Docawit of

The World Bank

FOR OMCUL USE ONLY

4,;W~. ut. N. F'-- t; '-t l . TvpI- ( FiY:ti~~vt P: PKSY A ND N iN IN O 'ECT~N t2A: AS

A*th. l R t X > , i . ( . ;; r P. NoI P-6039-PE'>! :;"s;.i; 1'-,,n: +r-I ' I D~-S.t . .JU '

MORAND)UN A1ND RECONNATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPtMET

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED LOAN

IN THE AMOUNT EQUIVAL1NT TO US$11.8 MILLION

TO

THE REPU3BLIC OF PERU

FOR AN

ENERGY AND MINIG TECHNICAL ASSISTANCE LOAN (EI)

MAY 12, 1993

This document has a restricted distribution and may be sed by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EOUIVALENTS(as of March 11, 1993)

Currency Unit = SolUS$1.00= 1.77

1 Sol = US$.5650

FISCAL YEAR

January 1 to December 31

ABBREVIATIONS AND ACRONYMS

AMDEP - Asociaci6n Multidisciplinaria de Investigacidn en Poblaci6nCAP - Andean Development Fund (Corporaci6n Andina de Fomento)CTE - Electricity Tariff Commission (Comisi6n de Tarifas Electricas)COES - Comit6 de Operaci6n Econ6mica del Sistema InterconectadoCONERO - Nationa Energy Council (Consejo Nacional de Energfa)COPRI - Commission for Promotion of Private Investment (Comisi6n de

Promocion de la Inversi6n Pnvada)DGE - General Electricity DirectorateD1GH - General Hydrocarbons DirectorateDGM - General Mining DirectorateDGAA - General Directorabt on Environmental Matters (Direcci6n General

de Asuntos Ambientales)DIGESA - Direcci6n General de Salud AmbientalElectrolima - Lima Electricity CompanyElectroperu - Peru Electricity Conpany (Empresa de Blectricidad del Peru)EMS - Energy Management SystemEMTAL - Energy and Mining Technical Asistance LoanINMADI - Investigacidn Medio Ambiente InutriaINAPMAS - Instituto Nacional de Protecci6n del Medio AmbientbINGEMMET Instituto Geol6gico Minero y MetaldrgicoIB L- Limited Intemational Bidding

MEM - Ministry of Energy and MinesNBF - Non-Bank FinanceNGO - Non-Govemmental OrganizationONERN - National Evaluation Office of Natural Resources (Oficina Naciona

de Evaluaci6n de Recursos Naturales)PAHO - Pan American Health OrganizationSAL - Structural Adjustment LoanSCADA - Supervisory Control and Data AcquisitionSICN - Central-Northern Interconnected SystemSOE - State-owned EnterpaiseTOR - Terms of ReferenceUNDP - United Nations Development ProgramVME - Viceministry of EnergyVMM - Viceministry of Mining

FOR OFFICIAL USE ONLY

ENYM AND MNG TFCWAL ASSISTANCE LOAN ETL

Laan and uWect U==

Republic of Peru

Executitir Age: MMistry of Energy and Mines (MM

Boneffcades: MEM and its centralized and autonomos agencies

AmQImt: US$11.8 milion equivalent

MmrXs: Repayment in 20 yeas, including five years of grace, at the standard variable interestrate.

Proj gWect vre: To assist the Government of Peru in the insttutional development of the Ministry ofEnergy and Mines (MEM) and its related entitias in order to ensure their adequatecontribution to economic stabilization and structural reform in the energy and miningsectors, in particular to the privaizaion effort.

DeItdfl: The project consists of: (a) (i consltancy (firms and individuals) for carrying outstudies which would provide recommendations for MEM's institonal developmentand fli) implementation of the recommendations of these studies; (b) traiing progamfor MEM and other relevant staff, in Peru and abroad; and (c) compute software andhardware, particularly to provide adequate stadstical information to the market and tohelp MEM to develop its policies. These services would assist MEM in: (i)completing the process of lega and regulatory reforms for the energy and miningsectors; (ii) strengthening its organizational unks and procedures; (iii) increasing theprofessional capabilities of its staff, and (iv) developing specific guidelines forenvironmental protection in energy and mining projects.

fstimated Project Cost:

C=onwonets LalFe(1) Overall Energy 0.16 0.74 0.90(2) Eleetricity 0.77 2.00 2.77(3) Hydrocarbons 0.42 3.63 4.05(4) Mining 1.90 1.90 3.80(5) Environment 055 2 6320

Subtotal 3.80 10.92 14.72

Physical Contingencies 0.19 0.55 0.74Price Contingencies 0.38 1.09 1.47Project Coordinating Unit 0.02 0.22 0.24UNDP Administrative Fee 0M 0303 0.36

Total L44

This document has a restricted distribution and may be used by recipients only in the performance |of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

Proosd Financing Plan (in USS million):

IBRD 11.8Goverment 2.7Japanese Grants .0

Estimate Disbursemept Banlc PY: 4l9S1612Annual: 2.3 3.3 3.1 3.1Cumulative: 2.3 5.6 8.7 11.8

Economic Rate of Retun: Not Applicable

hEnmronmentaltCJassificatio: C

MEMORANDUM AND RECOMDUMATIONOF THE PRESIDENT OF TIRE INTERNATIONAL

BANK FOR RECONSTRUCTION AM DEVELOPNTTOT EXECUTIVE DIRECTORS

ON A PROPOSED LOAN TO THE REPUBLIC OF PERUMRI AN MD= AN CRM wMICUA S ME.PR

1. I submit the following memon and ommendation on a proposed loan to theRepublic of Peru, for the equivalent of US$11.8 million, to help finnce an energy and miningtechWcal assce project. Ihe loan would be repaid over 20 yers, including 5 years of grace, atthe Bank's standard variable rate.

2. Bacund On taking office in August 1990, President Fujimori's Governmentaumched a major stabilization and struwtal reform progam. It expanded its reform program In mid-1991 to include privatization, with the objective of privatzing all state-owned enterprises (SOBs)before Its term expires in mid-1995. Ihe privadzation program is supervised by an intr-ministriacommission (COPRI), reporting direcy to the President of the Republic. The privaizaton processhas already strut in the hydrocarbons sector with the sale of Solgas and 74 of Petropr's 82 servicestadons and in the mining sector with the sae of Hierroperu nd holdin Mineroperu (MineraCondestable, Quellaveco, and Mipeco USA). Preparatory studies for privatzation are being caiedout for the other hydrocarons, power and minig companies.

3. The Government is also enacaing new policy, legal and regulatory measures topromote compeition and to facilite prvate investment. Recent economy-wide meastues include newanti-ust and labor legslation. Comprehensive new legislation has been passed for electricity andmining, and is being prepared for hydrocarbons. The policy reform and privatzation effots,however, require for their completion and success the strengthening of Government insittons whichare responsible to: (1) monitor the implementation of the new policies; (iU) complement the sector legalframework with the corresponding reguations and guidelines; (iii) absorb the strategy and regulatoryfimctiom which were previously vested in the SOEs now being privatized; (Iv) protect againstmonopolistic conditions; and (v) ensure evironmental protection.

4. Cau= Assistanc Sg. In March 1993, Peru successuly completed a debtworkout program and cleared its arrears with the Bank and the IMP. The Govemt also agreedwit e d PW on a three-year stabiization program and finacing plan to be supported by an ExtendedFund Facility. The Bnks counry assistance strategy for Peru was discussed and approved by theBoard on Aprfl 20, 1993, together with ihe $250 million Privadzatlon Adjustment Loan. Under theassistnc strategy, lending iS forecast at $500 milliou annually from FY94-96, auming mainteof a satisfatory macroeconomic program and finmcing plan The assistance strategy has four mainobjectives: (a) to susti stabilization and consolidate stuctural reforms; (b) to fter prvate sectordevelopmet and public sector reform; (c) to alleviate poverty and promote human resourcedevelopment; and (d) to rehabiltate key irstucure and reform related policies. Strengtheningistituional capacity is fundmental to all four strategic objectives.

5. The project will assist the Government in Implementing new institutional andregulry hfrmework for the electricity, hydrocarbons, and mning sectors, thereby faciitaingprIva hation and prWate investment in these key sects. It will also help develop new envimelpolicies/guidelines and strengthen enviromenal monitoring and enforcement capacity In thesesectors.

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6. ihnnerEn and Mining Sectors. The energy and miring sectors play a key role inPeru's economy: they contribute an estimated 11 % of GDP, 53% of exports, and 35-40 % of fiscalrevenues. Sector enterprises constitute over 70% of Government holdings (in book value). Bothsectors took a serious down-tn during the second half of the 1980s, triggered by the decline in theoverall economy, which they in turn aggravated. The root causes of the decline of energy- andmining-related activites were (i) institutional and policy inadequacies, especially regarding energyprices which weakened the enterprises so that these were unable to carry out maintenance, let aloneexpand their productive capacities; (ii) wide-spread government ownership and control in both sectors:and (iii) operational inefficiencies at the enterprises. The Government recognizes that therehabilitation and growth of the overall economy hinges on profound reforms and strengthening of theenergy and miulng sectors. The Government, with the assistance of the Bank and well-qualifieuadvisors, has established long-range policies for the energy and mining sectors (Annex 2), to: (i)modernize and strengthen the legal/regulatory and institutional frameworks; (ii) maximize the play ofmarket forces; (iii) establist a pricing system which reflects economic costs; (iv) privatize SOEs andpromote private investment in -aew facilities; and (v) reform the corporate structure of SOEs whiletbey are not yet privatized.

7. Responsibility for overall energy strategy and policy advise is vested in the NationalEnergy Council (Consejo Nacional de Energfa, CONERG). This institution is weak and requiressubstanti strengthening to carry out its functions. The institutional framework for the electricesbor~ has been defined in a decree law on electricity concessions enacted in November 1992. It

establishes the following principles: (a) generation is deregulated and sudoject to market forces throughcompetition; (b) transmission provides open access to suppliers and purchasers under a commoncarrier system with an adequately rgulated toll scheme and node prices; (c) distribution as a naturalmonopoly is fully regulated in regard to rights and duties of the market participants; and (d) pricesare liberalized at the generation stage and regulated at the transmission and distnrbution stages.

8. The Government policy for hrocabons establishes that (a) all prices bederegulated, competition established where contestable markets exist, and natural monopolies be madesubject to arms-length regulation; (b) the development and operation of the sector be undertaken bythe private sector; (c) efficient operations and optimal contribution of the sector to public revenues beachieved through appropriate pricing (including taxation, linkage to international markets, anddomestic competition) and a clear policy of contractual arrangements with the private sectorconcerning exploration/development, rather than through government ownership.

9. In the case of ming, the Government policy establishes: (a) an enabling legalframework conducive to private investment; (b) the strengthening of sector institutions with well-defined mandates to effectively administer and monitor compliance with established regulations(including environmental); and (c) promotion of private investment through the provision of basicgeological data and other services.

10. ionale for Bank I'Mmer. The Bank's strategy in Peru is to support strategies,policies, and investments that encourage the resumption of economic growth and social developmentin a context of structural change and environmental sustainability. The emphasis is on efficientresource allocation, increased effectiveness in the public sector, and the appropriate targeting anddelivery of support systems to the poor. Ihe energy and mining sectors are key to this strategy:electricity and hydrocarbons are essential to any productive activity in the economy, whereas miningas principal export sector has to generate the foreign exchange needed for economic growth. Bothsectors are at a crossoads where pervasive state intervention and government ownership are beingreplaced by greater compettion and private participation. However, a strategy aimed atdecentralization and privatization requires a strong and effective regulatory and monitoring system,

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which has yet to be put into place. Ihis entails the preparation of regulations, administrativeguidelines, and tehical nonr.. In support of legislation euacted or to be enacted. It also entails thestrenghening of government and other public insitions that are responsible for implementing theGovement's new energy and mining policies. In support of this process, the Bank can bring to bearits knowledge of Peru's energy and mining sectors gained through previous loans and sector studies,its experience with sector reforms in comparable countries, and its recent involvement in several otheroperations, Including for privatization, which seek to reform Peru's economic policies.

11. Since May 1991, the Bank has been working closely with the Government to helpprepare and implement an economy-wide privatization program and related secoral policy/legalreforms. For this proposa!, substantial technical assistance is being supplied, financed by the UNDP,by two Japanese grants of US$2.2 million and US$0.8 million for mining and energy respectively, bythe US$30 million Privatzation TA loan, and by this proposed EMTAL. Under the SAL, the Bankhas agreed with the Government on sectoral development policies and strategies which will besupported kiW ia by: (a) the US$250 million Privaization Adjustment Loan and (b) a proposedFY94 Electricity Privatization Adjustment Loan.

12. I esons LeaMrd from Past Bank Projects. lhe design of this EMTAL reflectslessons learned from the Bank's internaional experience in sector reform and in institutionaldevelopment under a recently liberalized and privatized setting, and experience in Peru prior to themid-1980s under technical assistance opetions for public sector management and investment forenergy and mining projects. Key lessons include the need to: (a) ensure the continuity of *he reformprogram, during and after the execution of the TA operaton; (b) ensure consistency and coordinationbetween the reform/privazaton and the Institutional development process; (c) limit the scope andsize of the TA loan to keep it focussed and manageable; and (d) have well-defined loan administrationand financing arrangements in place up-front.

13. ect ObjeAives. In view of the requirements for sector reform, the project aims atassisting the Government in: (a) implementing sector strategies and policies, especiallydemonopolization and privatizaton of state-owned enterprises; (b) completing the legal and regulatoryreform of the energy and mining sectors, including environmental regulation; and (c) strengtheningthe capabilities of MEM and the related instiutions, especiall!' the autonomous regulatory entities, toregulate and monitor the operations of the enterprises in the sector. Ihe project thus would enableMEM and its agencies to contribute adequately to the Governmentes privaization, deregulation, andsector development efforts.

14. The specific outcome/implemenation indicators linked to each of the major projectobjectives, are as folows: (a) for implementation of energy sector strategies and policies-theprogress in demonopolization and privatzation of statowned enterprises; (b) for legal and regulaoryreform-he submission to Congress of the relevant laws and the issunce of the relevan regulations;and (c) for institutional strengthening-the capability of MEM to recruit qualified staff and toadeqty perform all tasks, including those currently carried out by consultants. Over the longerterm, key sectoral performance indicators would be monitored, including adequacy of supplies,evironmenta sustainability of operations, and revenues, costs, and staffing of the entprises.

15. Projec Do ci. The project consists of the following components (see Annex 1for the detailed project description and summary TORs):

(a) OverallEnergy: X() evaluation and development of an integrated Energy SectorStrate; and OiI) institutional strengthening of CONERG.

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(b) Electig: (i) comletion of the reglatory framework and reform implemenion atsector udlities; (ii) design of an energy managem system for the Central-NorthemSystem; (iii) Istitutonal strenghing of the General Electrieitty Directorate (DGE);(iV) institutional strengthenring of the Electicity Tariff Commission (CTE); and (v)tariff Implementation.

(c) Hyfltcadaoot : (i) completion of the legal and regulatory framework; (i) institutionalstrengthening of the General Hydrocarbons Directorate (DIGH); and (iii) petroleumexploration and exploitation promotion through the design and development of a databank and establishment of Peru-Petrol, S.A., us the entity in charge of thesefunctions.

(d) M:Ig (i) execution of a mining promotion progrrm under the Vice-Ministry ofMiig; (ii) creion of the Mining Information System under the General MimingDirectorate (DGM); and (iii) development of a cadastral/concession system throughthe formation of the Mining Registry and procedures to process mining concessions.

(e) Emionment: (i) policy fomlation and implementaion; (Hi) institutionalstrengthening of the General Directorate on Environmental Matters (Direccion Generalde Asuntos AmbientrAes, DGAA); vii) environmental management and mitigation ofenergy and mining projects; and (v) sectoral asessment studies.

16. Proiect Cost and Pa ing. The total estimated cost of the project (Schedule A) isUS$17.5 million, of which US$2.2 million are physical and price contingencies, US$0.2 million isthe expense of the project coordinating unit and US$0.4 million UNDP's adminison fee. ITeforeign exchange component of the project is estimated at US$13.1 million. The Bank, through thisloan, will finance US$11.8 million, the Japanese Grant Facilities for Energy and Mining/Environmentwill finanoe US$0.8 million and US$2.2 million, respectively, while the local contribution will beUS$2.7 million, primarily consisting of counterpart staff and office support. The local share of thefinacing will come from budgetary resources of MEM and selfgenerated fur4s of its agencies.Asuaces have been obtained from the Government that the fumds required to cover the localcoributio will be made available to MEM. ITe fiancing plan is set out in Schedule A. Allcontracts will be individually and sepaatey financed by the funding institutions, rather than cost-hared, for administrative simplicity.

17. Proect Ipementon. he project will be managed by MEM. The Minstry willbe assisted by a Project Coodination Unit, to be financed under the Project, comprised of a principalcoordinatr and one sectoral coordinator each for the electricity, hydrocarbons, mining, andenvionment-related componenis of the project. The principal coordinator has already been appointedby the Ministry. The relevant sectoral coordinators of the Unit would initially be employed full-ime,but they would be gradually replaced by MEM higher-level staff as project implementation advances.n addition, he project includes the financing of a limited number of short-term specialists o advise

the Govenm In institutional and policy reform andlor participate in sector policy evaluations. Allreports and re n ons ofthe consultants engaged to assist in the execution of the project willbe submitted to the Bank for its review and comments. Ihe total involvement of individual nationalspeciaists will be less than ten person-years.

18. Each MEM organizational unit or autonomous agency will have primary responsibilityfor preparing terms of reference and short lists, and selecdng consultants, subject to approval by theProject Coordination Unit and Bank no-objection. All conslta financed by the Bank will beselected and hired in accordace with the Bank's Guidelines for Use of Consultants. For consulting

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contracts fanced by other sources under the project, the Bank wll review the tems of reference.Draft opeatonal guidelines for the TA program, settng out the procedures and responsibilities, areIn Annex 4.

19. The Government has proposed, and the Bank lac agreed, to use UNDP as theadinisrte agency t ad the contcs and payment under a management arrangementsatisfactory to the Bank. Its management fee of US$0.4 million will be financed from the proceeds ofthe loan. UNDP will disburse directly to consultan and will mainain supporting documenton onfile for review by Bank supenrision missions.

20. 1niromn AMeX. lhe Project belongs to Eavironmental Cagory C and hasno adverse enviiromea impacts. It will Include Sector Enviromental Assessments and thedeveopment of sectoral eironmea guidelines for energy and mining projects and, as such, willsupport the Government's environmental ste.

21. Erng=m Objecve Catey. The Project belongs to the category of Public andPrivate Sector Development.

22. . Methods for prouremen and disbursemens are shown in Schedule B.Procrement of goods to be ficed wivth proceeds from the loan would foUlow procedures inaccordance with Bank Guidelnes fo procurement. Couting services totaling about US$10 millionfor the cont of fim to carry out secoral, institudonal ad management studies under thevarous components of the project, and of individual consultants for the strengthening of MEM andthe operaions of the Project Co nating Unit, would be in accordace with Bank Guidelines for theuse of consultants. Procurement of computng, communications, and ancillary equipment for thempleentaion of the energy management system, hydrocarbons data bank, mining information

system, and the general strengthening of MEM units, for an esmated amount of about US$1.1million would be procured through Limited Intrnonal Bidding (lU) because of the specializednate of such equipment. An estated US$0.3 million of the loan proceeds would be used for thereimbursement of training expenses such as tuition fees and travel expenses for courses and seminansin accorjance with a plan to be previously approved by the Bank, and for fees of Wdividualconsultants acceptable to the Bank. UNDP's administrative expenses (US$0.4 million) would be paidwith proceeds from the loan directly to UNDP. Prior review of documenion and procuementdecisions wil be required for all procurement including the proposed UNDP management serviceagreeme.

23. Dibumen MEM will request disbursements and submit these requests throughthe Project Coordinating Unit to UNDP for processing. UNDP will disburse payments out of its ownresources directly to consultants. The applicator for withdrawal requests submitted by the Borrowerof eligible expenditures made under the Bank Loan to UNDP will be in amounts of aboutUS$500,000. For all contracts requiring Bank's prior review, UNDP will submit full documentation.Since the project is largely composed of short-term technical assistance, disbursements would be madeover a four-year period, which is shortar than the average disburement profile for technicalassistance projects in the Latn America and the Caribbean Region. Retroactive financing not toexceed US$1.1 million (i.e., about 10% of the loan amount) would be applied to finance eligibleexpenditures made after December 31, 1992. The closing date of the proposed Loan would beDecember 31, 1997.

24. Accunts ad Audi. UNDP will maintain separate accounts for receipt of projectfinds and payments for all project activities. UNDP accounts and statements of expenditures, both ofthe Coordinating Unit and of UNDP, would be audited each year by auditors acceptable to the Bank

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in accordance with the Bank's Auditing Guidelines. The audited reports would be submitted to theBank not later than four monuis after the close of its fiscal year.

25. s AgMd. During negotiations, agreement was obtaned on: (a) the TA to befinanced under the Loan, and the financing plan (Schedule A); (b) a project description and an actionplan on all project components, including a cooperation agreement between the rGAA and aspecialized agenq for the purpose of carying out the Eavironmcntal Protection Plan (Annex 1);(c) operational guidelines for loan administration and cansultant hiring, conracting and supervision(Annex 4); (d) model procurement documents and UNDP/Government project documents(Annex 5); the latter will provide the basis for UNDP to administer contracts and disbursementsunder the loan; (e) TORs for consulting assistance to prepare/implement the project cotaponents; (t)submission of an annual forecast of the sources and uses of funds, and a semi-annual report on theresults of the program; (g) a semi-annual review of the implementation timetable; (h) a mid termreview to realign project resources to the evolving needs of . nrogram; (I) submission of all renortsand recommendations of the consultants engaged to assist in tht execution of the Project; 0)submission of an annual exteral audit report of the project accounts.

26. Conditions of effectiveness will be (a) the issuance of operational guidelines, asagreed between the Bank and the Government, to MEM's organizational units and autonomousagencies, and (b) the signature of a project administration agreement, satisfactory to the Bank,between UNDP and the Governmezit.

27. Conditions of disbursement for consultants' services in each of the areas of electricity,hydrocarbns, mining and environment, will be the appointment of the project unit's relevantspecialist.

28. Benefits. Te proposed loan would assist the Government in the implementation oflegal/regulatory reforms and the strengthening of public institutions, which would improve efficiencyand attract private Investors to the energy and mining sectors. Economic pricing of electricity andpetroleum products would eliminate the financial burden that these sectors pose to the Government byallowing these sectors to fund their own investment needs, and would reduce energy waste andpollution. Sector efficiency woud be further enhanced through increased private participation, andscaling-down of government intervention which would be limited to market-based regulation.Environmental monitoring and management of energy-related and mining operations would be muchimproved.

29. Rigka. Because of its nature, the project poses no significant tedhnical risks.However, the implenentation of the broad range of institutional and policy reforms that It is designedto support greatly depends on congressional and popular support, the availability of competenttechnical staff in the public administration, and the outcome of the ongoing efforts to reestablishphysical securt in the country. First, opponents of the Govermnent's reform and privatizationpolicies are likely to be critical of the policy goals of the operation. 'Te new Congress may insist onreconsidering the mining and electricity laws enacted by the Government as decree laws, and itsconsideration of the draft hydrocarbons law may entail a delay in enacting this law. Second, theGovernment lacks experienced staff to regulate public utilities and the regulatory framework is still inan inception stage. hwus, the sustainability of the institutional strengthening program will depend to agreat extent on overall civil service reform, especially as it relates to salary levels. Third, the abilityto attract well qualified consultants, and the future participation of private investors in the energy andmining sectors would be affected if teorist activities do not abate.

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30. These risks will be mitigated substantially through training (fiunded by the loan) and apublic information camaign that the Government is undertaldng. By and large, the risks outside thecontrol of Governent are expected to be offset by the significant potential benefits of the reformprocess, which is adready under way. To avert political risk, the Govement moving as quicklyas possible to make the reform process irreversible. It will also launch a public reladons campaign onthe advantages of te refonr, and continue to advance with Its regulatory reform and privtizatioprocess to give positive signs to national and intenaional investors. 7Te Government Is aware ofthe need to include, within its overall institudonal strengthening, civil service regulations which allowthe hiring of well-experienced and qualified personnel, and it intends to take the necessary steps intothis direction. Government performance under the economic stabilization and adjustment program hasbeen excellent, reflecting a strong commitment to its goais.

31. RoeMdadon. I am satsfied that the proposed loan would comply with theArticles of Agreement of the Bank and recommend that the Executive Directors approve U.

Lewis T. PrestonPresident

Attachments

Washington, D.C.May 12, 1993

| S"8= i 081 W lEoi § f A bt s§ i 8

S W"t SaSESE Bt E Wot aBgg ol

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SCHEDULE B

ENFRGY AND XMN -ECHNICAL ASSISTANCE LOAN

Procurement Methods and Disbursements

A. Procurement Method

Amount (US$ millions) and Procurement Methodse

Other NBF Total

Consulting Services w 9.8 3.0 12.8(9.8) (9.8)

Computing, Communications, andAncillary Equipment' 1.1 0.1 1.2

(1.1) (1.1)Training Expenses d 0.3 2.6 2.9

(0.3) (0.3)Consulting Services for theProject Coordinating Unit wI 0.2 0.2

(0.2) (0.2)UNDP's Administration Fee v 0.4 0.4

(0.4) (0.4)

Total 11.8 5.7 17.5(11.8) (11.8)

ai Figures in Parenthesis are amounts financed by the proposed Bank loan.b/ Conacting of consulting firms and individual consultants in accordance with Bank Guidelines.b/ Expenditures acceptable to the Bank to be reimbursed.c/ Limited Intwnational Bidding.

NBF: Non-Bank Financed

B. Disbursements

Category Amount Percentage of Expenditure to be(USS million) ed with Proceeds frnm the

Consulting Services 10.0 100% of expendituresEquipment and Materals 1.1 100% of foreign expendituresReimbursement Expenses forTraining Program 0.3 100% of expenditures

UNDP Administration Fees 0.4 100% of expenditures

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SCHEDULE c

PERI

ENERGY AND MOMW( TE-}SAL ASgSITANCE: LOAN I

Timetable of Key Project Processing Events

(a) Tume taken to prepare: Seven Months

(b) Prepared by: Ministry of Energy and Mining and CTE, withBank Assistance

(c) Appraisa mission departure: December 1992

(d) Negotiations: April 1993

(e) Planned date of effectiveness: June 1993

(f) List of relevt PCRs and PARs: Fifth Power Project (Loan 1215-PE) - ProjectCompletion Report

Petroleum Production Rehabilitation Project(Loan 1806-PE) - Performance Audit Report

Petroleum Refineries Engineering Project (Loan2117-PE) - Project Completion Report

Petroleum Production Enhancement Project (Loan2195-PE) - Project Completion Report

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Schedul DPage 1 of 2

THE STATUS OF BANK GROUP OPERATlONS IN PERU

A. SUMMARY STATEMENT OF LOANS

(As of March 31, 1993)

Amount lessLgua XN z Bor lPme Cancellation Undisb

(USS mifllon)

Sixty Two (62) Loans fuly disbursed 1801.69

of which Program Loan 1

*1693 1979 Peru PrOgram Loan

3489 1992 Peru Financial Sector Adjustment 400.00 100.003540' 1993 Peru Privadzadon T. A. I= 30.00

TOTAL 2231.69

of which has been rep aid

Total now outstanding 1359.00

Amount sold 18.31of which has been repaid

Total now held by Bank 1340.

Total undisbursed

* SECAL, SAL or Program Loan

11 Apprv& during FY792/ Not yet signed

NOTE: The stats of th projects listed in Part A is described in a separate report on all BankflDA financedprojects in execution, which is updated twice yearly and circued to the Executive Directors on April 30and October 31. -

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&hodute Dhagp 2 of 2

. VIAM l OF IFEC JINVEMI(As of Match 31, 1993)

_--YUSS Million_Di Bower nuo of Business Eai t fAb

1979183186190 Bucavntur Meal Ore Mning 6.00 2.97 8.971986 CARISA Non-Feroas Oto Mining 6.00 0.50 6.501962 Cemento Andino Cement Lime & Plaster 2.46 0.20 2.661982 Coabuha Electric Light & Power 4.50 4.501975 Poru Copper Non-Ferrous Ore Mining 15.00 - 15.001960 Durisol Fabric Metl Products 0.30 - 0.301960162 Fedrtlizt Ferizrs & Pestcides 4.09 - 4.0K1960 Luton Non-Motalic Minal PR 0.28 - 0.281985 Minera Regina Non-Ferrous Oro Mining 6.08 0.24 6.321986 Orcopampa Non-Ferrous Ore Mining 9.00 - 9.001964/67 Pacasmayo Cement Lime & Plaster 1.60 0.50 2.101983 Paln Vegetable & Ani Oil 15.00 - 15.001986 Podeoa Non-Ferrous Ore Mining 3.30 - 3.301960 Rounidss Fabinc Met Prducts 0.25 - 0.25.1980/85 SIMSA Non-Feous Ote Minig 6.70 0.50 7.201982/92 SOGEWESE Lasing Companies 13.00 1.S7 14.S7

Total GCs commitment 93.56 6.47 100.03Less Cancellatons, Terminations

sad Sae izi8

Total Commitmn now held by IFC 9.02 3.70 12.82

Total Uudisbursed 0 .0

- 13 -

PERUENERGY AND MNING TECICAL ASSISTANCE PROJECT

Tlechnical Annee

Annex 1 Detaile Project DescriptionAnnex 2 Status of Sectoral Policies and Regulatory ReformsAnnex 3 Summary of Lessons of Bank/Internatonal ExperienceAnnex 4 Operational Guidelines for Technical Assistance LoanAnnex 5 Draft Loan Administration Agreement Between the

Government of Peru and UNDPAnnex 6 Implementation Tmetable

-14- ANNEX 1

ERU

ENMRGY AND =NING IEHNiCAL AS$S,STANI LOAN

DErAILED PROJECr DESCRIPTION

OVERALL ENERGY

Badcground

1. With the ransformation of Peru's energy sector to a market-based and largely privately ownedsystem, the focus of the Governet's responsibilities and functions shifts, from being the principalproducer and investor towards designing strategies and formulating and implementing policies.Traditiondly, these stategic and policy fimctions have not been carried out satisfactorily, largely becauseof the instituional weaknesses at the Ministry of Energy and Mines, especially at the National EsergyCouncil (Consejo Nacional de Energfa CONERG) charged with saegy formulation and policy advicein the energy sector. CONERG does not have the analytical capabilities required to carry out thesefiUctions. In view of the need for appropriate energy sStegies and policies following sectortton, the Government has requested the Bank to provide technical assistance in preparing anindicative energy strat and for strengthening CONERG in its analytical and policy advisory finctions.

Energy Sector Strategy Evaluation

Objectves and Scope

2. The Evaluation is to indicate a strategy to secure adequate energy supplies and efficient energyuse over the medium- and longer term that are environmentally sustainable. Specil emphasis wMl begiven to meeting the energy requirements of the rural population.

3. The Evaluation comprises the following elements:

(a) Analyze energy requirements of the overall economy and of the principal energy-consumingsectors and geographic regions: Medium- to longer term energy scenarios will be developed,based on past trends and realistic assumptions concerning future overall economic and sectoralgrowth, and population and income growth.

(b) Identify economically viable options to meet energy requirements adequately, at least cost, andwith the least possible impact on the environment: Both supply and demand options will beevaluated, covering all major energy supplies both domestic and imported (i.e., crude oil andpetroleum products; natural gas; electricity; biomass; coal) and major sectors of energy demand.This includes options for energy efficiency enhancement through conservation and substitutionand for energy demand management. The environmental Impact of these options will be animportant consideration. The evaluation of rural energy options will comprise both the sourcesof supplies and principal activities of demand.

-15- ANNEX 1

(c) Identify policy impacts and requirements: The Evaluation will analyze (1) on the supply side,requirements to stimulate competition, liberalize markets, and enhance private ownership in theenergy sector, and (i) on the demand side, energy pricing, taxation and subsidization, and non-pricing interventions to enhance energy efficiency.

(d) Identify institutional requirements: Following the legislative and regulatory reforms in theelectricity and hydrocabons sectors, institutional requirements in terms of responsibilities,procedures, and resources will be evaluated, comprising CONERG, the General Directorates ofElectricity, Hydrocarbons, and Environmental Matters, and the Electricity Tariff Commission.

Results

4. The Evaluation will formulate a consistent set of policies, specific measures, and projectsprimarily to be implemented by the prvate sector, which ensure the economically optimal andenvironmentally sustainable supply and use of energy. CONERG through its coordinating role in theEvaluation will be strengthened as the Government's principal entity for preparing strategies and advisingon policies in the energy sector.

inplementation

S. The Evaluation will be carried out by a team of international and national specialists. The taskcoordinator-a senior professional with long-range experience in analyzing energy issues and formulatingenergy strategies-will prepare detailed terms of reference and select the individual specialists. Theimplementation period is estimated to take approximately 12 months including the preparation of the termsof reference, team selection, analysis, and report preparation and review. The Evaluation is estimatedto require about 60 person-months and to cost about US$700,000.

Institutional Strengthening of CONERG

Objectives and Scope

6. Consultant services to be provided to CONERG aim at identifying requirements and options forCONERG's institutional strengthening, so that the entity can comply with its responsibilities to formulatestrategies and advise on policies in the energy sector.

7. In the frst phase, the individual consultant - an international expert with at least ten years ofexperience in managing and restructuring governmental advisory institutions in the energy field - willprovide the following services, as part of the Energy Sector Strategy Evaluation:

(a) Analyze (i) CONERG's current position within the Ministry of Energy and Mines, in regard toits functions, organization, procedures, relationships with other entities of the Ministry and otherpublic and private sector entities, and (ii) resources available to CONERG;

(b) Determine to which degree CONERG has complied with its functions, and establish performancecriteria;

(c) Defilne CONERG's material and staff requirements for complying with its functions; and

-16- ANNEX 1

(d) Recommnd a program of strengthening CONERG and adapting the entity to the new frameworkof the energy sector.

S. As member of the Energy Strategy Evaluation team, the specialist would define the approach andprocedures for undertaking the institutional analysis of the Energy Strategy Evaluation (paras. 24).

ImplementaIo

9. The services under Phase I are estimaed to take about two months. Based on the consultant'sreport, the Bank will seek agreement with the Government on specific measures ensuring CONERG'sinstitutional strengthening. These measures will be implemented during Phase 2. Both phases of theactivity are esmated to be carried out intermittently over a period of 15 months, at a cost ofUS$200,000.

ELECRICrTY

Badkground

10. The institudonal changes following the 1992 Law on Electricity Concessions will result in freeconracing between producers and distributors/consumers, creation of a supply pool (Comite deOperacion Economica del Sistema Interconectado; COES) and guidepost regulation of electricity pricing.In order to ensure the proper functioning of the new system, It is necessary to reinforce its regulatoryfiramework. The concomitant economic/financal and technical regulations for system operation need tobe prepared, including tariff setting, valuation criteria for contacts, granting of concessions, technicalsafety, settlement of disputes, and monitoring of compliance by the electricity enterprises with their newobligations. Economic reguation related to tariffs and valuation issues wfll be the responsibility of theeclricity Tarifi Commission (Comision de Tarifas Eldctricas; CTh whereas MEM's General

Eletricity Direcrate (DGE) wil be responsible for granting concessions, approving contas, and fortenical regulation.

11. The project will therefbre provide technical assistance to (a) CTE for contract and tariffregulation and (b) DGE for institutional strengthening, through the services of weil-qualified consultantseither national or intenational for the preparation of implementation schemes.

Completlon of Regulatory Framework and Reform Inplementation

12. Significant advances have been made in the preparation of the legal and regulatory frameworkfor electricity through financing from the Japanese Grant Facility for Energy. However, someadjustments and refinements are required especially in the areas of detailed regulation and specificguidelines for the operation of the sector under the new legal framework, including environmentalguidelines. This component of the project intends to fill that void.

13. Albeit the corporate aspects of the reform are the responsibility of the Privatization Committee(COPRI), MEM will follow closely the implementation of the reform program in the electricity utilitiesin particular with regard to urgently needed investments while the transition from the old to the newsystem takes place. This component will finance the consultant services to the Vice-Ministry of Energyof one professional to advise the Government for the period of one year.

-17- ANNEX 1

Energy Mangement System (EMS)

Background

14. As the outcome of the restrcturing of the electricity sector, in the Central-NorthernInterconnected System (SICN) will be transformed into: (i) several generation companies, (-i) onetransmission company (IC), and (iii) several distribution companies. Electroperu currently owns thetrunk transmission system, four hydro plants (MantaroJRestitucion, Cahua, Canon del Pato,Carhuaquero) and small thermal plants C(rujillo, Chimbote, Chiclayo and Plura) and is expected to besplit Into a number of generation companies and one transmission company. Electrolima, owner ofseveral hydroplants near Lima (Huinco, Callahuanca, Moyopampa, Huanpani, and Matucana), athermal plant (Santa Rosa), some transmission facilities in the greater Lima area, and the Limadistibution system, is expected to be split Into one or more generation companies, transfer itstransmission facilities to the TC and form one or more distribution companies.

15. The 1992 Electricity Law foresees the creation of a Committee for the Economic Operation(COES) for each interconnected system, to be formed by all major generators Currently there arethree systems (i.e. SICN, the South-Western and the South-Eastern systems; the latter two are likelyto be interconnected to form the Southern system). It is recommended (a) to establish uniform by-laws and rules for all systems, in preparation for integrating them into a future unified system, and(b) to create one COES, for each system (for SICN and the Southern system). This would permit toapply common rules and methodologies, and similar system programming and operating models.

RequIrments, Objectives, and Scope

16. Implementing of the new regulatory framework entails the need to optimize systemoperations, register energy transactions among the participants (the transmission company and manygenerators), compute short-term energy and power contractual charges and marginal costs, as well asfunctions reated to system security of supply and record keeping of the wheeling contracts. A two-tier system would be the best way to structure the energy transactions and control: the highest levelwould correspond to a central Energy Management System (EMS), whereas second-level centerswould be operated by the generating companies. Ihe EMS would be-at least initially-associated tothe TC and must handle two different kinds of operations; i.e., (A) supervising and controlling thegeneration and transmission network which is required to comply with security of supply and tooptimize system operations, and (ii) registering energy transactions for the correspondiA& COES.Functions and responsibilities of the COES require easy and periodic access to information of theEMS but do not require to be on-line with it.

17. To ensure the efficient and reliable operation of the grid, the future transmission companyneeds an effilcient Supervisory Control and Data Acquisition (SCADA) system, approprie software,and reliable communications facilities to provide for an adequate security of supply and interphaseequipment to efflciently transfer information to the COES. The design of an energy managementsystm for the Central Northern Interconnected System is under the responsibility of Electroperu andElectrolima.

- 18 - ANNEX I

Edsfting Dispatch Faciidies

18. Electroperu's current dispatch facilities are inadequate for handling the operation of the SICN.Ihe entity has prepared a pre-feasibility study for the implementation of a modern dispatch center andof a building to house it. The location is adequate to serve the SICN and the space could easily housethe EMS' facilkies. However, the dispatch center has been conceived under the concept of averticaly integrated utility, while the refbrmed sector is based on a clear separation of entitiesresponsible for generation, transmission, and distribution.

19. Electrolima's relatively modem dispatch center is also conceived for an independent,veraly integrated utility. Thus, because of the proposed splitting of the company in a number ofgeneration and distribution companies, changes must be made to separate the functions thatcorrespond to generation only -which would be linked to the EMS- from the supervisory functionsthat correspond to the distribution facilities.

20. Financing of the EMS is justified because of the need to ensure reliable system operation forthe TC and implement effective support for the functions established in the proposed legal andregulatory framework. Bank participation is essential to ensure that the philosophy and procedures ofenergy transactons of the proposed law and regulations (in regard to tariffs, wheeling, and COBS)are duly reflected in the design of the new EMS. The proposed operation would finance the finaldesig and preparaion of bidding documents by specialized international consultants including theadatation of Electrolima's dispatch facilities as well as the acquisition of computer equipment foriplementing a center for electricity transactions in the SICN.

Implementaion

21. The implemention period of the EMS is estimated at about 40 months, of which about 20months are needed for the design and bidding process. Computer facilities for the .OLS (which areneeded as soon as the COES for the SICN is established) could be in place in about. v months. Thesector reforms will be mostly implemented before the EMS is completed. Since the sector must relyon existing facilities for managing the SICN under the revised regulatory framework for some time tocome, the consultants' services include a review of the existing facilities and recommendations onhow the system could be operated during the transition period.

22. The EMS will be part of the transmision company expected to evolve from Electoperu, butby absorbing Electrolima's transmission facilities. Electroperu, as the major operator of transmissionfacilities, is In a position to implement the project and it should be entrusted with the projectexecution. Electrolimna would implement the transformation of its Dispatch Center. It is technicallycapable of doing so.

StrengtheinJg of the General Directorate of Electricity

Objectves and Scope

23. Ihe objectve of this project component is to equip DOE for effecive arms-length regulationof the electricity sector, wfihin the new legal/regulatory and institional framework, to ensureefficient sector operations.

-19- ANNEX 1

24. The following specific tasks will be carried out:

(a) Preparar model contracts for granting concessions which ensure least-cost supply of electricity,fina&i4al viability of operations, and efficient use of the country's energy resources;

(b) Recommend methods and instruments for monitoring and supervision to ensure efficient, safe,and reliable sector operations, and assist in implementing the corresponding monitoring andsupervision;

(c) Prepare a system of registration of, and data on, concessions and authorizations for electricitygeneration for installed capacities exceeding 500kW, and assist in its implementation; and

(d) Recommend an organiational structure for DOE, in accordance with its functions as definedin the 1992 Electricity Law, and prepare a training program for DGE staff.

JmplementF'lOn

25. The project component will be carried out in two phases. During Phase 1 (diagnostic phase)extending over approximately three months, the consultant will analyze the implications of newlegal/regulatory framework on sector administration and prepare tems of reference for a detailedassessment of the options to deal with these implications.

26. Under Phase 2 (implementation phase) extending over 15 months, the following tasks wil becarried out:

(a) Detailed assessment of the requirements for monitoring and supervision of the contractualobligations of the concession holders;

(b) Preparation of selection criteria for engaging outside entities to carry out monitoring andsupervision tasks, including reporting requirements for these entities; and

(c) Preparation of an organizational structure and training program for DGE, and initiation oftrainng for DGE staff.

27. 'Te services of a consultant with at least 15 years of international experience are required forthis activity. Ihe costs of this activity are preliminarily estimated at US$250,000.

Strengthenlng of the Electridty Tariff Commission

Objectves, Scope, and Expected Results

28. A series of studies, to be carried out by a qualified consulting firm, is to assist in preparingthe regulatory framework that Is required for effective monitoring and supervision of operations in thereformed electricity sector.

29. The studies will address (a) regulation of the power pool (COES), economic load dispatch,and geneaion costs, (b) transmission costs and node prices, and (c) value-added and replacement

-20- ANNEX 1

values in the distribution system. The studies will assist in (a) organizing COES so as to ensurereliable and leasw-cost generation and distribution, based on marginal costs for instatneousoperations as well as for operations over the next 24-48 months; (b) identifying ransfer nodes in thetransmission system and corresponding transmission losses and costs, and determining for eachtransfer node the capacity and energy charges for transactions between generen and distributionenterprises; (c) establishing the costs of electricity distribution for model eneprises and for typicalareas, establishing a tariff structure for distribution based on economic costs of generation,transmission, and distribution, and simuIating the results of applying these tariffs to distributionenterprises.

30. The following specific tasks will be carried out:

(a) Economic load dispatch and generation costs: Establish reguations for the operation of thepower pool; develop a simulation model for operation and dispatch of the interconnectedsystems, and evaluate the intermediate results following about two months of operating thepool; develop a mathematical model to establish the capacity and firm energy requirements ofeach generating plant for economic dispatch.

(b) Transmission costs and node prices: Define the trunk transmission network and transfer nodesfor each integrted system; analyze load flows, determine marginal capacity and energy lossesand corresponding penalty factors for each transfer node, as a basis for establishing nodeprices; and determine replacement values, transmission costs, and wheeling charges for thetrunk transmission and subtransmission systems, based on maginal energy costs, for a periodof 24-48 months.

(c) Distrbution costs for typical areas and tariffs for final consumers: Determine the fixed costsassociated with serving final users, standard costs of capacity related to investment,operations, and maintenance in the distribution system, and average costs of energy losses (atdifferent voltage levels, for capacity and energy); determine replacement costs of installationsin the distribution systems; prepare tarff structures refleting the economic costs of supply atdifferent voltage levels and a methodology for their application (over a four-year period); andsimulate the results for the distribution enterprises of applying the tariff options, with the aimto estimate the economic rAturn "or the distribution enterprises in their entirety, as a basis fortariff adjustments as appropriate.

Implementation

31. The studies will be carried out during a period of six months, under the direct supervision ofCTE. The costs of the studies are estimated at US$441,000, of which US$256,000 will be financedthrough the Japanese Grant Facility administered by the Bank.

-21- ANNEX 1

HYDROCARBONS

Baqcground

32. Since late 1990, the Government has received Bank assistance in developing programs forderegulating petroleum markets and privatizing the petoleum products storage depots and inpreparing a new hydrocarbons law. In addition, Bank staff have advised the Governmen'sprivatizatdon committee (COPRI) on the privadzaton of Petroperu's subsidiaries. The Governmenthas requested further technical assistance from the Bank in strengthening the policy and regulatoryfunctions of MEM to manage in the future a largely privatized hydrocarbons sector. The Governmentis concerned that environmental problems associated with petroleum operations have not beenadequately handled. While environmental guidelines have been issued, there is a danger these may bedifficult to be implemented given their lack of operational applicability and lack of resources of theimplementing agency. The Government, therefore, wants to ensure the appropriate implementationof, and compliance with, environmental guidelines in the field.

Objectives and Scope

33. The main objective of the Project's hydrocarbons component is to assist the Government inthe implementation of its hydrocarbons sector strategy, aimed at deregulating the market,implementing appropriate legal and regulatory reforms, and privatizing Petroperu and its subsidiaries.

34. The hydrocarbons component comprises three main activities as well as the financng ofhardware and software:

(a) Assist MEM to complete the new hydrocarbons legLslation, follow up on its review byinterested parties, and support its enactment by the national Congress;

(b) Strengthen the capacity of the Vice Ministry of Energy (VME) to (i) define sector strategies,(Ii) implement, supervise, and coordinate sector policies, (iii) coordinate with othergovernment agencies, and (iv) promote investments by the private sector. This requires thefollowing:

(i) strengten the capacity of the General Directorate of Hydrocarbons (DGH) to establishnorms and standards that are necessary for an efficient functioning of the sector;provide training; support qualified technical staff; and implement systems to facilitateand make DGH more service-oriented and efficient;

(ii) strengthen the role of VME in developing Peru's strategy in promoting and attractingprivate sector investments in exploration/development. This strategy will be carriedout by an autonomous and self-financing entity operating under private company law,Peru-Petro S.A., which will take over the role until now being played by Petropera.Peru-Petro will be an exploration data marketing and promoting entity and will be incharge of setting up the exploration data bank and making it available to all interestedcompanies, as well as carrying out exploration studies to upgrade data quality andpromoting them to potential investors. Peru-Petro will represent the Government innegotiations for awarding exploration contracts or concessions, and will be responslble

-22- ANNEX I

for ensuring compliance with contract commitments by the companies (in regard totheir investment commitments and payments of the government share In the contracts).These fimctions would be primarily carried out by private subcontractors on behalfand for the account of Peru-Petro. The Project component will provide assistance toreview the orgaization, staffing, training and the development of managementsystems that will be required by Peru-Petro to become a serviceoriented and efficiententity;

(ii) strengthen the capacity of VME to develop environmental guidelines forhydrocarbons-related operations, and ensure that VME has the staffing, training,technical assistance, and computer systems to carry out its environmental supervisorycapacity diligenty and efficiently; and provide training and consultant support toMEM's General Directorate of Environmental Affairs (DGAA); and

(c) Provide of computer hardware and software systems for Peru-Petro and DGH to strengthentheir ability to implement and supervise operations.

Impl eme nt affon

35. MEM wil be responsible for project implementation, assisted by a project unit coordinatorand hydrocarbons sector specialist to be specifically recruited to perform this function. Theexecution of the different activities requires the provision of external consultants.

36. Mhe sector reforms as planned by the Government will be completed well before EMTAL Isfilly implemented. The implementation period is estimated at about 36 months. Studies required toevaluate how VME could be strengthened before a new organization and systems are put In place forDGH and Peru-Petro are expected to take six months. Training and staffing assistance for DGH andPeru-Petro cover a period of 24 months.

37. Project Sustainability. To ensure that activities required for continued support of sectoraldevelopment are carried out after project completion, strong emphasis will be placed on institutionbuilding, human resource development, and a'equate funding of the sector institutions' operatingcosts. Peru-Petro will be an autonomous self-financing entity whose resources will be raised throughfees on petroleum operations and the sale of exploration data. Provision is made in the Projectcomponent for support by consultants in the initial phase of operations and training both on-the-joband outside, as an important element of project sustainability.

MINING

Objectives and Scope

38. In implementing the Government's mining strategy, it should be possible to carry out thebasic institutional restructuring within a period of about 12 months, but it will take longer to completethe transformation into well-functioning new entities. The mining component of the Project aims at

-23 - ANNEX I

supporting sectoral reform through well-focused technical assistance. The component comprises thefollowing activities:

1. National Mining Information System2. Mining Promotion3. Strengthening of Mining Institutions

(a) Inplementation of new Mining Cadastral Concession System(b) Completion of the regulatory framework and Implementation of the mining sector reforms

including those related to the environmental protection

Each Project component will have its base in one particular state institution. In addition to achievingtheir operational objectives, the Project components wiUl serve to strengthen their host institution.

39. The expenditure categories are as follows:

- Investment in equipment at the different organizations required for their proper functioning.

- Training of personnel.

- Salaries for outside specialists over a fixed period, during which their involvement will bephased out.

40. Proiect OrganSion. According to the experience gained in other countries with similarprojects, the task of selecting, negotiating, and coordinating technical assistance is best fulfilled withthe support of a specific Project Coordination Unit. A number of tasks such as setting up andoperating the mining cadastral systems, will be carried out with significant private sectorparticipation.

41. Consultancy Assistane . The main responsibility of consultants, either national orinternational will be to ensure that the project is carried out in accordance with the project objectives,and to ensure that the project is well-integrated in the work of the institution.

42. Training. An important element of the execution of the Project's mining-related componentsis training of local personnel. Training has the objective that project activities would continue afterthe project is formally completed and the consultants have left. As a complement to in-servicetraining, more formal training would provide up-dating and/or deepening of previously receivedtraining. Such training should preferably take the form of specialized courses (1-3 weeks) orworkshops in Peru, organized by consultants of recognized international experience within specificfields. The participation in professional seminars in Peru and abroad is also considered. The exactneeds will be defined in the course of the program implementation.

linplementation

43. Implementation varies between three and four years, depending on the specific projectcomponent. While most of the support to the institutions will be medium-term in nature, the othercomponents are planned to be carried out over a shorter period. The institutional strengtheningprogram includes three main cost components, viz. (i) investment costs for complementary equipment

-24- ANNEX I

of the institutions, (11) operational costs related to implementadon of the components, including thecost of consultants over a fixed period, and fiii) training costs. The latter cover the programs to bedeveloped as resutt of the specific projects (participation in seminars, organization of workshops,etc.). The cost of the Project's mining component is estimated at US$3.8 millon.

ENVIRONMENT

44. The four main environmental components of the Project would be implemented over a four-year period.

Strengthening of the Policy/Regulatory Frmework

45. In light of major enviromnental policy deficiencies, funding will be provided in four mainareas:

(a) Review, streamline, and consolidate existing fragmented regulations into a consistentframework. Regulations will be enacted for areas not covered hitherto (e.g., areas ofenvironmental liability);

(b) Development of eavironmental operating guidelines for specific activities;

(c) Development of (i) airlwaterlsoils discharge emission standards and (ii) criteria for keyindicators (e.g., SQ, NO,. heavy metals, BOD, COD); and

(d) Organization of workshops and seminars to disseminate the relevant policy and regulatoryInformation to the concemed industries and government departments.

anstitutional Strhening of the General Diredorate of Environmental Matters

46. DGAA, established in 1991 within MEM, is to address environmental problems fromminig/energy sectoral activities. DGAA faces typical start-up problems, including insufficientfunding, inadequate infrastructure and logistics, and manpower and skills constraints. To alleviateDGAA constraints, the project provides technical assistance in (a) institutional and organizationalstrengthening; (b) human resource development/training; and (c) logistics support. Funds will beprovided for DGAAWs strengthening and restructuring in a manner to enhance its efficiency atcarrying out environment planning, inter-sectoral coordination, and environmental management.The Project component supports institutional development through staff training and improvedenvironmental management structures, backed by appropriate information systems, and throughstrengthening the inter-and intra-departmental linkages with the various related agencies.

47. Training. DGAA staff will be trained in key environmental management skills. Theseinclude: enviromnental Impact assessments and environmental auditing; data base development andmanagement; development of environmentl information systems and library services; anddevelopment of environmental education and awareness programs. Short-term consultants recruitedboth nationally and internationally will assist with this training effort. Specialized training (both localand overseas) will support the continuing development of local capabilities in these fields. Funds

-25 - ANNEX 1

would also be available for the purchase of computers, vehicles, office equipment and officefurniture.

Development of Environmental Management and Environmental Mitigation

43. Enviromnental AssesTh Procedu. Ibis Project component would ensure thatenvironmental considerations are fully integrated into sectoral development plans, through addressingthem ad initio, rather than ex-post through formulation and implementation of appropriate EIAscreening procedures. Funding will be provided (a) for training of DGAA staff in EIA evaluations,and (b) environmental audits and assessments to assist DGAA to manage its operations.

49. iro_ n On itoring. A pilot project will support the monitoring ofair/water/soils quality in specific "hot spots" (e.g., La Oroya). As DGAA does not have the requisitelaboratories and staff for sampling and analysis, nor would it have the comparative advantage ofdoing so, it will enter into a cooperation arrangement with a specialized agency on terms andconditions acceptable to the Bank. The project would finance (a) the purchase of air/water/solidwaste sampling equipment, and (b) associated training and field allowances. DGAA would beresponsible for the preparation and supervision of the program, but the specialized agency would beresponsible for the quality of the program. A Memorandum of Understanding will be concludedbetween the specialized agency and DGAA/MEM prior to the commencement of this Projectcomponent.

50. EUnvom InfTrmation Sy This component includes:

(a) Environmental Quality Information, i.e., provision of environmental baseline data;determination of the effectiveness of environmental protection and mitigation measures;managing the information outputs from the environmental quality data; and developingcapabilities within MEM to predict environmental changes in a proactive rather than reactivemanner; and

(b) DGAA Library Services for cataloguing information and documents required for decision-making.

51. Educion and Awareness ProUmi. These efforts are aimed at DGAA, the industries, andthe general public. They will focus on environmental education, environmental management, policydevelopment, data management, and information services. Collaboration with NGOs will be sought,such as INMADI (investigacidn Medio Ambiente Industrial), the Catholic University, and AMIDEP(Asociaci6n Multidisciplinaria de Investigaci6n en Poblacidn). Funding would be provided for (a) ihedesign, production and distribution of printed materials and posters on environmental subjects,including to local communities, and (b) workshops and seminars for the mining, energy and electricitysectors.

52. Strengthenini the Participation of Local and Native Communities. This includes (a)developing public involvement workshops and forums in collaboration with INMADI and AMIDEP;(b) designing and producing information materiats for viewing at education centers; (c) conducting asocio-economic impact study to assess the changes in community/traditional lifestyles, and population

-26- ANNEX 1

dynamics, brought about by sectoral development activities, with recommendations formplementaion by local and district governmens.

Sectoral Envirounental Assessments and Studies

53. In accordance with Bank requirements, two sectoral EAs (energy and mtiing) would becaied out to evaluate and develop the policy framework necessary for optimizing sectoraldevelopments while minimzing environmental risks. As an outcome of these studies, action planswould address the specific environmental issues pertaining to these sectors.

Project Benefits/Justification and Risks

54. Bems and Jugification.The Project would support the Government's strategy forenvironment sustainabiity as set out in the National Environmental Code. As its principal benefit,the ProJect would (a) alleviate or slow down environmental degradation and the correspondingImpacts on public health and ecosystems; (b) halt the decline in agricultural, fisheries, and othereconomic productivities stemming from pollution; and (c) Improve the avaflability of informationrequired for decision-making, and improve the understanding of environmental management practicesapplicable to Peru.

55. 1ia. These are associated with the effectiveness with which environmental managementsystems can be implemented, given the serious lack of environmental skills and the innovative natureof such a program in Peru. (Ihis is the Baek's first environmenal management activity in Peru).Other risks relate to DGAA's ability to achieve the required levels of inter-sectoral coordinationbetween the relevant government agencies required for effective project implementation, and theGovernment's ability to provide resources for the incremental and recurrent/operating costs for theProject. Care has been taken to mitigate these risks through the training and institution buildingcomponents which would focus on strengthening DGAAs management and strengthening the inter-and intra-institutional linkages. To ensure the effectiveness of the cooperative arrangement,Memoranda of Understanding would be conchrAed between DGAA and ONERN and CEPIS, settngout schedules and costs for providing agreed services. Project supervision would be closely linked tothe Project implementation schedule and would involve monitoring the critical indicators, with theProject Coordination Unit to play a key role.

PERUE3NERGY AND MI41G DUCHNCAL AS$1X$TANCE LOAN

Action Plan(wincuTinglme Table and Implementat lndieators)

Activity and rimnmgrrargets Responsbleovemmeut Ojectives Adivity Components Expected Resultimpa (MonthYear) Agency(ies)

Inteurated Enera State: a) Prearion of deailed TORs, and a of a con_stent et 07/93 - 08/94 CONERGI MistryTo ensue adeqwe energy selection of evuation team of states and policies, specific TORs approved Sept. '93. of Energy andsupplies and efficient ene measures and projects primaily to Evaluation team fielded Mines (MEM)use over the meium to long (b) Evaluato of sragic opto to be implemented by the pnvae Nov. '93tenn, in line with the growing ensure adequate energy supplis over sector. This is to ensreeconomy. the medium to longer term at least econo ly optimal and First draft report Mareb '94.

cost and minimum adver impact on eavironmtay susainable uppygthe envitomeat. and use of energy. Disussion with Goverment

and agreement on N

(c) Iteraftiv analysis of initil rts impl aon of studyof evalation, with a view to adjusting cmdations July '94.policies.

Final report Aug. '94.

Activity and I -imigarges RerGovemment Objectives Acdvity (p Expeced Re _/dlVaI (Monti/Yea) AgeI__s)

onstiutional Strthenina of (a) Assmet of CONBRG's Eance CON°tO's -CONERGMEMCONERG: position within MEM; evalution of capacity to comply with its Inception report Marc '94.To coordinato the prepaion its requirements (in terms of responsibilities to f_nlateof the energy sector strategy functios, pocedues, ru s, etc) strateg and advise on policies ill niuaiot of dbort-ermNd policies. to ass tie rlevant gonm the energy sector. MTis is abo to co g services May '94.

entities m energy strategy and policy be acived through CONERG'sanalysis. paticipatin the evaluation of the Ii1tion of tiing July '94

eegy secto strtg.)(b) Implementiinnthrough shodt-tem consulting

(c) Traning of CONERG staff instegy and policy analysis.

CornDiction of (a) Prepartion of TORs for (a) Preparation of regaons for 01/93 - 11193 Vieinsy ofLeual/Resulatoq Framewoth individual consultants that are to asist new decty law, by-laws of TORTs prqaed Apr.'93. Eey (VME)and Reform Imementation: in implemeting sectoral reforms. organizational entities, and other Norms and proceduresTo ensure the norms and pt .edue prepaed JuL'93.comprehensiveness of te new (b) Peparon of norms and Restuing programlega/rOegUIatory system and its procedures to adapt enterpises to new () Application of the concession prepared OcL'93.consistency with the system of concessions. pnciples tefered to in the 1992Government's sectoral Law of Electriy Comcessions.objectives, through the (c) Preparaton of program for thecompletion and adequae restrcturing of electicity nterpises. (c) Functioning of the electrictyadoption of new regulations sevices under the revised

regulaty fraework, and of theprocess of unbundling utilities intosepar genratio, trasmssionand distibution activities. ..

GJoveaut Objectives Avity Components Expected ResultsAmpact (MonDt/Year) Agmeny(as)

Design of Ener Desigi of energy mnagemet sysem Optimizati of oprati on the 09M -1 Ele06_96Managacemt Svstem facilities and acquisition of computer Central-Nortiem Intercouneed TORs for coudting services El _oimTo improve system operaions epupmnt for implmenting a ceter System, hmough (i) ens g system prard Sept '93efficincy and reliability and for electicity transctions in the reliability, (ii) istering electritypermit electricity commercia Central-Northem 1nerot trasctios among the parcipants, Contracing of consultants;transactions under new System. and (ii;) omptng sbort-erm acquistion of equiptentregtuatory fmework energy and power con_tacta Dec. '93.

exchanges and maginal coss.Compli of sdiesDec. '95.

Institutioil Diagnostic phase: (a) Develoet of a set of 07/93 - 06/94 DGEAMEMStrensthening of DoE: Analysis of DE's cuurent position; reo d s to meet Diagnostic study prepaedTo ensmue adequate definition of new functions, within organizaional and resouc Sept.'93.implementation of DOE's reformed sectr f ewk reqreit. Statof impregulaty functions. evuation of institutiond need to Nov.'93.

carry out these funcions (i.e. Complefio of inommative and monitoring funons, JUL'94administration of conceosd);prepare model conacts for grtigconcessions.

Implemetfltion phase: () Establishment of a compett(a) Implementation of enity to supervi the qWlity of therecommendations prepared in service provided by the utilities,diagnostic phase, in regard to: (i) grnt concesso, and settemon g and supetvision of servic disputes.quaity; (ii) registration andauthorization of concessions; (iii) (c) To build up DOE for effectiveresoluin of disputes; and (iv) arms-length supervision of theprepaing and maintiing a data electicity sector, within the newbase. legal and institiod framewo.

(b) Tranng

| Tanff l a : Evaluation of (a) economic load (a) Prering the framwork IlU% 113 CTETo estabIh a tariff syst dipawh and geoeo costs, required for effective billig and Megl sdyconistent with t stipulations (b) ou costs, CO 4Weeling supervision of eleicity trding. completed Feb,'93.of the Law of Electricity charges, and node prices, and Study completed & Semina-Concessioo. (c) distribution costs and tariff for (b) ablis n of genaion, Mar.'93.

final consumen transmission and distribution Ms. New tars irpltenrtdMay.'93

Acity a Irm_in,irars R.sposib.leGovenment Objectives Activity Components Epecte Results/Impact _ (Moaler) Agecy(ies)

Institutional StMntbenina of (a) Adaptation of Clhs functions and Streagtening ClTs technical 0793 - I/ c£11;: organization to the Law of Electricity capacity to aet tariffs in accordace Adapto of CTE's futionTo ensure adequae concesdons. with the Law of Electricity & orgnio; developmentfunctioning of CM as Concof infonai sytemsreguatory entity. (h) Dveopment of nomation Sept.'93

sydtem, establihmnt of a data nk Evaluation of ex_and a manage_et in&fomaion Nav.'93systemF

(c) Taining _ ..

w

Activity and , ResnsieGovernment Objectives ctivity Componts Expected Resultmpact (Maon ear) Agency(ios)

Complet.;an of Assi VMB in complting the New hrc s legislation and OIM119Z(2.4 VMELegal/Regulatory Prainmrk: prepatory wodc on the new reuatm. MIBM submson of dRftTo improve the opeations of legisation and reguatons, bWld up Law to Cons May '93the hydrocab sector. oonem and follow up passge byCoess. mnce of reguations

____ __ __ ___ Dec. '93 ,__Institutinal Senen of (a) Define the new role and functons (a) Etamnt ad Mast-up of the 710193 i VMEIDH; P. -PGH: of DGH and Peam-Petro in light of new agencies eponble for. New ageies estad PetroTo strengthen the capacity to new polic objectives and srat in (i) promotion and nego_ ation of the Dec.'93.implement, supevise, and the sector. new bydrocabos exploration andcoordinate hydr ons- exploitation oontact, and (i) First contat under new Lawrlatod policies. (b) Defin the ogai ton staffing supew'sw of fiai noad Ju'95.

and infmatin syems of the two and tAzcal elements ofagencies. hydrocarbored activities.

(¢) Evaluat t ech sisumncereuiemes, incuding tenns ofrefeence and tnmg needs ofagencis.

(d) Provide direct support of (b) Preparation of ptofessials of Consl.tants ele IaL'94.peciaid contants to VME, DQH both agencie for reparton and Consultants assigms

and Peru-Petro in technical, negotito of conts and complded Jun.'96administrae, and finani areas. supervision of the cotatig fims.

(e) Trainig on tho job and thugh Ting pogrm itiatedwinning aangement with utal Jan.'94.agecies in othe ountries.

Tining progrm ompltedJUnL'96.

i. If II I

it ii [}|t'§

Ii. [li _

s1 t [ | £41 K :1:$!~

S- S~~~

Activity and If Timingfrargets epnilGovrment Objectives Acvty Components Expected Results/Impact (M) I _A8 q(ies)I

|i&Z MngrmatiEon (a) Deveopmt and conpueiati (a) Oaf 10 - VMMDGMDevelpmAnt of mining of geotecimical and geol naonal geological srvey to Data Bank Aptil '95.infomation sysem ti bases pvie upgaded geotchit Dec. $95.enhae minel sector infora n key o di.development. (b) D rveopment of data bank of

mining p -duclio (b) Senghedning temeasures/mechanisms and the

(c) Caaloguing of mining and inormaon bas requid tometlugi op oes. filiat sectoa

(d)Taining. (c) Comteraon ofdmistrtiveprw es

Strenethenine of Miino (a) Development and computerization (a) Strengthenig of tie procedures 07/93 - p6195 RPM/DGMInsti n. of minig cadal register. for grating and management of(a) Cmmma Coessig nghts and Now c System: Development of a (b) Stngbening of imp Sept.'93 -mining cadatl suvey procedns of mining (b) Compteization/streamlining of Dec.'95.system and proedur for co ons an rghts, including administaive mechanisms andprocesing minig envirment reglations. procedures for granting nd Backlogged applicationscoooessions. administration of mining rib. p Mar.94.

(c) Processig of backtogged/(b) Compktion of the otstading mining applcton. (c) Stegtaing of the linkges Seamined administafiveregulaty framework and between the granting of mining procedure applied Dec.'94.implementation of mining (d) Tining. concesiondrights and land usesector refrms including dtose pling.related to the enviromentalprtctio

- 34 -

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-36- ANNEX 2

ENERCi AND) MINING TECHNICAL ASSISTANCE LA

STATUS OF SECTORAL POUCIES AND REGULATORY REPORM

ENERGY

Energy Sector Structure

1. Eno= Resour. Peru's energy resources are considerable, but mostly distant fromconsumpion centers and costly to develop. The k p potntial estimated at nearly 60,000MW- compared to an installed capacity of less than 2,100 MW- is largely located east of the Andes,whfle sites west of the Andes are susceptible to droughts. Proven reserves of hydrocarbon in 1991amounted to 387 mn bbls of crude oil and 6.6 tr cf of natural gas, without fully including gasreserves of the Camisea field. Deposits of mineral coal are relatively minor (proven reserves areestimated at 126 mm mt, not all of which are economically mineable). Frestyi regm areabundant covering about 60% of the national territory, but more than 95% are located in the thinlypopulated Selva region, and their use needs to be restricted for environmental reasons. The wind andsolar potential is significant especially in the Sierra region but is limited to localized use only.

2. EneruM In the Economv. Commercial energy supplies composed of hydrocarbons,electricity, and coal accounted in the late 1980s/early 1990s for nearly 7% of GDP. Iheirconsumption has been a significant source of fiscal revenue, generating 22% of central governmenttax receipts, with taxes on energy production (largely from Petroperu) accounting for another 3-5%.While significant exportable surpluses of petroleum were generated during 1978-87 (pealing in 1982at US$685mn, or 17% of foreign exchange earnings), the economy subsequently shifted to net energyimports, which absorbed some 4% of foreign exchange earnings in 1991. Investment in the energysector, estimated at US$250mn equivalent in 1991, accounts for about 4% of gross fixed investment.In contrast, direct employment probably is not much more than 1% of the total labor force.

3. Eneay Supply - Demand Balance. Gross energy supply/ demand in 1991 totalled11.7mn toe (I.e., 654 toe per US$mn of GDP) and final energy consumption, 10.1mn toe, which Isonly slightly above that in 1985. Petroleum products and natural gas combined met 49% of 1991final energy consumption (natral gas consumptior is largely limited to field operations), biomassincluding charcoal, 39%, and electricity, 11%, with coal and coke accounting for the remainder. Theresidential and commercial sectors absorb the largest portion of final energy consumption (42%),followed by transport (22 %), and industry and mining (I s. than 26% combined). The rural sectoraccounts for the bulk of biomass consumption, as little commercial energy reaches rural consumers.Y

jflinis consumption pattern has been largely the result of price distortions over extensiveperiods, both in absolute and relative terms. Wiith economic pricing of energy results wouldnrobablv have been different.

-37- ANNEX 2

4. Reflecting depressed economic activity and following declines in 1988-89, netconsumption of cIectricity in the public system grew at only 2.6% p.a. in 1990-91 to 12.1 TWh,with above-average increases for residental and industrial use. Severe droughts have affectedgeneration in the 90% hydro-based system, aggravating the interuptions in power supplies due toterrorism. Output of cggl oil has declined since 1982 at 5.6% p.a. to 110 thousand bid in 1992.Consumption of petroleum products also was lower in 1991 (by 9%, following nearly unchangedlevels in 1990), but this did not compensate for the decline in output such that petroleum importsincreased in 1990-1991 from US$53mn to US$186mn. the decline in domestic crude output has beenaggravated by the shift in consumption toward lighter products, which has to be met through importsas domestic refineries have limited conversion capacity to process heavy local crude. Should thedeclining trend in petroleum output continue and domestic demand resume growth at its historical rateof about 3.6% p.a., imports by 1995 could exceed US$500nm (current prices). Consumption ofmineal g largely in industry has stagnated at less than 0.2mn mt/year, but imports have increasedand are substituting for domestically produced fuel oil as well as coal.

Ener Sector Organization

5. The Ministry of Energy and Mines (MEM) is responsible for formulating policies andthrough its General Electricity and Hydrocarbons Directorates (Direccidn General de Electricidad,Direccion General de Hidrocarburos), for supervising the state-owned enterprises in the electricity andhydrocarbons sectors. The autonomous Electricity Tariff Commission (Comision de TarifasElectricas, CIE), whose directorate is composed of representatives of Government and electricityproducers, is charged with setting electricity tariffs. An ierministrial committee representing theMinistries of Energy and Mines, Economy and Finance, Industry, and Transport is advising onpetroleum products pricing.

6. Public electricity service since the early 1970s has been provided by the national utilityElectricidad de Perd (Electroperd), Electrolima, and nine regionai utilities'. Electroperu,Electrolima, and Electro Norte-Medio account for threequarters of electricity sales and income andfor more than 90% of sector assets. Electroperu is the largest generating company, accounting fortwo-thirds of sector investment, and sells entirely in bulk to the other companies. These resellelectricity to final consumers, besides generating electricity of their own. Electrolima is the second-largest generating company and the largest distribution company, accounting for 25% of generatingcapacity and 60% of sales in the public system. Self-generation is significant among the largermining and manufackvring enterprises. Their installed capacity totals about 1,300 MW (1,000 MWthermal) and some enterprises supply electricity to the public system. Hydrocarbons operations arecontrolled by the fully state-owned company Petrdleos del Perd (Petroperu) and its affiliates Petromar,Transoceanica, Serpetro, and Solgas. Petroperu directly accounts for just under one-half of crudeproduction and is the sole owner of the pipeline, refining (189,000 b/d capacity in six refineries),marine terminal, storage, and wholesale distribution systems. Private oil companies work undercontract with Petroperu in exploration/production.

2/ These are: Electro Norte, Electro Nor-Oeste, Electro Norte-Medio (formerlyHidroandina), Eleco Centro, Electro Sur-Medio, Electro Sur-Este, Electro Sur-Oeste,

- 38 - ANNEX 2

Enera Sector Issues

7. 'he situaion of the energy sector is critical as a result of past policies based on stonglycentralized decision making and goverment ownership, ad disregard of sound fnaces, aggrvatedby Inefficiencies at the enterprises. Weak sector peformance over extended periods, which waslargely a reflecdon of weaknesses in the overall economy, in tur has aggravated overal economicproblems. Inadequacies in the legallregulatory framework impaired sector efficiency. Corporatedynamics were stifled by over-regulation and lack of managerial autonomy. Government interferenceand financial constraints firther weakened the sector management and worsened employmentconditions. Past governments considered the sector as a public operation to extend subsidies and tocontrol inflation, and not as an economic activity. Prices of electricity and hydrocarons were set atlevels well below economic costs, and their Increases were Irregular and much less than domesticinflation. Uneconomic pricing has led to wasteful consumption and misalocation of energy resourcesthroughout the economy and financial paralysis at the enterprises, which were unable to maintain letalone expand their productive capacity. Finances were furher weakened by the lack of financialexpertise, outdated finacial systems, and inadequate control and auditing mechanisms at theenterprises.

8. Inmediately after assuming office in August 1990, the present Government started toraise energy prices at regular intervals and at rates substantially above domesic inflation andinternational energy price increases, in order to correct unsustainable financial losses at theenterprises, reduce subsidies, and increase fiscal revenues from the energy sector. Ihis policy wastemporarily discontinued in early 1993 as the Government became concerned that devaluation-triggered increases in energy prices would aggravate inflationary pressures, but significant energyprice increases were again enacted In May 1993.

lectricity

9. Electricity supplies over extended periods were affected by frequent interruptions, lowreliability, and high losses. Generating capacity is not sufficient to meet demand: in 198089, only736 MW was added to the public system, compared to 1,000 MW of increased demand. 220 MW ofcapacity is out of service, and the capacity margin in major systems has been just about 5%.Transmission and distribution networks are in poor condition. Ihe systems have become extremelyvulnerable to contingencies, such as the droughts in 1989 and 1992.

10. Financial Issues. The main problems result from inadequate tariff action In the face ofsevere inflation, non-transparent debt relationships between the Government and the sectorenterprises, and delays in collecting electricity bills, especially from government agencies. The sectorsustained losses each year since 1985, which reached US$560mn equivalent in 1989. Investment as ashare of the enterprises' uses of funds declined from 59% to 39% over the 1980s. Inernal cashgeneration as a share of sources of funds declined as well, from 44% in the late 1970s to 4% in thelate 1980s. The enterprises' liquidity position is precarious. The income share of operating revenuesdeclined from 29% in 1978 to 8% in 1985 and has been negative since then (-154% in 1989,improving to -8% in 1991). Depreciation is understated because assets are undervalued anddepreciation periods are excessively long. The debt service coverage and self-fincing ratiosdeclined during 1978-89 from 3.7 to -1.3 and from 78% to -159%, respectively. There is excessivereliance on outside financing, primarily government contributions and external borrowing (which, bythe late 1980s, contributed 79% and 18%, respectively, to sources of funds). The sector's long-termdebt In 1989 was estimated at US$1.5bn equivalent and its short-term debt, at US$250mn, 90% of

-39- ANNEX2

which was contracted by Electropu. As a consequence of large borrowings in the lat 1970slearly1980s, the enterprises' debt service rose in 1980-89 from 30% to 47% of their use of funds. Delaysin servicing extena debt in the fce of extemal financing needs came to a crisis point in the mid-1980s. The Government in 1987 assumed a significant portion of the enterprises' unpaid debt andstarted to make transfers to cover the enterprises' debt service and to finance the bulk of theirinvestment.

11. The 1982 Electricity Law recognized a 12% rate of return on revalued assets, and aminimum return of 4% was set in 1987. In the event, the sector's return deteriorated from 5% to -8% in 1979-90. Tariffs were to be set by CTE according to technical and economic criteria, but CTEunder previous administrions was overruled by the Ministry of Economy and Finance on politicalgrounds, and its autonomy in taiff matters was all but eliminated. Tariffs declined by 60% in 1985-89 and in 1989 averaged only about US cents 1.8/kWh, 40% of unit operating costs. Tariff increasesin 1992 are expected to have resulted in a finanil retun on net revalued assets averaging 1.1% forEletroperu, but most regional utilities still incur losses. Taes and surchar on electricityconsumption increased in number and complexity over the years. They included selectiveconsumption taxes (85% of the revenue was returned to the utilities), municipal charges, andcontributions earmarked for the expansion of electricity services. As the share of selectiveconsumption taxes returned to the enteprises was incorporated into the tariff base in early 1992,average tariff increases in tariffs in 1992 amounted to 77%, whereas total charges to consumersincluding taxes amounted to 55% only, or less than inflation (57%) and devaluation vis-a-vis the USdollar (65%). While total charges including taxes exceed long-run marginal cost (estimated at aboutUS$cents 8/kWh for the entire system), the enterprises do not fully receive the correspondingrevenues, since taxes and surcharges amount to 25-40% of the final price. Average tariffs inDecember 1992 were 77% of economic costs (65% for residential consumers). The tariffslmclredoes not reflect the relative costs of supplying electricity to different user groups. There still are highsubsidies for residentW consumption below 500 kWh/month (these tariffs, which include 73% ofresidential consumption, cover less than 60% of their economic costs), streedighting, and agriculturaluses whereas industrial tariffs are close to and commercial tariffs exceed their economic cost. On theother hand, the Government continues to undertake transfers to cover the enterprises' debt service.

12. Qgrtoal Problms. Notwithsanding notable progress over the past two years, theenterprises' management and accounting information systems are deficient and labor productivity islow, largely because of overstaffing and inefficient deployment of labor. Operational efficiency hasdeteriorated as evidenced by the increase in the suppliers' own consumption and losses from 11% ofgross energy available in 1979 to and 22% (nearly 2,000 GWh) in 1990-91. Collection arrearsdeteriorated to 151 days in end-1991 (235 days for Electroperu).

Hydrocarbons

13. Exploratio is insufficient to reestablish crude reserves at levels that ensure adequateoutput over the medium to longer term. Because of low investment and poor exploration results,crude reserves by 1991 had declined to less than 50% of their 1982 levels. Following the abrogationof investment incentives in 1985 and ensuring contractual problems with private companies,exploration activity fell off to US$40mn p.a. in the late 1980s, compared to a peak of US$380mn in1975 (the number of completed exploration wells fell from 17 in 1981 to 1 in 1991). Recentcontracts mainly involve relatively small-scale firms with limited work commitments. Q)put ofcrude declined from its 1982 peak of 195,000 bbls/d at 6% p.a., to 112,000 bbls/d in 1992.Refineries in Peru are ill-equipped to treat heavy local crude and have inadequate secondaryconversion facilities. Wholesale marketing of petroleum products continues to be under Petroperu's

-40- ANNEX 2

monopoly which, combined with inadequate pricing, have constituted the main barriers to antry.Altiough most retail outlets have recently been privatized, Petroperu maintains a strong influe..since most products bear its trade name.

14. Finangial Issues. The absence of economic criteria and of transparent procedures fordetermining prices, taxes, and subsidies for petroleum products has been one of the principal obstaclesto sector development. There is no automatic price adjustment mechanism tied to the variation ofiernational prices and exchange rates for ex-refinery prices and to marketing costs for consumerprices. Prices of all petroleum products are negotiated between Petroperu and the Government.Ihese prices lump together what is needed to run Petroperu's production operations, which usuallygenerate large economic rents, and downstream operations, which produce losses. Prices realized byPetroperu reached cif Import costs by mid-1992 and were subsequently deregulated. But pricecotrols were reimposed in October and by December 1992. Cnmer gdri of petroleum productswithout exception exceed their combined cif and domestic marketing costs as a result of (i) selectiveconsumption taxes (about 44% of ex-depot prices, down from 57% before January 1992), (ii) specificlevies on gasoline, and (iii) general sales tax (18%) since January 1993. Relative pricea do not reflectintnational price relationships: diesel, kerosene, and LPG are cross-subsidized, with the intenion tolimit their impact on the cost of living (prices of diesel amount to only 58% and those of kerosene,51 % of the price of gasoline). Fuels for electricity generation have been supplied tax-free. Themisalignment in relative prices on account of cross-subsidization of substitutes, which has prevailedover many years, has produced serious distortions in the consumption pattern and resourcemisallocation in the economy.

15. Fuel taxation has been used mainly to balance shortcomings in other areas, e.g. thefailure to tax resource rent which otherwise would have accrued to consumers under conditions ofunder-pricing of crude at the refinery level. Occasionally, the Government undertook corrections toalleviate discriminations against certain consumer groups. Following the differentiation of tax ratesfor different petroleum products in early 1992, fuel taxation has become highly discrimiaory. The10% tax on gross domestic saes applied as an income tax substitute was removed in January 1993,but a 2% tax on gross assets and a 15% import duty on crude and petroleum products continue to bepaid by all petroleum operators. Because of inadequate prices, high debt service, and operationalinefficiencies, Petroperu and most of its affiliates are loss-making. Petroperu's accumulated losses forthe 198W0 period exceeded US$2. lbn and are esdmated to have been at least US$120 mn in 1992.Govement policies aggravated this situation, as in past years, Petoperu (a) was not able tosreamline its workforce to match declining output or to pay competitve salaries; (b) over-invested incertain equipment as govemment-imposed procurement rules disallowed the hiring of equipment andservices, resulting in high equipment-related fixed costs when activities declined; (c) was unable tooptimize investment because of uncertain budget allocations from the Government; and (d) had tocatry the expenditure of government regulation and even of some core government services.

-41- ANNEX 2

Ener Sector Reform

Development Requirements

16. Adequate supplies of energy are a key condition for the rehabilitation and growth ofPeru's economy. In order to improve efficiency in the energy sector, allow market forces to playtheir allocative role, and alleviate the financial burden of energy enterprises on public finances, far-reaching reforms are required, as well as large-scale investments in rehabilitation and expansion. Anew legal/regatory/insttutional framework and coherent policies are needed; managerial, financial,and operational performance at the enterprises has to be improved; a least-cost investment programfor meeting future energy requirements has to be developed, as a fmnework for projects; and energy-related operations have to be made e onmentally susnable. At the operational level, it isnecessary to (i) corporatize the enterprises, freeing them from political interference and interventionin day-to-day operations but establishing clear managerial objectives; (ii) eliminate unnecessarilybureaucratic procurement and contracting procedures; and (iii) establish clear rules for commercialtansactions between the various sector enterprises.

Reform Objectives and Strategy

17. The Government seeks to increase revenues and to limit the financial burden on theeconomy from the energy sector, and secure adequate energy supplies to the economy. TheGovernment has initiated a program for restructuring the energy sector to lead to the sector'sprivatzatlon, for which it has established a new policy for sector development, a strategy toimplement it, and an agenda of specific actions to execute its reform program. Electricity andpetroleum products prices have been increased toward their economic cost and subsidies have beenreduced; energy taxation is being rationalized through shifting from multiple-rate levies, oftenearmarked for different authorities, toward more evenly-structured consumer taxes and taxes onentepies; and overstaff1mg at the energy enterprises has been significantly reduced. Nevertheless,the more difficult reforms needed to transform the sector to a marketbased, largely privately-ownedsystem stfll lie ahead.

18. The principal elements of the Government's reform program are as follows:

(a) redefining the role of the state, clearly separating its policy and regulatory role from itsrole as owner of public enterprises and of natural resources;

(b) allowing the maximum feasible role of market forces through privatization of state-owned energy enterprises and promoting private investment in new facilities;

(c) recognizing that energy enterprises need to be financially and economically viable, andtherefore need to be commercialy oriented, corporatized, and eventually privatized; and

(d) setting energy prices at levels at which they cover economic costs, liberalizing energyprices, and establishing price regulation that reflects economic costs where monopolyconditions exist.

-42 - ANNEX 2

19. Achieving the Government objective of increasing efficiency and competition in theenergy sector through liberalization, decentralization, and privatization requires an effectiveregulatory system. To provide a cohesive legal/regulatory framework for energy sector reform, theGovernment has enacted in late 1992 a Law on Electricity Concessions and attendant regulations andis advancing the preparation of a Hydrocarbons Law, all of which incorporate the most advancedconcepts successfidly applied in other Latin American countries. They will define the roles of publicinstitutions in policy making, sector entry and exit, investments, quality of service, and pricing.Restrictions on private participation in electricity and hydrocarbons operations are being eliminated.Competition in the energy sector is to be reinforced through antitrust legislation and support to thedevelopment of local financial markets. The Government seeks an institutional structure for theenergy sector that ensures full coherence between the corporate structure of the enterprises and theregulatory system. The reforms envisage (a) for electricity, the separation of gentration, transmissionand distribution into independent companies which would then be privatized; and (b) forhydrocarbons, the privatization of Petroperu's affilites and direct operations.

20. E£r.icit. The Government is also promoting private operation for all those activitiesthat can be deregulated (e.g., generation for major consumers) and self-service in small and isolatedrural setdements. The new structure as defined in the 1992 Law on Electricity Concessions is basedon decentralization and competition to the feasible extent, in order to foster efficiency, free access toall stages of the electricity system, and free negotiations between producers and distributors and majorconsumers. Ite new Law incorporates anti-monopolistic safeguards and principles for environmentalprotection. Under the new regulatory framework, (a) generation will be decentralized andderegulated, and be made subject to market forces tirough competition; (b) the transmission networkwill provide access to all suppliers and purchasers under a common carrier system with an adequatelyregulated toll scheme; and (c) distribution of electricity, a natural monopoly, will be carried out withfilly regulated rights and duties of suppliers and consumers, including the obligation to serve and toprovide service of adequate quality. Integrated companies being de-concentrated; separateindependent companies are to be created for generation, transmission, and distribution; and cross-shareholdings are to be strictly limited. Tariff regulation will be based on marginal costs - as theclosest surrogate for market forces - for natural monopolies (i.e., through node prices in thetransmission system and distribution tariffs to final consumers), but sales to large-volume consumersand transactions between generation enterprises covering about 40% of total sales have beenderegulated.

21. The Government plans to privatize the publicly-owned utilities by mid 1995, startingwith Electrolima by end-1993, including through issue of shares to ensure widespread ownership.Special Privatization Commitees have been set up for Electrolima and Electroperu. In order toensure a consistent approach to the restrcturing/privadzation process, advise from well-qualifiedspecialists will be sought, to guide the Government on sector strategies as well as on eachprivatzation project, in regard to the configuration of units/companies to be sold, the required degreeof restructuring, and optimal method of sale. The following sequence of actions is envisaged:

(1) Electroperu and Electrolima will form companies/units, including transmissioncompanies, which will be offered for sale to the private sector as going concerns;

(2) Electroperu and the Regional Governments will sell their shares in the regional utilitiesto the private sector;

(3) New distribution concessions will be granted where the regional utilities are unable toprovide adequate service; and

-43 - ANNEX 2

(4) The transmission enterprises will be privatized.

22. HXftO&n=. The Government's main objectives in the hydrocarbons sector are to (a)increase reserves and output through sustained exploration, primarily by foreign companies; 0)privatize Petroperu; and (c) maintain adequate refining and marketing capacity to meet domesticdemand. With the aim to stabilize output and to streamline operations, Petroperu has taken measuresto Increase efficiency, such as well work-overs, reducing the number of drilling rigS and of otherequipment, and reducing staff. The Government has taken important steps to strengthen the sector'sproductive capacity, and is intensifying its efforts to attract foreign companies to invest in thehydrocarbons sector. First, some outstanding claims from previous nationalizations have been settled.Second, terms and conditions for exploration and field development have been made more attractive.Periods for service and production sharing contracts have been extended, the payment of conactorsin convertible currencies has been guaranteed, private producers are allowed to export crude over andabove those volumes required to meet domestic demand and to cover tax liabilities, and proceduresfor investment approvals have been simplified. Third, Petroperu's monopoly for imports anddomestic refining and marketing of petroleum products has been abolished. Finally, a newHydrocarbons Law is being prepared that envisages (i) the option for private investors to concludelicense agreements that govern relationships with the Government under the same terms andconditions for Petroperu; (ii) Petroperu's privatization either wholly or in parts, and (Hii) more activeexploration promotion by a new government institution, Perupetro S.A. operating under the Law ofprivate companies. The taxation of rent will be undertaken within the framework of concessionagreements between the Government and producing companies (including Petroperu), which willprovide an appropriate mechanism through the application of royalties and income tax.

23. Agenda for Action. The Government has set June 1995 as the deadline to acieve Itssector objectives. Following the tariff action of April 1993 (which raised electricity prices to at least90% of economic cost in all segments, except residential consumption below 300 kWh/month), theGovernment is pursuing the subsequent ambitious targets, to monitor the process of reform:

Eilectri!ft Seoo

Jun 30, 1993 Legal separation of the electricity sector into generation,transmission, and distribution enterprises is completed

Jul 31, 1993 New supply from Ventanilla thermal plant to Electrolima iscontracted

Environmental and social protection manual is issued

Nov 30, 1993 New tariff system is completed through introduction of tariffsystem for final consumers to be valid for four years

Tariffs for residential consumption below 300 kwhlmonth willreach at least 90% of economic cost except, possibly, forconsumption below 50 kwh/month

Antitust guidelines are issued

-4M- ANNEX2

Dec 31, 1993 First utility, or portion, Is offered for sale

Jun 30, 1994 At least two utlities have been offered for saleGovermment shares equivalent to 30% have been soldAnti-trust gwdelines are implemented

Dec 31, 1994 Government shares equivalent to 60% have been soldAt least two regional utilities have been offered for sale

Jun 30, 1995 All government shares in the secoor have been sold. Allutilities have been privadzed

Jun 30, 1993 Hydrocarbons Law and Law of Peru-Petro, S.A. aresubmitted to CongressPlan to privatize Petroperu is completedNew model ,ontract is preparedTechnical. conomic, and legal norms on contractingenterprist are completed

Aug 31, 1993 Contract between MEM and Petroperu on firther operatonsof producing fields is concludedAgreement between the Govermment and the Bank on theaction plan to privatize Petroperu is reached

Sep 30, 1993 Reguations and technical norms on environmental maus,operational safety, and transport and processing ofhydrocarbons are completed

Eneg Prldng

24. Eectrici Tarffs and Taxadon. The principles and procedures for determiningelectricity prices are being brought into line with a market-oriented system, so that tariffs reflect coststrucures. First, the basis for tariffs is being changed from accounting to economic costs; subsidiesare to be eliminated for all consumer groups except, possibly, residential consumption of less than 50kWhfmontlh; and cost differences in providing service to different regions are reflected in the tariffs.The Governent is commited to supporting the Electricity Tariff Commission's decisions, free frompolitical considerations, as the autonomous technical body with sole responsibility for tariff regulation.Second, distortions among and within categories of electricity users are being corrected as tariffs arebeing unified according to voltage level, irrespective of consumer category. The Government plans toconsolidate the tariff categories into three - i.e., low, medium, and high/very high voltage - and toestablish a lifeline tariff for very low residendal consumption below 50 kWh/month. Discretionarysurcharges that distort price signals are being removed. Third, taxation of electricity consumption hasbeen simplified and consolidated by incorporating a 68% surtax into the rate base and increasing thegeneral sales tax from 16% to its general rate of 18% (with a largely neutral effect on flscal revenue),thus phasing out the practice of collecting revenues for different fiscal authorities via the electricitybill. A 22% municipal tax on elctricity consumption will also be incorporated into the tariff base bySeptember 1993. On the other hand, the Government plans to revoke the electricity enteprises'exemption from fuel taxes (which now causes a fiscal revenue loss of US$3-4mn equivalentlmonth)

-45 - ANNEY 2

and expects to make the enterprises liable to corporate income tax irrespecdve of their form ofownership.

25. PFreum Prduc Following the reintroduction of price controls, permanent priceliberalization Is likely to be linked to the enactment of the new Hydrocarbons Law. Without price .decontrol, however, the liberalization measures taken thus far - i.e. the removal of Petroperu'simport monopoly and Import protection for refined products - will not achieve their fill Impact.Liberalizing petroleum products prices is key to the restructuring of the hydrocarbons sector because

(a) Combined with free market entry, It ensures full deregulation of refining, foreign trade,and domestic marketing of petroleum products and thus, facilitates the participation ofprivate firms in these activities;

(b) It links domestic prices automatically to the movements of international prices, increasesas well as declines, preventing the former from falling out of line with their economiccosts;

(c) It reduces inflationary expectations and avoids the political costs associated withgovernment-decreed price adjustments perceived to be discretionary and arbitrary.

26. In order to eliminate discriminatory pricing of petroleum products, the stucture oftaxation needs to be simplified and unified through levying broadly similar taxes. Petroleum productshave become liable to general sales tax starting in 1993, but the Government plans to reduce specifictaxes so that the overall tax burden on petroleum products does not change. Specific taxes on fuelsprovide more revenue stability but less elasticity and responsiveness to changing market conditions.Because of the value-added tax nature of Peru's general consumption tax, fuels used for commercialpurposes (mdustral and agricultural production; commercial transport) do not bear that tax.Consideration also should be given to levying road user charges through relatively higher taxes ontransport fuels. Under current conditions of Petroperu's production monopoly, the resource rent frompetroleum production is not properly taxed. A 10% tax on gross domestic sales applied throughout1992 has been removed, but Petroperu still is subject to a 2% tax on assets. Therefore, the pricingand consumption taxaadon of petroleum products are intertwined with resource rent taxation, whichwill have to be revamped once the sector is liberalized. The proposed new Hydrocarbons Lawenvisages that the sector enterprises will be subject to royalties on crude production and corporateincome taxes, as the principal means to transfer the economic rent from hydrocarbons productionback to the Nation, in addition to consumption taxes on petroleum products.

Institutional Reforms

27. MEM will continue to exert the policy making role in the energy sector. Its NaticnalCouncil of Energy (CONERG) is to comply more adequately with its responsibilities of evaluatingenergy development options, and is to act as a high-level advisory entity for key policies anddecisions. The General Directorates of Electricity and Hydrocarbons, respectively, will beresponsible for granting concessions and licenses, setting technical standards, and supervising servicequality. They will maintain their regulatory functions to ensure competitive markets once mostenergy prices are liberalized and most energy enterprises are privatized. The Electricity TariffCommission will continue to be in charge of regulating tariffs, but the generating enterprises'Committees for Economic System Operation (COES) will be responsible for calculating tariffs. TheMinistry of Economy and Finance plans to continue monitoring energy- and environment-relateddevelopments, in order to ensure their consistency with the Government's macroeconomic strategy.

-46- ANNEX 2

The selection of investments In electricity generation and transmission is envisaged to be monitoredby CONERG within the framework of an indicative plan, while investments in distribution will beunder the direct responsibility of the utilites. The Government will require that sector projects folownot only the regulations specifically related to electricity and hydrocarbons, but also those establishedfor competition, taxation, envitonmental and social protection, health, and urban planning. TheGovernment will Insist that energy-related projects adequately internalize the corresponding costs ofenvironmental and social protection, and that the necessary measures are taken to reduce negativeImpacts of existing installations. When legislation does not exist or is insufflcient to address theseaspects, MEM wil be responsible to establish the required norms.

Ilavetmt Requirenents

28. Throughout the 1980s, investment was insufficient to maintain the productive capacity ofthe energy sector, let alone to provide for its expansion. Projects to a large extent were selected onpolitical grounds and were poorly Implemented. Major investments are needed both for rehabilitationand expansion, but they will be determined by the ongoing privatization process, in particular theprogress in forming new private companies.

29. EBricly, In the short term, high priority should be given to rehabilitadtg thedistribution networks, reducing losses, and thus, increasing the availability and reliability of supplies.Financing is being sought from institutional lenders for a loss reduction program, whose costs areestimated at US$S15mn p.a. for Electrolima alone. Since current dispatch facilities are inadequate forefficient market-oriented operations in integrated grids, there is need to (a) establish a National Centerfor Coordination and Supervision to ensure proper management of the electricity system, and (b)adopt Electrolima's generation/distribution control center to the operations under the new regulatoryframework, at a cost of approximately US$17mn. In view of the drought-induced energy shortages inthe recent past, 200 MW of thermal (gas tubine) capacity in the Central-North system is beinginstalled by mid-1993 and additional thermal capacity in the following years. Medium-terminvestment requirements are indicated in a 1991 study prepared by Electroperu, which is based onassumptions of modest economic growth throughout the 1990sN and of electricity demand growthprojected at 3.4% p.a. during 1991-95 and 4.3% p.a. during 1996-2000. According to this study,investnent requirements for the 1992-96 period exceed 1991 US$1bn (36% for generation; 19% fortransmission; 14% for distribution; the remainder for rehabilitation and other items). The bulk(US$600mn) would be for the Cenr-North system, especially Lima.

30. Jy.rcarbons. Because of severe financial constraints, Petroperu in recent years basrarely carried out more than 40% of its budgeted investment. The entity meanwhile accounts for justabout one-half of petroleum-related investment overall and less for upstream investment, where thebulk is carried out by private firms operating under service contracts. This, however, is also anindication of the relative success in attracting outside companies to petroleum exploration and fielddevelopment, especially after Petroperu had given up acreage, the approval process was simplified,exploration terms were made more flexible, and restrictions on profit remittances were removedfollowing the enactment of Legislative Decree No. 655 (August 1991). This process is likely togather momentum once the new Hydrocarbons Law and attendant regulations are enacted. It is alsolikely that Petroperu in future will invest less as its activities are being scaled back. In the shortterm, expenditures of at least US$80-100mn p.a. are needed to rehabilitate Petroperu's productivecapacity. Petroperu projects its own investment to average US$1 10mn p.a. (1991 prices and

31 i.e., GDP growth of 2.6% p.a. for 1991-95 and 3.2% p.a. for 1995-2000.

- 47- ANNEX 2

exdhange rates), largely for rehbiitating existing fields and surface installations for which IIDB andCAF financing has been obtained, but also for adding conversion capacity to refineries. Majorrehabilitation of handling and storage facilities and new investment should be undertaken by theprivate sector only. This is particularly so for the Caisea natural gas schem estimated to holdnearly 1 tr cf of recoverable reserves. Among the various alternatives, Petroperu envisages a frst-stage net output of about 300mn cf/d of gas (an additional 700mn cfd would be reinjected) and60,000 b/d of liquids and transmission of gas and liquids to Lima and Cuzco for electricity generationand industrial use. Project implementation is to take five years. Capital costs for appraisal drilling,field development, pipelines, and gas treatment facilities are preliminarily estmated at 1991 US$l.Sbn(over and above US$200mn already spent by Shell on exploration). According to Petroperu, 40% offinancing is to be provided through equity and the remainder through loans from internationaldevelopment banks and suppliers. However, no progress has been made as yet in committinginvestors to this project. The development strategy for the electricity will be strongly influenced bythe outcome of the scheme to develop Camisea as a possible primary energy source for powergeneration. The Government is also seeking investors for the smaller Aguayl (0.25 tr cfrecoverable reserves) naural gas scheme whose development is expected to cost US$25-30mn butwhich would be of local significance only, as well as for the Maqufa and Agua Caliente oilflelds.

Mining

Bacdground

31. Mining is a major activity of the Peruvian economy, contributing about 5 percent ofGDP and 50 percent of total exports. The sector's poor performance in recent years had a significantadverse impact on the overall economy. Three large state-owned mining companies, Centromin,HierroPeru, and MineroPeru are responsible for 40 percent of total sector output.

32. Over the last 20 years, the mining sector has been hampered by inward-looking, import-substitution economic policies and state ownership and control of productive facilities to exploitnatural resources. The 1971 mining law resulted in the nationalization of Cerro de Pasco (Centromin)and Marcona (HierroPeru), and the creation of MineroPeru. In addition, the law gave the state themonopoly for the marketing of all mining exports. Minpeco was founded in 1975 to administer thistrading monopoly.

33. Mining is a global industry. Almost all of Peru's mineral production is exported andsold at prices set in international markets. In order to survive and prosper, Peru's producers must becompetitive with producers worldwide. Changes in the global economy over the past decade havecaused an increasing divergence between the performance of private and state-ontrolled miningcompanies in most countries. Most private companies are entering the 1990s organizationally leanand operating modem, competitive facilities. In contrast, most state-controlled companies areentering the 1990s with little change except that their facilities are older.

34. The evolution of mining in Peru during the 1980s can be separated into two periods.Output grew by 1.8 percent p.a. during 1980-85 but declined by about 4.5 percent p.a. during thesecond half of the decade when net investment was negative. Between 1982 and 1986, a pardcularlydifficult period for world mining due to low prices for minerals, Peruvian mining stagnated. Duringthe second half of the 1980s, international prices of metals improved and international miningenterprises resumed investment activities in major mining countries (Chile, U.S., Canada). Despitethis favorable world-wide climate, in Peru inadequate economic policies, labor issues, poor

-48- ANNEX 2

this favorable world-wide climate, in Peru Inadequate economic policies, labor issues, poorperformance of the state-owned enterprises, and the threat of terrorism in important mining areasresulted in the negative growth of sector output.

Govenment Strategy and Policies

35. The Government recognizes that the speedy revival of the mining sector is essential foreconomic growth, and that this revival will only be possible with private sector participation. Theprivatization process has been moving quicldy in the mining sector. It started with the Goverment'sLegislative Decree No. 647 (July 1991) authorizing private participation of a minimum of 51% inCentromin, HierroPeru, and MineroPeru, through an increase of capital that would provide privateInvestors with the majority stake in these companies. Decree 675 (October 1991) authorized theprivadzatlon of Minpeco. The privaization program in mining is continuing under Legilative Decree674 which established the legal and institutional fiamework for the overal privatization program. Inaccordance with Decree 6V4, the Government established in 1992 Special Privatization Committeesfor HierroPeru, MineroPeru, and Centromin. Meanwhile, HierroPeru, some holdings of M-neroPeru- Minera Condestable and Quellaveco - and the US subsidiary of MinPeco have been privatized, whilethe technical/economic evaluations of the operadons of Centromin and MineroPeru have beencompleted in preparation of their respective privatzation.

Lga and Regulatory Frahmewrk

36. With respect to the Lega and Regulatory Framework, the Government in November1992, promulgated Legislative Decree No. 708 for the promotion of private investment in the miningsetor. This Law guarantees mining companies tax stability and the right to operate under the sameforeign exchange regime effective at the time operations started. Concessions will be granted for theexploration and exploitation of minerals and metals. A drawback system has been introduced in1993, allowing mining companies to deduct local taxes (including indirect taxes) from their incometaxes. This law also allows for the formation of joint ventures for all mining activities, includingmarketing. In addition, the law guarantees mining companies the same treatment as other companiesregarding the right to remit profits, free access to foreign exchange, and to freely market theproduction, both ntonally and abroad. The associated regulations are being prepared by a jointMEM Private Sector Committee.

37. The new mining legislation has established an adequate framework for privateinvestment, which the Government must maintain in order to ensure the success of the privatzationand the continued development of the sector. The streamlining of the sector Institions requires aprogram to establish an instiutional famework that is clear and effective for allocating, directing andcontrolling mining rights and activities.

nuiSonal RequIrmets

38. An institutional restructuring program is presently being implemented. The newstructure is expected to result in Improved performance with respect to sectoral policy, regulation,promotion, administration, and generation of required basic Information to develop mining activities.The structure of the sector has been simplified and the personnel in enterprises reduced. Thefunmctons have been clarified and have been distributed based on the following principles:

(a) clear definiton of sector objectives;

-49 - ANNEX 2

(0) separation of the different roles (policy; normative; operative), in order to optimizeefficiency; and

(c) clear definition of the mandate of each institution.

39. The requirements of the remaiing principal sector institutions are as follows:

(a) General Mining-Directorate. DGM needs to focus on the definition of policy, theupdating of norms and regulations, and sector development strategy. It should also be Incharge of coordinating and monitoring the activities of the sectorial institutions. Alloperative fiunctions would be transferred to other institutions.

(b) RM. To establish a single interface between the governmental institutions and theprivate sector, all concession and permit granting procedures, as well as the technicalcontrol of the application of the norms and regulations, should be transferred to RPM.This would improve the confidence of the private sector in the administration, as RPM isa technical and autonomous organization.

(c) MINPERU. Following the privatization of the statowned mining companies, the Statewill need an organization which represents its financial interests in the minin portfolio,constituted by the Government's share in the new companies. This should be in theform of a financial holding company, operating under the supervision of MEM. GivenMinperu's competence in mining, mineral economics, and management, this entityshould be made also responsible for project promotion. Ithe contracs established withnational and foreign companies will be an important asset to fulfill this function.

(d) INGEMM[. The main responsibility of INGEMMET is to generate and disseminatebasic geological data and carry out regional mineral inventories and assessments. This isof high priority to attract investors and promote the development of the sector. Appliedinvestigations should be carried out on a contract basis only, or within the framework ofbi- or multilateral support. However, external assistance should be oriented first to thebasic tasks of the institution. Exploration should become the exclusive responsibility ofthe private sector. INGEMUET should also develop its capacity to provide professionalservices contracted commercially by the private mining industry. Private sectorparticipation should be sought to the feasible extent.

Envhrnment

Badwround

40. Pollution from the energy and mining sectors is recognized as a major national problem,and there X concern about the state of water quality of Peru's principal river systems. There is alsolocalzed concern about air and coastal pollution from hydrocarbon - and mining-related activities.No quantitative assessments have been made of the scale and gravity of the pollution, and of prioritiesfor dean-up. Nonetheless evaluation of the available rudimentary data indicates that the country'swaer resources are being degraded. Addidonally, the institutional framework is complicated by thenum of governmental and non-governmental institutions active in the environmental field, withlittle coordination between them. A recently created General Directorate of EnviroLmenWt Affairs(Dicd General de Asuntos Ambientales; DGAA) at MEM is responsible for dealing withenvironmt issues in energy and mining. Establishing a system to mitigate environmental

- 50 - ANNEX 2

degradation requires an adequate legal/regplatory framework, effective institutions to develop andenforce the appropriate reglations, and an information base relevant to policy-setting. TheGovernment recently has taken a series of measures to improve the environmental policy frameworkand specifically to tackle the environment problems caused by energy- and mining-related activities.Additionally, the Government needs to take further measures to remove or reduce the institutional andpolicy constnts that limit the effectiveness of its efforts to tackle environmental risks to publichealth and sensitive ecosystems, and to halt the decline in the productivity of agriculture and fisheries.The Government's efforts need to focus specific priorities for which solutions and benefits can bereadily demonstrated, whie allowing for expanding these efforts once the relevant institutions gainexperience.

Insfftutional Reform

Ihe primary problem in implementing environmena management of theenergylmining/electricity sectors in Peru is institutionaL. There is currendy no single responsibleagency, but rather six or more prefectures (Ministry of Agriculture, Ministry of Health, Ministry ofLands, CONAMA, DIGESA, INAPMAS, ONERN, MEM-DGAA) responsible for various aspects ofeavironmena management. Problems facing these various institutions range from weak planning,limitations In manpower skills, conflicting functions and responsibilities, and weak institutionallinkages resulting in inefficient resource use, fragmentation and poor motivation.

Further efforts will be required by the GOP to strengthen and reform its environmentalistionral process with the objective of:

a. Enuing the establishment and functioning of CONAMA (Consejo Nacional de MedioAmbiente), the national EPA agency;

b. Saving resources by eliminaing the current unnecessary duplications of efforts;

c. Ensuring and strengthening coordination between the relevant institutions; and

d. Enhancing its technical expertise in the broad understanding of environmenl issues.

The GOP has signed a law, establishing the country's national environmental protectionagency - CONAMA. At the same time, this law establishes national environmental sYstem - SNA(Sysems Nacional Ambiento). The concept is to have CONAMA functioning as the overall watchdognationa EPA type agency and operating at the local and regional levels through the SNA. CONAMAcrrenldy has two operational staff.

DGAA is ,he insttution with the responsibility within MEM for developing, coordinating andmanaging the sector's environmental issues. Once CONAMA is on board, DGAA will interact withCONAMA in the area of policy enforcement. This project provides technical assistance to DGAA toenable it to undertake its functions and to strengthen its interdepartmental linkages through improvedmanagement structres, data management procedures, and providing a one window approach fordealing with environmental issues in energy and mining sector investments.

-51 - ANNEX 2

Regulatory Framework

The various key environmental regulations enacted or to be enacted are outlined below:

(a) National Environment Code (1990)

This represents a long term commitment by the GOP to environmental protection, andthe maintenance of public health and safety.

(b) Environmental Assessment Regulation. (Ammended 1992)

The enacted Environment as Assessment Regulation provides a means of assessing thepotential environmental impacts of major investment activities. The EnvironmentalAssessment (EA) Regulation establishes:

Activities subject to mandatory environmental assessment;

Procedures for providing EA's; and

Procedures for public involvement.

(c) Sectoral Codes of Practice

The required enabling environmental regulations and guidelines required to ensuresectoral compliance to the enviromental laws are not yet in place, and are to bedeveloped under the project.

(d) Emission and Discharge Standards

The regulatory outlines for maximum levels of air emissions and levels ofconcentrations of substances that may be released into the environment from specifiedsources e.g.: NO., SO., CO, BOD, COD, etc. are not yet in place and are to bedeveloped under the project

(e) Environmental Liability Regplation

The Bank supports the GOP's position to develop and define environmental liabilityregulations. In knowing the applicable criteria, stakeholders and parties to businesstransactions will be able to appraise the economic costs of their environmentalliabilities.

(t Economic Instruments.

The existing environmental framework currently relies predominantly on the commandand control approach. DGAA plans to study the feasibility of using economic and

- 52 - ANNEX 2

finacial istumen In curbing setoral polludon and in support of the environmentregulatory framework. Given the required level of dependence on the legal system,which the ommand and control approach dictates, the government, industry, and theindusties %vuld benefit from this flexible and innovative approach in addressing thecomplex and tostly environmental issues.

-53- ANNEX3

RU

ENERGY AND MINING TECHNICAL ASSISANAE LOAN

SUtMMRY OF LESSONS OF BANKMJTERNATIONAL EXPERIENCE

ELECTRICITY

Background

1. There is a Bankwide deteriorating trend in power projects. In the LAC region, thecrisis of the power sectors is also reflected in the slowdown of new operations which hit bottom inFY1991, the first year with no lending for power. Ihe Region's experience has been that weakeconomic management affects not only the macroeconomic performance, but also sector and projectperformance. Sound macro-economic management is critical to successful project implementation,especially regarding: (a) availability of counterpart funds; (b) adequacy of cost recovery and inteallygenerated funds; (c) avoidance of cost overruns; and (d) efficient management and avoidance of highstaff rotation (FY91 ARIS). The LAC lending strategy establishes that economic and sector reformprograms are essential complements, and that sectoral investment loans are a more effective tool forinfluencing sector policies and investment programs, provided that the institutional base is able tosupport their implementation.

2. I1 1 1b. IEN's 1988 review of Bank lending for electric power indicateseither stagnation at unsatisfactory levels or a declining trend in overall sector performance. Althoughavailability, access to service, and consumption of electricity have increased in most developingcountries, the quality of supply and degree of losses have remained unsatisfactory despite largeinvestments. Electricity prices have consistendy lagged behind costs. Price-related covenants ofBank-financed projects (invariably reflecting the bare minimu of financial requirements) havefrequently been ignored, undermined, or postponed. The review recommends: (a) improvingproductive and allocative efficiency; (b) increasing incentives for enhanced utility efficiency; (c)strengthening power-energy-macroeconomic linkages; (d) improving investment planning to achieve abetter balance between generation and distribution; and (e) giving greater emphasis to rehabilitationand maintenance. Sector restructuring and institutional reform is also necessary to improve the socialcompact between government, consumers, and electricity utilities.

3. OED Perseiv. The principal lessons drawn by OED from its FY91 review ofpower projects are:

* close monitoring and frequent supervision increases the likelihood of project success;

O institutional development can only be successful when strategies are based on arealistic consideration of political constraints and government commitment to reform;

* further Bank lending to borrowers experiencing financial decline increases the riskthat financial covenants will not be observed;

* tariff increases and steps to achieve financil rehabilitation should be conditions oflending which, if not met, should lead to suspension of disbursements; and

* sector lending should be based on a carefully evaluated macro economic framework.

-54- ANNEX 3

The Coo of LAC and of Peru

4. LATIE (1991) analyzed the major crisi facig the electic power secrs of the LACreon. Electricity demand growth in LAC during the last two decades was about four percentageponts higher than econoric growth. Since most counrsies In the Region are implemeang economlcstabilization and reform programs and envisage to resume economic growth after the sagnation of the1980s, it can be expected that such spread In gowth wil condnue and that electicity demand wilgrow faster In the 1990s than in the 1980s. The consequence of such increasing demand of electricityis a high requirement of resources for the capital-intensive electricity sector.

The Propc3ed Operation

S. Based on lessons learned from past experience, the proposed Project would help theGovernment to carry out basic reforms in the sector by (a) clearly separtg Its regulatory andcorporate roles; (0) establishing a modern regulatory framework where generation would be subject tomarket forces, transmission would allow free access to suppliers and buyers, and distribution wouldremain as a natral but fully regulated monopoly; (c) realigning the sectores corporate frameworkwith its regulatory framework; (d) privatizing government-owned utilities; and (e) seeking privaecapital for all new investments. Ihis reform process would significantly improve sector efficiencythrough improved resource allocation, from the corporate point of view (utilities would be run ascommercial enterprises), and from the consumers' point of view (prices would give the right signalsfor conservation). The objectives of the proposed Project would be consistent wifth themacroeconomic objectives of the Bank's economic adjustment operations, within the Government'seconomic stabilization and reform program.

EIYDROCARBONS

Background

6. The Bank has undertaken three hydrocarbon-related projects in Peru, I.e., thePetroleum Rehabilitation Project (Loan 1806-PE), Petroleum Refinery Engieering Project Loan2117-PE) and Petroleum Production Enhcement Project (Loan 2195-PB). While the Bank'sexperience in strenghening policy-making institutions in the hydrabons sector is relatively limited,the experience gained with projects in Peru and in other LAC countries, especially the Argentina GasUtilization and Technical Assistance Project (Loan 2592-AR) and the Oil and Gas EngieeringProjects in Argentina (Loan 1880-AR) and Bolivia (an S-25-BO) is relevant to the design of thisproposed project, whose objective is to strengthen MEM as key policy making and monioringinstitution in the to-be-privatized oil and gas sector. This experience primariy pertains t tree areas,i.e. sector strategy, insdtution building, and project financing. Many of the relevant lessons aregeneric to technical assistance projects focussing on instiuion building. However, the complextechnical nature of the hydrocarbons sector and the importance of technology transfer impose specificrequirements, over and above those for institution building in other sectors.

Lessons Related to Institution Building

7. The Bank's experience with oil and gas projects in LAC and other regions hasprovided a framework for successful hydrocarbons sector operatons. The most important factorshave been incorporated into the hydrocarbons component of the Project, as follows:

* project implementation depends critically on the existence of a strong project uni toact as counterpart entity to exernal specialists;

-55- 3ANNEX3

* to the exten that substantal indhtution changes occur as a result of projetimplementation, strong goverment and industry commitment needs to be ensured,above and beyond the commitment by those agencies and offcias directly nvolved inimplementg the changes;

* the active involvement of government offlcials In the design and Implementation oftechnical assistce activities is Important, as is the training of local speciists. Toobtain maximum benefits from high-technology projects) including technologytransfer, amrgements are needed to ensure close cooperation between govenmentofficials and local specialists on the one hand and external specialists on the other;

* the sustainability of the project depends critically on the government's wmingness toimplement the recommendatons of the extera consultants and to ensure theavailability of qualified staff for critical tasks, irrespective of political changes in thecountry. In particular, benefits from training are sustWnable only if Incenives toretain staff are offered. Ilstitution building is an important safeguard to avoid the lossof qualified staff for financial and political reasons; and

* stting at an early stage of project implementation, the Bank's policy dialogue withthe government needs to reinforce the objectives and focus of the technicalassistance/institution building activities.

Lssons Related to Sectoral Strategy

8. The weak performance of the hydrocarbons sector underline the need for reform inthe sector organization and management, including deregulation, privatization of PelroPeru, and,pening the sector to private investment and competition. These requirements are being addresseddhrough this Project and the Bank's forthcoming Privatization Project, respectively.

Lessons Reled to Project F1nandng

9. The following lessons are relevant:

(a) Given the uncertain nawre of technical assistance activities in general and in thehydrocarbons area in particular, the project budget should make adequate allowancefor condngencies, to avoid that project objectives are impaired due to lack of funds.In particular, the availability of adequate counterpart funds needs to be ensured;

(b) For project sustainability, it is essential that funding is available beyond the period ofBank involvement, to ensure that salaries and other working conditions offered to thehydrocarbon specialists in government service bear a meaningfil relation to those forcomparable private sector employment.

MINING

Background

10. Bank-wide experience in implementing mining projects in LAC (Bolivia, Mexico,Ecuador) and other Regions has resulted in information and knowledge as well as the development ofa framework for mining sector adjustment. Whereas the policies of countries with expanding mining

-56 - ANNEX 3

sectors might differ from each other in detail, there are important common factors which make themsuccessfuW, such as: stable and transparent regulations defining the rights and obligations of theinvestor and the governwt; a competitive and well-structured fiscal regime which provides anadequate return to investors and a fair share to the government; assured access to foreign exchange atmarket rates for profit and capital remittances as well as for operational needs; and effective supportand monitoring of private minig investment by well-organized government insiuons.

Proposed Operation

11. Incorporating these experiences, the mining component of the Project would assist theGovernment in implementing its sector strateg and policies, which aim at attracting privateInvestment. They consist of the following elements:

(a) Existing state companies will be privatized at the earliest opportunity to improve theirproductivity and to give a clear signal to investors with respect to the Government'sintention to follow a private-sector based strategy.

(b) Incentives to investors will be clearly determined in the relevant legislation. Taxationof mining companies will be consistent with the overall tax regime, but it will take thespecific nature of mining as a resource-based industry into account, as well as taxlevels In other mining coutries, with a view to maintaining or establishingcompetitiveness of the national industry. Mining taxes will be eanings-related ratherthan output- or input-related to avoid distortions in investment and operaionaldecisions.

(c) Mining legisation will reduce risk and uncertainty for potential investors and ensureeasy access to exploration permits and mining concessions. Permits and concessionswill be transferable with a minimum of government interference. Investmentagreements, where required, will provide additional assurances to protect Investorsfrom unwarraned government interference, as well as safeguards for the Governmentto ensure that investors meet their obligations.

(d) Mining institutions-i.e., MEM, Geological Survey, environmental protection andmine safety institutions-will be reorganized and strengthened to better perform theirpromotional, regulatory, and monitoring functions. Government institutions willdiscontinue operational and marketing functions which they assumed during the periodof state-led mining development.

(e) Environmental aspects of mining have been neglected in the past. In order to ensureenvironmentlly sustainable mining development, appropriate regulations and

adards wfll be established together with effectve monitoring and enforcementcapabilities.

-57- ANNEX4

ENERGY AND BUS TEHICA ASSISTANCEC LOAN

OPERATIONAL GUIDELINES FOR TECHNICAL ASSISrANCE LOAN

L Preparation of Terus of ReferenceThe implementing ager ies (i.e., MEM entities and autonomous agencies, asappropriate) prepare draft TORs, with assistance of the Bank when requested. DraftTORs are submitted to the EMTAL Coordinating Unit manager for approva and tothe Bank for no-objection prior to issuing to consultants.

2. Creation of Short List for Recruitment of a FirmThe implementing agencies prepare an inital list for review/approval by theCoordinadng Unit manager. The short list will be submitted to the Bank for no-objection.

3. Selection of Individual ConsultantsThe implementing agencies make an initial selection, but send the curriculum vitae(with a brief justification of the fee), to the Coordinating Unit manager for approvaland to the Bank for no-objection.

4. Draft Letter of Invitation, including Evaluation Criteria, and ContractThe implementing agencies draft the documents (based on an agreed model) and sendthem to the Bank for no-objection.

S. Evaluation of ProposalsIhe implementing agencies evaluate proposals and select the winning firm. Beforenotiying the firms, the selection committees will send the evaluation report andwinning proposal to the Coordinating Unit manager for approval and to the Bank forno-objection.

6. Negodation of ContractThe negotiation of the contract is handled by the Implementing agencies (based onguidelines issued by the Coordinating Unit manager). Prior to signatu, thenegodated conteact wil be sent to the Coordinang Unit manager for approval and tothe Bank for no-objection.

7. Supevision of C,onsultantsSupervision is the responsibility of the implementing agencies. Progress reports ontechal assistance will be included in the current overall special committee reportingto the Coordinating Unit manager.

-58- ANNEX4

8. DisbursementPaymn to couldts and suppliers will be made direly by the AdministrativeAgency from Its own resources. MEM will request disbursements, through theProject Coordinting Unit, of Bank loan funds to reimburse the AdministativeAgency for eligible expenditures made. Ihe Application for Withdral requestssubmitted by the Borrower to the Bank should be for a minimum of $500,000.Individual requests for reimbursement of expenditures corresponding to contracts of$100,000 or above equivent will be fully documented. The Borrower will submit tothe Bank a Summary Sheet with all relevant documentation. For expenditures ofcontracts below $100,000 equivalent, the Borrower will submit Statements ofExpenditures, and will maintain the supporting docmation which should be readilyavailable for review by Bank supervision missions and the auditors.

9. AuditAn annual audit of the Project accounts will be undertaken by independent auditorsand submitted to the Bank.

-59 - ANNEX 5

ENERGY AND MINING TECNICAL ASSISTANCE LOAN

LOAN ADMINISTRATION AGREEMENT BETWEEN TEE GOVERNMENT OF PERlT AND UNDP

1. The Ministry of Energy and Mining will be the Executing Agency on behalf of the Government for theEnergy and Mining Technical Assistance Loan (EMTAL) to be extended by the World Bank. UNDP will be incharge of the project administraton as agreed among MEF, MEM, and UNDP in a letter of agreement.

2. For recruiting and managing consultants to be financed by the proceeds of the Loan, the division ofresponsibilities among MEF, MEM, and UNDP will be as follows:

MEF- Repayment of principal amount, interest, and other loan related charges- Grantig approval to the Loan Adminitration Agreement- Compliance with Loan Conditionalities as specified in the Loan Agreement between the Bank

and the Government of Peru

MEM (Project Coordinating Unit)- 3dentification of consultants and preparation of short lists- Drafting of terms of reference- Preparation of leuers of invitation for proposals- Evaluation of proposals and seleution- Negotiation and signing of contracts- Supervision of performance and review and acceptance of reports- Preparation and Mung of withdrawal applications- Approve UNDP's selection of exte auditors for accounts certification and financial

statements- Supervision of funds allocation- Submitnmg quarterly financial status reports of the Project to the Directorate of Public Credit

of the Ministry of Economy and Finance- Obtaining the Bank's no-objection for consultants' short lists, terms of reference, and

Contracts- Compliance with budget norms outlined in the current budget law- Establishment of a Budget Section to which MEF will assign disbursements of the World

Bank Loan- Submitting disbursement information to MEF immediately after it becomes available

UNDPAdministration of consultants' contracts including verification of payments, requests, andpayments to consultanS

- Opening and mantaining separate accounts for receipt of Project funds and effectuatingpayments

- Preparation of financial statements- Selection of outside auditors of UNDP's Project accounts and financial statements- Submission to MEM of all information and supporting documentation necessary to enable

MEM to prepare appropriate withdrawal applications- Provision of MEM with such other services incidental to the above as MEM may reasonably

request

i60 *ANNEX S

3. I discrg the responsibllties set forth above, UNDP should act as agent and on behalf of MEM.

4. It is undeod that UNDP should make all payments required under contracts admiised by it and shouldbe peridically reimbursed by the Bank It is further understood that, for this purpose, MEM should submitwithdrawal applications to the World Bank on a monthly basis, except as the World Bank may othwise require inaccdace with the provisions of the Loan Agreement

In payment of its services and expenses, UNDP wll charge, and the Govnment wM pay, an all-inclusive fee of3.0% of the amount of payment made by UNDP. MEM should include said fee In Its disbursement reqests theWorld Bank MEM should request the World Bank to makce all disbursements from the Loan Account to the order ofUNDP into the UNDP Contrbutions Account No. 015.02284, Chemical Bank, New York, N.Y., U.S.A..

5. UNDP agrees to cooperate with MEM'and the Government at large to enable them to comply with allrequrements of the Loan Agreement, Including the General Conditions. Without limitation upon the generality of theforegoing, UNDP should keep records and separate accounts and provide for the audit thereof in such manner as toenable the Government to comply with its obligations under the correspondent Section of the Loan Agreement andwith the provisions of the disbursement letter.

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