structure 3.21 As discussed in Chapter 11, the price structure of refined products in Ecuador shows two major distortions: the first has to do with diesel fuel and the second with LPG. lTus, the ratio of the price of Diesel No. 2/Premium Gasoline is 60%, and that of LPG/average price is 56%. The proposed change in the refined product price structure, independent of the high and low alternatives for the average price, is aimed at decreasing such distortions in the short-term, considering social aspects of the LPG prices and the advisability of showing the growth of LPG consumption. Table No. 3.6 PRICE STRUCTURE s . .............. ........................................................... Current Proposed "Super" gasolin. 190 150 "Extra" gasoline 155 130 DieseL 1 95 115 Diesel 2 95 115 Residual Fuel 60 60 Kerosene (Home Use) 52 80 LPG 56 100 Average Price 100 100 Source: DNH and Work Group. 3.22 Tne proposed price structure is narrower than the current one and makes it possible to approximate the international structure, particularly in gasolines and other middle distillates. It would decrease diesel fuel subsidies, and tc a lesser extent, LPG subsidies. The relative price of super gasoline/extra gasoline will make for higher consumption of super gasoline, whie the relative reduction of the ,rice of extra gasoline would be offset by the increase of diesel fuel prices. Kerosene for household use and LPG would remain competitively priced (though with a relative prico advantage to -67 - kerosene, which is used in the poorest households), and the incentive for using fuel oil instead of diesel No. 1 would be maintained. 3.23 This is an indicative price structure and may be modulated and progressively adapted as prices are adjusted. Table No. 3.7 shows individual prices of refined products, under the current structure and under the proposed structure, given the recommended alternative of the average weighted price of refined products. Tabte No. 3.7 REFINED PRODUCT PRICES (1987 doltara per barrel) (REPLACEMENT COSTS, UNDER THE URRENT STRUCTURE> ..... ................... ................ ..................................... CURRENT 1988 1989 ............................................................. Super Gasoline 15.4 33.1 42.9 Extra Gasoline 12.6 27.1 35.1 Dlesel 1 7.7 16.5 21.5 Diesel 2 7.7 16.5 21.5 Residual Fuel 4.9 10.5 13.7 LPG 4.5 9.8 12.7 Kerosene Nme Use 3.B 8.2 10.6 CREPLACENENT COSTS UNDER THE PROOED STRUCTURE) 1988 1989 ............................................................. Super Gasoline 26.6 34.5 Extra Gasoline 23.0 29.9 Diesel 1 20.4 26.4 Diesel 2 20.4 26.4 Residuum 10.6 13.8 LPG 17.7 23.0 Kerosene Home Use 14.2 18.4 .... ......................................................... Source: DNH nd Work Group Calculations. 3.24 These price structures demonstrate the effect on the relative prices of hydrocarbons in the household, transportation, and industrial sectors. Kerosene for household use is less expensive than LPG for cooking purposes and supports the recommended policy of promoting the use of kerosene in ural areas. Diesel 2 maintains its comparative advantage over extra gasoline in transportation, so as to give moderate encouragement to "dieselizing" heavy transportation. Fuel oil also maintains its comparative advantage over diesel 1 for heat generation. -68 - Table No. 3.8 RELUTIVE PRICES OF REFINED PROOUCTS WITH THE RECO MENOED PRICINO OPTION ................................................................. CURRENT STRUCTURE PR0POS£D SITRUCItE COST USF. ENER. REL. L°ST USF. EIER. REL. SECTOR USSITCE PRICE 1987 USS/TOE PRICE ................................................................. NHUSEHOLD (1) - KEROSEME 226 1.00 395 1.00 - LPG 246 1.09 48 1.13 TRAhSPORT - DIESEL 2 618 1.00 759 1.00 - GASOLINE 1.438 2.33 1.225 1.61 INDUSTRIAL (2) - FUEL OIL 149 1.00 150 1.00 - DIESEL 1 258 1.73 316 2.10 NOTE: (1) Cooktng; (2) Neat zource: OUOE, WIE. Proœram for the Inimediate Adjustment of Refined Products Prices 3.25 As an immediate measure, historical costs must be revised by introducing the revalued assets in depreciation estimates adding all exploration costs and estimates of the minimum retura on investment. Ibis will offer a precise idea of current costs. Ihe concept of crude oil production costa set forth in the Law should be reinterpreted as the replacement cost in order to readjust fture prices until the Hydrocarbons Law is changed to allow for the use of economic costs in the pricing formula. Furthermore, legal changes should empower the Executive Branch to graduaJly incorporate such cost in the pricing of refined products, so that tde national economy wil gradually adjust to an oil-importing situation, as is anticipated for the late 1990s. 3.26 Ihe specific for the average price of refined products is that by mid-1988 the level of the Hydrocarbons Law be reached (125 current sucres/gallon), that is, a 1 15%. increase over current prices, and toat tdese prices be kept stable in real tenrs. Starting in 1989, the aim should be to reach replacement cost, in real terms and in the short run. ibis implies that the increase for that year, in real terms, should be about 30%. Subsequendy, current prices should be adjusted, at least to offset inflation. -69 - Table No. 3.9 REAL INCREASE IM REFINED PRODUCT PRICES ,................................................................. APRIL 1987 JUME 1988 JUNE 1988 1989 CURRENT MEi (*) ................................................................. 87 SUCRES/GALLON 58 39 84 110 PERCENTAGE VARIATION -33% 115% 30% ................................................................. (*>If the prtce adjustment takem place In the ltst quarter of 1988, the fnerease shautd be arou~d 140X, oawng to cuimletive Infletion. lourçe: Wok Grorup. Proposais for a Financial Solution for CEPE 3.27 Chapter U suggested that to prevent CEPE's financial collapse in the short run, its entrepreneurial activity should be rescaled and structural changes in the oil revenue distribution system should be made. lThe measures that wil lead to CEPE's financial rehabiitationby establishinginvestment priorities and by bringing changes to the allocation of oil revenues are described in the following paragraphs. Establishing Investment Priorities for CEPE 3.28 CEPE's investment program, according to the Five-Year Plan updated in Jnme 1988, provides for a $1,102 million investment over the 1988-92 period. Of this amount, 64% represents processing and transport projecta that should be of low prlority. lhis study proposes a five-year program of US$ 653 million, 23% of which is earmarked for processing and transport. The program would emphasize exploration and developmentlproduction. The proposed program is described in the following paragraphs. 3.29 TIe following discussion of certain specific projects included in CEPE's Five-Year Program aims to review each of these projecta. The first recommendation, which is of the utmost importance for CEPE, addresses the preparation of CEPE'a investment budget. It is recommended that CEPE reinforce die team that coordinates the investment budget in the planning department to improve the economic analysis of projects submitted by the several sectoral departmenta. Ibis team, which would use consistent economic criteria, must have authority to prioritze projecta submitted, on the basis of ecownmic returns. lhus, the total investment budget would only include those projects that are absolutely essential to CEPE and economically viable, and they would be classified according to economic priorities for the optimum use of the scarce investment funds. - 70 - Exploration 3.30 During the last three yea's, CEPE's exploration efforts have declined substantially: only three wells have been drilled, and 2200 km of seismic lines have been run in the Amazon Region and 3247 km in the Gulf of Guayaquil. In contrast, the activities of the international companies grew with the drilling of 15 wildcat wells and the running of 15,000 km of seismic lines in that time span. This imbalance will be corrected in the future: beginning in 1990, the iiternational companies' exploration investments will significantly decrease, upon the expiration of the exploration period that appears in the contracts, in accordance with the Hydrocarbons Law. 3.31 CEPE estimates a US$79.2 MM investment over a five-year period for the drilling of 14 wildcat wells and the running of 5000 km of seismic lines. Minimum investments, totalling US$111.4 MM, envisaged in this study, will increase the number of proposed wells to 23, with the same length of seismic lines. 3.32 The difference betwe,n the investments is due to the higher cost of the wildcat wells estimated in this study (,US$2.0 MM/well) compared to the CEPE plan (US$800 thousand/well). For the above-stated reasons, CEPE will increase its exploration activities as cf 1990 to five wells a year, and will drill 15 wells a year over the 1993-2000 period. This figure is based on the fact that the Corporation will have more resources available for exploration from its 25% share in the net income of the contracts. 3.33 The limited seismic work carried out by CEPE in recent years reduced the potential number of prospects to be drilled in 1988-1992. ibis situation will change after 1993, with the reactivation of seismic investment since 1988. 3.34 Oil-company investment in exploration will reach US$370.1 MM by 1992. ibis covers the drilling of 40 wells and the running of 5000 ¡um of seismic lines. 3.35 Wildcat and outpost wells will have to be drilled in the Amistad Field in order to determine whether or not it has commercial gas reserves. Any gas-use project will have to be based on a reliable evaluation of proven reserves. If the project is to be economically viable, it should guarantee a production capacity of 50 MM PCD of gas for 20 years, equivalent to a reserve of 365 billion cubic feet. This high-risk exploration should be left to foreign investors. Production 3.36 Production investments proposed in this study for 1988-1992 are higher by US$80.6 million than those envisaged by CEPE. ibis is because CEPE does not consider the development of fields in the Central Oriente, such as Capiron (N-C), Tivacuno, Curaray, and Primavera. On the other hand, k underestimates the erount of investment for development wells (US$660 thousand/well), as compared with US$1.2 millionlwell in the proposed plan (based on more recent cost experience). -71 - 3.37 lThe investment policy proposed in this study is based on the Optimistic production hypothesis. According to this hypothesis, the Tilputini-West Ficld and the undeveloped zones of the Northeast would be incorporated between 1992 and 2000 and, as of 1995, the Tiputini-Yasunl-Lorocachí deposits. Petroleum companies would invest around US$500 million in production up to 1992, while CEPE would invest US$340 millton over the same period under the proposed program. 3.38 Oil-company investments decrease from 1992 on and disappear by 1995, assuming the continued historical average of positive exploration results, or 50%. As of 1992, a substantial portion of the exploration efforts will fall to CEPE, for the above-mentioned reasons, and also because the CEPE-TEXACO Consortium exploration area will have reverted to the Corporation under its contractual provisions. 3.39 Investments in field development could be financed by international organizations, given the very high profitability of this type of operation, as is the case of the North Oriente flelds. Exploration investments would be made by CEPE on its own. Otl Refining 3.40 It is recommended that CEPE's project of installing conversion units in the Peninsula refineries be reviewed at the close of the present five-year period. Such a review should study the most economical means to meet demand and take into account new available technologies that provide greater flexibility in the slate of refined products, particularly of LPG, gasoline and diesel, whie minimizing the output of fuel oil. 3.41 Another gas-liquefaction plant with a 15-million cubic feet/day capacity, in CEPE's Campo Libertador, near Shushufindi, is now up for bidding. Any future scheme to use that gas should take into account the potential prodection decline that the Shushufindi-Aguarico Field, as well as the Campo Libertador, will experience as of 1992 with declining volumes of gas. CEPE should consider substituting the gas-lift system with electric or hydrault: systems when the water content of wells increases. This would imply that the amount of gas available in the fields wil diminish significantly over the coming years as will the volume of liquids for recovery by the gas-lift compressors. 3.42 Prior to making a decision regarding the new liquefaction plant, it would seem advisable to make comparative technical-economic studies of the following alternatives, among others: - The plant with a 15 MMCFD capacity in Libertador, now under bidding. -72 - A plant similar to the above, but installed in Shushufindi. Expansion of the present plant in Shushufindi. A fractionatlng plant for liquids obtalned la the gas-lft compressors to be installed in Libertador and for the curent surplus of the Shushufindi compressora. Industrial Projects in Association with Other Comnanies 3.43 It is recommended tbat CEPE act as supplier of raw materlais to the aromatica plant (US$4.5 million) that is to be established next to tee Esmeraldas Refinery. It is also recommended that the private sector be the sole investor. As for plans for a methanol processing plant (US$9.9 million) to be located near the future Libertador gas plant, it is recommended that they be cancelled because the project is not profitable. 3.44 Plants for processing essential olls for lubricants/paraffins (US$147.6 million), as weIl aS the ammonia-urea plant (US$10.2 million), shouid be postponed because these investments have low ecnomic retrna and uncertala markets. Besides, the ammonia-urea plant would depead on whether gas actually exists in the Gulf of Guayaquil and on its profitabiity and economic prospecta at the time this is confirmed. 3.45 CEPE's investment program includes US$5.6 million to study the possibility of building an asphalt plant in the Amazonas Refinery and an ammonia-urea plant in the Oriente. For reasons already mentioned in Chapter U (adequate capacity for asphalt and absence of economic justification for an ammonia-urea plant), it is recommended that these studies be cancelled. lra~so and tre 3.46 CEPE's investment program for a new seaport terminal in Monteverde, for products pipelines to Libertad-Monteverde, Manta and Monteverde-Pascuales, should be evaluated separately. T'e products pipeline project, Pascuales-Naranjal-Cuenca and Naranjal-Machala, should also be evaluated separately, comparing its costs with those of the current transport and distribution system. 3.47 CEPE's budget provides for the expansion of the Tran-Ecuadorian Pipeline (US$2.7 million). Based on oil production estimates of the Work Group, it la recommended that planned basic and detailed engineering work be postponed until the reserves and output potentiais require an expansion. 3.48 'Te following table provides an alternativo five-year lnvestment program, in line with the above recommendations: -73 - TibIe No. 3.10 CFPE: RECNENED I TMEUNT PROOM W (in mil11m of 198? doloara) _................................................................. 1968 19S9 1990 1991 1992 TOTAL Exploratlon 14.1 22.0 27.1 23.9 24.3 111.4 Prodctton 76.7 47.7 68.3 68.3 79.1 340.1 Proclnu 9.7 33.0 0.9 0.9 0.8 45.3 Trport & *torae 39.1 26.9 17.8 8.5 9.3 101.6 Nark.ting & Other Serv. 14.4 9.8 8.1 8.0 8.5 48.8 .... @ -------------------------.Totel 154.0 139.4 122.2 109.6 122.0 647.2 £it lncludes m Incread Wot for the Libertador plant, í» fra $26.7 mlilton to 831 miltton (eost recent estlmte). SOUce: Nork Group. 3.49 he proposed five-year investment totais US$647.2 million, or US$455 million lesa than CEPE's original program. Emphasis ¡a on exploration and production investments, with only 23% allotted to processing, transport, and storage. Alternate Financial Solutiona for CEPE By Mema of Allocadion of Oi, Revenues 3.50 As may be seen in Table No. 3.10, reduction in CEPE's investment program for the 1988-1992 period; although it entails a 41% reduction in comparison with the original five-year plan, will bring only a partial solution to the Corporatdon's unbalanced budget. The deficit would still remain high (40%) and operational deficits would still persist. .74 - Table No. 3.11 CEPE'S FINANCIAL SITUATION WITH MIINIM INVESTNENT PROGRAK fn milItan. of 1987 dollaro) ................................................................... ¡TEN 1988 1989 1990 1991 1992 TOTAL ANNUAL AVERAGE ................................................................... Incoem 479 403 380 382 381 2025 405 Current Expen. 519 533 549 550 565 2717 54S Surpltu (Op. Deficit) ( 40) (130) (169) (168> (184> ( 692> <138> Capital Expen. (154> (139> (122> (110> (122> ( 647> (129> Surplus (Total DefIc1t0 (195) (270> (291> (278> (306> (1340> (268> .................... ............................................................................... X SURPLUS (DefIcIt> ( 29> ( 40> ( 43) ( 42> < 45> t 40> *> The doltar rete of inflation a assumed to be 3.5X a yer. gource: Work Cro*p. 3.51 lbe alternate solutions proposed below are based on three rationales: the first deala with the need for confronting CEPE's financial troubles by eliminating basic causes (exchange rate ceilings and non-recovery of costs); the second refers to the possibiity of changes in revenue allocation because of the impact on other recipients; and the last to consideration of legal obstacles that must be overcome. These solutions wUl be examinned in light of the general hypotheses in this study with regard to production of crude, domestic demand for refined products, investment, inflation and monetary devaluation, and the increases of refined product price to leveis allowed by the Hydrocarbons Law. 3.52 Alternate solutions are evaluated with regard to CEPE's deficit for the 1988-1992 period and to the degree of self-financing of investments as shown in Table No. 3.12. Chapter IV analyzes the impact these solutiona would have on the income of other oil revenue recipients. 3.53 As shown in the following table, unless fuel p,rices are increased at least to the leveis established by the Hydrocarbons Law, and are maintained in real value, CEPE's deficit wUl rise to 43%, and the corporation will have no resources of its own for investment. The base case includes fuel price readjustments, and it is against this case that several alternative solutions are compared. -75 - Tabte No. 3.12 CEPE: FINANCIAL ALTERNATIVES FOR THE 1988-1992 PERtOD ....................... ................................................... . ALTERNATIVE SURPLUS SURPLUS SELF-FIN. SELF-FIN. (DEFICIT) (DEFICIT> INVEST. INVEST. Km 1987 US X m 1987 USS X .....................Bwie case................ -..-Boqe case non-adj. Fuel Prtces (1453) (43) 0 0 Base case, adjust. Fuel Prices (1340> (40> 0 0 Elimination exchange rate ceitinga (53> (2) 594 92 Cost recovery wIth current jncame (420) (13) 228 35 Cost recovery + 52 01 Income (259) (8> 389 60 SaLes Costs Recovery +202 Prof. of Refined products (371> (11> 376 43 tource: Work Group. Elimination of Exchange Rate Ceilinga 3.54 With this alternative solution, which assumes that CEPE will receive its income from the North Oriente crude-oil exports, from the CEPE-TEXACO Consortium and from fuel oil exports at the Central Bank managed rate of exchange instead of at the rato of 44 and 66 sucres/dollar, CEPE's deficit would practically disappear and 92% of Ps investments would be covered. Revenues would increase by US$1306 million compared to the bas- case, with an annual average of US$257 million, mainly because of the above-mentioned increases in the sucre value of export earnings. 3.55 This alternative requires that Law No. 138 on Rural Roads and Law 02 on Wage Increases be changed by Congress and that Law 08 on the Second Wage Increase be amended. Such a solution would generate income for CEPE far above that required to maintain a sound rate of self-finanzcd investment (from 30 to 40%) on the one hand, and it would have a significant negative impact on the Government Budget on the other. If adopted, it would have to be implemented pari-passu with a high profits tax on CEPE. Cost Recovery If Current Revenue Allocation System Is Maintained 3.56 CEPE's deficit for 1988-1992 would drop to 12% as its income grows by US$919 million, mainly due to recovery of costs of crude oil and fuel oil exports, and to sales of refined products on the domestic market. This would allow 35% of investmnents to be self-financed. 3.57 Tbe viability of thls solution would imply tie enactment of a new law to strengthen the provisions of the current Hydrocarbons Law (which states that CEPE must recover its costs in all ita -76 - actvities) and overrule other existlng laws and regulationa which prevent CEPE from recovering ita costa. Further legal changes would not be necessary. 3.58 l'is alternative, howevcr, containa a basic flaw: that CEPE, by virtue of economic logic, would tend to be inefflcient, since its income would depend on cost Increases rather than on the impact of international oil prices, or of refined product prices on the domestic market, or on the efficiency of ita entrepreneurial activities. Cost Recovery Plus Percentage of Oil Revenue 3.59 Prom the standpointof CEPE's own operational economic logic, this alternative ls without any doubt the only long-term solution, not only because of its financial implications, but also bocause it could serve to transform the Corporation into a real enterprise. 3.60 The assumption underlying this analysis is that in addition to recovering its costa and eolminating all current interesta In other companies, CEPE would receive 5% of the oil profits generated by each of its activities. As a result, the budget deficit would drop from 40% to 8%. Income would increase by US$1,080 million over the five-year period, and 60% of investment would be covered duo to lmprovement li income from all corporate activities. 3.61 Besides the legal changes mentioned above, this solution requires the derogation of the provisionS governlng CEPE's current share of oil revenues. Cost Recovery Plus Perce&tage of Profit of Refined Products 3.62 For the immediate future, in order that CEPE may cover its 1988 budget deficit and reduce deficits in the 1988-1992 period, it ¡a proposed that CEPE recover the costs of refining and distributing products li the domestic market, plus a 20% profit margin ci each of these activities. Ibis option would reduce the deficit over the five-year period to 11% and generate US$968 million in additional income. 3.63 This would requiro no legal changes. 11e only requirement would be that the Regulations of die Law (without number) of the National House of Representatives, plus Ministerial Resolution No. 440 of the Ministry of Finance, be revokcd and dhat regulations for the implementation of Article 73 of the Hydrocarbons Law be issued. 3.64 It la clear that this is but a partial solution that can only be effective lf fuel prices in the 1988-1992 period are systematically adjusted to the levels of die Hydrocarbons Law. -77- 3.65 Ihe alternadves of ellmluatln excbango rato collinga, recovering cost and having a percentage of profits should be consideroed within global reordering of oil revenues. In tbis manner, CEPE's financial situation Md the publlc sector's medium- and longem fnaucing priorities would be considered. 'Iis reorganization ia imperative for CEPE's normal development ad for endlng the present chaotic allocation of oil revenues. Ita implementatlon will require several noths of analysis, decisions, ad legal reforms. 3.66 lie third option ís pro~ed as an immediate alternative which would permit covering the 1988 deficit md would provide some rdllef for the 1989 deficit. lais alteive la all the more viable as it must go hand in band with the fuel price increases suggested for this year. MeasureM Related to Institutional and legal Aspects 3.67 Three sets of refoman must be underaen i¡ the oil sector: an overall organizational restructurig, legal ad financial reforms within CEPE, md improvementa in supervision of oil company opons. a zado Restructu rng 3.68 fie MEM should mould INE into a strong and permanent advisory body responsible for the formulation of regulatory policies for CEPE and INECEL and the follow-up md adjustment of such policies. To this end, by amending the Hydrocarbons Law, the advisory committee on petroleum policies should be transformed into an advisory committee on energy policy, with the participation of INE, whose Director ahould be a member of CEPE and INECEL Boards of Directors. To speed up the implementation of this proposal, it is suggested that officials of INE be posted to CEPE and INECEL, in order to reinforce coordination in sectoral planing with better knowledge of these flims. In addition, INE's administrative and salary status should be improved. 3.69 `he DNH shou!d focus on technical control of CEPE and the operators and abandon its financial audit role in favor of the Superintendence of Companies. In this regard, we suggest that the Law of Companies be amended so that the Superintendence is allowed to cover public enterprises such as CEPE and INECEL which aro now outside its purview. Judicial and Einancial Reforms 3.70 A drastic reformulation of CEPE's enabling legislation is required to grant CEPE managerial and financial autonomy. CEPE's new Law should include the following major features: - 78 - - hI.e same rules that apply in privatt sector management should be applied to CEPE's operational, financial and human resources management. - CEPE may establish affillated companles and subsidiaries a required over time, so that in the medium-term and once it has achieved an appropriate managerial and administrative devolopment, it can become a holding company. - All of CEPE's equity stock must remain with the Ecuadorian State in the case of main activities such as exploration, production, transportation along products pipelines and oil pipelines, and also external marketing. In other activities, such as domestic distribution and marketing of products and their processing, stock ownership could be opened, with national and foreign private capital, to affiliated companies or to mixed (public-private) companies. This will ensure access to capital, technology and managerial know-how. - CEPE's top management should represent the interests of the Ecuadorian State in the management of oil resources while retaining the administrative and operational autonomy of a corporation. To this end, it is suggested that the Board of Directors include permanent delegates of the Executive Branch, appointed by the Pre.idency of the Republic, rather than delegates from the different ministries. - CEPE should be audited periodically, just as private corporations are, and it should also be audited by the Superintendence of Companios. 3.71 CEPE's new Incorporation Charter should inciude the Corporation's financial rationale, under the following guidelines: cost recovery at each stage of tne industry and a percentage of oil profit generated by each activity, according to their characteristics. aio Board should fund a reserve for investment in exploration on an annual basis and according to the financial results of CEPE and to the need for exploration programa. This would apply until the 25% of net earnings from service contracts for hydrocarbons exploration and production begin to materialize, in accordance with the Hydrocarbons Law. As for the production, transport, marketing and refining stages, CEPE should turn over to the Ecuadorian State as income tax no less than 90% of oil profits. Supervision of Operators ) (In mittiona of June 1987 doliera) ................................................................. TOTAL YEAR 8 89 90 91 92 93 94 95 96 97 88-92 ................................................................. Genration 36 71 22 12 38 26 81 160 100 51 179 Treuisaion 26 35 24 2 2 1 2 13 16 6 89 Distribution 76 48 29 30 26 29 30 26 26 25 207 Other lnvest. 12 16 11 4 3 3 2 3 2 3 46 ..................................... ......................................................... .............. Stotal 148 170 86 48 69 59 115 262 144 85 521 -................................................................. Interest during Construction 9 9 6 6 6 8 11 19 26 22 36 ................................................................. Total 157 179 92 54 75 67 126 221 170 107 557 ........................... .................................................., Source: Work Group. Compared with the Master Plan (Table No. 2.20, Chapter 11), it wil be noted that in the 1988-92 period alone, the Alternate Plan shows a reduction of $416 million ($973 million versus $557 million). ITis means that investments are reduced to less than 60% of their initial valuo. The reduction is maintained throughout the 1993-97 period, although in less significant amounts. -84- 3.80 The Alternate Plan has the following Source and Applications of Funda. Table No. 3.15 ALTERNATE EXPANSION PLAN (Saurce and Applfcatlon of Funds) (In .tltlon of jum 1987 doltars EAR e8 89 90 91 92 93 94 95 96 97 88-92 ~~~~~~........... ..................... .............................................. Total lnvestmnit 157 179 92 54 75 67 126 221 170 107 557 Net Internat GCratlon -21 -82 -76 -68 -34 -12 -10 - 6 -16 -33 -281 Loan C'> 99 60 20 18 28 21 n 153 98 46 225 Deficlt 79 201 148 104 81 56 64 74 88 94 613 ............................................................................. * Dtsbursets on outstandIng lo dur nhgotietfon 3.81 In view of the tariff assumptions in this study, to adopt the Alernate rather dhan the existing Master Plan would cut the deficit for the 1988-92 period from $734 to $613 million, which means a reduction of $121 million. Net internal generation of funds remains negative throughout the 1988-97 period, but in the Alternate Plan there is a hefty reduction of loan disbursements (postponement of costly projects). 3.82 Top priority would be given to revising the expansion plan, beginning with the revislon of demand projections. Quite probably, after Paute C and Daule Peripa, the next power plant will not be required until 1996 or 1997. As no new short-term investmenta are necessary, feasibility studies for the new hydroelectric projects should be done in time to revise the expansion plan on the basis of more accurate project characteristics and costs. Tariffs 3.83 Tariffs must be fixed at leveis that will cover power supply costs in the short-erm and contribute to investment in the medium-term. Measures adopted shouW include mechanisms to prevent the future deterioration of tariffs due to inflation, and consider a tariff structure that differentiates use by level of tension, time of day and season of the year. 3.84 In the short-term, a positive net internal generation of funds should be pursued. ibis could be achieved gradually, with annual increases, in real terma, for a few years, or quickly, with substantial increases. ibe study of tariffs determined global average costs for bulk sales and sales to final uswr. In 1988 sucres, these costs are 7.5 S/lkWh and 12.8 S/lkWh, respectively. On the basis of the - 85 - provisionas in force until ¡une 1988, It was estimated that this year distrlbuting companles wouid be paylng an average of 3.8 S/lkWh for bulk sales, and final usen, an average of 9.15 SlkWh. 3.85 ITe aboye figures are already outdated, due to the suspension in Juno 1988 of monthly increases. There are advantages to electricity tariffs being increased in conjunction with the prices of refined products. The first substantial increase should aim to cover supply costs, plus depreciatdon and financial charges. TIbis would mean a 100% increase for bulk sales and a 40% increase for sales to final users. 3.86 On the assumption that tariffs will be increased in Auguat/September 1988, the new average costa would be almost 7.5 S/kWh for bulk sales and 13 S/kWh, on the average, for sales to finad users.l/ 3.87 These tariffs couid be maintained in real terms for one year. (Mhis would require regular nominal increases equal to the rate of inflation). At the end of this period, a new increase would be made for adjustment purposes. After the second increase, tariffs should rise moderately, in real terns, until revenues contribute 20-30% of investment under the then approved expansion plan. Tariff increase should bring about some decrease in the growth rate of demand, that would, in tun, reduce the need for investment. 3.88 These increases could be used to introduce a more appropriate tariff structure, ono more in tune with the expected results of the long-run marginal costs study, and which would involve: a) Different increases according to different tension levels. b) Standardize tariff blocks in all the distributing companies. 3.89 In bulk sale tariffs and in final user tarifas, all increases should be done simultaneously. Reduction of Distribution Losses 3.90 Distribution losses should be reduced to acceptable values such as 15% in 1990-91 and 12%-13% in 1992-93. To this end, a campaign should be launched to measure and identify the major Ji Pcrie hikes for refined products wUl inerease the operation costa of the electricity semr in relation to those used for the tariffs study. Consequently, it wUl be neoessary to estimato dhis effect and add it to the proposed tariff increase. -86- causes of loss througb specific programs. The sequential implementation of these programs by company wDl be according to the absolute loss figures. Capitalization of the Subsector 3.91 Tariffs alone cannot solve the financial deficit in the short-erm. Solving tbis deficit is imperative for executing the new programs included in the expansion plan and for completing those in progress. It is essential that the government make annual contributions to INECEL's capital, according to investment needs, borrowing capacity, and income from power sales. Furthermore, the S/66.50 per dollar exchange rate ceilings should be eliminated from eventual royalties allocated by the National Electrification Fund. Annual contributions could be determinned on the basis of these royalties. Structure of the Subsector 3.92 It is necessary to integrate EMELEC into the structure of the subsector, according to contract terms and to current legislation, since unilateral decisions taken by this company have given rise to a very significant debt with INECEL and have also hindered the optimization of power generation (operation of inefficient plants and non-operation of efficient plants). Institutional and Legal Asmects- Changos in INECEL's Legal Framework 3.93 The most far-reaching measure recommended on these matters is changing INECEL's legal framework, in order to turn it into a public company, under the control of the Superintendence of Companies. 'his would enable INECEL to analyze its performance and to integrate its social role with its economic interests: in other words, to pursue corporate efficiency. The following improvements could be obtained from this measure: Limit political interference by the Board of Directors, whose responsibilities would be: to define the policies that should be considered in the Master Electrification Plan; to approve the Master Plan; and to control its implementation. 3.94 Revisa the composition, functions, and type of involvement of INECEL's Board of Directors, so tdat it may be institutionalized and include representatives from entities with related interesta. It la also recommended tdat users be represented on the Board. - 87 - 3.95 Reestablish control over the electricity companles, so u to harmonizo planning and oversee investment. 3.96 Establish more normal and balanced labor relations that will enable middle management to regain ita authority and create incentives for increased productivity. 3.97 Revise and simplify the Basic Law of Electrification and related laws, by eliminating controis that have no place in the operations of an ordinary stock company, L.e. controls such as approvals by bureaucratic entities, the law regulating bida, etc. Alternatively, a Law for Public Contracts could be enacted to take into account the size and complexity of power projects. INECEL: Intenal Organizational and Pyblic Relations As~ecta 3.98 INECEL's intra-subsectoral coordination with the distribution companies should be improved by simplifying relations until such time as the Institutional Development Study, sponsored by the World Bank, is completed and implemented. 3.99 It is also recommended that both the quality and timelineas of accounting information be radically improved. It should be systematized within INECEL and consolidated with the distribution companies. 3.100 INECEL should implement a comprehensive public relations program to improve the subsector's image. This image appears distorted to consumers, who only hear of tariff increases, and to the government, which mistakenly regards the subsector as successful and solid. Energy Conservation Measures and Altemate Sources 3.101 The energy sector and the national economy can benefit from energy conservation and alternate sources of energy by integrating their development into the national energy policy. 3.102 lTough lower subsidies for conventional energy products and continued development by INE will contribute to the promotion of energy conservation and to the use of alternate sources of energy, this needs to be complemented by certain policy and organizational changes that can be effected through the following policy measures: -88- Po'_i A§ 3.103 To update energy policy objectives this study recommends the following steps: Diversify sources and technologies, in order to bring energy supplies more In line with demand. Include environmental protection as a factor ín the selection of energy projects and as a goal in the management of the energy sector. Update legislation and organization of the energy sector to ma~e possible, when economically and technically feasible, the use of decentralized energy sources. Unblock private initiative by permitting co-generation. Establish expeditious financial arrangements (through development lending ínstitutions) for investment in the conservation of energy and in alternate sources of energy, so long as the macroeconomic benefits exceed microeconomic benefits. .Soecific Measures for Ener Conservation la the Industrial Sector Continue the energy conservation program, by means of energy audits, training programs, technical assistance to the industrial sector, etc., that INE has been carrying out since 1981. Promote the optimum use of process heat in industry through co-generation, particularly in the sugar, paper, chemical, and glass industries. Elaborate and enact pertinent legal refÓrms. Study the feasibility of substituting non-commercial fuels (bagasse, industrial wastes, old tires, town garbage, etc.) andlor geothermal fluids (mdustrial parks in areas with geothermal reservoirs, not subject to volcanic risk, and with environmental safeguards for oil producta). -89 - In the Tansport Sector - Revise legal regulations in order to improve the efficiency aid use of the ex~sting vebiclo fleet, partlcularly cargo vehicles (which aro the largest fuel consumers), which have a relatively low load factor, and masa transport vehicles (which have greater potential for improving specific consumption of fuel per pasaengerlkm). - Reorganize urban trafffc in order to improve ita flow. - Carry out a detailed study of fuel consumption (which la quite high) in shipping to develop a strategy for saving fuel. In the Household Sector Ioe urban household sectr has a potential for saving on electricity consumption. Tbis can be achieved by improving the efficiency of home appliances, controlling the time of use, and utilizing other energy sources. - lt is possible to locally produce better and more efficient lampa, fais, air conditioners, refrigerators, stoves, heat pumps, eoc., than those currently used; this procesa should be encouraged. Specific Measures for Altemate Sources of Energy Solar Energ y Employ, whenever possible and feasible, solar water-heating systems in projects promoted or built by the public sector. Consider photovoltaic systems in communications (IEIEL) and health facilities (IEOS), in remote sites. Prepare design manuais for passivo solar energy (INE), in coordination with the United Nations Environmental Program. Train professionais of the construction industry in the principies of passive solar energy (IE. - 90 - Transmit knowledge about passive solar energy to local agencies responsible for urban development (INE). Continue improving kilns for drying wood, graina and fish (INE). Mini-Hydroelectric Planta - Program the construction of mini-hydro plants already identified, using domestic technology (INECEL-INE), after having made a financial evaluation. - Acquire better understanding of the potential of mini-hydroelectric plants. Geothermal: Completion of Feasibility Studies - Continue work on the low-enthalpy project in the Valle de los Chillos (INE). If results are favorable, the feasbibity of an industrial park should be considered. - Continue work on the bi-national high-enthalpy project with Colombia (INECEL). Increase the number of studies of geothermal potential (INECEL-INE-Polytechnic Schools). Biomass Coordinate (INE-Ministry of Agriculture) a program of incentives for forest plantions in Chimborazo, Cotopaxi, Tungurahua, Bolivar, Loja (the provinces with the largest firewood shortages). Aside from supplying industry, this would improve firewood supplies to households and other users. Promote training in forest management. Identify environmental protection projects with generation of energy, such as: treatment of sewage, using Imhoff tanks, processing of slaughterhouse wastes and of other industries, processing of solid garbage for heat genoration, etc. 91 CHAPTER IV IMPACI OF PROPOSED MEASURES ON THE ECONOMY 4.1 Ibis chapter analyzes the impact that oil export measures would have on main economic indicators such as GDP, Balance of Payments, Public Finances, and domestíc prices. The effects of the proposed measures, especially of prices and institutional changes (such as the distribution of oil revenue), on sector enterprises have been estirnated and are covered in Chapter mI, as are certain effects on the Government Budget. 4.2 The following summarizes the main conclusions reached concerning the effect of the proposed measures. i) Under the optimistic hypothesis of growth in non-petroleum exports, a reduction in non- productive consumption, and a substantial increase in capital formation, it has been estimated that GDP growth for the four scenarios will fluctuate between 3.8% and 2. 1% over the period 1988-1995. Only the first two would avoid the gradual impoverishment of the population, since Ecuador's annual demographic growtL rate in coming years is estimated at above 2.6%. Under the low growth circumstances, the economy would suffer recession and high inflation. ii) Resulta show the strong impact of the volume and prices of oil exports on economic growth. iii) Readjustment of refined product prices, as well as change in their structure, would tend to increase exportable petroleum surpluses, as the additional revenue would lower consumption and smuggling, and increase investments. iv) Increase in fuel prices would have a lower inflationary effect than is generally believed. Econometrically, a 100% increase should not have an impact greater than 3.6%. The real figure could be slighdy higher because of psychological and speculative factors. Ibis could be attenuated at the consumer level through monetary measures and proper controls. Furthermore, 15%-20% of the additional revenue could be used to subsidize mass transport and other needs which could palliate the impact of higher energy prices on the poorer sectors of the population. v) The volume of petroleum exports would diminish between 1988 and 1995 due to the depletion of reserves, technical restrictions of production, and increase in domestic demand. Por the high reserve scenarlo, the drop would be at an annual average rate of 6.6%; for the low reserve scenarlo, the drop would be 9.8% a year. 92 vi) This situation makes it essential to rationalize CEPE's investments, giving priority to exploration and ficid development whlcb yield immediate returns. Ibis would make it possible to increase exportable petroleum surpluses in the short mn. High-risk investment should be undertaken by foreign companies. vil) lhe two hypotheses of international prices and proj3ctiona of the value of crude exporta (and equivalent) in current pricea show rates which range froin 2.6% for the high scenario to -2.0% for the low acenarbo. Considering an average annual dollar inflation of 3.5%, a real decrease in the value of petroleum exports occurs under all scenarios- viii) Revenue prospects from hydrocarbons exports, which are rather disheartening, require that non-petroleum exports be encouraged to compensate for futuro decrease of crude exports, which will tend to disappear by the end of the nineties. ix) For both scenarios, the size of the Trade Balance will resemblo that of recent years, with a slight growth in current dollars but a decrease in real terms. Consequently, it is necesary to attract foreign capital. x) Tlus, containment of public and private consumption is fundamental, as is the establishment of investment priorides to channel investment into those other export activities which, in the medium- and long-ten, may bocome alternate sources of foreign exchange. xi) Ibe deficit in the Public Sector Budget, as is true in CEPE's and INECEL's budgets, can be diminished by increasing refined product prices and electricity tarifEs and permitting only bigh priority investments. xii) In view of the importance of oil exports, lower domesdc consumption of oil products should be encouraged, and a fund should be created for investments la energy conservation. xiii) Because electricity is used leas tdan oil in productive sectors and households, an increase in electricity tarifas would haye a lower inflationary eff;ct than an increase in oil tarifas. Ibe incidence of electricity as a production input, even in branches which use dectricity intensively, such as the cement industry, does not exceed 3% of total production costa. Even tdough the increase in electricity tarifas does not haye the same useful economic effects as an increase in the prices of refined products, it would help lower futuro demand and therefore reduce investment and foreign currency requirements. xiv) Current inflation levola and trends require immediate price revisions at the suggested levels and the maintenance of these prices in real teums. A delay in revision, or the setting of lower prices, would be quickly nulliffed by intlation and would require repeated drastic increases, at much higher economic and social costa. 93 xv) lie strong impact of tho exchange rate on econmic activity, CEPE and INECEL finances, the Public Sector Budget, Balance of Payz -nts, etc., requires careful handling of the foreign exchango policy. Ibh present framework generates great distortiona; consequently, this pollcy should be revised so as to maintain a real dollar excbange rato which would make investment, import and export decisiona easier, and artificial exchange rate ceiings should be eliminated at the same time. lipat nEconomic Indicaor 4.3 Estimates were mado of the impact caused by marginal varlations in different parametw on the principal econonic indicators (GDP and Value Added) by changing the structure of the inriut- output matrix. It is assumed that petroleum exporta aro the main explanatory variable of the behavior of GDP in the short- and medium-term. Impact of Increased Crude Exports 4.4 Under the present economic structure (1986 intersectoral relations), an increase of 10% in petroleum exports represents an increase of 1. 1% in GDP and in the Value Added of the economy. On the other hand, a 10% decrease in domestic demand for refined producta, due to a price increase or some other energy conservation measure, produces decreased economic activity which results in a reduction of 0. 1% in GDP. Consequently. for each 10% increase in fuel exporta (which would require a reduction of approximately 20% in domestdc consumption), a net increase of approximately 1% is obtained in GDP. II ¡mp of Reduced Elriciy D d 4.5 Using the same type of analysis, a reduction of 10% in electricity consumption would cause a smail declino in GDP (0.01%) and slightly higher savings of foreign exchange (0.02%). However, it should be borne in mind that substantial indirect savings of foreign currency would result from the decrease in electricity demand because of reduced constuction programa, which hayo a largo imported component. Ihis would, moreover, help channel substantial financial resources into the electricity subsector, reducing INECEL's deficit considerably and therefore its meed for govcrnment subsidies (and the growth of money supply). 'he foregoing, and the size of lnvestment reductiom, would 1/ A 100% to 150% increase in the prices of refined products could causo a substantial decroase In Ihe smuggling of those products out of the country and a 10% reduction in domesdc consumptlon, thus increasing exports by approximately 10%, which could result In a 1% increase in GDP. 94 conserve electricty by setting tariffs which discourage waste, by reducing losses (technical and economic), and by improving the efficiency of end use equipment, etc. Imac of Inflation 4.6 Based on the production and final consumption structures of 1986, estimates have been made, as shown in the following tables, of the impact of the increase In refined product prices and electricity tariffs on inflation at the gross production and final consumer leveis. These estimates are shown in the following table. Table No. 4.1 STRUCTURE OF DONESTIC CONSUNPTION AND FINAL ENERGY DEMANO AVERAGE PERCENTAGE OF ENERGY CONSU (MS> (HIPO) (MS> 1988 294.7 946.2 310.2 1021.5 310.2 1033.6 1989 286.9 846.1 312.3 1034.1 319.9 1034.1 1990 277.8 823.7 304.2 974.9 318.9 1017.4 1991 258.0 738.8 289.3 903.4 309.2 961.8 199 247.4 719.7 286.1 904.7 324.4 1007.9 1993 228.9 939.6 280.2 883.9 326.1 1122.9 1994 212.1 565.4 257.5 823.9 347.1 1247.7 1995 196.7 496.7 236.9 771.3 346.2 1170.8 2000 85.9 276.1 145.6 482.4 275.7 927.4 2005 17.5 195.4 87.2 275.5 164.4 585.5 Source: Work Group esttimte Evaluation of the Three Scenarios 4.15 Comparison of the low and medium acenarios shows that, in thd pessimistic scenarlo, daily output would be lower by almost 16,000 barrels in 1989, 40,000, in 1995 and 60,000 in the year 2000. Production according to the optimistic scenario would be similar to production of the middle scenario in 1988, 109,000 more in 1995 and 130,000 more in the year 2000. Refined Product Demand and Exportable Petroleum Surplus 4.16 Based on the estimated volumes of remaining petroleum reserves and production projectionm according to the middle (expected) scenarlo, the following exportable petroleum and refined product surpluses have been calculated using CEPE and INE figures for projectod domestic ded. 98 High Demand 4.17 CEPE's demand projections estimates for refined products were used to calculate exportable surpluses. The estimated average annual growth rate over the 1988-1995 period is 4.3% starting from 33.1 million barreis in 1988 (see Table 4.5). Table No. 4.5 PROJECTIONS OF PETROLEUN PRODUCTION, CONSIIPTION10A EXPORTS MILLIONS OF BARRELS (CEPE DEMANO) 1 T E N 1988 1989 1990 1991 1992 1995 Totat Productfon 113 114 111 106 104 86 Refinery Throughputs 37 38 40 41 42 46 Imports of Crude Equiv. 7 7 7 7 9 7 Exports of Crude Equtv. 4 4 5 5 6 7 Total DamestIc Consumpt1on 43 45 47 48 51 52 Crude Exporte 70 69 64 58 53 34 Total Crude Exports 74 73 69 63 59 41 Source: CEPE and Work Group estimates. 4.18 By 1995, the volume of petroleum exports wil be 55% of the 1988 volume. Ibis wil cause a decrease in foreign currency revenue, which wil have a negative impact on economic growth. 4.19 This decrease in exportable surpluses of crude and refined products, which will average an annual 8% over the period 1988-1992, is the result of the reduction in production (-3.7%) and of the increased domestic demand for refined products. Lw Demand 4.20 'Iis estimate of exportable surpluses is based on INE's projection of domestic demand for refined products, which forecasts an average annual growth rate of 3.7% based on 27.8 MM barreis a year in 1988, that is, 16% less than CEPE's estimate for that year (See Table No. 4.6). It should be noted that the difference between INE's and CEPE's demand projections is that CEPE's includes contraband whie INE's corrects for the estimated amounts of contraband. This study prefers to use INE's projections because it is expected that a better price policy wili eliminate or strongly reduce contraband in the future. 99 Tabte No. 4.6 PROJECTIONS OF PETROLEUN PRODUCTION, COdSIMPTION, AND EXPORTS MILLIONS Oé BARRELS YEAR BALANCE ADDITIONAL REVENUE FINAL BALANCE 1 2 3 45 With Correc- Losa Reas6gn. Renegot. Subtotal Accum4ated tive Tariff Reduction of Royal- of Debt 2. 3 and Annual tie$ 4 1988 - 79.2 42.7 42.7 - 36.2 - 36.2 1989 .180.8 3.2 14.7 50.8 68.7 -112.1 -148.6 1990 -106.9 6.5 20.3 47.2 74.0 - 32.9 -181.5 1991 - 42.2 11.5 20.3 41.3 77.7 35.5 -146.0 1992 13.4 14.6 24.9 37.0 80.7 94.1 - 51.9 1993 85.8 13.5 33.1 19.5 66.1 151.9 100.0 Note: The resutta are evatuated for the alternative plan usfng a steam plant at San Francsco, whdch helpa reduce tnvestmenta. source: INECEL, Work Group. 4.43 The financiat rehabilitation proposed through the analyzed measures will mean that annual deficits would disappear after 1991, and the accumulated deficit would be covered by the year 1993, when there would be a positive balance. It should be noted that these results are merely theoretical and that a more important reordering of the entire sector, for example, the reorganization of the oil revenue distribution system, would render certain measures obsolete (for example, the elimination of exchange rate ceilings). It is also probable that in five years INECEL will no longer receive any petroleum funds. The only effect of these measures outside the electric subsector would be that, to the extent that the subsector covers its costs, government subsidies would be reduced.