world bank document...petrolera andina, that were made by dividing ypfb production properties into...

Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 19476

IMPLEMENTATION COMPLETION REPORT

BOLIVIA

HYDROCARBON SECTOR REFORM AND CAPITALIZATIONTECHNICAL ASSISTANCE PROJECT

(Credit 2762 BO)

June 29, 1999

Bolivia, Paraguay and Peru Country UnitFinance, Private Sector & Infrastructure Sector UnitLatin America & Caribbean Region

This document has a restricted distribution and may be used by recipients only in theperformwhce of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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FISCAL YEAR OF BORROWER

January I - December 31

WEIGHTS AND MEASURES

Metric System

ABBREVIATIONS AND ACRONYMS

CAPU Capitalization UnitESMAP Energy Sector Management Assistance ProgramGDP Gross Domestic ProductGOB Government of BoliviaIDA International Development AssociationLPG Liquefied Petroleum GasMIS Management Information SystemMOC Ministry of CapitalizationMOP Memorandum of the PresidentNSE National Secretariat of EnergyPEU Project Executing UnitSAM or MEC Sociedades An6nimas Mixtas/Mixed Economy CorporationSIRESE Sistema de Regulaci6n Sectorial/Regulation System LawSOE State Owned EnterpriseVMEH Vice Ministry of Energy and HydrocarbonsYPFB Yacimientos Petroliferos Fiscales Bolivianos/State Owned Oil

Company

Vice President: : Shahid Javed BurkiCountry Director: : Isabel GuerreroSector Manager: : Danny LeipzigerTask Team Leader: : Chakib Khelil


BOLIVIA FOR OFFICLIL USE ONLY


(Credit 2762 BO)

Table of Contents

PrefaceEvaluation Summary

PART I - PROJECT IMPLEMENTATION ASSESSMENT

Introduction ............................................. 1Project Objectives and Scope ............................................. 2Project Implementation ............................................. 3Achievement of Objectives ............................................. 7Major Factors Affecting the Project ............................................. 7Project Sustainability ............................................. 8IDA Performance ............................................. 8Borrower Performance ............................................. 9Assessment of Outcome ............................................. 9Future Operation ............................................ 10Key Findings ............................................ 10Key Lessons Learned ............................................ 10

PART II - STATISTICAL TABLESTable 1: Summary of Assessments .12Table 2: Related Bank Loans/Credits .13Table 3: Project Timetable .13Table 4: Cumulative Estimate and Actual Loan Disbursement (SDR) .14Table 5: Key Indicators for Project Implementation .14Table 6: Key Indicators for Project Operation .14Table 7: Studies Included in Project .15Table 8A: Project Costs (US$mm) ............................................. 16Table 8B: Project Financing (US$mm) ............................................ 17Table 9: Economic Costs and Benefits ............................................ 17Table 10: Compliance with Operational Manual Statements ......................................... 17Table 11: Status of Legal Covenants ............................................ 18Table 12: Use of IDA Resources: Staff Inputs ............................................ 19Table 13: Use of IDA Resources: Major Project Missions ............................................ 19

APPENDIX A - BORROWER'S CONTRIBUTION (Translation from Spanish)

MAP - IBRD 26624RProject Identification Number: BO-PA-6178

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.


BOLIVIA


(Credit 2762 BO)

Preface

This is the Implementation Completion Report (ICR) for the Hydrocarbon SectorReform and Capitalization Technical Assistance Project in Bolivia, for which Credit2762-BO in the amount of SDR6.8 million (US$10.64 million equivalent) to theGovernment of Bolivia was approved on July 6, 1995 and made effective on December 5,1995.

The Credit closed as scheduled on December 31, 1998. Final disbursement tookplace on May 11, 1999, at which time a balance of SDR 272,891.79 was cancelled.

The ICR was prepared by H. Morsli, Principal Petroleum Engineer (EMTOG) andreviewed by Mr. Chakib Khelil, Petroleum Adviser and Task Team Leader (EMTOG),Susan Goldmark, Sector Leader (LCSFP), Maria Victoria Lister, Quality AssuranceOfficer (LCSFP) and David Varela, Counsel (LEGLR).

Preparation of the ICR began during the IDA's final supervision'and completionmission in December 1998 prior to the Credit's closing date. It is based on material inthe project file and discussions with and information provided by GOB and theimplementing agencies. The Borrower contributed to the ICR by preparing its ownproject evaluation (Appendix A).


BOLIVIA


(Credit 2762 BO)

Evaluation Summary

i. Introduction. Bolivia's hydrocarbon sector provides the country with significantnatural gas export opportunities to neighboring liberalized energy markets. However, thesector requires capital-intensive investments that are beyond public sector financingcapabilities. In 1990, the government of Bolivia promulgated a new hydrocarbon lawexpanding the role of the private sector, but the response was limited. Some of the majorreasons were the overwhelming predominance of the national oil company (YacimientosPetroliferos Fiscales Bolivianos/YPFB) and the limited attractiveness of the hydrocarbonlaw. Privatization was an obvious option, but like in many developing countries, it wascontentious and feared as a loss of jobs and the nation's patrimony. Yet, to develop thecountry's hydrocarbon potential and take advantage of the regional markets, GOB had noalternative than to involve the private sector. In 1993, therefore, the incomingGovernment conceived a privatization scheme for six state owned enterprises (SOEs)with investment opportunities in hydrocarbons, electricity, mining, telecommunications,railway and aviation, with a total value estimated at about $4 billion (exceeding 65percent of GDP). Under the scheme, GOB contributes to the formation of newcorporations, in which pre-qualified companies would be invited to bid for 50 percent ofthe shares. The investor's contribution is not paid to GOB, but invested into thecorporations in the form of capitalization for further development. The scheme providesthe investor with a full management contract for a fixed period of time after which theinvestor would be able to increase its shareholding. The State's equity representing 50%of each company's capital is transferred into a collective pension fund, to benefit allBolivian citizens, over the age of 65 (about 3.2 million people), initially this was in apayment of 250 US dollars per year, later the new Government changed the cash paymentto a participation in a mutual fund representing the value of the Government's share inthe Capitalized Companies. To ensure adequate redistribution of the state's equity, thepension fund would be privately operated (later the new Government requested thepension fund to report to the superintendent of pensions) and created from the reform ofthe country's inefficient pension and social security systems. For the scheme to succeedand stimulate expansion with job creation, GOB needed to proceed with a number ofinter-sectoral policy initiatives, involving substantial changes in the legal and regulatoryframework to ensure effective and transparent process, including in the hydrocarbonsector, for which this project was designed.

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ii. Project Objectives and Scope. The project's objectives were to assist thegovernment in developing sector policy initiatives for (i) the reform of the hydrocarbonsector, including the strengthening of the government's agencies which will bemonitoring and regulating activities in the sector; and (ii) the capitalization, by privateinvestors, of YPFB assets. To achieve these objectives, the project provided assistance in(a) developing and implementing a legal and regulatory framework for the hydrocarbonsector; (b) designing a strategy and a master plan leading to the capitalization of YPFB;and (c) strengthening the regulatory agencies. The project's objectives and the scoperequired no changes during implementation and they proved to be realistic and of theutmost importance to the country's hydrocarbon sector.

iii. Project Implementation. The project was a continuation of a sectoral reformprogram that was initiated a few years earlier with the support of IDA through twoProject Preparation Facilities (PPFs). Prior to the project, therefore, GOB approved thenecessary general enabling legislation consisting of a number of enterprise reform relatedlaws and regulations. In March 1994, GOB passed the Capitalization Law, whichestablished the legal framework for the program, and, in October 1994, the GOB passedthe Sectoral Regulation System Law (Sistema de Regulaci6n Sectorial/SIRESE), whichestablished the regulatory and oversight structure for the capitalized sectors. In March1994, GOB established a Ministry of Capitalization (MOC) to develop a capitalizationplan and carry out the multi-sector reform policy. MOC, which relied on a small group ofhigh level and competent officials, became a strong focal point with the full backing ofthe President of the Republic. MOC devoted more than a year developing thecapitalization program before proceeding with its implementation at the sectoral level.

iv. Implementation of the hydrocarbon capitalization plan began with the creation oftwo implementation units, the Project Executing Unit (PEU) to carry out the regulatoryframework and institutional strengthening under the Ministry of Economic Development,and the Capitalization Unit (CAPU) to develop the capitalization of YPFB under MOC.Both units were staffed essentially with local and foreign high level professionalconsultants, covering all area of activities, including technical, financial and legal. YPFBcapitalization began with a series of studies, including a number of seminars organized inand outside Bolivia and a detailed asset valuation that allowed the government to set abaseline benchmark to ensure a fair process. A pre-qualification of bidders attractedthirty-seven oil and gas companies that also provided useful input into the process.

v. The government decided to capitalize YPFB's assets into three mixed economycorporations (Sociedades Anonimas Mixtas/SAMs), two in production and one inpipeline transportation. YPFB's technical services, consisting essentially of well drillingwere not capitalized, but privatized in February 1998 by direct sale. The downstreamactivities, consisting of two refineries (50,000 bbl/d), thirty-two bulk storage depots andseven large LPG bottling plants were also taken out of the capitalization program becauseof labor union pressure and also market conditions under which they appeared to be betteroff privatized rather than capitalized. The privatization of the downstream activities wasinitiated in mid-1998 and would be completed in 1999. To facilitate YPFB's

capitalization, a number of laws and regulations were adopted. A Hydrocarbon Lawpassed in April 1996 enhanced substantially the value of YPFB companies and equallyimportant, provided significant incentives for the exploration of the country's largesedimentary basins without reducing the government's long-term tax revenues. In May1997, the government geographically delimited the areas to be promoted under a newcontract of operations with transparent bidding procedures. Within the same month, anenvironmental protection regulation was introduced, enforcing application of the newlypassed Environmental Law. Several other important regulations were adopted within ayear later to implement the hydrocarbon law.

vi. YPFB two production SAMs were: (i) Empresa Petrolera Chaco, and (ii) EmpresaPetrolera Andina, that were made by dividing YPFB production properties into two equalparts. YPFB pipeline properties were organized into one SAM, Transportadora Bolivianade Hidrocarburos (Transredes). Each SAM consisted of two series of shares of equalvalue and consisting of "A" shares for the Republic of Bolivia and "B" shares for theprivate participation. The "B" shares were issued to be entirely subscribed and paid for incash and full amount by the new investor. The investor's funds were deposited in fullamount into the SAM's account to be invested in Bolivia petroleum sector over a periodof eight years with no restrictions put on the capitalized enterprise.

vii. Sixteen bidders were pre-qualified to bid for Chaco and Andina productioncorporations and nine bidders were pre-qualified to bid for the Transredes pipelinecorporation. Only one multinational oil and gas company was pre-qualified to bid for allthree corporations. However, it would have been awarded only one production companyand the pipeline company because of the government's intention to enforce the third partyaccess to the transmission system. The bids were submitted and opened on December 5,1996. Under public disclosure of the bid amounts, Empresa Petrolera Chaco productionSAM was awarded to AMOCO, USA, Empresa Petrolera Andina production SAM toYPF-Perez-Pluspetrol, Argentina and Transredes pipeline SAM to Enron-Shell OverseasHoldings, USA. AMOCO and YPF-Perez-Pluspetrol took over the operations of theirrespective companies on April 10, 1997 and Enron-Shell took over theirs on May 16,1997.

viii. YPFB workers were offered early retirement packages and given preferentialoptions to subscribe "A" shares in the SAMs, at book value and up to an amount equal totheir social benefits, bought about 4% of the production SAMs and 16% of the pipelineSAM. The remaining "A" shares were transferred to a collective pension fund on behalfof all Bolivian citizens. In addition, the government also took advantage of the reform ofits key economic sectors to replace the country's nearly bankrupt social security by apension system aimed at increasing the well-being of Bolivian citizens and developingcapital markets with the resources transferred from the newly capitalized enterprises.Both the worker stock options and social security reform enabled the government to drawsome support from unions that helped the implementation process.

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ix. Under the new legal framework, YPFB has no more operating rights and remainsas a government agency, for monitoring the compliance of the oil companies with theircontractual exploration and production obligations. The new YPFB will also aggregategas export contract commitments to Argentina and Brazil and manages the government'sshare of petroleum liquids and gas resulting from contracts of operations. Under the newlegal framework, the government is paid a royalty and not anymore a share of production.

x. Achievement of Objectives. The project achieved its key objectives of assistingthe government to: (i) establish a regulatory framework to properly regulate thecapitalized enterprises; (ii) develop an accountability mechanism to ensure that theprivate investors will comply with the capitalization terms; (iii) maximize the value of theBolivian's share in key petroleum sector entities before and after capitalization; (iv)redefine the role of the government by transferring the hydrocarbon operations to theprivate sector; and (v) enhance competition, promote efficiency and protect the consumerand the environment. The achievement of these objectives was attained with theassistance of various foreign and local consultants financed under the projectcomponents, details of which can be seen in table 7 and 8A of the ICR.

xi. Major Factors Affecting the Project. The concept of capitalization was complexand its implementation proved to be more difficult than anticipated. The government'spublicity campaign to mobilize general public support was limited resulting in some wideopposition to the capitalization organized by the Confederation of Bolivian Workers. Theprivatization of the downstream activities and field technical services were delayed untillate 1998 and 1999. In addition, critics indicated that poverty would have been betteralleviated if the capitalization's proceeds were used for current social needs, such as thelarge deficits in basic health and education. Criticism was also drawn to the insufficientlogistics associated with the implementation of the pension fund scheme, particularlywith regard to locating, documenting and paying a dispersed population of pensioners.

xii. Project Sustainability. The project's achievements are highly likely to besustainable. Bolivia's new government, which took office in August 1997, despite someinitial reservations about (i) the scope of autonomy provided to the superintendence (ii)the issuance of regulations without obtaining the consensus of all the Ministries, not onlypreserved the reforns, but has been deepening them, such as the ongoing privatization ofthe refineries. Since then, the capitalization of the petroleum sector is being legitimizedby a number of other important follow-up reform actions, which would make the projectirreversible and, therefore, sustainable.

xiii. IDA Performance. IDA performance was highly satisfactory throughout theproject's cycle. IDA played an important role during the capitalization program bysupporting through ESMAP and other grant funds a number of studies, which enhancedthe government's implementation performance and increased Bolivia's credibility withinthe international oil and gas industry. During implementation, IDA contributed importantand timely advice to the borrower on various implementation issues allowing the projectto be completed as scheduled.

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xiv. Borrower Performance. The Borrower's performance was highly satisfactory.First, the design of the Bolivian reform had a unique feature, which mitigated the populardoubts about traditional trade-sale privatization that undermined so many reformselsewhere in the world. Second, the project implementation, in spite of the program'scomplexity, was carried out in a transparent manner.

xv. Assessment of Outcome. Bolivia's capitalization attracted investors whosubscribed $835 million in 3 corporations with a joint book value of about $383 million.In addition, an amount of about $1.6 billion has been committed to other sectordevelopment activities, such as in new contracts of operations and other sector relatedactivities. Furthermore, ongoing negotiations for new petroleum exploration agreementsand other activities are expected to generate and commit as much as $2 billion within thenext two to three years. Moreover, the Bolivia-Brazil gas pipeline, a project that wasdecided between both countries in 1975, has been finally implemented and the pipelineinaugurated in February 1999. Another major outcome, in the form of povertyalleviation, is making some 300,000 elderly Bolivians, the majority of whom are poor,benefit from a total of about $75 million in pension funds as early as 1998. The numberof pension beneficiaries is expected to rise by about 10,000 per year. In addition, byfreeing state budget resources, more government funds become available for expendituresin social sectors that would benefit poor rural areas.

xvi. Future Operation. Although no explicit arrangements were made about theproject's future operation, there was an understanding between GOB and IDA that thepetroleum sector reform process will continue. In fact, the government has initiated theprivatization of YPFB refining and other related activities. A Learning and InnovationCredit is in the process of preparation to finance a Hydrocarbon EnvironmentalManagement Capacity Building Pilot Project.

xvii. Key Findings. The project's key finding were: (i) the program was completedabout one year behind schedule, but comparatively speaking, it was implemented fasterand with less problems than reforrn programs in other countries; (ii) changes in macropolicy facilitated the implementation of the reform program; (iii) the employment level inthe capitalized enterprises was not dramatically affected; (iv) the conversion of stateshareholdings into pension fund for all citizens is a unique approach by which privatecorporate-led economic expansion is associated with the welfare of the population; and(v) prospects of exporting gas to Brazil was critical in attracting foreign investors.

xviii. Key Lessons Learned. The project's key lessons were: (i) quality staff with aclear mandate, sufficient autonomy and authority is critical to implementing reformprograms, particularly privatization of SOE; (ii) to succeed, the reforms have to be notonly economically but also politically sustainable; (iii) privatization process should betransparent with continued education of the public to ensure their understanding,particularly in countries with an exclusionary decision making history; (iv) for theprivatization to lead to greater competition, it is necessary to prepare a transparent

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regulatory framework, prior to the divestiture process; (v) Bolivia's capitalization mightbe worth considering in other countries, because compared to a regular privatizationunder which the sales proceeds will be allocated to the state treasury, the capitalization'ssales money is invested into the enterprise, providing it with the necessary capital for itsgrowth. The distribution of the state shares, or the benefits from them, to the public inthe form of workers' compensation benefits or retirement pensions, would make thereform process more acceptable to the population, and (vi) a committed central powerrepresented by the President helped smoothen the differences between the Capitalizationentity and the Ministry of Energy.


BOLIVIA


(Credit 2762 BO)

Part I - Project Implementation Assessment

Introduction

1. Bolivia's hydrocarbon sector predominates the country's economic activitiesalthough it is still largely undeveloped. In 1997, it represented about 6.3 percent of GDP,40 percent of government revenues of which 10 percent from export and has the potentialof a much greater source of government fiscal revenue. It offers a significant natural gasreserve potential and large unexplored sedimentary basins that provide importantcommercial opportunities, particularly in the area of natural gas export to the recentlyliberalized energy markets in the region. To achieve a meaningful level of developmentand take advantage of these markets, Bolivia's hydrocarbon sector requires large capital-intensive investments, which are beyond the public sector's financial resources. Toattract foreign direct investment, the government revised the hydrocarbon law in 1990,expanding the role of the private sector. While the law generated some interest,particularly with Brazil's natural gas market potential, private participation remainedmodest and lagged far behind the one experienced in neighboring countries such asArgentina and Peru, where the petroleum sectors were privatized earlier. One of thereasons was the overwhelming predominance of the State through YPFB, which washolding more than 80% of the proven oil and gas reserves and most of the prospectivepetroleum exploration areas. YPFB was also controlling most of the country's oil andgas production, all of the refining, pipeline transport and wholesale distribution ofpetroleum products and natural gas. Other reasons were a weak local market, aprecarious export capability and a limited attractiveness of the hydrocarbon law andsector related regulations.

2. Privatization was one obvious answer to Bolivia's hydrocarbon sector's lack ofdevelopment. However, like in many developing countries with a limited economy andcapital market, privatization is contentious and feared as a loss of jobs and the nation'spatrimony. With no alternative, the government, therefore, had to conceive a unique andinnovative privatization scheme for selected key state owned enterprises (SOEs) withinvestment opportunities in hydrocarbons, electricity, mining, telecommunication,railway and aviation, with a total value estimated to be more than $4 billion (exceeding65 percent of GDP). Under the scheme, the government does not sell its net worth, butcontributes to the formation of new corporations, in which, rigorously pre-qualified

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international companies would be selected through international competitive bidding, topurchase 50 percent of the new corporation's shares. The investor's contribution is notpaid to the government, but invested into the corporations in the form of capitalization forexpansion and further development. A 50 percent share of the capitalized corporation isusually enough to ensure management control. However, to avoid any uncertainty, thescheme is flexible enough to provide the investor with a management contract for a fixedperiod of time after which the investor would be able to increase its shareholding. TheState's equity (about $2 billion) is transferred into a collective pension fund, which willhave the legal obligation to provide a universal and equal annual pension payment ofabout $250 to all Bolivian citizens, over the age of 65 (about 3.2 million people). Toensure adequate administration and redistribution of the state's equity, the pension fundwould be privately operated and created from the reform of the country's inefficientpension and social security systems. For the scheme to succeed and stimulate expansionwith job creation, the government needed to proceed with a number of inter-sectoralpolicy initiatives, involving substantial changes in legal and regulatory framework toensure effective and transparent process, including in the hydrocarbon sector, for whichthis project was designed.

Project Objectives and Scope

3. The project's objectives were to support the government's capitalization processof the hydrocarbon sector, particularly the policy initiatives to maximize the long-termeconomic benefits from foreign direct investment and protect the consumers and theenvironment. Specifically, the project was designed to assist the government indeveloping the policy and regulatory framework for (i) the reform of the hydrocarbonsector, including the strengthening of the government's agencies that will be monitoringand regulating activities in the sector; and (ii) the capitalization, by private investors, ofYPFB assets. To assist the government achieving its objectives, the project consisted ofthree main components: (a) development and implementation of a legal and regulatoryframework for the hydrocarbon sector; (b) design of a strategy and a master plan thatwould include measures leading to the capitalization of YPFB; and (c) institutionalstrengthening of the sector's regulating agencies. Another project component was theset-up of a petroleum data center to help the government promote petroleum explorationand development through risk sharing contracts (concession type contracts) with privatecompanies.

4. Neither the project's objectives nor the scope required changes duringimplementation. Both proved to have been well designed and of the utmost importanceto the country's hydrocarbon sector. The project was implemented by two ministries, theMinistry of Capitalization and the Ministry of Economic Development, which were incharge of different, but inter-related aspects.

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Project Implementation

5. The project was a continuation of a sectoral reform program that was initiated afew years earlier with the support of IDA through two Project Preparation Facilities(PPFs). Prior to the project, therefore, GOB approved the necessary general enablinglegislation consisting of a number of enterprise reform related laws (i.e., capitalization,hydrocarbon, environment and tax) and regulations (i.e., environmental management,environmental control and prevention, atmospheric pollution control and water pollutioncontrol). In March 1994, GOB passed the Capitalization Law, which established the legalframework to support the program, and, in October 1994, the government passed theSectoral Regulation System Law (Sistema de Regulaci6n Sectorial/SIRESE), whichestablished the regulatory framework and oversight structure for the capitalized sectors.SIRESE consisted of a General Superintendent authority and Sectoral Superintendence,operationally autonomous, intended to ensure efficient operations in their specific area ofactivities with the objective to safeguard the rights and obligations of the state, privateoperators and consumers. One of the Superintendences (Hydrocarbon Superintendence),is in charge of regulating the activities in petroleum transport, refining and distribution.In March 1994, GOB established a Ministry of Capitalization (MOC) to carry out themulti-sector reform policy. The Ministry of Capitalization reported directly to thePresident of the Republic and relied on a small group of high level and competentofficials with clear mandate and sufficient autonomy to develop a capitalization planwithin the scope of the reforms defined by GOB. MOC became a strong focal point withthe full back up of the President, who was himself deeply involved in the process,providing the necessary strong executive authority to define strategy and take keydecisions. MOC devoted more than a year working out the scope, timing, method andpace of the capitalization program before proceeding with its implementation at thesectoral level.

6. Implementation of the hydrocarbon capitalization plan began at the sectoral levelin 1995 with the creation of two implementation units, consisting of: (a) the ProjectExecuting Unit (PEU) to carry out the legal regulatory and institutional strengtheningunder the Ministry of Economic Development; and (b) the Capitalization Unit (CAPU) todevelop the specific sector related strategy and implementation plan leading to thecapitalization of YPFB under MOC. PEU consisted of 4 working groups (legal andregulatory framework, petroleum pricing and taxation, institutional strengthening andenvironmental regulations). The groups were staffed essentially with local long-termhigh level professional consultants, who were supported (on an ad-hoc basis) by foreignconsultants. CAPU was supported by short and long-term technical, financial and legallocal and foreign consultants. CAPU was under the control of an Advisory Committee,consisting of high-level government officials, chaired by the Minister of Capitalization.Both PEU and CAPU were subject to rigorous implementation schedule, although thedetails of their activities were worked out on a learn-as-you-go basis.

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7. The YPFB capitalization program began with a series of studies covering allaspects of the process. Although the transfer price of the companies to be capitalized wasto be decided through competitive bidding procedures, a detailed and thorough assetvaluation was carried out in accordance with nationally and internationally acceptedaccounting and auditing standards. This allowed the government to set an essentialbaseline benchmark to ensure a fair process. A number of seminars were organized inand outside Bolivia, during which potential investors were given the opportunity toprovide input into the process. A key step taken early in the process was a rigorous pre-qualification of bidders that attracted some thirty-seven oil and gas companies thatexpressed interest. Data rooms were organized by a specialized consulting firmnproviding complete financial, corporate, legal, technical and other operationalinformation on YPFB.

8. The studies and a continuous dialogue with the international oil and gas industryallowed the government to (i) develop a strategy of maximizing competition, the value ofYPFB and the investments to be derived from the capitalization; and (ii) consolidateYPFB activities to be capitalized into operationally and financially viable companies,while minimizing the risk of establishing private monopolies. Therefore, the governmentdecided to capitalize all of YPFB production and pipeline assets into three mixedeconomy corporations (Sociedades An6nimas Mixtas/SAMs), two in production and onein pipeline transportation. Smaller financially viable business units, which would haveprobably increased competition, entail the risk of attracting investors that may not havethe capital to meet the large investment requirements, especially in natural gas pipelineinfrastructure. YPFB downstream activities, consisting of two refineries of a totalcapacity of about 50,000 bbl/d and related marketing facilities with thirty-two bulkstorage depots and seven large LPG bottling plants, were taken out of the capitalizationprogram because of labor union pressure and also market conditions under which theyappeared to be better off privatized rather than capitalized. Similarly, the technicalservices, consisting essentially of well drilling units, were taken out of the capitalization.The well drilling services were privatized in February 1998 while the downstreamactivities are being prepared for privatization in 1999/2000.

9. A Hydrocarbon Law promulgated in April 1996 enhanced substantially the valueof YPFB companies to be capitalized and, equally important, provided significantincentives for the exploration of the country's large sedimentary basins without reducingthe government's long-term tax revenues. Some of the Law's key features included: (i)attractive fiscal and tax incentives for petroleum exploration and developmentinvestments with reduction in royalty payments from the equivalent of 50 percentpreviously paid on gross production to 18 percent and introduction of a 25 percentincome tax and a surtax of 25 percent for windfall profits; (ii) independent, non-discretionary framework to petroleum exploration through open access to acreage to anytechnically and financially qualified company subject to a minimum work programcommitment; (iii) internationally competitive prices for petroleum products with thepossibility for a full price deregulation within the next 5 years; and (iv) third party accesswith non-discriminatory tariffs to gas, oil and product pipelines. In May 1997, the

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government geographically delimited the areas to be promoted for petroleum explorationand development within the potential sedimentary basins and issued the modelexploration and production contract with clear and transparent bidding procedures, whichwere designed for a much faster process than in the past. Within the same month, anenvironmental protection regulation was introduced, enforcing application of theEnvironmental Law and focusing on management, prevention and control, atmosphericpollution, water pollution and handling of dangerous substances and solid residues.Within a year later, several sets of important regulations were adopted.

10. YPFB production assets were organized into two SAMs: (i) Empresa PetroleraChaco, and (ii) Empresa Petrolera Andina, by dividing all of YPFB production propertiesinto two equal parts. YPFB pipeline assets were organized into one corporation,Transportadora Boliviana de Hidrocarburos (Transredes), to operate all of YPFB crudeoil and natural gas pipelines, including the Bolivian portion of the Bolivia-Brazil naturalgas pipeline and a small participation in the Brazilian side. Each SAM was governed byits own by-laws and with two series of shares of equal value and consisting of "A" sharesfor the Republic of Bolivia and "B" shares for the private participation, throughcapitalization. The "B" shares were issued to be entirely subscribed and paid for in cashand full amount by the new investor. To attract bidder interests and minimize the risk ofnegative impact on the bidding price, the capitalization law provides the investor with afull management control of the SAM through an administration contract to be signed withthe government for a fixed period of time. After that time, the investor would be able tobuy shares in the open market to increase its holding beyond 50 percent. The full cashpayment by the new investor would be made before or no later than the award of thecapitalization contract to ensure that the SAM is with a healthy balance sheet when it istaken over. The new investor's funds deposited in the SAM's account would be investedin Bolivia petroleum sector over a period of eight years with no restrictions put on thecapitalized enterprise. The new investor would decide on how to carry out its investmentprogram, without enforcement mechanisms or sanctions spelled out at the time of thetransaction, except the contractual obligation to complete the investment within 8 years.

11. Sixteen bidders with strong production experience were pre-qualified to bid forChaco and Andina production corporations. Because of their financial resources, twelveof these bidders could bid for the two production corporations and four bidders could bidonly for one of the two companies. Nine bidders with strong pipeline experience werepre-qualified to bid for the Transredes. Only one multinational oil and gas company waspre-qualified to bid for all three corporations. However, it would have been awarded onlyone production company and the pipeline company because of the government's intentionto apply the third party access to the transmission system. The bidders were carefullypre-qualified based on their proposed business plans, technical qualification and financialresources. The bids were submitted and opened on December 5, 1996. The capitalizationimplementation team made great effort to ensure the transparency of the process, throughclearly defined competitive procedures and proper bid evaluation. The winning bidders,whose quotation amounts were publicly disclosed, were AMOCO for Empresa PetroleraChaco, YPF/Perez Compane/Pluspetrol for Empresa Petrolera Andina, and Enron/ShellOverseas Holdings for Transportadora Boliviana de Hidrocarburos, Transredes. AMOCO

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and YPF/Perez Companc/Pluspetrol took over the operations of their respectivecompanies on April 10, 1997 and Enron/Shell took over theirs on May 16, 1997, afterhaving completed the share subscription they quoted for and signed the SAMadministration contract allowing them to manage the capitalized enterprises as freely aspossible within the limits set by the law. All of the involved parties, including theinternational oil and gas industry conceded that Bolivia's hydrocarbon capitalization waswell conceived and coherently implemented through a transparent process. It succeededto move away from traditional privatization strategies that aim primarily to sell off stateenterprises to private investors.

12. Until the closing date of the bidding process, YPFB workers were givenpreferential options to subscribe "A" shares in the SAMs, at book value and up to anamount equal to their social benefits (such as pension contributions and disabilityinsurance), to be exercised within a year after the bidding. The worker participation wasquite high with an estimated total of about 4% in the production SAMs and 16% in thepipeline SAM. The remaining "A" shares were transferred to the collective pension fundon behalf of all Bolivian citizens. Workers were also offered early retirement packages.In addition, the government also took advantage of the reform of its key economic sectorsto replace the country's nearly bankrupt social security by a pension system aimed atincreasing the well-being of Bolivian citizens and developing capital markets with theresources transferred from the newly capitalized enterprises. The new pension systemconsists of two government regulated private funds established through competitivebidding. Both the worker stock options and social security reform enable the governmentto draft some support from unions that helped the implementation process.

13. On the institutional side, the elaborate structure of regulatory system set-up priorto capitalization has become almost fully operational in 1997. Since then, thehydrocarbon sector regulating agency has been provided with number of specificallydeveloped hydrocarbon related regulations, including operational safety in all upstream,downstream and pipeline transportation activities. An Environmental Unit to deal withenvironmental regulations and environmental impact assessments in the hydrocarbonsector was also established in 1997 under the Vice Ministry of Energy and Hydrocarbons.

14. Under the new legal framework, YPFB has been retained as a government agency,for monitoring, on behalf of the government, the compliance of the oil companies withtheir petroleum exploration and development contracts. The new YPFB has no moreoperating rights and cannot act as a working interest partner in any of the existing orfuture petroleum exploration and development contracts of operations. It will aggregategas export contract commitments with Argentina and Brazil and handle the percentagesof petroleum liquids and gas resulting from exploration and production contracts betweenthe government and the operating companies. It will also administer the petroleum datainformation center, which was financed under the project for petroleum explorationpromotion and development. In this regard, YPFB organized after the capitalization, ahighly successful petroleum exploration promotion in USA that led to the award of 34exploration areas. A management information system (MIS) is being installed tointerconnect YPFB with the other petroleum sector agencies to facilitate exchange of

7

information between them.

Achievement of Objectives

15. The project achieved its key objectives of assisting the borrower to: (i) establish aregulatory framework that not only helped in implementing the capitalization programbut provided the state with the capability to properly regulate the capitalized enterprisesin the future, including avoiding the risk of establishing private monopolies; (ii) developan accountability mechanism to ensure that the private investors will comply with thecapitalization terms, and a legal framework that will guarantee the rights of all relevantparties; (iii) maximize the value of the Bolivian's share in key petroleum sector entitiesbefore and after capitalization; (iv) redefine the role of the government by transferring allof the country's petroleum exploration, development, production and transportationoperations to the private sector; (v) attract the necessary private investment; and (iv)enhance competition, promote efficiency and protect the consumer and the environment.The achievement of these objectives was attained through the studies done byconsultants, the individual consultants and the consulting firms financed under the projectcomponents, details of which can be seen in table 7 and 8A of the ICR.

Major Factors Affecting the Project

16. The concept of capitalization was complex and its implementation proved to bemore difficult than anticipated. The government's publicity campaign to convince thegeneral public and gain its support, was limited, too technical and political. As a resultand in spite of the govermnent's explicit attempt to involve the majority of the Boliviansin the process, the Confederation of Bolivian Workers managed to oppose thecapitalization program and organize sufficient labor union movements and social unrestthat resulted in delaying the program and postponing the privatization of the refineriesand some of the technical services. In spite of a strong focal point within the ministry ofcapitalization and a clear mandate with the officials in charge of the program, there havebeen implementation difficulties and disagreements between the various ministries andgovernment agencies, which required the President of the Republic oftentimes to refereethe process.

17. In spite of having established a regulatory framework (SIRESE) prior tocapitalization, the regulatory agencies came into operation only after the capitalizationdue to the lack of adequate staffing and resources.

18. The pension scheme proposed as a benefit resulting from the Capitalizationprocess has drawn criticism, which affected, to some extent, the project implementationperformance. The critics indicated that there are many social needs, including largedeficits in basic health and education that would have a better development impact on thecountry if they benefited from the capitalization's proceeds. Criticism was also drawn tothe insufficient logistics associated with the implementation of the pension fund schemeas the survey to locate the pension beneficiaries proved to be very difficult to carry out.The law specifies that payment can only be made to those in possession of an identity

8

card, which must include a photograph, a fingerprint and date of birth. Reportedly, manyold people have no way of proving their date of birth and may even not know how oldthey are. The law provides that authorities should issue an ID to any individual claimingto be of a certain age provided he is backed by two other persons. In rural areas, locating,documenting and paying a dispersed population of pensioners, often illiterate, proved tobe more difficult than anticipated.

Project Sustainability

19. The project's achievements are highly likely to be sustainable. The hydrocarboncapitalization process was part of a broader reform program initiated in 1993 aimed atsustainable development, national income redistribution and administrativedecentralization and involving other sectors such as electricity, mining,telecommunication, railway and aviation that would make the project irreversible and,therefore, sustainable. In fact, the reforms achieved in the petroleum sector are so wellinterconnected and, in some cases, intricate with some of other reforms covering a muchlarger economic activity in the country, such as the national social security reforms, thatany attempt to revert the capitalization process would seriously affect the country'seconomy. Bolivia's new government, which took office in August 1997 and opposed theprivatization when it was initiated in 1993-94, not only preserved the reforms so farmade, but has been deepening them, such as the ongoing privatization of the refineries.Since then, the capitalization of the petroleum sector, like other restructured economicactivities, is no longer being viewed as the result on one political party and, therefore, isbeing legitimized by a number of other important follow-up reform actions.

20. The project's sustainability is also highly likely because of the personal stake for alarge part of the population in the capitalized enterprises through the pension fundscheme. In fact the distribution of state shares in the form of retirement pension funds isa form of ownership of the people in the capitalized enterprises, that provides some long-term credibility for the privatization, as was experienced by the distribution of shares insome East European countries.

IDA Performance

21. IDA performance was satisfactory throughout the project's cycle, from appraisalto implementation supervision and this view is shared by almost all of the Bolivianofficials associated with the project. IDA played an important role during the crucialearly stage of the capitalization program by supporting through ESMAP and other grantfunds a number of studies, which enhanced the government's implementationperformance and increased Bolivia's credibility within the international oil and gasindustry. During implementation, IDA provided consistent supervision with thenecessary expertise and continuity, which developed a very close collaboration betweenIDA and all government agencies involved in the process. IDA contributed importantand timely advice to the borrower on various implementation issues allowing the projectto be completed as scheduled.

9

Borrower Performance

22. The Borrower's perfornance was highly satisfactory. First, the design of theBolivian reform had a unique feature, which was the popular participation by which thegovernment's share in the new company was distributed to the people. This approachmitigated the popular doubts about traditional trade-sale privatization that undermined somany reforms elsewhere in the world. Second, the project implementation was carriedout in a fairly transparent manner, in spite of the complexity caused by the fact that thehydrocarbon sector capitalization was part of a much wider macroeconomic policyreform, involving among other sectors, financial, institutional and social systems. In thisregard, most of the international oil and gas companies conceded that Bolivia's petroleumupstream privatization was a remarkable achievement. There was no improper behaviorfrom the implementing agencies and government officials and the few technicalimplementation problems experienced early in the process were essentially due to thelack of experience and limited skilled staff in the area of sector regulations.

Assessment of Outcome

23. Bolivia's capitalization process attracted the right investors, which have thenecessary incentives to develop the country's hydrocarbon potential and human resourcesand, therefore maximize the value of the capitalized corporations. The investors havealready subscribed for $835 million in three corporations with a joint book value of about$383 million. As per the capitalization agreement, the subscribed amount, of whichabout $200 million has already been paid as of December 1998, will be fully utilized ininvestment with eight years from the capitalization in 1997. In addition, an amount ofabout $1.6 billion has been committed to other sector development activities, such as thedown stream part and new contracts of operations between the government and otheroperating companies, which joined Bolivia for petroleum exploration and developmentafter the capitalization. Moreover, the Bolivia-Brazil gas pipeline, a project that wasdecided between both countries in 1975, has been finally implemented and the pipelineinaugurated in February 1999. Furthermore, ongoing negotiations for new petroleumexploration agreements and other sector related activities are expected to generate andcommit as much as $2 billion within the next two to three years. The investment levelexpected to be generated by the capitalization will provide the petroleum sector with far-reaching economic development and job creation possibilities and a significant impact onthe country's GDP growth.

24. Investing fifty percent of the shares of the capitalized enterprises in a socialsecurity system to benefit all elderly Bolivian, the majority of whom are poor, will tacklea major poverty related problem making the project's outcome a significant contributionto poverty alleviation. Initially this was in a payment of 250 US dollars per year, later thenew Government changed the cash payment to a participation in a mutual fundrepresenting the value of the Government's share in the Capitalized Companies. Thepension scheme started in 1998, involving some 300,000 Bolivians. In subsequent years,the expected number of beneficiaries would rise by about 10,000 per year. In addition, by

10

freeing state budget resources that previously went to support state-owned enterprises,more resources become available for other govermment expenditures in social sectors thatcould benefit poor rural areas.

Future Operation

25. There was an understanding between GOB and IDA that the petroleum sectorreform process will continue. In fact, the government has initiated the privatization ofYPFB refining and other related activities, and a Learning and Innovation Credit is in theprocess of preparation to finance a Hydrocarbon Environmental Management CapacityBuilding Pilot.

Key Findings

26. The project implementation schedule seems to have been somewhat toooptimistic, particularly for achieving such radical policy changes. The program wascompleted about one year behind schedule, but comparatively speaking, it wasimplemented faster and with less problems than reform programs in other countries. Ingeneral, achieving policy objectives, particularly privatization of important largeeconomic sectors, should be viewed as a long-term process and forrnulated for animplementation beyond the project's scope.

27. The close coordination with changes in macro policy, such as trade and laborliberalization, and financial and pension reform, that were taking place in Bolivia duringthe petroleum sector's capitalization, facilitated the implementation of the reformprogram.

28. While social implications were expected, particularly from the transition of laid-off workers, the employment level in the capitalized enterprises was not dramaticallyaffected, even though YPFB is still with some surplus of personnel and for which aredeployment program is reportedly under consideration.

29. The conversion of state shareholdings into passive dividend for all citizens is aunique and innovative approach of private corporate-led economic expansion whereprivate corporations are associated with a whole population.

30. Only investors who were prepared to invest significant amounts of capital inBolivia's hydrocarbon sector were involved in the capitalization process. They wereattracted by the prospects of exporting gas to Brazil where consumption is projected toincrease more than five times (from 18 to 100 mmcm/d) within the next 10 years.

Key Lessons Learned

31. Successful implementation requires high quality staff with a clear mandate,sufficient autonomy and authority, minimal bureaucracy and quick access to top decision-makers is critical to implementing reform programs, particularly the privatization ofSOEs.

11

32. For market-oriented reforms to succeed, they have to be not only economicallybut also politically sustainable. For this purpose, during the reform process, thegovernment should demonstrate the political will to carry out the reforms and the politicalcapacity to implement all the changes necessary to achieve the reform objectives.

33. Privatization concept and implementation design should be transparent to avert allsort of critiques, including allegations of corruption. Adequate and continued educationof the public to ensure their understanding and gain their support is essential, particularlyin countries with an exclusionary decision-making history. Similarly, if the privatizationis intended for foreign investors, a well prepared international media campaign, carriedout with the assistance of an experienced public relations firm, could significantlyincrease investor interest and competition.

34. For the privatization to lead to greater competition, which is one of its majorobjectives, it is necessary to thoroughly prepare and define a transparent regulatoryframework, prior to the divestiture process.

35. Bolivia's capitalization offers two aspects, which might be worth considering forreforms of SOEs in other countries, particularly those that lack the financial resources andwould like to have direct and tangible benefits from their SOEs to the public. The firstaspect is that, compared to a regular privatization under which the sales proceeds will beallocated to the state treasury, the capitalization's sales money is deposited into theenterprise, providing it with the necessary capital for its growth. The second aspect is thedistribution of the state shares, or the benefits from them, to the public in various forms,i.e., workers' compensation benefits, retirement pensions, disability insurance, includingsocial safety nets and other urgent social and poverty alleviation needs. This could beconsidered in countries where political resistance has been preventing privatization.

12


BOLIVIA


(Credit 2762 BO)

Part II - Statistical Tables

A. Achievements of Objectives Substantial Partial Negligible Not Applicable

Macroeconomic Policies F3 0 u Sector Policies F : Financial ObjectivesInstitutional Objectives D D 3 IPhysical Objectives D LI 0 Poverty Reduction L L LIGender Concerns LI LI LIOther Social Objectives L L L IPublic Sector Management LI 0 0 IPrivate Sector Development L L LIEnvironmental Objectives n n LI

B. Project Sustainability Likely Unlikely Uncertain

C. Bank Performance Highly Satisfactory DeficientSatisfactoryD

Identification l z FAppraisal 0 I DSupervision -I Eii

D. Overall Borrower Performance

Preparation L E

Implementation LI XICovenant Compliance L 0Operation LI LnI

E. Assessment of Outcome Highly Satisfactory Unsatisfactory HighlySatSatisfacto Sr Unsatisfactory

E L L I

Source: Bank staff estimates.

13

Loan/Credit Title Purpose Approval Status

Preceding Operations

Bolivia - Power Sector (18180) Power Sector 1998 Lending

Bolivia - Finan Sctr (C1925) Power Sector Rehabilitation 1988 Lending

Bolivia - Mining Sctr (C2013) Mining Sector 1989 Lending

Bolivia - Private Entrp Dev (C2134) Private Enterprise Development 1990 Lending

Bolivia - SAC (C2298) Structural Adjustment Credit 1992 Lending

Bolivia - SAC (22983) Structural Adjustment Credit 1995 Lending

Bolivia - SAC (22983) Structural Adjustment Credit 1995 Lending

Following Operations:

There has been no other petroleumoperations.

Source: Bank Records

_~~~~~~~~~~~~' iSteps in Project Cycle Date Planned Actual Date

Identification NR NR

Appraisal NR June 1995

Negotiations May 1995 May 9-11, 1995

Board Presentation July 1995 July 06, 1995

Signing July 1995 July 19, 1995

Effectiveness October 17, 1995 December 05, 1995

Project completion June 30, 1998 June 30, 1998

Loan closing December 31, 1998 December 31, 1998

NR = Not ReportedSource: Project files

14

FY 1996 FY 1997 FY 1998 FY 1999

Appraisal Estimate* 1,917,295.00 5,751,885.00 6,288,725.00 6,800,000.00

Actual 2,972,779.55 4,845,910.70 5,692,387.55 6,527,108.21

Actual as % of 155.05% 84.25% 90.52% 95.99%estimate

Date of Final Disbursement: May 11, 1999

Source: Disbursement OfficeI SDR = 1.56 USD (Calculated for appraisal purposes only)

Key Implementation Indicators Estimated Actual

A. Legal and Regulatory Framework 4th quarter of 1995 1st Quarter of 1998

B. Capitalization of YPFB 4th Quarter of 1995 4 th Quarter of 1997

C. Institutional Strengthening 2nd Quarter of 1998 4th Quarter of 1998

Source: Project files and Borrower Records

Key project operations Key Indicators/Date Issued

Hydrocarbon Law Law 1689, passed April 30, 1996

Model Contract Drafting Issued, 1997

Various Regulations Implementing HC Law Including Supreme Decree Issued, July 19,1996Environmental onesDetermination of Legal Aspects Related to Natural Gas Seven Draft, October 30, 1997Distribution Companies

Organization Structure Set-up and Start-up Completed 1998

DGH Strengthening and Reorganization in NSE Completed 1998

Environmental Unit Set-up and Start-up in NSE Established 1997

HC Superintendence (SIRESE) Design and Set-up Law 1600, passed, October 29, 1994

YPFB Pre-Capitalization Studies Published, December, 1997

YPFB Capitalization Implementation Implemented, May 1997

Source: Project Files and Borrower Records

15

Studies Purpose as defined at appraisal Status Impact of Study

Technical and Indicate YPFB's present status, Completed Helped the governmentFinancial Valuation quality, maintenance and future determine sales value ofof YPFB' s Assets investment requirements. YPFB and circumvent

political issue of book valuesale

Business Unit (BU) Define the various BUs in the light of Completed Helped determine the bestorganization and the capitalization strategy adopted by way to capitalize thecost center Study the Government and the various cost company

centers related to these BUs in orderto have a better idea of the cost andprepare for the capitalization

Personnel Create a complete profile and Completed Helped determine a plan foroptimization and evaluation of the personnel, optimize shedding personnelIssues Follow-up the personnel, recommend an actionStudy plan to rationalize personnel prior to

capitalization

Follow-up Follow-up on an already Completed Helped to have a realisticInventory Study commissioned pilot study of the and meaningful balance

refining warehouses by expanding sheet inventory accountthis work to all warehouses todetermnine what material andequipment should be kept and whatshould be disposed

Debt Issues Study Analyze YPFB's debt to determine its Completed Helped determine theimpact on capitalization process and amount of responsibility fordefine how and how much of it will assuming YPFB's debtbe allocated to each MECs prior thecapitalization in the light of thecapitalization strategy

Data Bank Unit Design structure of the Data Bank Completed Helping setting up a dataOrganization Study Unit center required under the

new role of YPFB

Environmental Unit Design structure of the Environmental Completed Helped setting up, staffingOrganization Study Unit up and training up of new

environmental unit underthe VMEH

Hydrocarbon Design structure of the Hydrocarbon Completed Helped set up newSuperintendence Superintendence regulatory agency forOrganization Study transmission, and

distribution activities

Source: Project Files

16

Appraisal Estimate Actual

Project ComponentsLocal Forei'gn Ttl Local Foreign ToaProyect Components ~~Costs Costs Ttl Costs Costs Toa

A. Legal and Regulatory Framnework

* Regulations Implementing Hydrocarbons Law 120 180 300 185 1,277 1,462

* Model Contract for concession and others 40 60 100 39 261 300

* Environmental Regulations Standards and Norms 40 60 100 15 120 135

* Natural Gas Distribution Companies Legal Aspects 40 60 100 33 515 548

Subtotal 240 360 600 272 2,173 2,445

B. Capitalization of YPFB

1. Pre-capitalization Phase 1,692 2,568 4,260 --- 3,729,7 3,729.7

* Technical and Financial Valuation of YPFB Assets 280 420 700 --- 960 960

* Business Unit Organization and Cost Center Study 120 180 700 --- 151.8 151.8

* Follow-up on Personnel Optimization Pilot Study 80 150 230

* Debt Issues Study 120 180 300 --- 131.3 131.3

* Follow-up on Environmental Audit and Mitigation Plan 40 60 100

* Follow-up on Pilot Inventory Study 160 240 400 --- 390 390

* Administrative Support to CAPU 60 90 150 --- 613.4 613.4

* Legal Aspects of Pre-Capitalization 400 600 1,000 --- 634.4 614.4

* Establishment of Data Rooms and Operation 80 120 200 --- 186.9 186.9

* Public Information Campaign 320 480 800 --- 360.5 360.5

* Office equipment and furniture, computers hardware and 32 48 80 --- 41.6 41.6software for CAPU

* Reservory Studies* --- --- --- --- 218.8 218.8

* Others* --- --- --- --- 41 41

2. Capitalization Implementation Phase 80 120 200 --- 175.2 175.2

* Preparation of Marketing Strategy and Road Shows 80 120 200 --- 175.2 175.2

Subtotal 1,772 2,668 4,460 --- 3,904.9 3904.9

C. Institutional Strengthening

* ENTE/DGH Org. Study, Set-up & Staffing, and Start-up 600 900 1,500 23 144 167

* Data Bank Unit Org. Study, Set-up & Staffing, and Start-up 400 600 1,000 93 650 743

* Env. Unit Org. Study, Set-up & Staffing, and Start-up 200 300 500 14.7 92 106.7

* HCS at SIRESE Org. Study and Set-up 360 490 850 24.3 152 176.3

* E&P Promotion Campaign 80 120 200 2 18 20

* Training for NSE Personnel 240 360 600 1 6 7

* Office Equipment and Furniture, Computers Hardware and 168 252 420 38.2 239 277.2Software for NSE

* Administrative Support for PEU 100 150 250 --- 400 400

Subtotal 2,148 3,172 5,320 196.2 1,701 1,897.2

Base Cost 4,160 6,220 10,380 468.2 7,778.9 8,247.1

Price contingencies 360 560 920

Total project cost 4,520 6,780 11,300 468.2 7,778.9 8,247.1

PPF Refinancing --- 2,000 2,000 --- 1,884 1,884A and C Component --- 1,000 1,000 --- 884 884

B Component --- 1,000 1,000 ---

GRAND TOTAL 4,520 8,780 13,300 468.2 8,662.9 9,131.1Source: SAR and Borrower Finance Department * Not included in SAR

17

Appraisal Estimate Actual

Source of Financing Local Foreign Total Local Foreign Total_____________________ Costs Costs Costs Costs

Government of Bolivia 2,660 ----- 2,660 468.2 -468.2

IDA 1,860 8,760 10,640 ----- 8,662.9 8,662.9

Total 4,520 8,780 13,300 468.2 8,662.9 9,131.1Source: SAR and Borrower Finance Department

SAR ICR Re-estimate

Production

Major Costs Not Not

Capital Costs ($ million) Applicable ApplicableOperating Costs ($ million)

Economic Rate of Return (%)


4 _,

Statement number and title Describe and comment on lack of compliance

There has been no lack of compliance with applicable Bank Policies and Procedures


18

V~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~Agreement -Section Type Status Date Revse Description of Covenant

Credit Agreement

CA 2.02 (b) 13 C GOB to open special account for purposes of Parts A (Legal and Regulatory(_________ )Framework) and C (Institutional Strengthening) of the ProjectCA 2.02(c) 13 C GOB to open special account for purposes of Parts B (Capitalization of YPFB)

CA_2.02(c) 13 C of the ProjectGOB to carry out Part A and C of the Project through PEU and Part B throughCA 3.01 (a) 10 C CAPU

GOB to ensure environmental regulations for the hydrocarbon sector areCA 3.01 (c) 6 C developed, and to establish mechanisms for reviewing environmental audits

CA 3.01 (f) 10 C GOB to establish an Advisory CommitteeCA 4.01(b) 1 C GOB to have project accounts audited and provided to IDACA (Schedule 2-Part C-1) 13 c GOB to create a petroleum exploration and development promotion databank to

be made available to interested parties

Covenant types: Present status:

I = Accounts/Audits 8 = Indigenous People C = covenant complied with2 = Financial performance/revenue 9 = Monitoring, review, and reporting CD = complied with after delay

generation from beneficiaries 10= Project implementation not CP = complied with partially3 = Flow and utilization of project covered by categories 1-9 NC = not complied with

funds 11= Sectoral or cross-sectoral4 = Counterpart funding budgetary or other resource5 = Management aspects of the allocation

project or executing agency 12= Sectoral or cross-sectoral policy/6 = Environmental covenants regulatory/institutional action7 = Involuntary resettlement 13= Other

19

Stage of Planned Revised ActualProject Cycle Weeks US$mm Weeks US$mm Weeks US$mm

Through appraisal NR NR NR NR 84 314.50Board-effectiveness NR NR NR NR 18.20 70.90

Supervision NR NR NR NR 50.98 198.58Completion NR NR NR NR 7.00 27.27

Total NR NR NR NR 160.18 611.25

Source: Bank O0S NR: Not Reported

Performance RatingStage of Month/ Number of Days in Specialized Staff Implementation Development

Project Cycle Year Persons Field Skills Represented Status Impact10/95 4 PE,RE,ES,TS NA NA02/96 5 PE, RE, ES, TS NA NA

Through 05/96 1 RE NA NAAppraisal 12/96 1 ES NA NA

03/97 3 PE, RE, ES NA NA

11/95 3 NR FA, ES, TM S HS3/96 1 NR FA S HS7/96 1 NR TM S HS

Supervision 5/97 1 10 TM HS HS9/97 1 14 TM HS HS2/98 1 10 TM HS HS

6/98 1 9 TM S S12/98 1 10 TM HS HS

Special Staff Skills:

TM Task Manager EC Economist FA Financial AnalystTS Technical Specialist PS Procurement Specialist ES Environment SpecialistPE Petroleum Engineer RE Restructuring Expert

Source: Bank OIS and Project Files NR = Not Reported NA = Not Applicable

Appendix APage 1 of 5

Appendix A:

BORROWER'S CONTRIBUTION

(Translation from Spanish)

Introduction

The structural reforms being implemented by the Bolivian Government during the pastyears have focussed on establishing the most favorable conditions to achieve efficientallocation of resources within the Bolivian economy and the hydrocarbon sector, andfundamentally, to create a favorable environment in order for the private sector tobecome the protagonist for sustainable development in the long term, as a means toreduce poverty and increase the population's welfare, while preserving the environment.

The structural reforms also meant a redefinition of the state's role, which implied thestate leaving the production sector and strengthening its policy-making and regulatorycapacity, and the establishment of permanent "rules of the game" so that all the economicagents operate in the free market and allow the performance of an efficient andcompetitive private industry.

The main steps proposed within the sector scope of the structural transformation were thecapitalization of the state-owned company Yacimientos Petrol feros Fiscales Bolivianos(YPFB), the design and implementation of a new legal and regulatory framework like theNew Hydrocarbons Law (LH) and regulations, and liberalization or deregulation of thehydrocarbon market, all this within an environment of macroeconomic stability.

In harmony with the main government policy, on July 27, 1995 the Credit Agreement(Cr. 2762-BO) for a Technical Assistance Project for the reformn and capitalization of thehydrocarbon sector was signed between the Government of Bolivia and the InternationalDevelopment Association (IDA), for an amount of SDR 6.8 million, to support thestructural reforms of the hydrocarbon sector. The credit closing date was set forDecember 31, 1998.

A. Project Objectives

The project objectives were aimed to improve the policy and normative framework withthe purpose of completely changing the hydrocarbon sector structure and promotingprivate investment in that sector for the benefit of the Bolivian economy, including thestrengthening of the agencies in charge of the design, implementation, evaluation andregulation of sector activities, and the YPFB capitalization by private investors.

In agreement with the main government policy, the project provided technical assistancethrough three components: a) the development and implementation of legal andregulatory framework for the hydrocarbon sector, b) the design of a strategy that moves


toward the capitalization of the state agency, YPFB, and c) the strengthening of theagencies in charge of the policy and regulation of the sector.

B. Achievements of the Objectives

Since 1994, the government has created measures to generate the necessary legal basisfor the reforms in the hydrocarbon sector and the capitalization of the state agency,YPFB. These measures showed the strong commitment of the Bolivian government tocomplete the reforms by approving the following laws, regulations and doing otheractivities of institutional strengthening:

B.1 General Laws

- Law No. 15.14 of Capitalization of March 21 1994. This is a general law ofcapitalization of all public companies, including the petroleum state-owned companyYPFB, and basically authorizes the transfer of the state-owned companies shares for thecreation of Sociedades An6nimas Mixtas (SAM) or joint ventures, the capitalization ofeach public company, the transference of the shares of these companies to the Boliviancitizens older than 21 years, the establishment of the Trust Fund before the creation of thePension Fund and the subrogation to the state of the companies' debts before theircapitalization or sale.

-The Sectoral Regulation System Law (SIRESE) - Law NO. 1600 of October 29 1994.This law defines the activities to be regulated, the authorities responsible for theimplementation of the regulations and the establishment of mechanisms of impeachmentand litigation interposed by investors, consumers and public authorities.

-The General Tax System Law (N. 1606) of December 22 1994 that emended the GeneralLaw N.843 May 20 1995. This law creates a 25% tax on the utilities and introduces theSpecial Tax to the Hydrocarbons and its Derivatives (IERD), which is a tax toconsumption of specific Petroleum Derivatives.

B.2 Laws and Regulations Specific to the Hydrocarbon Sector

The objective of the Hydrocarbon Law of April 30, 1996 was to create conditions toattract private participation in the hydrocarbon sector and force the development of all therelated activities: (i) exploration, exploitation and commercialization of hydrocarbonsthrough risk contracts between YPFB and the private sector, with hydrocarbon transportand natural gas distribution under administrative concessions; (ii) in commercialization,the establishment of unrestricted export and import of liquids after guaranteeing thesupply of the local market, with the exception of natural gas; and (iii) the refining andindustrialization by YPFB and third parties. In addition, this law introduced acompetitive tax and royalties system for the upstream, and the new institutionalorganization of hydrocarbon sector.

The Surtax law of November 25 1996 (Law N. 16119) introduced in the general systemof taxes, the concept of a surtax on the exploitation of non-renewable resources(hydrocarbons and mining), through an additional rate of 25% to the utilities tax,previous to the deduction for the second time of the investments and a proportion of the


gross production (applicable to large discoveries that generate important surtaxes), thesesurtaxes being collectible by the state.

Finally, the development and approval of 25 regulations, that regulate among otheraspects: (i) Institutional, as the organization of the sector; (ii) Tributary, as the paymentof bonuses and participation on the production of hydrocarbons and the surtax; (iii)Upstream, as the relinquishment and retention of areas, technical units of exploration,right-of-path and right-of-way, commercialization of natural gas; (iv) Tariffs of transportof hydrocarbons for pipelines; (v) Prices of the derivatives, environmental aspects of thehydrocarbon sector and environmental liabilities; and (vi) Technical and security of allthe upstream and downstream activities. Two important regulations are in process ofcompletion: the handling of oil operations inside indigenous territories and thedistribution of natural gas systems.

All these legal dispositions and regulations were promulgated as supporting instrumentsfor the execution of the strategy, policies of the hydrocarbon sector.

B.3 Institutional Strengthening

At the same time, technical assistance was granted with the project for the sector'sinstitutional strengthening process, the initial establishment of the staff and the beginningof operations of the hydrocarbon sector institutions, including General Directorate ofHydrocarbons (DGH) now denominated Vice-presidency of Negotiations and Contracts(VPNC), the Data Bank denominated National Center of Hydrocarbon Information(CNIH), the ex-secretariat of Energy, now Vice ministry of Energy and Hydrocarbons(VMEH) and the Superintency of Hydrocarbons (SUPHYD). Additionally, a promotioncampaign for upstream areas was done in Houston as the first bidding round after havingpromulgated the Law of the Hydrocarbons and some of its regulations and finally thepersonnel's training and furniture acquisition and equipment for these institutions.

C. Major Factors Affecting the Project

Among the factors that affected the project's implementation process are the following:

- The available time was not enough to do such deep structural reforms within thehydrocarbon sector in spite of technical assistance received through IDA and otherorganisms like CIDA.

- The resistance of the state-owned company employees and other labor and civicorganizations of the country.

- Lack of flexibility for the design of a tax system for the upstream, which should becompetitive with other countries' and neutral from the fiscal revenues point of view.This fact originates a trade off among these two factors.

- The influence in the definition of the capitalization strategy of the state-ownedcompany YPFB, country partners and some international private companies.

- Government's lack of counterpart resources and knowledge of the financing entityprocedures.


- Service of the capitalized company's debt and the costs involved by therationalization process, the discharge of YPFB employees, factors of fiscal imbalancethat could be partly originated in the fiscal competitive system, and the tendency ofinternational prices to drop, which have diminished the transfers from thehydrocarbon sector to the Nation's General Treasury (TGN).

D. Project Sustainability

The structural reforms carried out in the hydrocarbon sector can be sustainable in the longterm, however it is necessary to evaluate the factors that support the sustainability andthose that could affect it.

D.1 Factors that Support Sustainability

- Investments committed in the hydrocarbon sector that would allow the fulfillment ofthe hydrocarbon policy's general objective of substantially increasing thehydrocarbons reserves, produce enough liquids to guarantee the supply in the mediumterm and generate exportable quantities in the long term, as well as the marketdiversification for the exportation of natural gas, transforming Bolivia in the SouthernCone's Distribution "Hub."

- The natural gas exports agreements with Brazil were finalized; the gas pipelineconstruction was complete at the end 1998 and started of gas export during the firsttrimester of 1999.

- Democracy and macroeconomic stability accompanied by liberalization of capitalflows, freedom to import and export, deregulation of activities and prices, and theestablishment of a more simplified tributary system with credibility in other countries,etc.

- Establishment of levies and participations to support the establishrnent andstrengthening of sector institutions, although in some cases these levies are notenough.

- Privatization of the remainder activities of YPFB and other minor companies in othersectors.

D.2 Potential Factors Against Sustainability

- During the implementation stage and enactment of the hydrocarbon sector laws andregulations, the lack of financial and human resources was evident in someinstitutions of the sector. This is the case of the Vice Ministry of Energy andHydrocarbons, which did not have the necessary financial resources to fulfill its roleas supervisor of the environmental aspects, and this has determined that they cannotattract and maintain qualified human resources in a sector where important revenuesare generated for the country; this also applies on a lesser extent to the VPNC.

- The implied cost derived form the structural reforms process like: the financial cost ofthe debts subrogated to the state as a result of the capitalization process; themaintenance cost of the old system of pensions for citizens 65 years and older; and


those derived from a reduction in the sector contribution to the public finances as aresult of the establishment of competitive tributary system and the drop ofhydrocarbons international prices.

E. Performance of the Financing Entity

IDA provided technical and financial assistance to the country in agreement with thepolicy of the government, and that assistance was done opportunely. The supportprovided through the credit agreement 2762BO for the Reform of the HydrocarbonSector and Technical Assistance for the Capitalization, has been fundamental in hiringinternational and local consultant firms, as well as individual consultants that helped tomake all the necessary studies, to carry out the structural reforms process, the design ofthe new legal and regulatory framework, the design of the capitalization strategy andsome conceptual discrepancies with the position or strategy defined by the governmentfor the upstream on the part of financing entity. The financial support for the initialestablishment and strengthening of the institutional organization of the sector has alsobeen indispensable and invaluable.

F. Project Contribution to the Objectives

The structural reforms carried out by the government in the hydrocarbon sector and in theeconomy as a whole have established new rules of the game and institutions in the sectorgenerating a favorable atmosphere for the private sector investment, internationallyperceived by the private sector as a reduction of risk of the country and the oil industry,this aspect have been translated in investment commitments around of 4.3 million dollarsfor the next years for the upstream and transport activities only, this represent 10 timesmore the state annual investments and 3 times superior to the investments within thesector during past years of highest investment.

G. Future Operations

The government decided to extend the structural reforms in the hydrocarbons sector bythe privatization of the YPFB remainders units and strengthening institutions like theVPNC and, fundamentally, the VMEH, head of the sector, to improve its policy-makingcapacity and the carrying out of its functions regarding the collection of royalties andprofit shares, and of environmental supervision in the hydrocarbon sector, functions thatwill require of financial support.

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