Documentof ' / The World Bank FOR OFFICIAL USE ONLY STAFF APPRAISAL REPORT ARGENTINA REFINERY CONVERSION PROJECT. June 15, 1981

Transcription

1 Documentof ' / The World Bank Public Disclosure Authorized FOR OFFICIAL USE ONLY Report No AR STAFF APPRAISAL REPORT ARGENTINA REFINERY CONVERSION PROJECT June 15, 1981 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Industrial Projects Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS (as of May 1, 1981) Currency Unit = Argentine Peso ($a) US$1 = $a 3,190 US$ 1 million = $a 3,190 million $a 1 million = US$313 $a 1,000 = US$0.313 WEIGHTS AND MEASURES 1 Barrel (bbl) of Crude Oil (0.85 Specific Gravity/35 0 API) = Metric Ton 1 Barrel (bbl) = Cubic Meter 1 British Thermal Unit (Btu) = Kilocalories 1 Cubic Foot (cu ft) = Cubic Meter 1 Standard Cubic Foot (SCF) of Natural Gas = 1,000 Btu 1 Metric Ton of Crude Oil = 44.4 x 106 Btu 1 Mile = Kilometers 1 Gallon = Liters PRINCIPAL ABBREVIATIONS AND ACRONYMS USED API bpd ERE FCC FMIP FWI GdE GDP HDPE ICB IRR LDPE LGO LIBOR LPG POIP PVC TOE tph tpy VCM YCF YPF American Petroleum Institute Barrels Per Day Esso Research and Engineering Fluid Catalytic Cracker Financial Management Improvement Program Foster Wheeler International Gas del Estado Gross Domestic Product High Density Polyethylene International Competitive Bidding Internal Rate of Return Low Density Polyethylene Light Gas Oil London Interbank Offered Rate Liquified Petroleum Gas Plant Operations Improvement Program Polyvinyl Chloride Tons of Oil Equivalent Tons Per Hour Tons Per Year Vinyl Chloride Monomer Yacimientos Carboniferos Fiscales Yacimientos Petroliferos Fiscales FISCAL YEAR January 1 to December 31

3 FOR OFFICIAL USE ONLY ARGENTINA REFINERY CONVERSION PROJECT TABLE OF CONTENTS Page No. I. INTRODUCTION... 1 II. INDUSTRY AND HYDROCARBON SECTORS... 2 A. Industrial Development... 2 B. Hydrocarbon Sector Energy Base Institutional Framework Hydrocarbon Exploration and Production Refining Natural Gas Investment Program Energy Conservation... 7 III. THE COMPANY... 8 A. Background... 8 B. Production Performance... 9 C. Organization and Management D. Accounting and Financial Management E. Operating Results and Financial Position IV. REFINERY PRODUCTS MARKET AND MARKETING A. Historical Consumption and Production B. Demand Forecast Through C. Supply of Selected Refinery Products Through D. Supply and Demand Balance E. Distribution and Transportation F. Marketing Organization and Policies of YPF G. Petroleum Products Pricing V. THE PROJECT A. Project Objectives and Scope B. Project Description Refinery Conversion Scheme Plant Operations Improvement Program Financial Management Improvement Program Training Program Industrial Energy Audit C. Raw Materials and Infrastructure D. Utilities Lujan de Cuyo Refinery La Plata Refinery E. Project Management and Implementation F. Project Schedule This report was prepared by Messrs. Y.T. Shetty, N. Krishnamurthy, A. McNamara and Mrs. P. Urbano of the Industrial Projects Department. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

4 - ii - TABLE OF CONTENTS (Cont'd) Page No. G. Staffing and Training H. Environmental Considerations VI. CAPITAL COST, FINANCING PLAN AND PROCUREMENT A. Capital Cost Estimates B. Financing Plan C. Procurement a D. Allocation and Disbursement of Bank Loan VII. FINANCIAL ANALYSIS A. Production and Production Costs B. Revenues C. Financial Projections for the Project D. Financial Rate of Return and Sensitivity Analysis 41 E. Analysis of YPF Refinery Division with the Project 41 F. Financial Covenants for the Company G. Auditing and Reporting Requirements H. Major Risks VIII. ECONOMIC ANALYSIS A. Economic Justification B. World Petroleum Prices C. Transportation Savings D. Economic Rate of Return E. Foreign Exchange Benefits F. Other Economic Benefits IX. AGREEMENTS ANNEXES 3-1 Company's Historical Income Statements 3-2 Company's Historical Balance Sheets 5 Project Implementation Schedule 6-1 Capital Cost Estimate 6-2 Working Capital 6-3 Disbursement Schedule for Bank Loan 7-1 Assumptions Used in Financial Analysis 7-2 Production Costs at 100% Capacity 7-3 Project--Projected Income Statement 7-4 Cost and Benefit Streams for Financial Rate of Return Calculation 7-5 Refinery Division--Projected Income Statements 7-6 Refinery Division--Sources and Application of Funds 7-7 Refinery Division--Projected Balance Sheets

5 - iii - TABLE OF CONTENTS (Cont'd) 8-1 Assumptions Used in Economic Analysis 8-2 Cost and Benefit Streams for Economic Rate of Return Calculation MAP IBRD ARGENTINA - Oil Industry Locations

6 - iv - DOCUMIENTS AVAILABLE IN Tl{E PROJECT FILE A. Financial and Market Information Al Audited Annual Reports of YPF ( ) A2 Company Annual Reports (1978 and 1979) A3 Draft Pricing Strategy, Secretariat of Fuels, August 1980 A4 File containing all Statements and Tables prepared by YPF, Gas del Estado A5 Additional Information (tables and statements prepared by the Mission) B. Technical Documentation Bl Contract with Foster Wheeler International B2 Draft Prequalification Document for Selection of Contractor for Detailed Engineering, Construction and Erection of the Conversion Project for Lujan de Cuyo and La Plata B3 File of information given to the Mtission by YPF at Lujan de Cuyo and La Plata Refineries and in Buenos Aires B4 Foster Wheeler Preliminary Estimate of the Investment of the Conversion Project for the Lujan de Cuyo and La Plata Refineries, October 1980 B5 Foster Wheeler Technical Proposal, May 1980 (selected cases) B6 Invitation to Bid for the Consulting Contract for the Lujan de Cuyo and La Plata Refineries B7 YPF Feasibility Studies of the Refinery Conversion Project, Octrober 13, 1978, September 17, 1980 and October 31, 1980

7 I. INTRODUCTION 1.01 The Government of Argentina and Yacimientos Petroliferos Fiscales Sociedad del Estado (YPF), a fully owned Government oil compaay and the largest enterprise in Argentina, have requested a Bank loan of USq200 million to finance YPF's proposed Refinery Conversion Scheme and relaled investments. The main objective of the Scheme is (i) to redress the imbalance in the product slate of YPF's two main refineries--la Plata and Lujan de Cuyo (see Map IBRD-15312)--by converting the surplus residual fuel oil, a heavy petroleum product, into higher value light and middle distillates which are in deficit in the country, and (ii) help bring the supply and demand of light and * heavy distillates in Argentina into better balance. The current fuel oil surplus is expected to increase further in the future as Argentina increasingly substitutes many current uses of fuel oil with natural gas, thus reducing the large quantity of associated gas currently being flared (about 350 million cu ft/day in 1979 approximately equivalent to 58,000 barrels of oil per day). With the steep increases in crude oil prices since 1973, a higher conversion of crude to more valuable lighter products has assumed still greater importance all over the world as discussed in "Background Paper on Petroleum Refining in Developing Countries," dated July 17, The Project will include, in addition to the Refinery Conversion Scheme, the following four components: (i) a Plant Operations Improvement Program (POIP); (ii) a Financial Management Improvement Program (FMIP); (iii) a Training Program; and (iv) an Industrial Energy Audit. Except for the Industrial Energy Audit which would be carried out under the auspices of the Secretariat of Fuels, all the other components of the Project relate to YPF. Total financing required for the Project is estimated at approximately US$878 million, including US$439 million in foreign exchange. The proposed Bank loan of US$200 million includes US$175 million for the Refinery Conversion Scheme with the rest for the other four components. The proposed improvement programs for YPF aim at upgrading the financial management and accounting systems as well as improving the operational efficiency of the existing refineries at La Plata and Lujan de Cuyo with special reference to energy conservation and pollution control. The Training Program will be geared to meet the needs of the improvement programs as well as the requirements of the proposed Refinery Conversion Scheme. The Industrial Energy Audit will review the scope and potential for energy conservation in selected industrial enterprises The proposed loan will be the second Bank operation with YPF. The first loan (US$27 million) was for an Oil and Gas Engineering Project 1/ (Report No. P-2745-AR, June 4, 1980) whose primary objectives are to: (i) improve information on countrywide oil and gas reserves as a basis for a rational program of field development; (ii) assist YPF in locating favorable geological hydrocarbon structures; and (iii) study the optimum development and utilization of natural gas primarily to avoid waste and to determine related investment requirements. The proposed second loan to YPF fits well into the country's overall objective of developing its hydrocarbon resources. 1/ Which became effective on December 2, 1980.

8 1.04 The Government and YPF approached the Bank in early 1980 to finance the Project. Subsequently, an identification mission consisting of Messrs. E. Segura, E. Tortorelli and Ms. P. Urbano visited Argentina in Mlarch 1980, followed by a preappraisal mission in June. The Project was appraised in October 1980 by a mission consisting of Messrs. Y. T. Shetty (Chief), E. Segura, N. C. Krishnamurthy, A. McNamara and Ms. P. Urbano, all of the Industrial Projects Department. II. INDUSTRY AND HYDROCARBON SECTORS A. Industrial Development 2.01 Argentina is a semi-industrialized country with a per capita income of about US$2,300 in 1979, fairly evenly distributed. Post-war growth of Gross Domestic Product (GDP) averaged 3.5% in real terms but has been subject to strong cyclical fluctuations. Manufacturing now represents the principal sector in the generation of GDP, its share exceeding 35%. Manufacturing output has been increasing at an annual rate of about 5% since 1950, primarily on account of the rapid expansion of the chemical, metal and engineering industries The first comprehensive Industrial Promotion Law was enacted in 1958 providing incentives to local investors to exploit Argentina's natural resources, decentralize and diversify industry, and expand exports. Subsequently, a number of revisions were carried out expanding and/or modifying these incentives. In July 1977, the Government promulgated a new law which no longer excludes foreign-owned enterprises from benefits and considerably simplifies the administrative procedures During , Government ownership of enterprises increased considerably. Besides expanding its traditional participation in the oil, gas and steel sectors, a petrochemical industry development program was elaborated in 1973 which assigned an increased role to the public sector. Further, the public sector took over a number of enterprises, both large and small, which faced bankruptcy. While this Government intervention avoided large increases in unemployment, fiscal burden of supporting these enterprises played an important role in the monetary expansion and consequent inflation. The Government which came to power in March 1976 moved to modify the previous policies and to limit the state's direct participation in manufacturing activities In the case of petroleum and petrochemicals, the Government has announced its intention to revise its role in the sector. Responsibility for energy development, particularly the hydrocarbons, will remain largely with

9 the present public sector enterprises--crude petroleum and petroleum refining with YPF and natural gas with Gas del Estado (GdE). However. the share of YPF in oil exploration and production is expected to decline in the future as the Government is encouraging private participation in those areas. For core or first generation upstream petrochemical refining projects, the Government intends to develop projects with majority public sector ownership (through Fabricaciones Militares) but with substantial private participation. Projects using these core products, the so-called second generation plants, are to be majority-owned by the private sector, but may have some participation from government-owned enterprises. All further (third generation) transformation plants will be completely owned by the private sector One of the major policy objectives of the present Government is to reduce its fiscal deficit and to achieve greater efficiency of the public sector. The Government is now also encouraging the private sector to mobilize private savings for industrial investments so as to reduce the need for allocation of industrial investment funds from the Government budget. In addition, it is encouraging public sector enterprises to mobilize, through flexible compensation policies, the technical expertise of the private sector to improve the performance of public sector enterprises. B. Hydrocarbon Sector 1. Energy Base 2.06 Argentina has a substantial and diversified energy base. Proven reserves of crude oil are estimated at 2.4 billion barrels (bbl) or 330 million tons equivalent and those of natural gas are estimated at 21.2 trillion cubic feet, i.e., 520 million tons of oil equivalent (TOE). The exploitable hydroelectric power potential is estimated at 2.5 billion TOE, but the installed capacity to date allows the harvesting of only about 7% of this potential. Coal reserves are put at 450 million tons, of which 224 million tons are classified as measured, 200 million tons as indicated and 26 million tons as inferred; most consist of highly volatile bituminous steam coal of a relatively low quality. Apart from hydroelectric power there is also potential for renewable energy based on vegetable fuels (firewood, bagasse), geothermal, nuclear, wind and solar energy. A large-scale expansion of hydroelectric power generation is underway, and a gradual expansion of nuclear generation based on domestic natural uranium is planned. As a primary development objective in the energy sector, the Government aims at eliminating petroleum imports by attaining self-sufficiency by the mid-1980s and building up exports as more reserves are identified with increased encouragement to private investment. Another important objective is to make increased use of associated natural gas in the country to minimize the flaring of this premium source of energy Petroleum and gas, while accounting for only 14% of identified energy reserves, currently meet about 82% of domestic energy demand. Total energy demand in 1980 is estimated at 42.8 million TOE, of which 56% is accounted for by petroleum products, 26% by natural gas, 10% by hydro/nuclear combined, 4% by coal and 4% by vegetable fuels. This high share of oil in the

10 total energy consumption in Argentina 1/ is expected to decline as the share of natural gas, hydropower and other sources of energy increases in the future Argentina has attained a high degree of self-sufficiency in hydrocarbons. In 1979, imports accounted for only about 13% of domestic petroleum needs and 20% of natural gas consumption. In that year, the country imported 12.6 million bbl of crude oil, 10.4 million bbl of petroleum products, 425,300 tons of liquid gas and 65 billion cu ft of gas at a total cost of nearly US$1,055 million, 2/ equivalent to 18% of total merchandise imports. As mentioned, Argentina plans to achieve self-sufficiency in crude oil by 1985 and possibly emerge as an exporter by In the case of natural gas also, the country could emerge as a net exporter if the current plans to supply gas to Brazil and Paraguay materialize. Meanwhile, Argentina is continuing to honor the 20-year gas import contract with Bolivia, signed in 1972 before the discovery of large domestic gas reserves. 2. Institutional Framework 2.09 Development of oil, gas and coal resources is the responsibility of three State-owned entities: YPF, GdE 3/ and Yacimientos Carboniferos Fiscales (YCF), respectively. All three organizations are under the Secretariat of Fuels, of the Ministry of Works and Public Service. The Secretariat is charged with responsibilities to: (i) regulate fuel prices; (ii) regulate the planning and investment activities of YPF, GdE and YCF; (iii) approve oil exploration and production contracts negotiated between YPF and private companies; and (iv) develop new sources of energy and carry out overall energy planning and conservation. The Secretariat also has direct control over three of the nine major State-owned power utilities. 3. Hydrocarbon Exploration and Production 2.10 Argentina's hydrocarbon bearing areas cover about 1.2 million sq km onshore and 0.6 million sq km offshore. Of the 10 known basins, the Cuyo basin is probably the best explored and the rest are yet to be adequately explored. Cumulative discoveries of crude from the early 1900s have amounted to about 5.6 billion bbl, of which 3.1 billion bbl have already been produced. Exploration activities have been surging since 1976 and the decline in known reserves has been reversed largely because of the resumption of exploration by private firms after the Government launched a policy of encouraging such investments to complement YPF's efforts. Recent increases in crude output have been brought about mainly by private firms. These firms now provide nearly one-third of the crude output, up from 27.5% in Associated with this development, there has been an increase in the crude processed through secondary recovery. During , the output of 11 For example, in the U.K. the share of oil in the total consumption of energy is 38% compared to 56% in Argentina. 2/ Including US$353.5 million worth of crude oil, US$468.5 million worth of petroleum products, US$119.6 million worth of liquid gas and US$112.9 million worth of natural gas. 3/ GdE is responsible for imports, processing and marketing of natural gas and liquified petroleum gas (LPG).

11 - 5 - crude oil increased by 18% from about 145 million bbl to 171 million bbl. During the same period, YPF's share in total production declined from 74% to 67%. 4. Refining 2.11 There are 12 refineries in Argentina with a total capacity of 705,600 barrels per day (bpd) of which YPF accounts for 65% as shown in the following table: Argentina - Capacity, Production and Utilization of Refineries ( ) (in '000 bbl) Annual Company Capacity a/ Crude Processed (m.bbl) Capacity Utilization (%) T_-(m.bbl) YPF La Plata Lujan de Cuyo San Lorenzo Campo Duran Plaza Huincul Dock Sud Sub-total Shell Dock Sud Esso Campana Galvan Sub-total Isaura b/ Bahia Blanca Astrasur b/ Comodoro Rivadavia DAPSA b/ Lomas de Zamora Total a/ On the basis of 340-day operation per year. b/ Private Argentine companies.

12 2.12 Most of the above twelve refineries are small and only four of them have a capacity of more than 100,000 bpd (4.7 million tpy) each. La Plata (YPF) is the biggest refinery with a capacity of 232,650 bpd (about 10.8 million tpy). The second biggest refinery is Lujan de Cuyo (YPF) with a capacity of 128,800 bpd (6 million tpy). The La Plata and Lujan de Cuyo refineries account for about 50% of total refining capacity in Argentina. Although the major refineries of YPF are based on advanced refining processes (such as catalytic cracking, hydrocracking, delayed coke, etc.), their relative capacity to produce lighter and middle distillates is below those of the private sector. In fact, whereas in 1979 YPF accounted for 73% of the total crude processed in the country, it generated only 69% of the total middle and light distillates and 79% of total fuel oil. As noted earlier, the Refinery Conversion Scheme aims at converting the surplus fuel oil produced at the two major YPF refineries into higher-value middle distillates In 1979, the average capacity utilization in all Argentine refineries was about 76% compared to 85% in the YPF refineries (and 60% in the private sector refineries). This is partly because the private refineries were not able to get an adequate allocation of domestic crude as the country is not yet self-sufficient in oil (para 3.05) and the Government has restricted import of crude. In 1980, however, the Government modified its crude allocation policy to give the private refineries a larger share of domestic crude and also allowed them to import part of their crude requirements. As petroleum products demand increases in Argentina and refinery configurations are converted to better reflect the demand pattern for different products, the average capacity utilization in the refinery sector is expected to increase to about 80% by 1985 and 90% by 1990 (para 4.08). 5. Natural Gas 2.14 Output of natural gas, which in Argentina is largely associated with crude, increased at an annual rate averaging about 6% during the 1970s. Natural gas output is concentrated in Santa Cruz and Neuquen, but the fastest growth in recent years has taken place in the Tierra del Fuego fields (Map IBRD-15312). During the last three years ( ), Argentina's gas reserves nearly tripled to 21.2 trillion cu ft as a result of the Government's new emphasis on exploration. Currently, gas production is running at about 1.2 billion cu ft/day, but about 30% of this production is being flared due to lack of demand, and inadequate gas gathering and distribution systems. However, use of gas is expected to grow rapidly between now and the turn of the century to account for nearly a third of domestic energy consumption, thus reducing the amount of gas flared. The country is expanding its gas gathering and distribution system to meet this objective. As an example, a major effort to increase gas use is underway in Buenos Aires, the capital city, where all heating systems are to be converted to natural gas by More generally, because of the considerable scope for gas use in industry, power generation and commercial sectors and the proposed changes in the relative prices of fuel oil and gas as discussed below, gas demand is expected to grow at about 10% a year through the mid-1980s. The above measures are geared to shift fuel demand to natural gas The natural gas now being flared amounts to 350 million cu ft/day and in terms of energy content is almost equivalent to Argentina's pretroleum and natural gas imports combined. The principal reasons for the gas flaring

13 - 7 - had been: (i) oil producers were reluctant to invest in gas gathering and distribution systems because of the low delivery price paid by GdE, the agency in charge of processing and marketing of natural gas as well as liquified petroleum gas (LPG); and (ii) fuel oil was priced nationally about 10% below the consumer price for gas to encourage the use of surplus fuel oil near refineries. Corrective measures are being taken to increase gradually natural gas prices to levels attractive to producers and raise fuel oil prices to a higher level than natural gas prices. At the same time, under the Project surplus fuel oil will be converted into middle distillates to allow natural gas to increase its share of the energy market. In addition, as part of the Bank-financed Oil and Gas Engineering Project (Report No. P-2745-AR, June 4, 1980), the Government is carrying out a Gas Utilization Study. This Study will analyze the optimum scope for natural gas output and use on a regional as well as national basis, together with an assessment of alternative uses for fuels replaced by gas and of related investment requirements. 6. Investment Program 2.16 The investment program in the oil and gas sector during aims at: (i) achieving self-sufficiency in crude oil; and (ii) expanding and adapting the transport infrastructure for moving oil and gas from production sites to the processing and consumption centers. The investment planning is based on the assumption that total energy demand will increase by 5% a year, while petroleum demand will grow at a lower rate (4% a year) as a result of the intended large-scale substitution of natural gas (mainly for fuel oil), expansion of hydroelectric power production and energy conservation efforts The Government is currently updating the investment program for the oil and gas sector. Based on projects prepared by YPF and GdE, total investment in the public sector during are expected to total about US$16 billion (in 1979 prices); private sector investments, though more difficult to forecast precisely, are likely to range from a minimum of US$5 billion (assuming maintenance of the current share of the private sector in oil exploration and development) to about US$10 billion (assuming a continuation of the Government policy to encourage a greater participation of private firms in the sector). Exploration and field development are expected to absorb nearly 80% of the total investment. It is anticipated that these public and private sector efforts will lead to the discovery and development of at least 2 billion bbl of additional crude reserves which would help maintain the reserves/production ratio at 15 years throughout the 1980s. Transport and distribution of gas would require about 13% of the investment (US$1,960 million) and refining (mainly for secondary processing) about 7% (US$1,000 million) of the public sector total. 7. Energy Conservation 2.18 Until recently, energy conservation measures in Argentina, as in most other countries, were lacking. The most important energy conservation tool, namely, pricing, was not used effectively due to the Government's concern with inflation. However, the Government has now become increasingly aware of the high use of energy particularly in the industrial sector, which currently consumes nearly half of petroleum products. Therefore, it is now developing a program for the conservation of energy resources by increasing the price of energy (para 4.18) and by encouraging their more efficient use in existing and new industrial enterprises. As an initial step, the Government plans to carry out an energy audit of major energy-consuming industries, with a view to

14 identifying priority areas and measures for energy conservation. Under the proposed project, the Bank would finance part of the cost of the audit which would (i) review the present pattern of energy consumption in major energyintensive industries and the scope for substitution; (ii) identify the scope for conservation in major industries and reduction of waste through retrofitting in industry; and (iii) review the potential for developing retrofitting equipment production in the country. The Government will consult with the Bank on the selection and terms and conditions of the consultants to undertake the study, and discuss the results of this study with the Bank and subsequently prepare a program for implementing the recommendations of the study by December 31, 1982 and then carry it out (para 5.11). A. Background III. THE COMPANY 3.01 Yacimientos Petroliferos Fiscales Sociedad del Estado (YPF), a public sector company, operates in every branch of the petroleum and natural gas sectors, except in the marketing of natural and liquified petroleum gas (LPG) which is the responsibility of Gas del Estado (GdE). In 1979, YPF accounted for 50% of exploration, 67% of crude oil production, 96% of natural gas output and 73% of petroleum refining, with the private sector accounting for the rest. With total assets of US$5.9 billion, an equity base of US$2.65 billion, gross sales of over US$4.5 billion and total personnel of 35,700 in 1979, YPF is the largest enterprise in Argentina and one of the largest oil companies in Latin America YPF is charged with negotiating and monitoring exploration and production contracts with private companies. Based on recent changes in Government policy, exploration and production by private firms under contract with YPF have been increasing. Private sector participation is on the basis of service-risk contracts with YPF awarded through competitive bidding. Under these contracts, ownership of crude oil remains with YPF, with the private companies receiving a fee for their exploration and production activities. The service fee is established as a percentage of the international price of crude, which is normally set at the time of bidding for exploration contracts and which is adjusted annually on the basis of a composite index of international prices, variation in exchange rates and inflation rates. Reference crude prices employed in recent awards have been about 55% of international prices with a ceiling of 60%. As noted above, the Government until recently allocated crude primarily to YPF's refineries. As a result of policy changes aimed at minimizing processing and marketing costs of petroleum products, domesticallyproduced crude from 1980 is allocated according to individual refineries' share of the market for petroleum products A number of international companies participate along with YPF in various petroleum commercial activities. Esso (Exxon) and Shell are active in exploration, refining and marketing; Cities Service and Amoco, in production; and TOTAL, Occidental, Union Oil of California and Union Oil of Texas, in exploration. About 30 domestic companies are producing hydrocarbons as contractors of YPF and an additional 15 specialized firms provide services to Argentina's petroleum industry. YPF owns and operates the country's entire network of crude and petroleum product pipelines, while the natural gas pipelines are operated by GdE. YPF also owns tankers to transport crude especially from southern production centers not served so far by pipelines.

15 -9- B. Production Performance 3.04 The following table shows the trend of oil and gas production by YPF and other producers during : Argentina - Crude Oil and Natural Gas Production Average Annual Growth Rate (%) A. Crude Oil (million bbl) YPF a/ Risk Contractors Total Crude Oil B. Natural Gas (million m ) YPF c/ 10,275 11,532 11,447 12,546 13, Others - b/ N.A. N.A. Total Natural Gas 10,275 11,663 11,504 13,031 N.A. N.A. a/ Excluding crude oil produced through YPF contracts with private firms. b/ Negligible. c/ Including gas produced by YPF contractors. Total oil production has increased at an annual rate of 5.2% since Based on YPF's policy to enlarge the role of the private sector in oil production, YPF's own production has remained stable in recent years and major production increases have been achieved by private firms under risk contracts. Production of natural gas is entirely associated with the production of oil and has, therefore, followed a similar rate of growth.

16 The recent development of refinery operations in Argentina between YPF and other companies is shown below: Argentina - Total Crude Oil Processed in Refineries (in million barrels) YPF Local Imported Sub-Total Others Local Imported Sub-Total All Companies Local Imported Total Of the total crude processed by YPF, local crude accounted for 88% in 1976, rising to 92% in With the increase in crude oil production in Argentina, the import dependence of YPF and other refineries has declined from about 22 million barrels in 1976 to 14.6 million barrels in 1980, accounting for less than 8% of the total crude oil processed in the country. The country is expected to be self-sufficient in crude oil by ; YPF owns and operates six of the 12 refineries in the country (para 2.11), and has a total refining capacity of 460,000 bpd or about 65% of Argentine refining capacity. Plantwise capacities and recent trends of capacity utilization ( ) for YPF are shown below: Trend of Capacity Utilization in YPF Refineries (in million barrels unless otherwise noted) Capacity Production Capacity Utilization (%) La Plata Lujan de Cuyo San Lorenzo Campo Duran Plaza Huincul Dock Sud Total

17 YPF-s refineries are operating well with the exception of the small refinery at Campo Duran (32,000 bpd capacity), which is not able to reach high capacity because the crude oil supply from nearby sources is being depleted and the refinery's interior location makes it difficult to transport imported crude for processing there. Excluding Campo Duran, the average capacity utilization in YPF refineries was close to 91% in With the proposed Plant Operations Improvement Program (POIP) included in the Project (para 5.05), the average capacity utilization is expected to go up to at least 95%. Besides, this program will help to conserve energy through increased yields and control pollution especially in La Plata and Lujan de Cuyo, the two largest refineries which account for nearly 79% of YPF's total refinery capacity. C. Organization and Management 3.07 As mentioned, YPF is one of the three State-owned entities 1/ in the energy sector under the Secretariat of Fuels, within the Ministry of Works and Public Service. YPF reports to the Secretariat through the Director-General for Fuels (para 2.09), and was established in 1922 as a Government department for developing the oil and gas resources of Argentina. In 1977, its status was changed to a State company under the Law of State Corporations, thereby increasing its operational autonomy. The Secretariat of Fuels is now involved primarily in investment and pricing decisions. The main objective of the change in the status of YPF is to encourage it to function more efficiently along commercial lines without depending on government budget support According to the Law of State Corporations, YPF cannot be declared bankrupt and can only be dissolved by law through the National Executive Power Committee of the Government. At present, all the shares of YPF belong to the Federal Government which has deposited them with the Sindicatura de Empresas Publicas (the Syndicate of Public Enterprises), the Governnment's holding and auditing company The direction and management of YPF is exercised by a Board of Directors consisting of nine members including a President, a Vice-President and seven Directors, all appointed for a term of three years and eligible for reappointment without limitation. The Board meets twice a month to formulate policies and overall development programs for the Company; it has an Executive Committee which consists of the Vice-President and two Directors who are in charge of three General Directorates namely Operations; Administration; and Civil Works and Contracts, besides being members of the Board. The Company, in accordance with Argentine Law, must have its accounts audited annually by the Sindicatura General de Empresas Publicas. 1/ The other two organizations are Gas del Estado (GdE) and Yacimientos Carboniferos Fiscales (YCF), the latter responsible for developing coal resources.

18 Overstaffing was a problem in YPF prior to Since then there has been a considerable reduction in total employment. declining from 51,700 in March 1976 to 34,806 in March 1980, a reduction of about 33%. However, during the same period, the number of professionals has increased slightly from 2,430 to 2,440, raising their share from 4.7% to 7% of total employment. By adopting increased flexibility in compensation policies, YPF has been able to attract more competent personnel, some from the private sector. Although general salary increases in Argentina are overseen by the Ministry of Economy, YPF now has sufficient freedom to determine adequate salaries and salary increases on an individual basis. With stabilization in the management situation, the introduction of a flexible compensation policy, the reduction and restructuring of personnel, and the generally more dynamic approach toward formulating and implementing its increasingly complex tasks, YPF appears to have made considerable progress in improving its organization and operations since YPF has already initiated two important measures to further improve its organization and management. In January 1980, it appointed TOTAL, a petroleum company of France, to review the operations of the La Plata refinery and recommend measures for modernizing its operation and improving its efficiency. Following submission of the TOTAL report in September 1980, YPF has developed with the help of TOTAL a Plant Operations Improvement Program for the La Plata as well as the Lujan de Cuyo refineries to supplement the proposed Refinery Conversion Scheme to serve those refineries. Secondly, YPF appointed Arthur Andersen & Co. in January 1980 to study the accounting and financial management systems of the Company and develop a program to streamline, upgrade and expand those systems. Arthur Andersen have completed their study and preparation of the Financial Management Improvement Program. YPF is, therefore, considered ready to derive maximum benefits from the comprehensive financial and operational improvement programs which the Company will implement with Bank assistance as part of the Project (para 5.02). D. Accounting and Financial Management 3.12 Since 1977, YPF's accounting system and procedures have been revised completely from the previous Government budgetary system to a financial accounting more suited for the changed status of YPF from a Government department to semi-autonomous industrial enterprise. YPF is now improving the reliability and timely availability of accounting data as well as establishing an integrated information system for accounting, costing, cash management and budgeting. With substantial additional recruitment of experienced staff for the finance and controller's departments, supplemented with technical assistance from Arthur Andersen, YPF is introducing a comprehensive cost accounting system throughout its operating departments. At the same time, YPF is integrating its management information system to serve not only its accounting needs but also its cash management, budget forecast and control, monthly reports, and cost accounting and control. The work of Arthur Andersen is currently concentrated in the important areas of development and implementation of cost accounting and management information systems. YPF will subsequently use their services for introducing long-term capital budgeting and financial planning. Arthur Andersen will also organize training for YPF personnel to improve the overall financial management of the Company (para 5.22).

19 Thus, substantial improvements in the Company's accounting and financial management have taken place recently and further steps are underway. However, continual substantial efforts will be needed to complete the transformation of YPF's management information system into an effective management tool to serve its diverse and complex operations. With continuity in management and the assistance of outside consultants, it is expected that YPF will establish an adequate information system within a reasonable period. E. Operating Results and Financial Position 3.13 The following table summarizes the sales and financial data of the Company shown in greater detail in Annexes 3-1 and 3-2: YPF - Selected Sales and Financial Dataa! (in current US$ million equivalent) b/ Aug. 1, July 1, June 30, 1978 Dec. 31, Gross Sales 3, , , ,571.2 Sales Discounts & Taxes 1, , ,397.6 Net Sales 2, , , ,173.6 Cost of Goods Sold 2, , , ,908.5 Operating Profit(Before Tax) Other Income c/ Contribution to Govt./Income Tax d/ Net Profit with Revaluation Gains Net Profit (Loss) w/o Revaluation Gains ( 60.9) (241.8) Cash Generation e/ Current Assets * , ,628.8 Current Liabilities f/ * , ,427.0 Net Fixed Assets * 3, , ,824.6 Equity * 1, , ,261.6 Ratios Operating Profit/Net Sales 0.1% 11.5% 6.3% 11.6% Return on Revalued Ave. Net Fixed Assets * * Current Ratio f/ * 1.0:1 1.3:1 1.1:1 Quick Ratio f/ 0.3:1 0.7:1 0.8:1 0.7:1 Long-term Debt/Equity Ratio * 31/69 29/71 23/77 Debt g//equity Ratio * 48/52 46/54 42/58 * Balance sheet items adjusted for inflation for 8/01/77 to 6/30/78 are not given in the audit report. I Adjusted for inflation according to general index set by the Government; accounting periods changed since 1978 (para 3.16). b/ Average exchange rates used for conversion into US$: August 1977-June 1978, $a 598; July-Dec. 1978, $a 878; January-Dec. 1979, $a 1,317; January-Dec. 1980, $a 1,837. c/ Mostly from revaluation gains; in 1979, revaluation gains amounted to US$676 million. d/ Contributions to Government were replaced by income tax in e/ After interest and contribution to the Government. f/ Excluding short-term bank payables rolled over and reclassified as long-term debt. / Including short-term bank payables rolled over.

20 Analysis of YPF's financial statements is complex because (a) the accounting system has gradually been changing since 1977 from a budgetary system to a financial accounting system, and (b) YPF's accounting periods have been somewhat irregular in the recent past (closing dates were July 31, June 30, 1978 and December 31, 1978). The comparability of audited statements for periods prior to June 30, 1978 is, therefore, limited. Operating profits, as an indicator of the Company's profitability, improved significantly in the second half of 1978 primarily due to a reduction in payroll expenses following the retrenchment of surplus staff, combined with the introduction of more efficient management and procurement practices. However, during 1979, operating profits as a percentage of net sales declined, as selling prices deteriorated sharply in real terms. To improve the financial position of YPF, in connection with the Oil and Gas Engineering Project, the Government decided as a first step to increase--starting from January retail prices of petroleum products and gas by 1.5 to 2% a month in real terms above the nonagricultural wholesale price index. These increases helped improve the Company's operating profit margin from 6.3% in 1979 to 11.6% in The price increases continued until the end of March 1981 and resulted in price increases of 25% in real terms for YPF products during 1980/81. t 3.15 YPF's profitability as reflected by net profit is significantly better than that shown by operating profit because of the Company's substantial revaluation gains. YPF's current ratio was 1:1 in 1978, improved to about 1.3:1 in 1979 but declined slightly to 1.1:1 in The quick ratio also improved from 0.7:1 in 1978 to 0.8:1 in 1979 but declined slightly to 0.7:1 in The low liquidity ratios of YPF are mainly due to high short-term borrowings, largely to make up for the non-availability of sufficient long-term financing from local sources in the light of high inflation. Local financial institutions lend mostly for short periods with interest rates to be established every month, and those short-term loans are normally rolled over. Besides, current liabilities include sales and other taxes (which amount to about 43% of the retail price of some petroleum products) collected by YPF, which are to be paid to the Government within 37 days. 1/ Thus, YPF can use that amount for about five weeks as working capital, while it sells petroleum products to private retailers on a cash basis. YPF prudently tries to minimize local borrowings, by keeping its inventory levels low and selling mostly for cash. It-borrows in foreign markets (enjoying as it does,a high credit rating) to finance foreign as well as local costs. Because of the above factors, YPF's liquidity position though tight is considered manageable The Company currently has a very sound -capital structure as a result of large gains from revaluation of assets. Such accounting practice is considered essential under the high inflation rates experienced in Argentina in recent years. Total equity of YPF at the end of 1980 was at the satisfactory level of about 50% of total assets. 1/ The time allowed in the past-was 52 days. It was reduced to 37 days in For any delay in payment beyond the specified period, YPF has to pay a monthly interest of 5%.

21 The following table shows the sources and application of funds for 1980: YPF - Sources and Application of Funds, 1980 (in US$ million) a/ Sources Funds from operations Increase in provision for retirement, etc Increase in deferred credits 8.8 Decrease in long-term investments 3.4 Decrease in working capital Total 1,042.2 Applications Increase in other assets 78.6 Increase in fixed assets Payment of long-term debt 15.0 Increase in intangible assets 1.6 Increase in deferred charges 4.0 Total 1,042.2 a/ At the average exchange rate for 1980 of US$1 = $a 1,837. The above figures show that only about 11% of YPF-s 1980 investment requirements was financed from self-generated funds from operations. The rest of the financing was derived mainly through working capital reduction. This highlights the fact that despite YPF's satisfactory capitalization ratios, its cash flow and operating profits (based on the current revenue/cost structure) are not adequate at present to finance a reasonable part of the projected large investment program of YPF--US$12.5 billion during The real increases of crude and petroleum product prices in 1980/81 are not yet adequate to enable the Company to earn a reasonable return on its assets which could then be channeled for reinvestment. Agreement has been reached with the Government that it will take measures to ensure that the ex-refinery prices of YPF's products are adequate to provide YPF, operating efficiently, with funds sufficient to cover all costs and expenses before interest, to earn a reasonable return on its revalued net fixed assets in service, and to meet sound financial ratios (paras 7.11 and 7.12). Also, an understanding has been reached with the Government that the domestic retail prices of petroleum products will be maintained in real terms at the May 1, 1981 level using the non-agricultural wholesale price index for periodic adjustment of the retail prices Currently, YPF does not prepare financial projections for all its operations including oil exploration and production, refining, marketing, etc. A capital budgeting and financial planning system will be established under the Financial Management Improvement Program, a part of the Project. Agreement has been reached with YPF that it will submit every year within four months of the

22 closing of the previous fiscal year 12-month projections of income statements, sources and applications of funds and balance sheets for the Company as a whole, the first such projection being due by end-april 1983 (para 7.12). IV. REFINERY PRODUCTS IARKET AND ILARKETING 4.01 As mentioned, the Project is designed to convert a significant part of Argentina's existing and projected fuel oil surplus into lighter and middle petroleum distillates in deficit in the country. The Project would, thus, correct the existing unbalance between the demand and supply of petroleum products in Argentina, and the marketing of the project output is not expected to be a problem. Still, to put the Project in proper perspective, this Chapter discusses in detail the various aspects of petroleum products market and marketing. A. Historical Consumption and Production 4.02 Although consumption of refinery products in Argentina over the last 19 years ( ) has increased by an average of about 3.9% annually, the growth rate has fluctuated substantially from year to year, in line with the economic growth and changes in relative prices of refinery products. The historic consumption and production of refinery products is shown below: Argentina - Historic Supply and Consumption of Refinery Products (in '000 barrels) Production Imports Exports a/ Consumption ,703 13,835 1,456 89, ,127 9,631 8, , ,143 14,730 4, , ,104 10,270 4, , ,350 9,621 6, , ,188 4,782 1,454 b/ 162, ,152 7,997 1, , ,823 6,609 1, , ,836 9,798 2, , ,658 8,598 2, , ,858 11,554 4, , ,293 4,078 7, , c/ 176,966 10,265 4, ,064 Average Annual Growth Rate (%) a/ Including bunkers for all flag ships. b/ Excluding bunkers. c/ Preliminary estimate. Source: U.S. Department of Energy, International Petroleum Annual for U.S. Department of the Interior, Bureau of Mines, World Petroleum Statistics for Secretariat of Fuels, Argentina for 1979.

23 As a result of a continued high rate of growth of the Argentine economy in the early 1970s, total consumption of refinery products increased at an annuai rate of 5.2% during the period. However, during the next three years ( ), consumption fell continuously because of the country's economic slump and the world oil and economic crisis. Consumption started its upturn in 1977 with the introduction of the economic stabilization program. Past apparent consumption, production and balance of principal refinery products, for 1960 and 1979 are shown below: Argentina - Consumption and Production of Refinery Products (in millions of bbls) Average Rate of Growth Consump- Pro- Consump- Pro- Consump- Protion duction Balance tion duction Balance tion duction Gasoline (0.1) (5.2) Gas Oil & Diesel Oil (3.8) (3.4) Kerosene & Jet Fuel (3.5) (0.2) Fuel Oil Other a/ (2.3) Total (3.2) (6.2) a/ Includes naphtha, lubricants, grease, asphalt, LPG, etc. During , consumption of various refinery products grew at different rates, changing significantly the relative consumption pattern of main products. While gasoline, gas oil and diesel oil increased their share in total consumption, the shares of kerosene and fuel oil declined, as less kerosene was being used with the improvement in the standard of living, and as residual fuel oil was gradually being replaced by natural gas During the same period ( ), production of refinery products increased at an average annual rate of only 3.9% or about the same rate as consumption. Similarly, the share of gasoline and gas oil and diesel oil in total refinery products went up while that of fuel oil and kerosene and jet fuel declined. A product-by-product comparison of production and consumption shows that the deficit occurs mostly in gas oil, diesel oil and in gasoline In 1979, the surplus of fuel oil in Argentina was about 4.9 million barrels. The surplus is expected to increase sharply in the future following the planned switch-over from the use of fuel oil to that of natural gas in industrial enterprises and utility companies to economically utilize the large quantities of associated gas currently being flared and that likely to be discovered through ongoing exploration. As noted previously, the Refinery Conversion Scheme of YPF is designed to convert a major part of this surplus fuel oil into lighter products (such as gasoline, gas oil, diesel oil, etc.) to bring about a better balance in the supply and demand of refinery products.

24 B. Demand Forecast Through Until recently, the Government had kept the domestic petroleum product and gas prices low compared to international prices. Starting in early 1980, however, the Government has been gradually increasing these prices. Furthermore, to encourage substitution of natural gas for petroleum products (especially for home heating, power generation, steam generation in industries and chemicals production), the Government intends to keep the gas prices slightly below (on an energy equivalent basis) the price of residual fuel oil; this should reduce the demand for residual fuel oil. As for kerosene, which is used primarily for household cooking, the demand is expected to decline gradually as per capita income increases and as people switch over to the use of gas for cooking. Further, the demand for diesel oil used in power stations is expected to decline sharply from 1982 onwards as additional gas gathering and distribution systems are completed and the power stations substitute gas for diesel oil. However, gas oil and diesel oil consumption by other consumers (such as railways and in truck transportation) is expected to increase significantly while their consumption (bunker gas oil and diesel oil) in shipping is forecast to show only a marginal increase. Apart from gas oil and diesel oil (for uses other than in power generation and shipping), the refinery products for which demand is expected to grow fast are naphtha (for the petrochemical industry), gasoline (for motor vehicles and aviation) and jet fuel (for aviation) Taking the above factors and the historical trend of consumption into consideration, the Bank staff estimates 1/ of refinery products' demand for the period are shown below: Argentina - Demand for Selected Refinery Products (in '000 barrels) Gas Oil & Gasoline Diesel Oil Kerosene Jet Fuel Naphtha Fuel Oil 1980 (est.) 46,420 51,075 5,000 5,220 4,530 50, ,276 52,863 4,843 5,598 4,530 49, ,208 54,713 4,749 6,038 4,969 47, ,216 56,628 4,686 6,479 5,787 43, ,305 58,610 4,623 6,982 5,787 39, ,477 60,661 4,560 7,485 8,050 42, ,736 62,784 4,466 8,051 8,050 44, ,086 64,982 4,372 8,617 8,177 40, ,529 67,256 4,246 9,246 8,177 37, ,070 69,610 4,089 9,875 8,177 34, ,713 72,046 3,930 10,565 8,177 32,745 Average Annual Growth Rate (%) / Demand estimates prepared by YPF for fuel oil, gasoline, and gas oil and diesel oil were on average about 20-25% higher than Bank estimates for 1990, partly because of lower increase in prices assumed by YPF for those products.

25 Gasoline demand is expected to increase by 4.0% p.a. between 1980 and 1990, slightly below the annual rate of 4.8% achieved in The rate of growth in demand for diesel and gas oil at 3.5% p.a. is expected to be significantly lower than the rates achieved in the past, as consumption of diesel oil in power plants declines with the switch over from diesel oil to natural gas. During , demand for kerosene is expected to decline annually at about 2.4% and for fuel oil at 4.2% in response to the increased availability of gas following investments in gas gathering and distribution systems and in response to the pricing and other measures aimed at promoting the substitution of kerosene and fuel oil with gas. In the light of the largescale expansion of the petrochemical sector envisaged for , naphtha demand is projected to grow at 12.1% per year; thereafter, plans for further growth of the petrochemical sector are not clear at present. Therefore, it is assumed that there would be only a marginal increase in naphtha consumption (0.3% per year) during Considering the expansion of aviation in Argentina, demand for jet fuel is expected to increase by 7.3% p.a. during the 1980's. C. Supply of Selected Refinery Products Through A review of the future production programs of all domestic refineries in operation along with that of the YPF Refinery Conversion Scheme, which is the only project in the refinery sector approved by the Ministry of Economy intending to add capacity, 1/ indicates the following domestic production forecast of selected refinery products: 1/ A new refinery project is in the intial stages of consideration by the private sector. This is not included in the projections.

26 ARGENTINA - Production Forecasts ('000 barrels unless otherwise noted) Gas Oil 6 Sponge Acicular Gasoline Diesel Oil Kerosene Jet Fuel Naphtha Fuel Oil LPG Coke Coke - -- '000 tons TPF 1979 (Actual) 24,110 36,425 3,673 4,120 3,150 45, ,448 37,247 9,851 2, , , ,955 39,778 9,894 2,560 3,150 17, , bago 1979 (Actual) 6,422 7, , ,351 9, , ,395 10, , Shell 1979 (Actual) 5,908 4, , ,593 7, , ,668 8, , lhaura 1979 (Actual) , , Astr aur 1979 (Actual) DAPSA 1979 (Actual) TOTAL 1979 (Actual) ,936 4,449 5,030 3,150 56, ,291 55,451 10,896 3,799 3,150 43,885 1,108 1, ,995 60,199 11,061 3,954 3,150 35,592 1,135 1, X of YPF in Total Production 1979 (Actual) _ Note: The increase in fuel oil production by Esso and Shell is entirely due to the:expected increase in capacity utilization. The production forecasts are based on the assumption,that the capacity utilization in the refinery sector as a whole will increase from 76% in 1979 to 80% in 1985 and 90% in 1990 (para 2.13). D..Supply. and'demand Balance 4.09 Based on above projections, the forecast supply/demand balance for selected refinery products for 1979, 1985 and 1990 is given below:

27 Argentina - Supply and Demand Comparison for Major Refinery Products in and 1990 (in '000 barrels) Annual Average Growth Rate (%) (Actual) Gasoline Demand 42, , Supply ,291 63, Surplus (Deficit) (5.138) (186) (4,718) Gas Oil & Diesel Oil Demand 53, , Supply 49, Surplus (Deficit) (3,403) (5.210) (11.847) Kerosene Demand 4, , Supply , Surplus (Deficit) (381) 6,336 7,131 Jet Fuel Demand 4, , Supply ,799 3, Surplus (Deficit) 117 (3,686) (6,611) Naphtha Demand , Supply 3,150 3,150 3, Surplus (Deficit) (1,290) (4,900) (5.027) Fuel Oil Demand ,855 32, Supply 56,920 43,885 35, Surplus (Deficit) ,030 2, Even after the commissioning of the Refinery Conversion Scheme in 1985, there would still be a deficit in some refinery products (e.g., gasoline, gas oil and diesel oil, naphtha and jet fuel). and surplus of fuel oil and also kerosene. Kerosene surplus is expected to reach around 6.3 million barrels in 1985, rising to 7.1 million by 1990 because of the expected decline in consumption due to the substitution of natural gas for kerosene for household use. The fuel oil surplus in 1985 would be about I million barrels, rising to 2.8 million barrels in 1990; without the Conversion Scheme, the fuel oil surplus in Argentina in 1985 would be 16.2 million barrels, increasing to 28.2 million barrels in Considering the relatively small quantities involved, no major problem is foreseen in marketing surplus fuel oil and kerosene in neighboring countries such as Colombia, Bolivia, Chile and Paraguay, which are projected to continue to import large quantities of these products. In case no further refinery capacity is installed, the deficit for gasoline, gas oil and diesel oil,

28 naphtha and jet fuel would worsen beyond Agreement has been reached with YPF and the Government that they would periodically exchange views with the Bank on the plans for expanding the refinery capacity in Argentina. E. Distribution and Transportation 4.11 Buenos Aires and the San Lorenzo region in the eastern part of Argentina account for about 50% of the total consumption of petroleum products, Mendoza and the surrounding areas in the western part account for an additional 25%, and the other parts of the country account for the remaining 25%. The main marketing area of the (YPF) La Plata Refinery is the Buenos Aires region, while the main marketing zone of the (YPF) Lujan de Cuyo Refinery is the Mendoza region where demand for petroleum products is also growing fast (Map IBRD-15312) Argentina s system of pipelines is owned and operated by YPF to transport crude and petroleum products between strategic locations. About 45% of crude and one-third of petroleum products are moved by pipelines, the remainder being transported by coastal tankers, rail and road. Crude oil pipelines total some 1,700 km in length, have 0.43 million tpd (3.2 million bbl/day) capacity, and are concentrated in Neuquen and the northern region (Map IBRD-15312). Crude from the southern production centers is transported by tankers entirely owned and operated by YPF. Product pipelines are 2,950 km in length and have a capacity for nearly 0.4 million tpd (3 million bbl/day). Storage capacity for crude oil and petroleum products is about 18 million bbl each or about 40-day supply which is adequate in light of Argentina s relatively high degree of self-sufficiency The Lujan de Cuyo Refinery is about 1,000 km away from the San Lorenzo and Buenos Aires regions, the major consuming centers of refinery products. There is a network of product pipelines from Lujan de Cuyo to San Lorenzo and La Matanza (near Buenos Aires). However, as the supply of refinery products from Lujan de Cuyo increases substantially following the Conversion Scheme, along certain sections of the pipeline where there is no surplus capacity available for product movement, either additional pumping stations will have to be established or the existing pumping stations expanded. Although these facilities will not involve significant investments, they are nevertheless essential for the movement of products. Agreement has been reached with YPF and the Government that they will expand the transport capacity of the petroleum product pipeline from Lujan de Cuyo to La Matanza and construct/provide the facilities for the transport of crude oil from Neuquen to Lujan-de Cuyo in time for the Conversion scheme. F. Marketing Organization and Policies of YPF 4.14 The marketing organization of YPF for refinery products is divided into two units, each under a Marketing Manager. One unit deals with the distribution to industrial consumers, shipping companies, commercial aviation and the armed forces, and the other deals with distribution to the general public. There are nine sales regions, each under the responsibility of a regional sales manager. Currently YPF sells about US$12 million worth of refinery products every day of which about US$8 million (two-thirds) is accounted for by sales to the general public. There are about 1,900 persons engaged in the marketing operation, including 1,600 for distribution to the general public.

29 There are about 6,000 petrol stations in the country of which 2,800 are outlets for YPF products, including 33 operated by YPF itself and the rest run by private dealers. YPF estimates that the net additions to the number of stations served by YPF will be about 20 per year during the next decade. From its experience in running its own petrol stations, YPF has estimated that a station has to sell at least 130,000 liters/day to break even. The average sale per station serving as YPF outlet is 170,000 liters/day. Average freight distance from the pipeline and storage depots to the petrol stations served by YPF is 250 km The marketing margin is fixed by the Government. It currently averages about 11.63% of the retail price, including 6.31% for the dealers and the rest for the Company. The marketing margin is reasonable and is adjusted periodically along with the adjustment of retail prices. Further, YPF is encouraging dealers in rural and semi-urban areas to sell soft-drinks, bottled LPG and briquets (for home heating) so that they can earn additional income and remain in petroleum distribution business even though their sales of petroleum products have not yet reached the economic level YPF has recently strengthened its marketing team and has prepared a preliminary marketing plan for the medium term ( ) which includes: (i) rationalization of the service station network by increasing the number in areas with good potential for sales and closing uneconomic stations in areas where sales are low; (ii) continuing the program for improving the operations of the storage and delivery stations to reduce loading time and freight charges; (iii) achieving better inventory control by installing volumetric meters in the storage and delivery stations; (iv) utilization of more transportation companies for contract distribution in order to reduce the risk from strikes; (v) increasing the share of profitable products (e.g., jet fuel) in total product mix and discontinuing or reducing the share of nonprofitable products (e.g., asphalt); (vi) implementing modifications in existing facilities to increase the quantity of jet fuel to meet the growing demand; (vii) studying and developing improved methods for the transportation and distribution of asphalt taking advantage of the existing infrastructure; (viii) promoting a reduction in the number of products to reduce the costs of stocks and storage and restructuring the sales network and discontinuing storage facilities which are not necessary in the light of reduced number of products distributed; and (ix) developing new visual identification systems for YPF for service stations, delivery plants, delivery tank wagons, storage tanks, publicity materials, etc. Agreement has been reached that YPF will finalize the marketing plan by March 31, 1982, and carry out the plan by June 30, G. Petroleum Products Pricing 4.18 Between early 1976 and mid-1978, the Government enacted price increases for petroleum products at all levels. Measured in current US dollar terms, increases over this period were about 40% for crude prices, 114% for retail prices of petroleum products and 85-90% for natural gas. However, in an attempt to slow down inflation (which was running at the rate of 175% in 1978 and 160% in 1979), the Government, during 1978 and 1979, kept these increases significantly below increases in the overall price level and in fuel import costs. As a result, at the end of 1979, prices of petroleum products in Argentina were below international levels.

30 However, in connection with the appraisal of the Oil and Gas Engineering Project (Report No. P-2745-AR, June 4, 1980), the Government conveyed to the Bank its intention to increase petroleum prices during 1980 by 1.8% per month in real terms over and above the increase in non-agricultural wholesale prices starting from January This approach was actually followed until the end of March 1981 when the new Government came to power. An understanding has been reached with the new Government that domestic retail prices of petroleum products will be maintained in real terms at the May 1, 1981 level. The retail prices in Argentina in May 1981 were substantially higher than in the US and were at levels comparable to those in India as shown below: Retail Prices for Selected Petroleum Products (US$ per gallon) Premium Regular Kerosene and Diesel Fuel Diesel Fuel For Gasoline Gasoline Gas Oil for Transport Power Generation Price a! Tax Price a/ Tax Price a/ Tax Price Tax Price Tax Argentina b/ (0.02) d/ U.S. c/ NA 1.13 NA NA NA India c/ NA NA France c/ NA NA a/ Includes tax. b/ As of May 1, c/ As of December 15, d/ The tax on diesel oil for power generation is negative. Sources: Energy Week, Harcourt Brace Jovanovich, Inc., Dec. 15, 1980 and Price Resolution, May 1, 1981 for Argentina Current petroleum product prices at the consumer level compare favorably with other countries. There is a need, however, to further rationalize the structure of petroleum product prices to induce optimum consumption patterns consistent with the resources available and energy conservation goals. For example, while retail gasoline prices are relatively high, the crude prices are extremely low (US$11.8/bbl) compared to the FOB international price of US$35/barrel. Also, the retail prices of diesel and fuel oil 1/ are low relative both to their current economic value and to other hydrocarbon product prices. The spread in prices between crude and final products do not accrue to the refineries, but are taxed heavily by the Government (taxes range from 6% of retail price for fuel oil to 58% for premium gasoline) and these taxes are used to finance federal and local transport related programs and to compensate crude importers for the difference between international and domestic crude prices The new Government which came into power in Aarch 1981 plans to continue the policy of revising the price of petroleum products periodically to reflect adequately the changes in internal price levels and international petroleum prices. 1/ The domestic fuel oil price in May 1981 was US$126/ton compared to the FOB international price of US$195/ton.

31 In order to ensure a rationalization of petroleum prices, an understal. ing has been reached with the Government that domestic crude oil price paid to YPF will be raised to levels comparable to those of private petroleum companies under risk-sharing contracts negotiated by the Government in 1980, and that domestic price of petroleum products will be maintained, in real terms at least at the May 1, 1981 level. Agreement has also been reached with the Government that ex-refinery product prices will be set at a level that would provide YPF, operating efficiently, with funds sufficient to cover all its costs and expenses before interest, to earn a reasonable return on its revalued net fixed assets in service, and to meet sound financial ratios (paras 7.11 and 7.12). Furthermore, the Government has agreed that the level and inter-product price structure at the consumer level between natural gas and petroleum products will be rationalized following the completion of the Gas Utilization Study (financed under the Oil and Gas Engineering Loan). V. THE PROJECT A. Project Objectives and Scope 5.01 The primary objectives of the Project are to convert Argentina's substantial surplus low-value residual fuel oil to higher-value refinery products in short supply, improve the performance of YPF's major refineries, strengthen the company's financial management system, training of YPF operational staff, and study the potential for energy saving in the industrial sector The proposed Project includes five components: (i) the Refinery Conversion Scheme to convert annually a total of about 4.2 million tons (28 million barrels) of fuel oil from the La Plata and Lujan de Cuyo refineries to about 3.9 million tons (26 million barrels) of higher-value lighter distillates and coke; (ii) a Plant Operations Improvement Program (POIP), with particular emphasis on energy saving and pollution control aspects at the La Plata and Lujan de Cuyo refineries based upon the recommendations made by TOTAL, the French petroleum company; (iii) a Financial Management Improvement Program (FMIP) for YPF, with particular attention to establishment of cost centers, and introduction of systems for cost-control, management information, capital budgeting and financial planning based upon a study carried out by Arthur Andersen & Co.; (iv) a Training Program for YPF, with particular emphasis on the needs of its refinery division; and (v) an Industrial Energy Audit of the major industrial enterprises of Argentina, to determine the scope for energy saving in those units along with the related investment requirements. The component (v) will be carried out with the assistance of consultants under the auspices of the Secretariat of Fuels of the Ministry of Works and Public Service, while the rest of the components will be carried out by YPF with the help of capable and experienced engineering firms for project design, engineering, procurement, and implementation.

32 B. Project Description 1. Refinery Conversion Scheme 5.03 The La Plata Refinery and the Lujan de Cuyo Refinery together account for 79% of YPF's total refinery capacity in its six refineries, and 51% of the total Argentine refining capacity. Individually, the La Plata and Lujan de Cuyo refineries are capable of processing 220,150 bpd and 128,950 bpd of crude oil, respectively. Although both the refineries have secondary processing facilities in the form of coking and fluid catalyticcracking, the respective capacities are relatively small and a large proportion of reduced crude 1/ is directly blended into the fuel oil pool. The Refinery Conversion Scheme is designed to process almost all of the reduced crude at each location into feedstocks for subsequent conversion into light or middle distillates as well as coke in the proposed coking and fluid catalytic cracking (FCC) plants. Coking plants have relatively low investment costs per unit of distillates produced compared to other conversion schemes such as hydro-cracking. Coking plants, however, can only be used if low-sulfur crudes are available, which is the case in Argentina where a large portion of the domestic crude oil has a low-sulfur content Through linear programming, YPF's Technical Department studied a number of configurations for the Refinery Conversion Scheme to optimize the output of both the La Plata and Lujan de Cuyo refineries. These alternatives included several combinations of conversion processes such as catalytic cracking and delayed coking and diasphalting as well as expansion of the existing vacuum distillation capacity. They were then ranked according to their revenue/investment ratios. Subsequently, three alternatives with the highest ratios were investigated in detail from a technical as well as economic point of view to select the basis for a feasibility study. The final project configuration was agreed during appraisal by modifying the one used in the feasibility study. The capacity of the hydrotreater in Lujan de Cuyo was reduced to reflect a higher proportion of low-sulfur crudes in the total feed than originally envisaged. Similarly, the capacity of the vacuum unit in La Plata was marginally reduced due to less than originally anticipated residue from the low-sulfur crude available to La Plata. A fluid catalytic cracker was also added at La Plata in the light of revised projections of fuel oil demand showing a further erosion due to an aggressive program for 11 Reduced crude is the crude fraction obtained after initial distillation of crude petroleum and which can be subjected to vacuum flashing and vacuum distillation.

33 switching over from the use of fuel oil to natural gas in industrial and power plants and consequent need for additional conversion capacity. The final project configuration thus derived is given below: Scope of Refinery Conversion Scheme Capacity (m 3/day) At La Plata Refinery Vacuum Fractionation 5,000 Fluid Catalytic Cracking (FCC) 4,500 Delayed Coking 3,000 Hydrotreating of Light Gas Oil (LGO) 1,100 LPG Merox Treatment 2,383 Gas Separation Unit Of suitable capacity to handle gases from FCC and delayed coker units At Lujan de Cuyo Refinery Fluid Catalytic Cracking (FCC) 3,300 Delayed Coking 3,200 Hydrotreating of LGO 1,900 LPG Merox Treatment 1,410 Gas Separation Unit Of suitable capacity to handle gases from FCC and delayed coker units Concurrently with the implementation of the conversion subproject at La Plata, the Company plans to carry out the following: (i) replacement of two of the old existing coking chambers with a capacity to produce about 123,000 tons per year of acicular coke; (ii) replacement and/or additions of pumps, drives, pipes, fractionators to ensure a sustained sponge coker charge stock capacity of 1,500 m3/day; and (iii) modification of the furnaces in the Topping Units 4 and 5 and improvement in the vacuum system so that the Conversion Scheme, supplemented by the proposed debottlenecking, would enable both refineries to operate close to their design capacity on a sustained basis. 2. Plant Operations Improvement Program 5.05 Based upon the study carried out by TOTAL for La Plata and by a study made by the specialists of Lujan de Cuyo, YPF has prepared a program for plant operations improvements in the La Plata and Lujan de Cuyo refineries. The improvement program will include: (i) energy conservation measures; (ii) pollution control measures; (iii) better maintenance to avoid unnecessary shutdowns; (iv) modernization of instrumentation; (v) improvements in production processes; (vi) better transportation management in relation to the selection and leasing of vehicles for product distribution, contract maintenance, etc.; (vii) introduction of a standard costing system; (viii) establishment of a management planning unit in each refinery; (ix) organizational changes on the lines of refineries in developed countries to increase efficiency of operation; (x) improvement in wage policy to minimize turnover of professionals; and (ix) optimization of process units through a dynamic mathematic model.

34 The implementation of the POIP is being initiated with technical assistance from TOTAL. The total cost of the POIP is estimated at US$113 million. Two important components of the POIP--energy conservation and pollution control subprojects--will be financed out of the proceeds of the proposed loan and the rest will be financed by YPF with its own internally generated funds. The energy conservation and pollution subprojects of POIP are estimated to cost about US$50 million including US$26 million in foreign exchange The Energy Conservation Subproject will include: (i) improvement in the accuracy of instrumentation to locate and minimize leaks; (ii) maximization of the use of flared gas: (iii) maximization of the recovery of LPG--butane and propane; (iv) optimization of the steam balance, loss prevention and condensate recovery; (v) introduction of air preheat and forced drought where necessary to save energy (which would save up to 7% of energy in each refinery); (vi) better combustion control of furnaces and boilers (which would save up to 2% of energy in each refinery); (vii) chemical cleaning of boilers (which would save about 1% of energy in each refinery); and (viii) switch-over from the use of fuel oil to refinery gas wherever possible The Pollution Control Subproject will concentrate on the La Plata Refinery, with particular attention to overcoming the water pollution problem there. (At Lujan de Cuyo, acceptable standards of pollution control have already been adopted.) Measures to be taken to solve the water pollution problem include: (i) direction of all clean water that can be separated from the oily water into side channels: (ii) reduction in the leakage and losses from the cooling water system: (iii) maximization of the use of tank traps for rainwater collection; (iv) improvement in the operation of API separators; and (v) reducing leakages and losses of water before it enters the API separator. As for overcoming the air pollution problem, modification of the existing fixed roof type for storage tanks is needed to prevent substantial losses of hydrocarbons due to thermal variations: and (vi) installation of necessary pollution control equipment. 3. Financial Management Improvement Program 5.09 The program is based on the recommendations of a detailed study of YPF's financial and accounting system completed by Arthur Andersen & Co. in September As noted, the program will initially concentrate on the establishment of cost centers and the introduction of the management information system (para 3.12). Subsequently, the program will emphasize the introduction of medium-term capital budgeting and financial planning. 4. Training Program 5.10 The training program will concentrate on training YPF personnel in modern financial management systems, energy saving and pollution control techniques, better operating and maintenance practices. This program excludes the training of selected personnel in operation and maintenance of the Refinery Conversion Scheme which will be carried out as part of the Scheme in vendor workshops and plants selected by the engineering contractor.

35 Industrial Energy Audit 5.11 The Industrial Energy Audit will examine and recommend the necessary measures to improve efficiency in the use of energy in major industrial undertakings, excluding YPF refineries which have already been studied. Agreement has been reached with the Government that the Bank will be given an opportunity to comment on the recommendations of the Audit and that the recommendations will be implemented expeditiously. C. Raw Materials and Infrastructure 5.12 Main raw materials for the Refinery Conversion Scheme will be: (i) residual fuel oil--about 2.5 million tpy for La Plata and 1.7 million tpy for Lujan de Cuyo--for conversion to higher value distillates, and (ii) refinery gas to replace fuel oil in utilities. The residual fuel oil will be supplied by the existing refineries in those locations. The crude oil supply to the La Plata Refinery is assured from the oilfields at Cuenca Neuquen, Santa Cruz, Chabut and Tierra del Fuego through pipelines and/or shipping. Currently, the La Plata Refinery meets about 90% of its crude oil requirement from local sources and the rest from imports. The import dependence of La Plata is expected to decrease in the future with increased local crude production from the oilfields mentioned above The Lujan de Cuyo Refinery, which relies at present entirely on the oilfields at Mendoza for crude, requires about 20,500 m3/day (128,945 bpd) of crude at full production but is presently getting only 18,500 m3/day (116,365 bpd), 15% less than its requirements, because the oil production in the Mendoza region is going down with the depletion of the known reserves there. The shortfall is expected to increase from the current daily level of 3,000 m3 to 6,200 m3 by 1985 and 13,430 m3 by 1990, unless measures are taken to increase the oil supply to the refinery from more distant oilfields. This requires the building of a 560-km pipeline to connect the refinery to the Neuquen region where substantial proven reserves of low sulfur, high quality crude oil exist. YPF has prepared plans for building this pipeline which is estimated to cost about US$120 million. YPF has carried out a feasibility study for this pipeline and has shown that the construction of this pipeline is the optimal alternative for the supply of oil to the Lujan de Cuyo Refinery as well as for the use of the Neuquen oil. The construction of the pipeline is expected to take two years compared to four years for the Conversion Scheme. Agreement has been reached with the Government and YPF that the facilities for the transport of crude oil from Neuquen to Lujan de Cuyo will be constructed in time for the proposed conversion facility at Lujan de Cuyo.

36 The available primary and secondary reserves of crude oil in the oilfields serving and/or expected to serve the refineries at La Plata and Lujan de Cuyo are given below: Available Crude Oil Reserves by Provinces as of Dec. 31, 1979 (in million bbl) Primary Secondary Total Neuquen Santa Cruz (North) Santa Cruz (South) Chubut Tierra del Fuego Mendoza (North) Mendoza (South) Salta Jujuy 9 9 Rio Negro La Pampa , , The available oil reserves as of December 31, 1979 in Argentina were 2.45 billion barrels which are adequate to meet the needs of the existing refineries at 90% production fot about 12 years. Prospects for further exploration and increased domestic production are considered bright given the large hydrocarbon-bearing areas (estimated at 1.2 million sq km onshore and 0.4 million sq km offshore) and limited exploration in nine of the ten basins (para 2.10). Agreement has been reached with the Government and YPF that adequate arrangements will be made to meet the crude oil requirements of La Plata and Lujan de Cuyo refineries. D. Utilities 1. Lujan de Cuyo Refinery 5.16 Water Supply: The refinery currently receives water from Mendoza river about 2 km away through the Lujan de Cuyo thermal electricity plant. Raw water is passed through a system of decanters and filters. Filtered water is in part demineralized in conventional zeolite system to produce boiler feed water; the rest is used for circulating cooling water makeup, potable water supply (after chlorination) and for firefighting water storage. The main supply system is designed for 860 liters per second and the refinery presently consumes at the rate of only 465 liters per second. The boilerfeed water treatment plant has a total capacity of 660 tons per hour (tph) against the present requirement of maximum 410 tph. Main water supply and boiler-feed water systems have adequate overcapacity to cover the additional requirements of the Conversion Scheme. No major additions to the recirculating cooling water system is envisaged.

37 Steam: Currently, the installed steam generation capacity totals 410 tph. To provide for the incremental steam requirement for the Conversion Scheme of 80 tph and to provide spare capacity, total new generation capacity of 150 tph is planned Electric Power: The refinery receives power supply from the adjacent thermal power station at 13.2 KV and is stepped down to 2.3 KV for supply to high voltage motors and to 415 V and 210 V for other plant prime movers and lighting. These arrangements are adequate In addition to 12 MVA purchased from the thermal power plant, the refinery generates 4 MVA. Incremental requirements of 4 MVA for the Conversion Scheme will be met by additional purchases from the thermal power plant where present generation capacity of 120 MVA is planned to be raised to 360 MVA by Power supply is dependable with very few breakdowns or voltage and frequency fluctuations. 2. La Plata Refinery 5.20 Water Supply: The present facilities include decantation and filtration facilities for 3,610 tph river water, treatment of 660 tph filtered water for boiler water feed and treatment of 100 tph water for potable uses. The facilities will be expanded to initial filtration capacity of 4,260 tph and 860 tph for boiler feedwater treatment Steam and Power Supply: No major additions to steam generation and power generation facilities for the Conversion Scheme are envisaged. E. Project Management and Implementation 5.22 As mentioned, YPF will be responsible for the implementation of all the components of the Project except the Industrial Energy Audit which will be carried out under the auspices of the Secretariat of Fuels of the Ministry of Works and Public Service. For the execution of the Refinery Conversion Scheme, and the Plant Operations Improvement Program, YPF has established a Project Management Unit at its headquarters in Buenos Aires, supplemented by two project teams--one at the La Plata Refinery and the other at the Lujan de Cuyo Refinery. The Financial Management Improvement Program will be executed under the supervision of the Finance Director of YPF with the assistance of Arthur Andersen & Co. The proposed training program will be implemented under the direction of the Training Manager of YPF The Refinery Conversion Scheme, the main component of the Project, will be carried out in two phases. The Phase I includes basic process design and engineering, detailed engineering for critical parts, and preparation of bidding documents. Phase II will include detailed engineering, construction and erection. Separate contractors will carry out Phase I and Phase II to avoid conflict of interest. For Phase I, YPF has selected Foster Wheeler International (FWI), of the U.S., a capable firm with extensive experience in designing and building refinery projects, after following procedures satisfactory to the Bank. FWI has selected Merox process for sulfur removal from LPG, Esso Research (ERE) Process for fluid catalytic cracking and FWI's own technology for delayed coking. These technologies are modern and commercially proven and

38 are acceptable. FWI will also serve as Technical Advisor to YPF during the implementation of the Refinery Conversion Scheme and direct the start-up and commissioning of the Scheme with the help of process and equipment vendors and the engineering contractor. FWI will provide the process guarantees while the engineering contractor will provide the mechanical guarantees for the Scheme. FWI will assign specialists to the office of the engineering contractor to supervise and approve detailed engineering and oversee the procurement work of the contractor. FWI specialists will be supplemented with specialists from YPF in carrying out this task As for Phase II, which includes detailed engineering, procurement of equipment and supplies and construction, YPF considered three alternative approaches to execution: (i) lumpsum turnkey contract restricting bidding to only those prequalified contractors who have local subsidiaries and/or partners; (ii) lump sum turnkey contract with bidding open to all prequalified contractors irrespective of whether they have local subsidiaries and/or partners; and (iii) fixed fee contract for detailed engineering and procurement services, construction and erection, and with equipment to be procured under international competitive bidding (ICB) on a reimbursable basis, with a bonus/penalty clause for timely completion, and with bidding open to all prequalified contractors. After detailed review of the three approaches mentioned, YPF has opted for alternative (iii) which reflects the implementation arrangements normally recommended by the Bank as most cost effective for process industries The Plant Operations Improvement Program which will be implemented under the direct control of the Refinery Division Manager, Mr. Fabiani, with technical assistance from TOTAL, of France, who carried out the study and made recommendations for the improvement of the operations of the La Plata Refinery. TOTAL recommendations for energy saving at La Plata are also applicable to the Lujan de Cuyo Refinery The Financial Management Improvement Program will be carried out under the direction of the Finance Director of YPF with technical assistance from Arthur Andersen & Co. who carried out the financial management study for YPF. The Training Program will be carried out under the direction of the Training Manager of YPF in collaboration with TOTAL and Arthur Andersen. Special attention will be paid to the training of YPF personnel in financial management. As already noted, the Industrial Energy Audit will be carried out with the help of consultants under the auspices of the Secretariat of Fuels.

39 F. Project Schedule 5.27 The implementation schedule for the Refinery Conversion Scheme is given in Annex 5. The contract with FWI was signed by YPF on May 1, 1981 and the process packages and the bidding documents prepared by FWI will be ready for release to potential engineering contractors by September The potential bidders will be allowed six months to bid and the contract with the selected engineering contractor is expected to be signed and become effective by June 1982, the zero date for the Scheme. From the zero date, the Scheme is expected to take 32 months until commissioning. On this basis, the date for commercial production is assumed to be June Implementation of the Plant Operations Improvement Program (POIP) has already been initiated. The two components of this program which have been selected for financing by the Bank, i.e., energy conservation and pollution control components, are expected to be implemented over a four-year period starting from April Implementation of the Financial Management Improvement Program (FMIP) has also started and is scheduled for completion by December The Training Program will be implemented concurrently with the POIP and FMIP. The Industrial Energy Audit will be carried out over a 12-month period starting from September 1981 when the consulting firm for the audit is expected to be selected. G. Staffing and Training 5.29 The Refinery Conversion Scheme is expected to employ at peak of construction about 3,500 people and is estimated to require a permanent staff of 320. The other parts of the Project are not expected to create additional permanent employment as they are mostly improvement and training programs. A number of key personnel have already been selected for project execution. While most of the training of operators and maintenance crews under the Training Program will be carried out in the existing YPF refineries, a limited number of selected personnel will be trained at facilities abroad similar to the arrangements under the Conversion Scheme and in vendors' workshops. This Scheme as well as other components of the Project will also benefit from the comprehensive training program to be financed by the Bank for the YPF Refinery Division as a whole with special attention to operation and maintenance, financial accounting and management. H. Environmental Considerations 5.30 The two sites for the Conversion Scheme differ quite considerably from an environmental aspect. The refinery at Lujan de Cuyo has a very modern plant for the handling of liquid effluents that was completed in 1979 at a cost of US$2.5 million. It involves API separators, flotation, oxidation and biological treatment facilities. Sour water is stripped and neutralized before it enters the treatment system. The effluent that is returned to the Mendoza river meets the Argentinian specification for industrial effluents (National Decree No. 2125/78), which is comparable to Bank recommended standards. The capacity of the treatment facilities will be expanded to handle additional loads consequent upon the Conversion Scheme taking into account the overcapacity presently available in existing facilities.

40 At La Plata there is clearly a liquid effluent problem and the TOTAL report has recommended specific measures to reduce the contaminants to an acceptable level. Those measures are included in the POIP. For the incremental quantities of effluents from the Conversion Scheme, new facilities for treatment to required standards will be created Air pollution at both sites is not a major problem because of the low sulfur content of Argentine crude. However, in this regard as part of the POIP, YPF will investigate the possibility of reduction and control of pollutant emissions at source (stacks, tank farm and process units) to applicable norms and will then take the necessary steps. Assurances have been obtained that both refineries related to the Project will meet satisfactory environmental standards. VI. CAPITAL COST, FINANCING PLAN AND PROCUREMENT A. Capital Cost Estimates 6.01 Total financing required for the Project including the Refinery Conversion Scheme, the Operations Improvement Program, the Financial Management Improvement Program, the Training Program and the Industrial Energy Audit, is estimated at approximately US$878 million equivalent of which US$439 million would be in foreign exchange. The capital cost estimates, details of which are given in Annex 6-1, are summarized in the table on the following page The base cost estimate for the Refinery Conversion Scheme is expressed in May 1981 prices and is derived from estimates made in October 1980 by Foster Wheeler International (FWI) based on data for a similar facility FWI is currently implementing in Spain, having already procured the equipment and bulk of materials. Basic information on the location factor for Argentina was developed by the FWI office in Buenos Aires. Adjustments were made for the differences in soil conditions and the ocean and inland freight costs for the two refinery locations. The cost estimates are based on the assumption that the Government would allow exemption from the Compre Argentino regulations for the Project in line with other Bank-financed projects (e.g., Segba Hydroelectric Project) and no customs duties, value added tax, or consular charges would be payable on equipment and materials imported for the Project. The estimates include (i) a physical contingency of 10%; and (ii) price escalation for foreign costs based on the forecast of international inflation rates in dollar terms of 9% for the last eight months of 1981, 8.5% for 1982 and 7.5% for 1983 and onwards; the same international rates have been used for local equipment and materials assuming that the difference in the domestic and international rates will be accounted for by adjustments in the foreign exchange rate. On civil works and erection, however, in the light of experience in recent years, higher annual increases in dollar terms have been used: 20% for the last eight months of 1981, declining to 8% in 1982 and onwards. Initial working capital requirements for the Project are estimated at US$22.4 million equivalent excluding the cost of spare parts for two years which are included under the equipment and material costs (Annex 6-2).

41 The financing requirements for the Plant Operations Improvement Program are estimated at US$50 million (including US$26 million in foreign exchange) based on estimates prepared by TOTAL. The cost estimates for the Financial Management Improvement Program and the Training Program have been prepared by the Bank in consultation with YPF and Arthur Andersen & Co. The cost of the Industrial Energy Audit has been estimated in consultation with the Secretariat of Fuels. Summary of Capital Cost Estimates a/ I. Refinery Conversion Scheme $a Billion US$ Million Local Foreign Total Local Foreign Total % Engineering and Licenses Equipment and Materials b/ Erection Civil Works Construction Supervision Start Up c/ Base Cost Estimate (BCE) , Physical Contingencies (10% of BCE) Price Escalation Installed Cost 1, , , Working Capital Interest During Const Total for Conv. Scheme 1, , , II. Plant Operations Improvement Program III. Financial Management Improvement Program IV. Training Program V. Industrial Energy Audit VI. Total Financing Required 1, , , a/ The costs expressed in $a have been calculated from the US$ cost using an exchange rate of $a 3,190 = US$1.00 as of May 1, b/ Includes spare parts, freight and insurance, port handling and other charges. c/ Includes costs of training in vendor workshops.

42 B. Financing Plan 6.04 The financing plan for the Project agreed with the Government and YPF is shown below: Project: Financing Plan US$ Million Total _ I. Debt II. Equity IBRD: - YPF Government a/ Foreign Commercial Sources Sub-total Internally Generated Funds/Government b/ 29.3 III. Total a/ For the Industrial Energy Audit. b/ Including US$0.2 million equivalent for the Industrial Energy Audit The Project is expected to be financed on a 71/29 debt/equity ratio. The proposed Bank loan of US$200 million will cover nearly 23% of the total costs. YPF will borrow an additional US$421 million equivalent by way of export credits and commercial bank loans from foreign sources. YPF has received offers from a number of international merchant and commercial banks for arranging necessary funds. The commercial loans are expected to be made under cofinancing arrangements with the Bank loan Of the Bank loan of US$200 million, US$198 million is proposed to be extended to YPF and US$2 million to the Government (for the Industrial Energy Audit) for 14 years including three and one-half years of grace at the prevailing rate of interest. An interest equalization fee of 10% of the

43 Bank lending rate on top of the Bank's standard lending rate will be charged to YPF. The Government will bear the cross exchange risk between the currencies disbursed by the Bank and the US dollar. YPF will bear the exchange risk between the US dollar and Argentine peso. Of the additional external financing of US$421 million for the Project, about 35% is likely to be in export credits and the rest in commercial bank loans. Export credits are expected to be for 14 years at 8.5% interest per annum, with the repayment of principal to begin six months after the forecast start-up of the Project. The down payment of 15% on export credits will be met from commercial loans. Commercial loans will also cover all other financing requirements not covered by the Bank, export credits and equity. It is assumed that these commercial loans would be for eight years with interest about 7/8% above LIBOR which is assumed to average 14% during the implementation period of the Project On the basis of the financing plan given above, the Project will require about US$257 million equivalent from internally generated funds of YPF or government funds. The financial projections indicate that YPF should be able to generate these funds during the project implementation period. However, because of the Government's substantial influence on the prices of petroleum products and to ensure availability of necessary resources to complete the Project, assurances have been received from the Government that it will meet any shortfall in funds to finance the Project. C. Procurement 6.08 The engineering contractor selected will be responsible for procurement of equipment. With its help YPF will prepare a list of goods and services for financing with export credits under competitive bidding by countries providing such credits. The rest of the items will be procured under the international competitive bidding (ICB) procedures of the Bank except for: (i) items costing less than US$100,000 equivalent each, not exceeding the aggregate amount of US$4 million, which will be procured by international shopping subject to the prior approval by the Bank of the list of items involved; and (ii) agreed proprietary and process and time critical items, whose aggregate cost is estimated not to exceed US$20 million, which will also be procured through international shopping. A preference of 15% or the customs duty, whichever is lower, will be allowed to qualified local manufacturers bidding under the ICB procedures. Construction and civil works will be bid competitively as part of the main engineering contract under consortium arrangements. D. Allocation and Disbursement of Bank Loan 6.09 The final make-up of the items for Bank financing will be determined by the supply capacity and price competitiveness of the potential export credit sources, and the final recommendations of the engineering contractor. ;entative allocation of the Bank loan is given below:

44 Allocation of Bank Loan Amount Application a/ (US$ million) I. Refinery Conversion Scheme - Engineering and Licenses % of foreign expenditures - Equipment, Materials & Spares % of foreign expenditures and 100% of local expenditures - Construction & Erection % of foreign and local expenditures II. Plant Operation Improvement Program Equipment, Materials & Spares % of foreign expenditures and 100% of local expenditures III. Financial Management Improvement Program % IV. Training Program % V. Industrial Energy Audit % VI. Unallocated 7.0 Total a! For foreign expenditures 100% of c.i.f. value and for local expenditures 100% of ex-factory value. Except for the Engineering and Licences category, both foreign and local expenditures will be eligible for Bank financing About 30% of the Bank loan is expected to be disbursed against local currency expenditures. The Bank loan would be used to finance the FWI contract and part of the main engineering contract including local currency costs. Retroactive financing of US$8 million is envisaged to meet expenditures incurred from May 1, 1981, by way of initial payments on: (i) the FWI contract (which became effective May 1, 1981) to have Bank participation in this crucial contract for basic engineering; and (ii) on the Plant Operations Improvement Program which is already underway. The Bank loan is expected to be disbursed fully by June 30, 1985, according to the schedule presented in Annex 6-3. Any surplus funds remaining in the loan account after project completion will be cancelled. VII. FINANCIAL ANALYSIS A. Production and Production Costs 7.01 The financial analysis of the Project is done in current terms in US$ and the major assumptions are detailed in Annex 7-1. This analysis considers only the results of the conversion facilities to be installed under the Project. For preparing the financial analysis of the Refinery Division, the financial performance of the Project is consolidated with the existing operations, including present facilities at the La Plata and Lujan de Cuyo refineries.

45 It is assumed that the Project will start commercial production on June 1, 1985 with capacity utilization increasing gradually from 60% in the first year of operation to 80% in the second and 95% in the third and subsequent years. Because of the Company's experience in operating its existing facilities at high capacity and the provision for training under the Project, the attainment of 95% capacity utilization from the third year of operation is considered realistic Fuel oil is the major input for the Project. At 95% operation, it will convert about 4.2 million tpy of fuel oil--2.5 million tons from the La Plata Refinery and 1.7 million tpy from the Lujan de Cuyo Refinery--into approximately 3.9 million tpy of higher-value petroleum products such as gasoline, gas oil and diesel oil, LPG, kerosene and coke. In addition, it will produce 224,500 tons of refinery gas as a by-product, a large part of which will be used internally to replace fuel oil in the production of utilities and the surplus would be supplied to the nearby power plants. The price of fuel oil as well as of other petroleum products is fixed by the Government. As of May 1, 1981, the local fuel oil prices per ton were equivalent to US$90 ex-refinery and US$126 retail. Labor costs are based on prevailing salary scales in YPF refineries. Utility costs are based on prevailing unit rates in Argentina. Maintenance and insurance costs are estimated at 4% and 1.5%, respectively, of the total capital investments on machinery, building and civil works, and construction and erection. Depreciation is calculated on a straight-line basis on the assumed 12-year life of the Project. General and administrative costs are assumed to be one-third of the payroll cost The following table (derived from Annex 7-2) shows the annual production costs of the Project at 95% capacity utilization: Project: Annual Production Costs at 95% Capacity Utilization (in May 1981 terms) US$ million Percentage (%) Fuel Oil Catalysts and Chemicals Utilities Maintenance Materials Payroll Depreciation Financial Charges Insurance General and Administrative At 95% capacity utilization, the principal input, fuel oil, is expected to account for 67% of the production costs (including depreciation and financial charges). Depreciation and financial charges represent only 24% of the total, reflecting low investment cost per unit of output of the Project compared to a grassroot refinery.

46 B. Revenues 7.05 As noted, Argentine ex-refinery prices as well as retail prices for petroleum products are controlled by the Government, which, during January 1980-March 1981, increased those prices at an average monthly rate of 1.8% in real terms above the non-agricultural whole-sale prices. 1/ This helped check the deterioration in real prices in the face of high inflation (85% in 1980) and achieve a real increase of 2% over the consumer price index in The current Government policy of granting price increases to public sector undertakings aims at compensating them for the real increases in their cost of production and encourage them to cut production costs by increasing their efficiency of operation. To achieve this, the Government follows the nonagricultural price index, not the consumer price index, as the representative index for price adjustment. Further, the Government is committed to set ex-refinery product prices at a level that would allow YPF to cover all its costs and expenses before interest, and to earn a reasonable rate of return on its revalued net fixed assets in operation. Revenue projections for the Project and YPF's Refinery Division are based on this new pricing policy.2/ C. Financial Projections for the Project 7.06 Financial projections for the Project based on the above assumptions are given in Annex 7-3, and summarized below: Project: Summary of Financial Projections (in current US$ million) Year Ending Dec Sales Volume ('000 tons) 1,386 2,851 3,514 3,762 Sales Revenue ,127 Production Costs Net Profit After Tax Depreciation Cash Generation Net Profit/Sales (%) Return on Revalued Net Fixed Assets (%) Debt Service Coverage (Times) / In 1980, the non-agricultural wholesale prices increased by 60%, while the consumer prices increased by 85%. 2/ Using 10% as a reasonable rate of return on revalued fixed assets in operation.

47 Total revenues of the Project are expected to increase froni US$386 million in 1985 to US$920 million in 1987 when the maximum capacity utilization (i.e., 95%) is expected to be reached. The Project is expected to show profits from the first year of operation; and the return on sales is expected to average around 10.5%. The Project is expected to generate adequate cash to more than meet its debt service obligations. D. Financial Rate of Return and Sensitivity Analysis 7.08 The cost and benefit streams for the financial internal rate of return (IRR) are shown in Annex 7-4. The return is satisfacctory at 24.6% before tax and 17.2% after tax. The financial rate of return is sensitive to changes in refinery product prices, operating costs and changes in the level of capacity utilization. The following table shows the results of the sensitivity analysis on the financial rate of return: Financial Rate of Return Before Tax 1. Base Case Capital Costs up 20% Operating Costs up 20% Revenues down 20% Attainment of only 75% capacity utilization Combination of delay of one year, (2) and (5) 17.1 E. Analysis of YPF Refinery Division with the Project 7.09 Details of consolidated financial projection for the YPF Refinery Division with the Project are given in Annex 7-5 to 7-7 and summarized below:

48 Summary of Financial Data for YPF Refinery Division with Project (in current US$ million) Year Ending Dec Income and Cash Flow Net Sales 2, , , , , ,271.5 Variable Costs 2, , , , , ,890.7 Fixed Costs Depreciation Interest Net Profit After Tax (PAT) Gash Generation Balance Sheet Items Current Assets , ,097.6 Surplus Cash (Deficit) ,251.3 Current Liabilities Net Fixed Assets 1, , , , , ,138.8 Long-Term Debt Equity a! 1, , , , , ,880.2 Ratios PAT/Net Sales (%) PAT/Net Fixed Assets (%) PAT/Equity a! (%) Current Ratio 1.0:1 1.3:1 1.4:1 1.9:1 2.1:1 2.4:1 Quick Ratio 0.3:1 0.4:1 0.6:1 1.0:1 1.2:1 1.5:1 Debt/Equity Ratio 14/86 11/89 17/83 21/79 18/82 15/85 Debt Service Coverage (times) a! Net of revaluation surplus. Sales of the Refinery Division are expected to increase sharply from 1985 due primarily to the commissioning of the Project. The share of the Project in total sales revenue is expected to increase from 15% in 1985 to 23% in 1987 with the production build-up in the Project. The debt/equity ratio of the Refinery Division reaches 21/79 in 1985 and declines subsequently to 15/85 in 1987, with repayment of debt and increased retained earnings, provided no further expansion is undertaken The projections show that the quick ratio would be low at 0.3:1 if surplus cash which builds up impressively is excluded from the ratio calculation. Therefore, YPF and the Government (the shareholder) would need to allocate sufficient funds from surplus cash to current assets to maintain the quick ratio at least 0.6:1. Should the anticipated surplus cash fail to materialize, YPF and the Government will have to provide necessary funds to help YPF maintain a quick ratio at that level (para 7.12). Even after allocation of surplus cash to current assets, there would be, according to the

49 projections, excess funds which are expected to be used by YPF to finance part of investments on oil exploration and production. Should there be surplus even after this, it is expected to be partly distributed as dividends to the Government and partly retained in the Company for future investments. F. Financial Covenants for the Company 7.11 Financial statements for the Company show a satisfactory debt/equity ratio (42/58 at the end of 1980) but the ability of the Company to generate cash to firnance large new investments in oil exploration and production are limited, particularly because of inadequate crude oil prices. As noted, an understanding has been reached with the Government that domestic crude oil prices paid to YPF will be raised to levels comparable to those paid to private petroleum companies under risk sharing contracts negotiated by the Government in 1980 and that domestic price of petroleum products will be maintained, in real terms at May 1, 1981 levels using the non-agricultural wholesale price index for periodic adjustment of retail prices. Agreement has also been reached with the Government that ex-refinery product prices will be set at levels that will provide YPF, operating efficiently, with funds sufficient to cover all its costs and expenses before interest, to earn a reasonable return on its revalued net fixed assets in service, and to meet sound financial ratios (para 7.12), and that inter-product price levels and natural gas prices will be rationalized following the completion of the Gas Utilization Study As of the end of 1980, the quick ratio of YPF was 0.7:1. With this ratio, the Company was able to function because of its current practice of collecting sales and related taxes and using them as working capital for about five weeks (as officially allowed) before paying them to the Government. Agreement has been reached with the Government and the Company that YPF will maintain at all times a quick ratio of at least 0.6 to 1. Further, the following agreements have been reached with YPF and the Government: the Company will (i) not incur any long-term and/or roll-over short-term debt, if, after incurring such debt, the debt/equity ratio of the Company will exceed 60/40; (ii) maintain a projected debt service coverage of at least 1.4 times; and (iii) not, without prior Bank consent, declare dividends or make any other cash distributions if, after such payments, the quick ratio falls below 0.8 to 1. Currently, YPF prepares financial projections for the Company for three months. To facilitate sound financial planning and capital budgeting, the Company will prepare and submit to the Bank 12-month financial projections within four months of the end of every fiscal year. It was agreed that the system will be introduced by YPF by 1982 with the first such projection due by end of April 1983 (para. 3.18). G. Auditing and Reporting Requirements 7.13 The Company's accounts are audited by the Sindicatura General de Empresas Publicas, a Government auditing agency. Three officials of the Sindicatura are assigned to YPF who attend Board meetings and have the authority to call special meetings of the Board if there are any serious issues. YPF will submit to the Bank audited annual financial reports within six months of the end of each fiscal year and will give prompt attention to audit recommendations. The audit reports will contain comments by the auditors whether the covenants in the Loan Agreement for the new Refinery Conversion Scheme are complied with. In addition to the annual audit reports, the Company will submit quarterly financial statements within 75 days after the end of each quarter and until Project Completion monthly project progress and procurement status reports in the format and scope agreed with the Bank. Finally, within

50 four months after the Closing Date of the Project, the Company will prepare and furnish to the Bank a Completion Report on the Project dealing with its implementation, initial operation, and the costs and benefits derived and expected to be derived. H. Major Risks 7.14 Risks associated with project technology, start-up and operations are moderate, as the Project is based on commercially proven technology, and adequate arrangements have been made under the Project for training personnel for operation and maintenance. However, commissioning problems and difficulties in attaining and maintaining a high operating rate cannot be ruled out. Considering the involvement of capable and experienced engineering and operating firms in the design, engineering, construction, erection commissioning and operations of the Project and the Company's experience in operating the existing refineries at high capacity, the risk of abnormal problems, shut-downs and low operating rate is not, however, considered serious The main risks associated with the Project concern potential delays in implementation, particularly civil works, and inadequate cost controls due to shortcomings in financial management. However, these risks have been reduced by: strenghtening the Project Team with technical advisory services from FWI during the entire period of project development, implementation and initial operation; involving capable and experienced firms for project design, engineering and implementation; prequalifying local construction firms with particular attention to their past performance in Argentina; and introducing cost control systems with the help of Arthur Andersen & Co. Further, the project management aspect will be continuously monitored by the Bank during project implementation No significant commercial risk is foreseen. Even on the basis of conservative market forecasts, the production capacity of the Project falls short of the expected demand except for sponge and acicular coke. YPF has already entered into a long-term contract with Great Lakes Carbon, of the U.S., to sell 250,000 tons per year of sponge coke. An additional 178,500 tons of sponge coke as well as 123,000 tons of acicular coke are likely to be available annually for exports at 95% operation. As demand for sponge and acicular coke is growing in the world because of the expansion of steel and aluminum production, no major problem is foreseen in exporting them The financing plan assumes that about US$257.4 million equivalent (29% of the total financing required) will come from internally generated funds of YPF; the ability to do so, however, depends on the Government allowing YPF prices adequate to earn a reasonable return on investment at efficient production. Measures have already been taken by the Government toward this objective. Should the internally generated funds fall short of the requirements, the Government will meet the deficit by injecting the necessary funds by way of additional share capital An external risk facing the Project is that it depends on the timely completion of a complementary project--a crude oil pipeline--which is critical to ensure adequate supply of crude oil to the Lujan de Cuyo Refinery. To diminish this risk, assurances have been received from the Government that the facilities for transporting crude oil from Neuquen to Lujan de Cuyo will be completed in time for the Project.

51 VIII. ECONOMIC ANALYSIS A. Economic Justification 8.01 YPF has six refineries of which only three, La Plata, Lujan de Cuyo and San Lorenzo have conversion facilities so far. About 40% of the product mix of the La Plata Refinery and 25% of that of Lujan de Cuyo are residual fuel oil. In 1979 the La Plata and Lujan de Cuyo accounted for 38.4 million barrels (5 million tons) of residual fuel oil--about 68% of the total for the country in that year. The Refinery Conversion Scheme is designed to convert the surplus low-value residual fuel oil into higher-value lighter refinery products such as gasoline, jet fuel, gas oil and diesel oil. Currently, Argentina is surplus in residual fuel oil but deficit in lighter refinery products. The Conversion Scheme would help reduce the need for imports of lighter products by helping YPF achieve a better balance in the product mix in the two refineries. B. World Petroleum Prices 8.02 A review of long-term inter-product prices for refinery products in the world shows the following approximate relationship assuming the crude oil price as 100: Gas, 137; motor gasoline (96 RON), 150; kerosene, 140; jet fuel, LPG, gas oil and diesel, 133; and fuel oil, 74. By applying the above indices to the mid-1980 crude oil price of US$257/ton (US$35/bbl), the following refinery product prices and derived: Estimated Prices Per Ton of Selected Refinery Products (May 1981 US$ in real terms) Gas 352 LPG 342 Gasoline (Premium) 385 Gasoline (Regular) 373 a/ Kerosene and Jet Fuel 360 Gas Oil and Diesel Fuel 342 Fuel Oil 190 a/ Assumed at 97% of the premium gasoline price. The above prices have been used for the economic rate of return calculation. However, the actual prices of petroleum products may periodically vary from these general relationships because of periodic distortions in the supply and demand for particular petroleum products.

52 C. Transportation Savings 8.03 At full production of the Project, Argentina would overcome the need for importing about 3.9 million tons of light petroleum products per year, thus saving the country about US$119 milion (calculated on the basis of US$30/ton savings in freight, port handling and inland transportation differential). In addition, the Project would avoid the need to transport about 1.7 million tons of fuel oil from Lujan de Cuyo to Buenos Aires for export. This would save annually another US$26 million equivalent in fuel oil transportation cost (assuming it costs US$15/ton for transporting fuel oil from Lujan de Cuyo to Buenos Aires). Thus the gross annual transportation savings to Argentina because-of the Project would be US$145 million. D. Economic Rate of Return 8.04 Detailed assumptions used in the economic rate of return calculations are shown in Annexes 8-1 and 8-2. The benefit stream is based on the price and transport cost savings assumptions discussed above (para 8.03). Operating costs have been derived by making appropriate adjustment to the financial costs to reflect the opportunity costs of the inputs; no shadow pricing is used for labor cost as the Project will employ mostly skilled employees. Transfer payments such as taxes and financial charges have been excluded. Based on the assumptions outlined above and assuming a 12-year life for the Project, the economic rate of return of the Project is estimated at 48%. Sensitivity tests carried out on the economic rate of return show the following results: Argentina - Sensitivity Tests on Economic Rate of Return Assumptions Rate of Return (%) 1. Base Case Capital Costs up 10% Capital Costs up 20% Operating Costs up 10% Operating Costs up 20% Benefits down 10% Benefits down 20% One-Year Project Delay Attainment of only 85% Capacity Utilization Attainment of only 75% Capacity Utilization Combination of (3) and (8) Combination of (3), (8) and (10) 39.5 As shown in the above table, the economic rate of return is sensitive to changes in refinery product prices, capital and operating costs, delays in construction, and capacity utilization. A 20% drop in revenue would reduce the return to 34%. A one-year delay in the Project combined with a 20% capital cost increase and the ultimate attainment of only 75% capacity utilization (as against 95% assumed) would reduce the return to 40%. Therefore, even under conceivable adverse conditions, the Project still yields an attractive economic rate of return.

53 E. Foreign Exchange Benefits 8.05 In 1981 terms, the net foreign exchange outflow due to the Refinery Conversion Scheme during the construction period ( ) would be about US$74 million. However, the net outflow turns into a significant net foreign exchange savings of about US$156 million in 1985, with the expected start-up of the Scheme in June The annual net savings would rise to US$722 million in 1987 as the Scheme attains 95% capacity utilization. The net savings would steadily increase further as the debt service obligation declines over the years. F. Other Economic Benefits 8.06 Operations of the existing YPF refineries at La Plata and Lujan de Cuyo are expected to be improved as a result of the Plant Operations Improvement Program prepared and to be implemented with the help of TOTAL of France. The management and organization of YPF will be streamlined with the implementation of the Financial Management Improvement Program prepared by Arthur Andersen. Further, as a part of an institution-building effort, YPF staff will be trained in modern practices of refinery operation and maintenance, accounting and financial management. Finally, the efforts of the Government for energy conservation will be accelerated through a study on energy conservation prospects in the petrochemical and other industrial sectors. Based upon the study, an energy conservation program for the industrial sector will be developed and implemented. IX. AGREEMENTS 9.01 The following major agreements have been reached: A. From the Government that it will: (i) prepare a program for implementing the recommendations of the Industrial Energy Audit by December 31, 1982 (paras 2.18 and 5.11); (ii) take measures to ensure that the ex-refinery prices of YPF's products are adequate to provide YPF, operating efficiently, with funds sufficient to cover all its costs and expenses before interest, to earn a reasonable return on its revalued net fixed assets in service and to meet sound financial ratios (paras 3.17, 4.21, 7.11 and 7.12); and (iii) meet any shortfall in funds to finance the Project (para 6.07).

54 B. From the Government and the Company that they will: (i) exchange views periodically with the Bank on the plans for expanding the refinery capacity in Argentina (para 4.10); (ii) expand the transport capacity of the product pipeline for the Lujan de Cuyo refinery in time for the Conversion Scheme (para 4.13); (iii) finalize the marketing improvement plan by March 31, 1982 and carry out the plan by June 30, 1985 (para 4.17); (iv) construct in time for the proposed conversion facility at Lujan de Cuyo refinery the facilities for the transport of crude oil from Neuquen (para 5.13); (v) make adequate arrangements to meet the crude oil requirements of La Plata and Lujan de Cuyo refineries (para 5.15); (vi) ensure that both refineries related to the Project will meet satisfactory environmental standards (para 5.32); and (vii) ensure that YPF will follow prudent financial practices and abide by the financial, auditing and reporting covenants, as enumerated in paras 7.11, 7.12, and 7.13) Based on the above agreements reached, the Project is considered suitable for a Bank loan of US$200 million equivalent on terms discussed in para Industrial Projects Department June 15, 1981

55 ARGENTINA: YPF REFINERY CONVERSION PRoJECT COMPANY'S HISTORICAL INCOME STATEMENTS -/ (in US$ Million)b/ 8/01/77 to 6/30/78 7/01/78 to 12/31/ Unadjusted Adjusted Unadjusted Adjusted Unadjusted Adiust Unadjusted Adilusted Gross Sales 2, , , , , , , ,571.2 Discounts Taxes , , _108.7 Net Sales 1, , , , , , , ,173.6 Cost of Goods Sold 1, , , , , , , ,908.5 Gross Profit , ,265.1 Administrative Expenses Marketing Expenses Financial Charges , , Other Income c/ Adjustment for Previous Year (52.1) (20.7) (27.6) Revaluation Gain Special Tax d/ Income Tax Net Profit (944.5) (386.1) (1,264.3) (1,259.3) a/ Adjusted column refers to accounts after revaluation. b/ Average exchange rates used for conversion into US$: Aug June 1978, $a 598; July - Dec. 1978, $a 878; Jan - Dec. 1979, $a 1,317; Jan - Dec. 1980, $a 1,837. c/ Including income from other sales of products and services. d/ Was abolished in Industrial Projects Department M- 1981

56 ANNEX 3-2 ARGENTINA: YPF REFINERY CONVERSION PROJECT COMPANY'S HISTORICAL BALANCE SHEETS-/ (in US$ million) b/ June 30, 1978s/ December December December ASSETS Unadiusted Unadiusted Adiusted Unadjusted Adjusted Unadjusted Adiusted Current Assets Cash and Bank Accounts Receivables Inventories Other Sub-total , , , ,628.8 Long-term Receivables Gross Fixed Assets 2, , , , , , ,069.6 Acc. Depreciation , ,245.0 Net Fixed Assets 2, , , , , , ,824.6 Investments Deferred Charges TOTAL ASSETS 3,220 _,,, & o. LIABILITIES Current Liabilities Trade Pavables , Other ' 48.0 Sub-total 1, , , , ,427.9 ono-current Liabilities (Bank Payables) , , , ,272.2 Long-term Debt Suppliers' Credit Local Foreign other Sub-total , , , ,600.7 Equity Share Capital , , ,261.6 Reserves 1, , , , Retained Earnings (1,341.0) (1,367.2) (138.8) (2,175.9) Revaluation Surplus _-_- Sub-total , , , , , ,261.6 TOTAL LIABILITIES & EQUITY, L WAL29 7 L23 L. L6.2 Current Ratio 0.7:1 0.8:1 1.0:1 1.1:1 1.3: :1 Quick Ratio 0.6:1 0.6:1 0.7:1 0.8:1 0.8:1 0.6,1 0.7:1 L/T Debt/Equity Ratio 55/45 43/57 31/ / t77 Debt d/ /Equity Ratio 74/26 62/38 48/52 68/32 46/ /58 a/ Adjusted column refers to accounts after revaluation. bt Average exchange rates used for conversion into US$: June 1978, $a 598; Dec. 1978, $a 878; Dec. 1979, $a 1,317; Dec. 1980, $a 1,837. c/ Balance sheet adjusted for inflation not available for this period. dt Including bank payables rolled over and reclassified as long-term debt. Industrial Projects Department May 1981

57 ARGENTINA - YPF REFINERIES CONVERSION PROJECT PROJECT IMPLEMENTATION SCHEDULE al Basl. EnWine-ring and Detailed Engineering of; Critical Items Pr-wluaiification of Phase 11 Contracors_ Bldding nf Phas- II C-nlrac-or_ Evaluation and Negotiaions Towers and Vessels Furnacas k Rochangers _ An Air Coolers Pumps - Compressors Piping - Instruments Electrical -. - C-ii Works Start Up and Commissioning Issue Enquiry and Order _villw~ _ C_ Dehvcry World Bank a/ Starting from May 1, 1981

58 ANNEX 6-1 ARGENTINA - YPF REFINERY CONVERSION PROJECT CAPITAL COST ESTIMATE $a Billion USS Million - Indirect Indirect Foreign Local Foreign Local Exchange Component Exchange Component Direct Component of of Local Direct Component of of Local Imports Local Purchases Purchases Total Imports Local Purchases Purchases Total Refinery Conversion Scheme 1. Equipment and Spares Vacuum Unit Fluid Catalytic Crackers Delayed Cokers Gas Recovery Hydro desulfurization Amine Treatment Herox Offsites Spares Subtotal Ocean Freight and Insurance 3. Inland Freight and Handling Engineering Services and Royalties Basic Engineering Detailed Eng. of Criti.al Items Detailed Engineering Royalties Subtotal Erection Civil Works 4Q ConbtLuctioni Supervision Start UIp Costs Base Cost Estimate (BCE) , (In Oct prices) Physical Contingencies (t0% of BCE) Price Escalation Installed Cost , , Working Capital Interest During Construction b/ Total For Conversion , , Scheme Plant Operation Improv. Program Financial Management Improv. Program Training Program Industrial Energy Audit Total Financing Required , , a/ Price escalation for foreign costs is based on the forecast of international inflation rates in dollar terms of 9% for , 8% for 1982, and 7% for 1983 onwards. The same international rates have been used for local equipment. On civil works and erection the following higher local rates of inflation in dollar terms have been used of 20% for declining to 8% in 1982 and onwards. b/ Assuming a 65:35 debt to equity ratio and capitalization of interest up to June Industrial Projects Department May 1981

59 ANNEX 6-2 ARGENTINA: YPF REFINERY CONVERSION PROJECT WORKING CAPITAL REQUIREMENTS I. Current Assets A. Accounts Receivable Million US$ 30 days of credit sales 10.3 B. Raw Material Inventory ( i) Local ( 7-day requirements) 9.1 (ii) Imported (120-day requirements) 0.3 C. Goods in Process Inventory 1 day of variable production costs 1.4 D. Finished Goods Inventory 6 days of cost of production 9.9 E. Operating Cash 7 days of cost of production 11.5 II. Current Liabilities Total Current Assets 42.5 F. Accounts Payable 30 days of suppliers' credits 27.1 Working Capital Requirements 15.4 Working Capital Requirements Escalated to 1985 Dollars 22.4 Industrial Projects Department May 1981

60 ANNEX 6-3 ARGENTINA - YPF REFINERY CONVERSION PROJECT ESTIMATED DISBURSEMENT SCHEDULE FOR BANK LOAN (US$ Million) Bank Fiscal Year and Quarter Disbursement Cumulative Undisbursed Amount 1982 II III IV I II III IV I II III IV I II III Industrial Projects Department May 1981

61 ANNEX 7-1 ARGENTINA: REFINERY CONVERSION PROJECT ASSUMPTIONS USED IN FINANCIAL ANALYSIS A. Financial Projections 1. The Argentine economy is characterized by high inflation. In this context, in order to reflect a reasonably accurate picture of YPF's financial obligation, cash generation and liquidity situation, the financial projections are made in current US$ terms. The output prices as well as production costs in current terms are projected to increase at an average rate of 9% in 1981, 8.5% in 1982, 7.5% during , and 6% in 1985 and onwards. B. Inflation Accounting 2. Early in 1975, the Argentine Institute of Public Accountants issued a decree 1/ to regulate the use of monetary and non-monetary correction factors in the financial statement of public and private companies. This decree called for (i) the restatement of all operating costs and revenues of the current accounting year according to an index based on the level of inflation at the close of the year; (ii) revaluation of all non-monetary assets and liabilities according to an index based on the level of inflation at the close of the accounting year, and (iii) adjustment of all liabilities in foreign currencies based on the actual exchange rates at the close of the year. 3 For the purpose of the financial projections, (i) above was applied with the exception that instead of the domestic monetary correction factor, the international inflation rate was applied as indexing factor. All revenues and expenses were calculated in terms of constant May 1981 dollars and then inflated to current US dollars. The computation of the indexed values of fixed assets, as required by (ii) above, was done by accumulating the yearly amounts and then inflating these accumulated amounts by the same indexing factor used for revenues and expenses (i.e., international price inflation rate). The difference between the indexed and yearly amounts was then credited as revaluation surplus. Since the financial projections are expressed in current US$, adjustments as mentioned under (iii) above reflecting increases in interest charges and principal repayments for foreign loans due to changes in exchange rate, are not applicable. 1/ Opinion No. 2, Argentine Technical Institute of Public Accountants

62 ANNEX 7-1 Page 2 C. Product Mix 4. The Project is assumed to start commercial operations June 1, 1985, with a production build-up of 60%, 80% and 95% of capacity for the first, second, and third operating years, respectively. The product mix at 95% capacity utilization would be as follows: Product Mix at 95% Capacity Utilization (in '000 tons per year) La Plata Lujan de Total Refinery Cuyo Refinery Project Premium Gasoline ,197.0 Regular Gasoline Kerosene Gas and Diesel Oil Refinery Gas LPG Acicular Coke Sponge Coke Total Production 2, , ,761.5 D. Product Prices 5. During , local selling prices of petroleum products set by the Government declined in real terms. As a result, average selling price in 1979 in real terms was about 20% lower than that in To improve the situation, the Government, in January 1980, decided to increase selling prices of petroleum products by an average of 1.8% per month in real terms over and above the increase in wholesale prices of non-agricultural products. This program of price increases was continued until the end of March 1981 when the new Government came into power. The new Government has agreed to maintain retail prices in real terms at May 1, 1981 levels. Further, it has agreed to ensure that, at efficient operation, YPF will get adequate funds to meet all its costs and expenses before interest, earn a reasonable return (about 10% by 1983) on revalued net fixed assets in operation, and meet sound financial ratios. The revenue projections are based on the assumption that ex-refinery prices will be increased gradually in real terms from the May 1, 1981 level to allow, by 1983, a 10% rate of return on revalued net fixed assets. E. Production Costs 6 Financial production costs are detailed in Annex 7-2. Economic costs are also shown for comparison. Requirements for raw materials and utilities were estimated by YPF's engineering staff and Foster Wheeler and verified by the Bank based on the experience of existing plants elsewhere of similar size and processes.

63 ANNEX 7-1 Page 3 7. Incremental labor requirements were estimated by YPF. Average annual salary per person based upon the present pay level within Argentina's refinery industry is about US$10,000. Annual insurance and maintenance expenses are estimated at 1% and 4%, respectively, of the total capital investments in equipment, machinery, erection, construction, building and civil works. General and administrative expenses are estimated at about one third of payroll cost. Depreciation of fixed assets is computed on a straight-line basis using an economic project life of 12 years. F. Interest Charges 8. The assumptions used for calculating debt service for the Project are given below: Amount (US$ million) Terms IBRD % p.a.; 14 years, including 3 1/2 years' grace period. Commercial Bank and 421 -/ 14% p.a., 8 years. 4 years' grace Export Credits for commercial bank loans; 8.5%, 14 years, 3 1/2 years' grace for export credits. G. Income Taxes 9. In the past, contributions to the Government had been fixed by the Government annually as a percentage rate of YPF's operating and investment costs. This percentage rate had been variable, and, in 1979, it ammounted to about 14%. From January 1, 1980, however, YPF is subject to a corporate income tax of 33%. H. Financial Return 10. Annex 7-4 gives a breakdown of the financial costs and benefits of the Project. The results of sensitivity tests are given in para of the main text. The financial rates of return of the Project are 24.6% before taxes and 17.2% after taxes. Including US$175 million for the Refinery Conversion Scheme and the rest for the other components of the Project. 2/ Including US$405 million for the Refinery Conversion Scheme and the rest for the other components of the Project.

64 ARGENTINA - REFINERY CONVERSION PROJECT PROJECT BENEFITS AT 100% CAPACITY (in May 1981 terms) Annual Production ('000 Tons) Unit Price Project Benefits Lujan de Economic Financial Economic Financial La Plata Cuyo Total (US$) ('000 $a) (mil US$) (bil $a) Revenues Refinery Gas LPG Premium Gasoline , Regular Gasoline Kerosene Gas & Diesel Oil Acicular Coke Sponge Coke Total Revenues 1, Add: Transportation Savings a) Freight, Port Handling and Inland Transportation Charges on Erstwhile Importation of 3.9 Million Tons of Light Products, at US$30/Ton b) Freight Charges on Erstwhile Transportation of 1.7 Million Tons of Fuel Oil from Lujan de Cuyo to Buenos Aires for Export, at US$15/Ton Total Project Benefits io5; == 704 Industrial Projects Department May 1981

65 ARGENTINA - REFINERY CONVERSION PROJECT PRODUCTION COSTS AT 100% CAPACITY (in May 1981 terms) Annual Consumption Unit Price Production Costs Lujan de Economic Financial Economic Financial La Plata Cuyo Total (US$) ('000 $a) (mil US$) (bil $a) Variable Costs Raw Materials Fuel Oil ('000 tons) 2, , , Sodium Hydroxide ('000 kgs) Catalysts ('000 kgs) Hydrogen (million Nm 3 ) Utilities Electric Power (million kwh) Steam (million tons) a/ Cooling Water (million m 3 ) Treated Water (million m 3 ) Total Variable Costs Fixed Costs Labor Maintenance Insurance General & Administrative Depreciation -7.0 Total Fixed Costs Total Production Costs a/ Reflects credit of 300,000 tons for steam produced. Industrial Projects Department May 1981

66 ARGENTINA : REFINERY 'ONVERSION PROJECI PROJIECT - PROJECTEDII INCOME STATEMENT (IN CURRENI US$ MILLION) EOUIVALENT CAPACITY UTILIZATION (ZI NET SALES ,V13.5'9 1, , , ,; , , , t, VARIABLE COSTS H , FIXED COSTS DEPRECIATION EXPENSE 7? tt2.90 t? NEr OPERATING PROFIT 74, t INTEREST NET PROFIT BEFORE TAX INCOME TAX , t.82 NEt PROFIL AFTER TAX /6 9S tO t CASN GENERATION t R NET REVALUED FiXEE ASSETS IN SERVICE ,20 1, ,104,70 1, , , , , ,567,10 1, NEI RETURN tln SALES (Zt) o t0.48 t RETURN ON NET REVALUED FIXED ASSFTS (X) , _ TIMES INTEREST EARNED , DEBT SERVICE COVERAGE RAlIO S INDUSTRIAL PR)OJECfS DEPARTMENT DATE PREPARED:06/0 9 /81

67 ARGENTINA - REFINERY CONVERSION PROJECT COST AND BENEFIT STREAMS FOR FINANCIAL RATE OF RETURN CALCULATION (In May 1981 Million US Dollars) Financial Benefits Financial Cost: Capital Costs Working Capital (15) Variable Production Costs Fixed Production Costs - _ Total Net Financial Benefits (Costs) (136) (182) (201) (54) a, l Financial Rate of Return: 24.6% Industrial Projects Department May 1981

68 ARGENTINA : REFINERY CONVERSION PROJECT REFINERY DIVISION - PROJECTED INCOMiE STATEMENT (IN CUIRRENT US$ MILLION) CRUDE THROUIGHPUI (OO0 M3) 19, , , , , ,589,00 20,589,00 NET SALES , , , ,275,79 4, , VARIABLE COSTS 2, , ,503.7? 2,? , , , FIXED COSTS DEPRECIATION EXPENSE t NET OPERATINGi PROFIT ,29 30X ,43 INTEREST , , NET PROFIT BEFORE TAX ,48 INCOME TAX , ,60 NET PROFIT A1TER FAX /8, , CASH GENERATION , , NET REVALUED FIXED ASSETS IN SERVICE , , , , , NET RETURN ON SALES (Z) 2, , RETURN ON NEr REVALUED FIXED ASSETS (X) 5,00 7, , TIMES INTEREST EARNED DEBT SERVICE COVERAGE RATIO 5, , INDUSTRIAL PROJECTS DEPARTMENT DAlE PREPARED:o 6 /o 9 /81

69 ARGENTINA : REFINERY CONVERSION PROJECT REFINERY DIVISION - PROJECTED CASH FLOW SIATEMENT (IN CLIRRENT USS MIL LION) SOURCES OF FUNDS TOTAL EARNINGS DEPRECIATION 8lt60 138, , FIJNDS FROM OPERATIONS ,90 323, ,70 LONG-TERM LOANS S EQUITY INVESTMENTS , WORKING CAPITAL TOTAL SOURCES OF FUNDS , , USES OF FUNDS REPAYMENT OF L.OANS JB INVESTMENTS IN FIXEIl ASSETS , INVESTMENIS IN OTHER ASSETS , INCREASE IN WORKING CAPIIAL TOTAL USES OF FUNDS 181*30 207* , * ANNUAL CASH SURPLUS ACCUMlJLArED CASH SURPLUS , , INDUSTRIAL PROJECTS DIVISION DATE PREPARED':06/05/81

70 ARGENTINA :'REFINERY CONVERSION PROJECT REFINERY DIVISION - PROJECTED BALANCE SHEET (IN CURRENT US$ MILLION) ASSETS CURRENT ASSETS OPERATING CASH ACCOUNI'S RECEIVABLE INVENTORIES ,00 621,00 673, ,20 SUB-TOTAL , , CASH SURPLUS ,30 477, , NET FIXED ASSETS 1, , , , , CONSTRUCTION IN PROGRESS OTHER ASSETS ,10 71, TOTAL ASSEIS 2, , , , , , , LIABILITIES AND EQUITY CURRENT LIABILII'IES , LONG-TERM DEBT EQUITY PAID-IN CAPITAL , , , , RETAINED EARNINGS , , , , REVALUATION SURPLUS , TOTAL EQUITY 1, , ,l , , , , TOTAL LIABILITlES AND EQUITY 2,245,70 2, ,40 4, , RATIOS CURRENT RATIO , QUICK RATIO ,79 1, CAPITALIZATION:o DEBT EQUITY , ,85

71 ANNEX 8-1 ARGENTINA - REFINERY CONVERSION PROJECT ASSUMPTIONS USED IN ECONOMIC ANALYSIS A. General 1. The economic rates of return for the Project are calculated in constant May 1981 dollars. Project life is assumed at 12 years with no terminal value credited to the Project except that for working capital recovery. B. Capital Cost Estimate 2. The economic capital cost of the Project is obtained by deflating the financial installed cost in current prices to May 1981 prices: Disbursement Economic Capital Cost Current US$ in May 1981 Year % Million Deflator Prices C. Working Capital 3. Economic working capital is estimated at US$15.4 million and includes inventories of raw materials and works in process. (ANNEX 6-2)

72 ANNEX 8-1 Page 2 D. Operating Costs 4. Economic input costs as of May 1981 are detailed in Annex 7-2. Labor, maintenance and other operating costs are base on those used for financial analysis. E. Economic Benefits 5. Product prices used in the economic analysis are based on a recent Bank study 1/ of long-term inter-product prices for refinery products which shows the following relationships, assuming crude oil price at 100: motor gasoline, 150; naphtha, 135; gas, 137; kerosene, 140; LPG, gas oil and diesel oil, 133; and fuel oil, 74. At the long-term world crude oil price of US$257/ton (US$35/bbl) the following refinery product long-term prices are derived: FOB US$/ton Premium Gasoline 385 Regular Gasoline a/ 373 Kerosene 360 Gas and Diesel Oil 342 Fuel Oil 190 Refinery Gas 352 LPG 342 a/ Assumed at 97% or premium gasoline price. Acicular and sponge coke are valued at the FOB Rotterdam prices of US$430 and US$375/ton, respectively. 8. At full production, the Project will produce about 4 million tons of light refinery products which would otherwise be imported. With freight, port handling and inland transportation costs averaging about US$30/ton, the Project would save the country about US$119 million per year. In addition, the conversion project at Lujan de Cuyo refinery will save the country another US$26 million per year, which is the cost of transporting the 1.7 million tons of fuel oil produced by the refinery to Buenos Aires for export if such fuel oil is not converted. Total annual transportation savings resulting from the Project at full prodution thus amount to about US$145 million at 1980 terms. Industrial Projects Department May l98i

73 ANNEX 8-2 ARGENTINA: REFINERY CONVERSION PROJECT COST AND BENEFIT STREAMS FOR ECONOMIC RATE OF RETURN CALCULATION BASE CASE (in million US$ of May 1981) Capital Working Production Costs Total Net (Cost) Costs Capital Variable Fixed Revenues Benefit (135.9) (182.2) (201.3) ( 58.7) , , , , , , , , , , (15.4) , Economic Rate of Return: 48.1% Industrial Projects Department May 1981

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