Polar Beer…”play it again Sam”



The Cemex Request-for-Proposal:

An Auto-Generation Energy Project[1],[2]

Bertrand d'Hautefeuille sipped on this, his fourth cup of café au lait of the morning as he sat on the fourth floor of his San Antonio office, overlooking the beautiful San Antonio Riverwalk. He simply could not avert his eyes from the package that sat on the edge of his desk. For the last two weeks, he and his committed team of business development associates and analysts had worked around the clock to complete a response to the Cemex request-for-proposal. Cemex had stated that proposals were due at 14:00 tomorrow, June 8, 1998. All that remained before shipping the package to Cemex was for him, the Vice-President of Business Development at SBS, S.A. (SBS) to insert the bottom line price. He had read the marketing group’s analysis and recommendations regarding pricing. Now it was time for him to once and for all determine just how cheap SBS was willing to contract the sale price of electricity in the PPA with Cemex. Could he be confident that this price would sufficiently reimburse investors for investing in a project of this risk caliber? Also, was there room for him to raise this price and not risk losing the bid to a competing bidder?

Termoelectrica Del Golfo (TEG), a Cemex legal entity, had been responsible for inviting selected participants to bid in an international tender. The TEG Project was intended to provide a cost-effective and efficient power supply to Cemex’s 12 cement plants in Mexico. Since electricity alone makes up 20% of the production costs for cement, TEG would provide a hedge against future electricity price increases. The power would be produced by the winning bidder, through use of Cemex’s auto-generation permit, and then wheeled by Cemex to its cement plants using the interconnected transmission grid of the Comisión Federal de Electricidad (CFE). The facility was to be located adjacent to Cemex’s Tamuin cement plant in the state of San Luis Potosi, Mexico. Once TEG had awarded the turnkey project to one of the participants, a “Master Agreement” would set the terms and conditions for the development, engineering, financing, construction, operation, and maintenance of a net 230 MW petroleum coke-fired power plant. Pursuant to Mexico’s self-supply legislation, the 230 MW plant would provide capacity and associated energy to Cemex at a contracted price, and it was based on this price (and this price’s ability to provide Cemex with the greatest possible net present value of savings) that Cemex would be evaluating bids.

Cemex

Brief History

Cemex was founded in 1906 with the opening of the Cementos Hidalgo plant in northern Mexico, the first modern cement plant in Latin America with a rotary kiln[3]. Cementos Portland Monterrey, the cornerstone of the company, initiated operations in 1920. From the mid-1960s through the mid-1980s, Cemex grew into Mexico's market leader in the cement industry. During this period, the company more than doubled its export volumes, became listed on the Mexican stock exchange and expanded its presence into central and southern Mexico. Cemex began its transformation into a multinational cement producer when the GATT agreement was signed in 1985.

To successfully compete in an increasingly open marketplace, the company acquired strategic cement operations in Spain, Venezuela, the United States, Panama, and the Dominican Republic. Cemex further focused on its core cement business and divested non-strategic interests in the mining, petrochemical, and tourism industries. From 1996 through the present, Cemex has continued its global geographic diversification, entering markets whose economic cycles largely operate independently and which offer long-term growth. The company is now the world's largest cement company. It is also the world's largest trader of cement and clinker. See Exhibit 1 for company’s recent financial history.

Cemex Strategy

Cemex owes its success partly to the fact that, unlike its European rivals (France's Lafarge and Switzerland's Holcim, known until recently as Holderbank):

1. It concentrates on developing countries, which are more dynamic markets, where the demand for housing, roads and other needed infrastructure is greatest.

2. It focuses on its core cement and ready-mix concrete business.

3. It maintains high growth by applying free cash flow toward selective investments that further its geographic diversification.

4. It combines a deep knowledge of the local markets with its global network and information technology systems.

With its geographically diverse portfolio and position as the world’s largest cement trader, Cemex is truly a global presence. This fact allows Cemex to capitalize on individual market declines. For example, the downturn in Asia enables Cemex to purchase low-cost cement from China for our California concrete operations. The positive impact of this move on Cemex cost structure is significant. Partly resulting from these positive impacts, Cemex is more profitable than either of its two big international rivals.

Production of cement is an energy-intensive process, with 40% to 50% of its manufacturing costs coming from energy (60% thermal energy, 40% electricity). This produces significant quantities of gases and consumes substantial raw materials. Cemex, historically among the leading global companies in the world, established its first formal environmental policy in 1993; this policy was implemented in all of its operations around the world. Then in 1994, Cemex established a sustainable development strategy, whereby it would employ cutting-edge technology in its operational processes in order to assure energy efficiency and to optimize the use of raw materials. This eco-efficiency program had two main objectives:

1. Reductions of environmental impact: developing and implementing innovative practices and technology in its production processes and new cement plant design; selective mining techniques; recycling and reusing materials; using alternative raw materials like blast furnace slag and fly ash, byproducts generated from steel manufacturing and power stations, among others; using natural cementing materials, such as pozzolana; using alternative fuels and reusing waste materials, including petroleum coke (petcoke), waste oils, and used solvents.

2. Economic savings: guarantee the energy supply for all of its cement production facilities and minimize its cost volatility, thereby reducing its operational and financial risk; optimize its local and global energy costs through synergies and economies of scale.

Between 1992 and 1994, Mexico’s energy regulation was amended which directly influenced Cemex’s decision to create the TEG Project. Among the changes in this new regulation were: to allow companies to produce electricity for its own consumption; to lead the fuel price setup by the international markets; and the use of non-budgetary, non-inflationary financing mechanisms, emphasizing international capital markets and private savings, thru BLT (Build-Lease-Transfer) and BOO (Built-Own-Operate) and free import and export of petcoke, no permit required like other fuels. (See further discussion in “Mexico and the Mexican Energy Sector.”)

In 1995, Cemex started to conduct several feasibility studies concerning the construction of an auto-generator power project. The studies considered and analyzed different fuel supplies, technologies, and unit configurations. In each case, the most attractive option for Cemex has consistently been to use circulating fluidized bed boiler technology[4] fueled by petroleum coke, in combination with a conventional condensing steam turbine. The primary factors, which contributed to that conclusion, were:

• low cost fuel supply;

• abundant and low cost limestone supply;

• established and mature technology contributing to the reliability and finance-ability of the project; and

• ability to use petroleum coke in cement kilns, resulting in reduced cement production costs.

Petroleum Coke[5]

“The largest obstacle to petroleum coke at this point is the industry only has two groups it can target: cement plants and electric generators”[6]

Petroleum coke is a by-product of the oil refining process. Ongoing advances in established refining technologies have markedly enhanced options for processing and economically using residues. While the year-to-year additions of new bottom-of-the-barrel conversion projects and the associated changes in production of petroleum coke depend on the price differential between light and heavy crude oil, experts predict an inevitable increase in the production of heavier crude oil. This is attributed to the fact that world crude oil demand has been increasing at an annual average rate of nearly 1 million barrels/day since 1985, and major producer/refining companies forecast this rate of increase to continue well into the next decade. Thus, over the long range, production of petroleum coke is expected to increase worldwide. As of January 1, 1998, total worldwide production of coke was reported to be approximately 46 million tons per year. Of this, North America (predominantly the U.S.) accounted for approximately 66.5 percent; Europe, about 17 percent; the Asia-Pacific region, about 9.5 percent; South America/Caribbean, about 4.5 percent; and the Middle East/Africa, about 2.5 percent. Nearly 90 percent of the total coke produced is delayed petroleum coke.

Petcoke has historically been priced at a discount relative to coal because of its poorer environmental characteristics, however, petcoke's high heating value and low ash content tend to lower transportation costs relative to coal, because it takes less total tons of petroleum coke to achieve the desired heat input. On the other hand, its high sulfur content, low volatile matter, and high metal content tend to make petroleum coke an unattractive fuel. However, its increasing supply and declining prices are hard to ignore.

In many developing countries, the existing fuel transportation systems are overstretched. As a result, governments in these countries are receptive to power plant developers bringing their own fuel. In a solid fuel-based power plant, fuel can constitute as much as 35 percent of the cost of electricity (COE). For gas and liquid fuel-based power plants, this figure can approach 70 percent. Thus there is a big incentive to use waste and other inexpensive fuels, provided they can be burned economically and in an environmentally friendly manner. In addition, the proximity of refineries to power plants also influences the amount of petcoke purchased for use in electricity generation. This is a win/win for both the refinery and the power plant because it gets the petcoke off the refinery's property and results in a cheap form of fuel for the power and cement plants. See Exhibit 2.

Cemex Partnership with Pemex

Guided by its the eco-efficiency, Cemex started to upgrade the majority of its cement plants[7] around the world, Mexico was not the exception (see Exhibit 3), to run on a more cost-efficient mix of fuels, completely replacing fuel oil with petcoke. Thanks to its international expansion and size, its motivation for using alternatives fuels, and its idea to reduce volatility, Cemex started winning an important place within the petcoke market

In March, 1998 Petroleos Mexiconos (Pemex), Mexico’s state-owned petroleum refinery company, and Cemex signed a 20 year petcoke supply contract; in which Pemex would annually supply 1.75 millions tons from its newly reconfigured Cadereyta and Madero Refineries to Cemex. This was a win-win opportunity: Pemex would secure a long-term buyer for the whole production of its refineries’ primary residual byproduct allowing them to instead focus on the production of high quality products such as gasoline and diesel; and Cemex would be guaranteed a long-term petcoke supply, a fuel for which the price is less volatile than for other fuels (see Exhibit 4). Nevertheless, at that time Cemex petcoke demand was not enough to consume the full 1.75 million tons, but thanks to its long-term vision and to some changes in the Mexican Energy regulations, Cemex conceived the “Termoelectrica del Golfo” (TEG) Project which would further utilize this favorable partnership and access to cheap electricity fuel.

The size and scope of the Pemex-Cemex agreement had been unprecedented—it was a long-term agreement between a state-owned company and a publicly owned company, and the contract was calling for 35 million tons of petcoke. From Pemex’s standpoint, the Cadereyta and Madero refinery reconfiguration and modernization would improve the structure of the Mexican petroleum industry, thereby satisfying growing demand for unleaded gasoline to meet Mexican environmental regulations, assisting Mexico’s electric utilities in shifting consumption from high sulfur fuel oil to natural gas, increasing light fuel production while reducing heavy fuel oil production, and modernizing and expanding its refining capacity. These were unparalleled huge-scale projects. And from Cemex’s standpoint, the TEG Project would be a 230 MW inside-the-fence power plant to be located in Tamuin, San Luis Potosi, Mexico, next door to one of its main cement production plants, and within close distance to the CFE electricity grid.

SBS, S.A.

SBS, a French conglomerate with operations and subsidiaries around the globe, serves the energy market through its activities in power generation, transmission, distribution and transport through its activities in rail and marine. Its core business is to design, supply and service a complete range of technologically advanced products and systems for customers. As a result, the company possesses a unique expertise in systems integration and through-life maintenance and service. See Exhibit 5 for allocation of SBS’ scope of work and financial statistics.

SBS has an international network of offices throughout the world that coordinates its sales and marketing activities. These are organized into five geographic regions: Western Europe, Eastern and Northern Europe, the Americas, Asia/Pacific Region and Africa/ Middle East and includes over 170 countries. In fiscal year 1997, SBS had annual sales in excess of €23 billion and employed more than 118,000 people in over 70 countries. SBS is listed on the Paris, London and New York stock exchanges. SBS offers a comprehensive range of turnkey solutions that cover the entire scope of service including site management studies, software development, design, engineering, project management and finance. Its track record includes over 180 combined cycle power plants worldwide, which equates to over 48,000 MW, and over 240 fossil fuel-fired power plants, which equates to over 44,000 MW. In addition, SBS installed more than 300 gas turbines worldwide. The short project execution times for combined cycle plants result in a fast and la lasting return on investment for the clients.

The Americas operations—the subsidiary responsible for developing the bid proposal for this request-for-proposal—are based out of San Antonio, Texas. In the current portfolio of orders Central America is underperforming, and management feels that the TEG Project could substantially increase SBS’s presence in the region.

Mexico and the Mexican Energy Sector

The site of advanced Amerindian civilizations, Mexico came under Spanish rule for three centuries before achieving independence early in the 19th century. A devaluation of the peso in late 1994 threw Mexico into economic turmoil, triggering the worst recession in over half a century. The nation continues to make an impressive recovery (see Exhibit 6). Ongoing economic and social concerns include low real wages, underemployment for a large segment of the population, inequitable income distribution, and few advancement opportunities for the largely Amerindian population in the impoverished southern states. Mexico is one of the most advanced emerging markets, with a stable political regime and growing economy. According the United Nations, Mexico ranked 49th out of 174 countries evaluated in the 1998 Human Development Index.[8] (See Exhibit 7.)

Background

In the post-World War II environment, Mexico, like many Latin American countries, implemented import substitution industrialization (ISI) strategies to foster economic and social development and shield the domestic economy from exogenous shocks while subsidizing infant industries. ISI policies failed, creating distortions in the local markets and fostering inefficient industries and substantial trade deficits financed by large fiscal deficits, massive debt and distorted exchange rates. These unsustainable policies finally collapsed in 1982. In the midst of the Debt Crisis, Mexico instituted a stabilization program and initiated a liberalization process. Prior to 1986, all energy investments had been from the public sector[9].

During his tenure, President Salinas (1988-1994) initiated the liberalization of the energy sector by eliminating energy subsidies, initiating deregulation and liberalization of electricity and petrochemical industries and restructuring the Federal entities involved in energy production and distribution. In 1992, Salinas passed a constitutional amendment changing the meaning of “public service,” implicitly legalizing private investment in electricity focused on generation for self-supply, cogeneration and independent power producers (IPPs). This amendment did not explicitly place these activities under the purview of the private sector. Despite the lack of a clear legal foundation, the private sector has become the driving force in developing the energy sector and making up the majority of investment in electricity generation[10].

Institutional Structure

There are two main players in Mexico’s energy sector, the CFE which is in charge of power generation, transmission and distribution nationwide (except Mexico City), and Luz y Fuerza del Centro (LFC), which is responsible for the distribution service in Mexico City and surrounding areas. Both are state owned and operated enterprises that together supply power to 95% of the approximately 100 million Mexican residents. As is the case with many large state-owned enterprises, these companies face technical, administrative, and financial problems that prevent them from expanding capacity and improving operations.

In terms of sector regulation, the Energy Secretariat oversees and regulates both CFE and LFC and participates in planning. In addition, there is the Energy Regulatory Commission (CRE), which is an independent regulatory body established in 1995 with the mandate of promoting efficient development of the electricity sector. CRE is responsible for regulation of private sector participation in the energy sector, as well as regulating the supply and sale of electricity to consumers and the acquisition of electricity destined for the public service.

Supply and Demand of Electricity

According to the Mexican Ministry of Energy, Mexico’s demand for electrical energy is growing at 5.5% per year[11] leaving a greater deficit to be covered by energy derivative imports.

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The Ministry estimates that to increase electricity generation capacity by 30%, the government would have to invest approximately US$25 billion. Electricity production, transmission, and distribution are concentrated in government hands and supplies power to 95% of the Mexican population[12]. The public sector does not have the resources to expand production to meet supply and expects the private sector to provide 92% of the required investment (see Exhibit 8)[13]. The relative price and quality of electricity is uncompetitive relative to Mexico’s NAFTA partners (see Exhibit 9)- despite substantial government subsidies. Though the United States has higher fuel prices for electricity generation, Mexican electricity rates for industry are 24.5% higher (46.5% higher if electricity subsidies were removed).

Energy Policies and Reform Efforts: Salinas Administration through Zedillo Administration

President Salinas’ 1992 Constitutional Amendment de-monopolized the electricity industry and spurred domestic investments in IPPs, private companies which produced electricity and sold it to the state-run CFE for about $0.02 / kilowatt hour (kWh). While this filled part of the demand, it was not enough: the legal framework limited foreign capital to “activities that are not part of the public utility electricity service (i.e., auto-supply).”[14] Moreover, expansion through IPPs was not viable for the government, since the state assumes all risks through PPAs and is required to pay back these investments with money it would prefer to allocate to social programs. This is undermining Mexico’s credit rating.

With demand growing, few resources to invest in the energy sector, and a growing trade deficit in petrochemical derivatives, the Zedillo Administration (1994-2000) furthered liberalization efforts-by-mandate and issued permits for self-supply, co-generation, and independent production centers. More importantly, these permits allowed for the use of foreign capital.

Over the same period, Pemex suffered a failed partial privatization effort and further budget cuts for petroleum plants forcing it to curtail production and causing its facilities fall further behind technologically.[15] More importantly, these cuts translated into less fuel for private energy producers and increased fuel imports, as Pemex continued to fail to meet production goals. Since attempts at partial privatization (49% of Pemex stock) attracted few investors, the government halted this partial sale and subsequent reform efforts by the government.

As Zedillo approached the end of his presidential term, the energy situation had not been resolved:

1. the electricity system has a reserve margin of only 4% (the lowest in Mexico’s history);

2. capacity grew by 5,306 MW (26.5% less than expected);

3. brownouts are expected- including in industrial zones; and

4. current production is not competitive relative to the competitiveness demanded by the global market.

Zedillo’s most significant reforms in this area involved the issuance of permits to allow for the generation of 6,528 MWs and almost US$4 billion in investments. Unfortunately, he could not fully legalize the permits before his term ended.

Election and Energy Politics

The Partido Revolucionario Institucional[16] (PRI) has been in power since the 1910 Mexican Revolution, partially by means of the application of electioneering, cuadillismo (generally understood to mean rule by charismatic leadership), and populism. Elections will be held in July 2000, perhaps the first truly free and fair elections since 1910. Given its eroded popularity, there is a high probability that the PRI will lose control of Congress and the Presidency. In this context, President Ernesto Zedillo introduced an energy reform package to amend the Constitution and allow the continuation of reforms. The pre-electoral process, the unpopularity of privatization, bank bailout and other political issues are taking precedence and it appears these reforms will not reach fruition.

Partido Revolucionario Insitucional. Zedillo’s PRI congressmen paralyzed the reform process, viewing generation and distribution of electricity as an activity of the State. While they will tolerate competition among IPPs, PRI congressmen hold that subsidies for residential and agro consumption of electricity must be preserved and further reform must consider workers’ rights.

Partido de la Revolucion Democratica. The opposition party, PRD, believes that reform should not be carried out at all. Moreover, they favor a gradual process through which the private sector continues investments in energy while the current State energy entities are restructured and gain financial autonomy. Additionally, they favor reforming the current subsidy program.

Both parties agree on the need to restructure the electricity industry, but reform is difficult because it touches on the social and ideological roots of the state. With the upcoming elections, it is unclear which party will dominate, especially given the PRI’s current low popularity. Vicente Fox’s platform is contradictory: at first favoring reform and liberalization in speeches in the U.S. followed by vows not to privatize oil and electricity industries.

Regardless, the next President needs to reform the Constitution before implementing further change. This requires a 2/3 vote in Congress and 51%+ of the 32 state legislatures. Whoever wins, though, will have to deal with a more fractured Congress and legislators who may or may not hold the party line.

The uncertainty and lack of clarity of energy reform has kept investors away and is considered the primary stumbling block for the development of the energy sector[17]. Moreover, some foreign electrical companies have cancelled US$3 billion in investments. These include Electricité de France and, more recently, Intergen’s cancellation of a 350 MW project in Monterrey[18].

Power Generation in Global Emerging Markets

As developing economies have opened their markets to foreign direct investment while liberalizing and privatizing key sectors, there has been a tremendous surge in the number of infrastructure projects being operated or financed by foreign investors. About 1700 such projects representing US$500 billion worth of investment were completed in developing countries through 1998[19]. Driven by the need to expand capacity and improve reliability, the energy sector has been at the center of this investment. From 1990 to 1999, over 700 energy projects (including natural gas and electricity projects) totaling US$187 billion in investments, were undertaken by foreign project developers. By 1997, the year prior to the bidding of the TEG project, electricity projects in developing countries around the world had reached close to $49 billion in investments (see figure below).

In Latin America, private participation in the energy sector has been encouraged as part of broader reform efforts aimed at creating more efficient, stable, and competitive energy market. Electricity demand has experienced a compounded annual growth rate of 5% per year, one of the highest in the world.

Of the total investments in the energy sector in Latin America involving private participation in the 1990s, 75% related to divestitures through privatization while the remaining 25% related to greenfield[20] IPP projects. These greenfield projects are typically highly levered, limited liability projects financed off the balance sheet of the project sponsors. This form of non-recourse or project financing means the investments are financed based upon the anticipated cash flows of the project, with the cash flows and the project’s assets serving as collateral.

Electricity generated through IPPs is usually sold to electric utilities or to the retail market of industrial or other customers. Many feature take-or-pay contracts which specify the quantity of output the utility or industrial customer is required to purchase. IPPs come in different forms depending on whether the project sponsor retains ownership and/or operating responsibility; they are typically classified as Build-Own-Operate (BOO), Build-Own-Operate-Transfer (BOOT), or Build-Lease-Transfer projects (BLT).

The growth of IPPs has been spurred by a number of factors. First, there is the immediate need for increasing capacity, while creating a more reliable supply of electricity for consumers. It is estimated that sudden blackouts can cost developing countries about US$1000 per MWh. Second, IPPs are attractive for their ability to transfer significant risks to the project developer, including construction and operating risks and some fuel availability risks. At the same time, IPPs shield developers from some political risks because they contain inherent regulatory measures, which are independent of (weak) government regulatory frameworks. Third, by liberalizing the energy sector, governments in developing countries have enabled public utilities and consumers to tap into new forms of financing in international capital markets, as well as a myriad of international players in the energy sector.

Sources of financing for IPPs include equity, loans and partial credit or partial risk guarantees from multilaterals, export credit agencies, commercial banks, bond issuances, and project developers. The World Bank and IFC have actively supported IPPs in developing countries. By 1995, one-third of all IPPs in developing countries received some form of equity and debt financing form the IFC. Similarly, the World Bank has supported IPPs by providing governments with assistance in developing appropriate legal and regulatory frameworks and assisting governments in undertaking competitive bidding for projects.

The TEG Project[21]

The Termoeléctrica del Golfo Project entails the development, financing, construction, operation and maintenance of a 230 MW Circulating Fluidized Bed (“CFB”) petroleum coke-fired power plant in the Mexican state of San Luis Potosí. The TEG Project will generate electricity for cement plants located in the central and northern regions of Mexico and surplus power will be sold to the CFE, the public electricity utility. This project is not the first in its kind and more independent power generation plants have been constructed in Mexico. As a result of public bidding competitions, potential independent producers have offered sales prices for CFE purchases of electricity ranging from 2-3 US$ cents per kWh, well under the average price at which CFE sells the electricity to end users (US$5.5 cents per kWh). A history of electricity prices in Mexico is given in Exhibit 4 (graph with prices over time). At this stage, it is projected that TEG will sell about 1% of the electricity produced at the TEG plant to CFE.

Town of Tamuín

Tamuín is a quiet town bordered by two rivers and located in the Mexican state of San Luis Potosí. As of the 1995 census, the municipality of Tamuín had a total population of approximately 36,500 with an average age of 19 years. The only other industrial activity in the town is the cement plant owned by Cemex. Agriculture (farming and ranching) is the main economic activity. The town was selected because it has good water, railway, and water access, and is close to the petcoke delivery routes and to limestone supply. The site for the plant is located in a remote and previously undeveloped area.

The project is expected to create employment for 1000 to 2000 people during the two-year construction period and employment for another 200 people once the facility is in operation. It is expected that workers will be paid a salary that is higher than average local wages (which are lower than minimum salaries).

Project Requirements

TEG is seeking a partner to jointly develop the TEG Project. The organization that is ultimately selected through this competitive bidding process will operate the project through a Mexican Business Trust (MBT), an entity that will specifically be formed by TEG and the winning bidder to jointly develop the project. To meet technology requirements, the total investment is estimated to be about $350 million (see Exhibit 10). Some key features of the project and responsibilities of the MBT include the following:

• The MBT will maintain the permit that authorizes the generation of electricity by the facility.

• Under the terms of the Power Supply Agreement, all power generated will be sold to Cemex or to CFE.

• The electricity price charged to Cemex will reflect any changes in the market price of petcoke.

• Both the electricity and petcoke prices are charged in U.S. dollars, while local inputs are paid for in pesos.

• The MBT is required to maintain a minimum output level during the 20-year operational period.

• The MBT will arrange a transmission agreement with CFE that also includes directives for the interconnection and possible excess energy requirements of Cemex (CFE will provide back-up power).

• There will be a bailout agreement between MBT and Cemex in case of default by Cemex affiliates.

• Following the 20-year period, ownership will revert to Cemex. At that time, Cemex is required to pay a $40 million transfer fee.

• Benefit or impacts of changes in interest rates are shared between operator and Cemex.

• The project is required to meet both the Mexican and IDB environmental standards. As per IDB rules, the operator will have to develop environmental monitoring plan, contingency plans, annual Environmental Performance Report, and health and safety plan.

• Contract can be renegotiated if there are changes in environmental legislation.

See Exhibit 11 for project cost details.

Cemex will only be responsible for obtaining the land clearing approval, water withdrawal permit, and wastewater discharge permit that will be assigned for the benefit of the project. The bidder is responsible for obtaining all other permits and approvals for the TEG Project including the ancillary support facilities. After its creation, the MBT will enter into agreements with other Cemex Affiliates for the supply of limestone and petroleum coke, the main inputs to the power plant. Cemex has already put the structure for these agreements in place.

The power generation facility will interconnect into the existing grid of CFE’s Anahuac Potencia substation just south of the project site. Power generated by the facility will be wheeled over CFE transmission lines to Cemex’s other cement facilities in Mexico.

Evaluation of Bids

To guarantee only competent companies bid on the project, a pre-qualification round has selected those that have the technical capabilities to perform the requirements. Due to this pre-qualification of bidders, the evaluation of responsive proposals will only focus on economics (SBS has successfully passed the pre-qualification hurdle). To evaluate the different offers on an equal basis, all are required to focus on the price for electricity that TEG will charge Cemex during the 20-year lifespan of the contract.

Cemex has forecasted the cost for continuing to purchase their power supply from the CFE. The economic evaluation will rank proposals according to the cumulative net present value of savings to Cemex over the 20-year contract term. The proposal, which results in, the largest savings to Cemex will rank highest. Because most of the costs would be the same no mater which party wins the contract, competition is primarily based upon the ability to offer the lowest possible purchase price for the contracted power to Cemex. The main factors therefore are the cost of capital to the bidder and the financial structure of TEG.

On the closing date of the bidding process, the winner of the bid must pay TEG US$12,000,000 as reimbursement for development costs incurred by TEG and its affiliates.

Sources of Funding

Coface, a French export credit bank, has shown interest in the project and is willing to participate in the financing of 36% of the estimated value of debt, with the remainder being financed through A and B type loans from the Inter-American Development Bank (IDB), a multilateral lending organization. IDB has stipulated that its participation in the TEG Project will require compliance with World Bank environmental guidelines, which in turn are more stringent than Mexican environmental, social, health and safety laws.

SBS has very good working relationships with both financing institutions and each committed to participate in the bidding consortium. The suggested debt structure is as follows:

Coface: US$100 million

IDB: US$75 million A loan

US$102 million B loan

In the case of a successful bid, the equity will be owned by the SBS and its partners (99%) and Cemex (1%). Mexican law requires Cemex to be an equity holder in the venture, but does not precise to what extent. The approximate total costs of the project have been estimated at US$369 million, suggesting an equity investment totaling approximately US$92 million.

Project Schedule

The bid documents are due tomorrow, June 8th, 1998, and the successful bidder will be announced August 7th. The commercial operation is expected to start on November 30th 2001. Further details regarding the project schedule are provided in Exhibit 12.

Conclusion

Bertrand d'Hautefeuille put down the Cemex request-for-proposal and started to think about what he needed to do to settle on a final bid price. He knew this would be an excellent opportunity for the Americas division for SBS, allowing it to position itself in Mexico as an operator for future projects similar to TEG. Also, with a strong foothold in Mexico, think of the opportunities that would arise if Mexican reforms under the next president continue to liberalize the electricity sector. But at the same time, he knew there could be other bidders capable of providing Cemex’s electricity for a capacity charge rate below his. Cemex represents a steady cash flow, but what price would secure total revenues that will be enough to cover the investment costs? Moreover, what risks does this project represent and just how valuable could it be for SBS? Bertrand d'Hautefeuille powered up his computer, opened up the files provided by his analysts, and hit the “send calls” button on his phone—he knew he faced quite a long night ahead of him.

Exhibit 1: Cemex Financial Statements

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Exhibit 2: Advantages and Disadvantages of Petroleum Coke as a Boiler Fuel

|Parameter |Advantages/Disadvantages |

|High Heating Value |Results in lower handling cost per GJ. |

| |Blending improves combustion of sub-bituminous coals. |

|Low Volatile Matter |Has possible ignition problems. |

| |May require supplemental fuel. |

|Low Ash Content |Reduces ash-handling cost. |

|High Vanadium/Other Metals |May make fly ash more marketable. |

| |Leads to deposits and corrosion problems. |

|High Sulfur Content |Inhibits ability to meet SO2 emissions Produces large amount of solid waste and may lead to high disposal |

| |cost. |

| |Leads to acid dew point problems. |

|Low Grindability Index |Reduces pulverizing and maintenance costs. |

Source: World Energy Council.

Exhibit 3: Fuel Strategy in Mexico

Exhibit 4: Price Volatility of Fuel Sources

Source: Cemex, 2002.

Exhibit 5: SBS, S.A. Global Presence and Financial Summary

Fictitiously created

|Financials |

|Equity (inc. Minority Int.): €2,193 M |

|Net Financial Debt: € 1,216M |

|Of which long-term deposits: € 417M |

|Gearing1: 55% |

|Interest Cover2: 10.6 |

|Net Debt /Market Cap.3: 18% |

| |

|1) Net debt including long-term deposits / shareholders’ |

|equity including minority interests. |

|2) EBITDA / financial expense. |

|3) Based on share price of €31 per share and 215.4 |

|million outstanding shares. |

Exhibit 6: Mexican Stock Exchange

|IPC 7500 |

|Mexico's key stock index is picking up momentum ahead of the next presidential |

|election. |

|[pic] |

Exhibit 7: Human Development Indicators and Relevant Mexican Statistics

|Source: CIA Factbook, 2002 | |

| | |

|Economics | |

|GDP Growth (2000 estimated) |7% |

|GDP (2000 estimated) |$930 Billion (ppp) |

|GDP/Capital |$9,000 |

| | |

|Social indicators: | |

|Population | 103,400,165 |

|0-14 years |32.80% |

|15-64 years |62.70% |

|65 years and over: |4.50% |

|Population growth rate: |1.47% |

|Infant mortality: |24.52 deaths/1,000 live births |

|Literacy rate |89.6% |

|Life expectancy |72 years |

|Population below poverty: 40% |40% |

|Inflation (2001 estimated) |6.5% |

|Unemployment |3% (considerable under-employment) |

Exhibit 8: Mexican Private Sector Investment in Electricity

[pic]

Exhibit 9: Comparison of Electricity Quality and Price

Average electricity prices for industrial use:

• World Average: US$.056 per KWHr

• Mexico: US$.0475

• USA: US$.0427

• Canada: US$.0386

Source: U.S. Department of Energy.

Minutes of Electricity Interruption (1998)

[pic]

Sources: Autorita per l´energia elettrica e il gas (Italia) and CFE.

Exhibit 10: Estimated TEG Project Investment Costs and Capital Structure

[pic]

Exhibit 11: Project Requirements, Terms of Debt, and Estimated Costs

[pic]

*Grey cell represents the capacity charge that SBS had to determine for the purpose of submitting a bid.

Exhibit 12: Cemex Request-for-Proposal Timeline

Source: Cemex.

Acknowledgements

We would like to extend a special thanks to Luis Farias of Cemex, Rafael Herz of Sithe, and Adriana De Aguinaga of the Inter-American Development Bank, for generously giving their time to talk to us about the TEG Project and their respective insights. We would also like to thank Professor Campbell Harvey for facilitating this case study.

Sources and References:

CRE, Mexico. “InfoCRE.” Special Edition. February 1999.

Grupo Estrategia Politica of Mexico City and Institute of the Americas, “21st Century Challenges

Facing the Mexican Energy Sector.” July 1999.

Kääntee, Ursula. “Alternative Fuels / The Impact of Alternative Fuels on the Cement

Manufacturing Process.” 1999.

Rodriguez-Padilla, Victor . “The Mexican Energy Sector.” 2000.

Secretaría de Energía, Mexico. “Propuesta de Cambio Estrucutral de la Industria Eléctrica en

Mexico.” 1999.

United Nations Development Program. “Human Development Report.” 1998.

Vaughan, Juan in a presentation for the 3rd National Congress. May 25, 2000.

Internet Resources:

.

(World Energy Council).

. (Platts Global Energy, “Hurdles to

Future Petroleum Coke Use”).



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[1] Research Associates Andrea Fernandez, Jason Haight, Michael Philipse, Douglas Rodriguez, and Cesar Villaseñor prepared this case under the supervision of Professor Campbell Harvey as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

[2] The numbers in this case do not represent the actual numbers used by the actual parties involved. Some elements of the case have been adjusted or simplified for the purpose of focusing the audience on those elements deemed most pertinent by the case writers.

[3] A rotary kiln is a kiln in which stone is burnt as it falls through a heated and slightly inclined steel tube and is a machine to produce cement.

[4] Boilers each with approximately 125 MW capacity.

[5] World Energy Council,

[6] Hurdles to Future Petroleum Coke Use, Platts Global Energy, .

[7] Cement manufacturing consists of raw meal grinding, blending, pre-calcining, clinker burning and cement rinding. In short, limestone and other materials containing calcium, silicon, aluminum and iron oxides are crushed and milled into a raw meal. This raw meal is blended and then heated in the pre-heating system (cyclones) to start the dissociation of calcium carbonate to oxide. The meal goes further into the kiln for heating and reaction between calcium oxide and other elements to form calcium silicates and aluminates at a temperature up to 1450o C: so-called clinker burning. The cyclone system is attached to the rotary kiln by a riser duct. Secondary fuel is fed to the riser duct, the main fuel mixture, coal/petcoke, fires the kiln. Reaction products leave the kiln as a nodular material called clinker. The clinker will be interground with gypsum and other materials to cement. Alternative Fuels / The Impact of Alternative Fuels on The Cement Manufacturing Process, Ursula Kääntee.

[8] Human Development Report, 1998.

[9] Juan Vaughan in a presentation for the 3rd National Congress, May 25, 2000.

[10] “The Mexican Energy Sector” by Victor Rodriguez-Padilla, 2000.

[11] CRE, Mexico. “InfoCRE”. Special Edition, February 1999.

[12] Grupo Estrategia Politica of Mexico City and Institute of the Americas, “21st Century Challenges Facing the Mexican Energy Sector”. July 1999.

[13] Secretaría de energía, Mexico. “Propuesta de Cambio Estrucutral de la Industria Eléctrica en Mexico”. 1999.

[14] Rodriguez-Padilla, 2000.

[15] Pemex. Petroleos Mexicanos, Pemex, is the State’s sole supplier of petroleum products authorized to exploit natural resources and manage the hydrocarbon industry.

[16] Institutional Revolutionary Party.

[17] Institute of the Americas, July 1999.

[18] , .

[19] The World Bank.

[20] Greenfield projects involve building a new power generation facility.

[21] The information in this paragraph has partly been taken from the original Cemex request-for-proposal.

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Petcoke

Gasoline

Natural Gas

[pic]

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